Inventories are stated at the lower of cost (first-in, first-out basis) or market and include materials, labor and overhead. Inventories are as follows:
Part I
Item 1
Management performs periodic reviews of inventory to dispose of items not required by their manufacturing plan and reduces the carrying cost of inventory to the lower of cost or market.
(4) STOCK BASED COMPENSATION
The Company accounts for employee stock options and share awards under the intrinsic-value method prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, (APB 25) and various interpretations. No compensation cost has been recognized for stock option grants since the options granted to date have exercise prices per share of not less than the fair value of the Company's stock at the date of the grant. Had the Company determined the stock-based compensation expense for the Company's stock options under the provisions of Statement of Financial Accounting Standards No. 123, Accounting for Stock Based Compensation, the Company's net loss and net loss per share based upon the fair value at the grant date for stock options awards would have increased the loss amounts as indicated below:
| (in thousands) | | Three Months Ended | | | Nine Months Ended | |
| | September 30, | | | September 30, | |
| | | 2004 | | | 2003 | | | 2004 | | | 2003 |
| Net loss as reported | | $ | (2,530 | ) | | $ | (2,453 | ) | | $ | (8,465 | ) | | $ | (6,993 | ) |
| Additional compensation expense | | | (1,127 | ) | | | (1,193 | ) | | | (3,080 | ) | | | (3,476 | ) |
| Pro forma | | $ | (3,657 | ) | | | (3,646 | ) | | $ | (11,545 | ) | | | (10,469 | ) |
| Net loss per share (basic and diluted) | | | | | | | | | | | | | | | | |
| As reported | | $ | (0.12 | ) | | $ | (0.17 | ) | | $ | (0.43 | ) | | $ | (0.52 | ) |
| Pro forma | | | (0.17 | ) | | | (0.25 | ) | | | (0.59 | ) | | | (0.78 | ) |
The fair value of options at the date of grant was estimated using the Black-Scholes option pricing model with the following assumptions:
| | | |
| For the Nine Months Ended
September 30, |
| 2004 | | 2003 |
| Volatility | 147% | | 137% |
| Expected option life-years from vest | 5 | | 5 |
| Interest rate (risk free) | 3.29% | | 2.77% |
| Dividends | - | | - |
(5) COMPREHENSIVE LOSS
SFAS No. 130, Reporting Comprehensive Income, requires disclosure of all components of comprehensive income (loss) on an annual and interim basis. Comprehensive income (loss) is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. The Company's total comprehensive loss is as follows:
| (in thousands) | | | Three Months Ended | | | Nine Months Ended |
| | | September 30, | | | September 30, |
| | | 2004 | | | | 2003 | | | | 2004 | | | | 2003 | |
| Net loss | | $ | (2,530 | ) | | $ | (2,453 | ) | | $ | (8,465 | ) | | $ | (6,993 | ) |
| Other comprehensive income (loss): | | | | | | | | | | | | | | | | |
| Cumulative translation adjustment | | | 401 | | | | 24 | | | | 96 | | | | 1,213 | |
| Comprehensive loss | | $ | (2,129 | ) | | $ | (2,429 | | | $ | (8,369 | ) | | | (5,780 | ) |
(6) INTANGIBLE ASSETS
Intangible assets consist primarily of acquired patented technology and trademarks. Intangible assets are amortized over their estimated useful lives that range from two to five years. The Company has no intangible assets with indefinite lives. The Company reviews intangible assets when indications of potential impairment exist, such as a significant reduction in cash flows associated with the assets. Intangible assets as of September 30, 2004 and December 31, 2003 are as follows:
| | |
| (in thousands) | | September 30, 2004 | | December 31, 2003 |
| Identified intangible assets | | $ | 3,549 | | | $ | 3,549 | |
| Less: accumulated amortization | | $ | 2,325 | | | $ | 2,086 | |
| | | $ | 1,224 | | | $ | 1,463 | |
Amortization of intangible assets was $80,000 and $80,000 for the three months ended September 30, 2004 and 2003, respectively and $239,000 and $239,000 for the nine months ended September 30, 2004 and 2003, respectively.
As of September 30, 2004, the estimated future amortization expense of intangible assets, in thousands, is as follows:
| 2004 | | 2005 | | 2006 | | 2007 | | 2008
and
thereafter |
$ | 82 | | | $ | 318 | | | $ | 318 | | | $ | 319 | | | $ | 187 |
(7) ASSET IMPAIRMENT
In the third quarter of 2003, the Company performed an impairment analysis as required by generally accepted accounting principles, resulting in an impairment charge of $605,000 related to closing the Company's Maryland specialty optical fiber facility and the write-off of equipment deposits for the optical segment of the business.
(8) USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of income and expenses during the reporting periods. Actual results in the future could vary from the amounts derived from management's estimates and assumptions.
(9) REVENUE RECOGNITION
The Company recognizes revenue from product sales at the time of shipment and when persuasive evidence of an arrangement exists, performance of the Company's obligation is complete, the price to the buyer is fixed or determinable, and collectibility is reasonably assured. In certain limited situations, customers have the right to return products. Such rights of return, have not precluded revenue recognition because the Company has a long history with such returns and accordingly is able to provide a reasonable estimate for sales returns and allowances.
Part I
Item 1
(10) RECENT ACCOUNTING PRONOUNCEMENTS
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." This statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). Many of those instruments were previously classified as equity instruments. Implementation of this statement had no material effect on the company's financial statements.
In January 2003 and December 2003, the Financial Accounting Standards Board (FASB) issued Interpretation No. 46, Consolidation for Variable Interest Entities (FIN 46) and its revision, FIN 46-R, respectively. FIN 46 and FIN 46-R address the consolidation of entities whose equity holders have either not provided sufficient equity at risk to allow the entity to finance its own activities or do not possess certain characteristics of a controlling financial interest. FIN 46 and FIN 46-R require the consolidation of these entities, known as variable interest entities (VIEs), by the primary beneficiary of the entity. The primary beneficiary is the entity, if any, that is subject to a majority of the risk of loss from the VIE's activities, entitled to receive a majority of the VIE's residual returns, or both. The adoption of FIN 46-R on January 1, 2004 did not have a material impact on the Company's financial position, results of operations or cash flows.
(11) OFFICER NOTE RECEIVABLE
As described in our annual report on Form 10-K, subsequent to the approval of the Board of Directors, the Company issued a promissory note to the chairman and chief executive officer of the Company on May 31, 2002 in the principal amount of $250,000. The note was payable upon demand and bears an annual interest rate of 4.5%. On May 7, 2004, the chairman and chief executive officer paid the Company $266,563, which represented the entire balance of principal and accrued interest outstanding for such Officer Note.
(12) SEGMENT INFORMATION
The Company has adopted the SFAS No. 131, Disclosures About Segments of an Enterprise and Related information. SFAS No. 131 requires financial and supplementary information to be disclosed on an annual and interim basis of each reportable segment of an enterprise. SFAS No. 131 also establishes standards for related disclosures about product and services, geographic areas and major customers. Operating segments are identified as components of an enterprise about which separate discrete financial information is available for evaluation by the chief decision-making group, in making decisions how to allocate resources and assess performance. The Company's chief decision-maker is the chief executive officer.
Prior to January 1, 2002, the Company operated in a single segment. In 2002 the Company began to operate in two segments, Illumination and Optical Components.
The illumination segment develops and manufactures specialized illumination products for the inspection, machine vision, medical and military markets. Illumination products are sold both through distributors as well as directly to original equipment manufacturers (OEM's). The optical components segment develops and manufactures specialty optical fibers and phase masks used primarily in sensor, gyroscope and telecommunication equipment. Optical component products are sold primarily to original equipment manufacturers (OEM's).
The Company evaluates performance and allocates resources based on revenues and operating income (loss). The operating loss for each segment includes selling, research and development and expenses directly attributable to the segment. In addition, the operating loss includes amortization of acquired intangible assets, including any impairment of these assets and of goodwill. The Company's non-allocable overhead costs, which include corporate general and administrative expenses, are allocated between the segments based upon an estimate of costs associated with each segment. Segment assets include accounts receivable, inventory, machinery and equipment, goodwill and intangible assets directly associated with the product line segment.
Part I
Item 1
The Corporate assets include cash and cash equivalents, buildings and furniture and fixtures.
| | | | | | | | | | | | | | | | | | | | | | | |
| Quarter Ended September 30, 2004 | | Quarter Ended September 30, 2003 |
| Illumination | | Optical Components | | Total | | Illumination(1) | | Optical Components | | Total |
| Net sales | $ | 4,714 | | | $ | 138 | | | $ | 4,852 | | | $ | 3,486 | | | $ | 184 | | | $ | 3,670 | |
| Gross margin | | 1,606 | | | | (146 | ) | | | 1,460 | | | | 1,054 | | | | (108 | ) | | | 946 | |
| Operating loss | | (457 | ) | | | (1,337 | ) | | | (1,794 | ) | | | (540 | ) | | | (1,624 | ) | | | (2,164 | ) |
| | | | | | | | | | | | | | | | | | | | | | | |
| | | | |
| Nine Months Ended September 30, 2004 | | Nine Months Ended September 30, 2003 |
| Illumination | | Optical Components | | Total | | Illumination(1) | | Optical Components | | Total |
| Net sales | $ | 12,761 | | | $ | 705 | | | $ | 13,466 | | | $ | 10,060 | | | $ | 780 | | | $ | 10,840 | |
| Gross margin | | 4,154 | | | | (256 | ) | | | 3,898 | | | | 3,009 | | | | (328 | ) | | | 2,681 | |
| Operating loss | | (1,562 | ) | | | (3,368 | ) | | | (4,930 | ) | | | (1,925 | ) | | | (4,362 | ) | | | (6,287 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | |
| September 30, 2004 | | December 31, 2003 |
| Illumination | | Optical Components | | Corporate | | Total | | Illumination | | Optical Components | | Corporate | | Total |
| Total current assets | $ | 7,211 | | | $ | 364 | | | $ | 1,210 | | | $ | 8,785 | | | $ | 5,827 | | | $ | 425 | | | $ | 845 | | | $ | 7,097 | |
| Property, plant & equipment | | 733 | | | | 7,983 | | | | 10,412 | | | | 19,128 | | | | 978 | | | | 7,847 | | | | 11,725 | | | | 20,550 | |
| Intangible assets | | 1,224 | | | | - | | | | - | | | | 1,224 | | | | 1,463 | | | | - | | | | - | | | | 1,463 | |
| Goodwill | | 2,677 | | | | - | | | | - | | | | 2,677 | | | | 2,677 | | | | - | | | | - | | | | 2,677 | |
| Other assets | | 4 | | | | - | | | | 605 | | | | 609 | | | | - | | | | - | | | | 902 | | | | 902 | |
| $ | 11,849 | | | $ | 8,347 | | | $ | 12,227 | | | $ | 32,423 | | | $ | 10,945 | | | $ | 8,272 | | | $ | 13,742 | | | $ | 32,689 | |
The Company's geographic sales are denominated in U.S. dollars. These sales are as follows:
| | Three Months Ended
September 30, | | Nine Months Ended
September 30, |
| Sales by geographic region (in thousands) | | 2004 | | 2003 | | 2004 | | 2003 |
| United States | | $ | 1,419 | | | $ | 2,202 | | | $ | 6,400 | | | $ | 6,504 |
| Canada | | | 461 | | | | 331 | | | | 1,323 | | | | 976 |
| Europe | | | 1,784 | | | | 807 | | | | 3,365 | | | | 2,384 |
| Asia | | | 1,187 | | | | 330 | | | | 2,377 | | | | 976 |
| Total sales | | $ | 4,851 | | | $ | 3,670 | | | $ | 13,465 | | | $ | 10,840 |
Part I
Item 1
(13) DEBT
Merrill Lynch Financial Services
On June 10, 2004, the Company paid the credit facility in full including outstanding principal and accrued interest of $3,370,000 and $7,000 respectively, with proceeds from a convertible note.The Company's obligations under the credit facility were secured by substantially all of the Company's Salem assets, excluding real property. The facility was also subject to various financial covenants, including having a minimum net worth of $10.0 million at all times. The Company was also required to repay amounts under the credit facility using 100% of the net excess proceeds, as defined, from the sale of its Salem facility; 80% of net proceeds from assets sales and 50% of the net proceeds from equity offerings.
On March 25, 2004, the Company entered into an amended agreement with Merrill Lynch. The amended agreement changed the maturity date from October 31, 2004 in the prior agreement to June 30, 2004. The amended agreement also increased the interest from LIBOR + 5.5% in the prior agreement to LIBOR + 7.5%.
TJJ Corporation
As of December 31, 2003, the Company had a $4,700,000 term note with TJJ Corporation secured by the Company's Salem headquarters. On February 25, 2004, the Company paid the note in full including outstanding principal and accrued interest of $4,400,000 and $25,000, respectively, with proceeds from a private placement of common stock, convertible notes and warrants.
Laurus Master Funds
As of May 4, 2004, the total value of the note issued on September 24, 2003 had been converted to 2,337,249 shares of common stock that resulted in an incremental non-cash charge related to accelerated amortization of debt discount of $514,000 for the nine months ending September 30, 2004.
On September 24, 2003, the Company issued a Convertible Note to Laurus Master Funds, Ltd. The $2,500,000 Convertible Note matures on September 24, 2006, bears interest at a rate equal to the Prime Rate plus 3.5%, but in no event less than 7.5%, and provides the holder with the option to convert the loan to common stock at $1.07 per share subject to certain adjustment features. StockerYale has the right to elect to make the monthly required payments on the convertible note (comprised of principal amortization and interest) in the form of shares of common stock, determined based on the $1.07 conversion price. The Company also issued to the holder seven-year warrants to purchase shares in the following warrant amounts and exercise prices per share of common stock: 225,000 shares at $1.23 per share, 150,000 shares at $1.34 per share and 100,000 shares at $1.44 per share. The aggregate purchase price of the convertible note and warrants ($2,500,000) was allocated between the note, the common stock conversion option and warrants based upon their relative fair market value. The purchase price assigned to the note, common stock beneficial conversion option and warrants was $1,551,700, $546,650 and $401,650 respectively. The difference between the face amount of the convertible note of $2,500,000 and the aggregate purchase price of the convertible note of $1,551,700 was recorded as a debt discount and is being amortized over the life of the convertible note. The Company used the Black-Scholes Model to calculate the fair value of the warrants. The underlying assumptions included in the Black-Scholes Model were: a risk-free interest rate of 2.7%; an expected life of seven years; and an expected volatility of 114% with no dividend yield.
The Company can elect to pay monthly principal amortization in cash at 103% of the principal amount. The Company may also elect to pay both principal amortization and interest in common stock, if the market price of the stock at the time of the payment is 110% of the fixed conversion price. The Company may elect to redeem the principal amount outstanding at 120% within the first year, 115% within the second year and 110% during the third year. The principal amortization payments began 120 days from the execution of the agreement at a rate of $78,125 per month. As of September 30, 2004 the note had been fully converted to common stock.
Part I
Items 1, 2
On February 25, 2004, the Company issued a Convertible Note to Laurus Master Funds, Ltd. The $4,000,000 Convertible Note matures on February 25, 2007, bears interest at a rate equal to the Prime Rate plus 2.0 %, but in no event less than 6.0 %, and provides the holder with the option to convert the loan to common stock at $1.30 per share subject to certain adjustment features. The Convertible Note is collateralized by a mortgage on the Salem building. StockerYale has the right to elect to make the monthly required payments on the convertible note (comprised of principal amortization and interest) in the form of shares of common stock, determined based on the $1.30 conversion price. The Company also issued to the holder seven-year warrants to purchase shares in the following warrant amounts and exercise prices per share of common stock: 375,000 shares at $1.56 per share, 250,000 shares at $1.75 per share and 75,000 shares at $1.94 per share. The aggregate purchase price of the convertible note and warrants ($4,000,000) was allocated between the note, the common stock conversion option and warrants based upon their relative fair market value. The purchase price assigned to the note, common stock beneficial conversion option and warrants was $2,319,047, $988,184 and $692,769 respectively. The difference between the face amount of the convertible note of $4,000,000 and the aggregate purchase price of the convertible note of $2,319,047 was recorded as a debt discount and is being amortized over the life of the convertible note. The Company used the Black-Scholes Model to calculate the fair value of the warrants. The underlying assumptions included in the Black-Scholes Model were: a risk-free interest rate of 3.0%; an expected life of seven years; and an expected volatility of 140% with no dividend yield. The Company can elect to pay monthly principal amortization in cash at 101% of the principal amount. The Company may also elect to pay both principal amortization and interest in common stock, if the market price of the stock at the time of the payment is 110% of the fixed conversion price. The Company may elect to redeem the principal amount outstanding at 115% within the first year, 110% within the second year and 105% during the third year. The principal amortization payments began 120 days from the execution of the agreement at a rate of $125,000 per month. As of September 30, 2004, $1,874,000 was outstanding under the convertible note and has been classified as long-term debt. The obligation has been reported net of $683,150 related to unamortized debt discount based upon beneficial conversion rights and warrants.
As of September 30, 2004, based upon the note issued on February 25, 2004, Laurus had converted $1,501,500 into 1,155,000 shares of common stock that resulted in an incremental non-cash charge related to accelerated amortization of debt discount of $631,000 for the nine months ended September 30, 2004.
On June 10, 2004, the Company issued a Convertible Note to Laurus Master Funds, LTD and another institutional investor. The $5,500,000 Convertible Note matures on June 20, 2007, bears interest at a rate equal to the Prime Rate plus 1.0 %, but in no event less than 5.0 %, and provides the holder with the option to convert the loan to common stock at $2.15 per share subject to certain adjustment features. The Convertible Note is collateralized by U.S. accounts receivable, inventory and equipment and a second mortgage on the Montreal, Canada building. StockerYale has the right to elect to make the monthly required payments on the convertible note (comprised of principal amortization and interest) in the form of shares of common stock, determined based on the $2.15 conversion price. The Company also issued to the holders seven-year warrants to purchase an aggregate of 440,000 shares at $3.12 per share The aggregate purchase price of the convertible note and warrants ($5,500,000) was allocated between the note, the common stock conversion option and warrants based upon their relative fair market value. The purchase price assigned to the note, common stock beneficial conversion option and warrants was $3,646,478, $1,093,511 and $760,011 respectively. The difference between the face amount of the convertible note of $5,500,000 and the aggregate purchase price of the convertible note of $3,646,478 was recorded as a debt discount and is being amortized over the life of the convertible note. The Company used the Black-Scholes Model to calculate the fair value of the warrants. The underlying assumptions included in the Black-Scholes Model were: a risk-free interest rate of 4.43%; an expected life of seven years; and an expected volatility of 145.92% with no dividend yield.
The Company can elect to pay monthly principal amortization in cash at 101% of the principal amount. The Company may also elect to pay both principal amortization and interest in common stock, if the market price of the stock at the time of the payment is 110% of the fixed conversion price. The Company may elect to redeem the principal amount outstanding at 115% within the first year, 110% within the second year and 105% during the third year. The principal amortization payments begin 120 days from the execution of the agreement at a rate of $171,875 per month. As of September 30, 2004, $5,500,000 was outstanding under the Convertible Note of which $2,062,500 has been classified as short-term debt and $1,964,800 has been classified as long-term debt. The obligation has been reported net of $1,473,312 related to unamortized debt discount based upon beneficial conversion rights and warrants.
Part I
Item 2
National Bank of Canada
On May 26, 2003, the Company entered into a credit agreement with the National Bank of Canada replacing the facility with Toronto Dominion Bank. The new agreement provided total borrowing availability up to C$4,050,000 ($3,000,000 US), including a line of credit of C$2,500,000 ($1,850,000 US) and a ten-year term note of C$1,550,000 ($1,150,000 US). Initial proceeds were used to pay off the credit agreement with Toronto Dominion Bank.
On August 23, 2003, the Company amended its credit facility with National Bank of Canada to reduce the restricted term deposit from C$1,000,000 ($740,000 US) to C$250,000 ($185,000 US) and reduce the term loan from C$2,300,000 ($1,702,000 US) to C$1,550,000 ($1,147,000 US). The net availability of the term loan remained the same. In addition, the bank added Canadian Provincial Government research and development tax credits as additional eligible accounts receivable, which increased the availability of the revolving credit facility by approximately C$300,000 ($222,000 US). All other terms of the credit facility remained the same, including StockerYale, Inc.'s guarantee to fund StockerYale Canada's deficits if requested by the bank.
On November 20, 2003, the credit facility was amended increasing the interest rate on the line of credit to the Canadian prime rate plus 2.00% and the term note to the Canadian prime rate plus 2.75%.
The National Bank of Canada credit facility requires the following financial covenants, including working capital, net worth, capital expenditures, a financial coverage ratio and maximum inventory levels.
On March 19, 2004, the Company entered into an amended agreement with the National Bank of Canada. The new agreement includes a line of credit of C$2,500,000 ($1,875,000 US) and a five-year term note of C$1,396,000 ($1,050,000 US). The amended agreement reduced the net worth covenant from C$10,800,000 in the May 26, 2003 agreement to C$8,000,000 in the March 19, 2004 agreement as of December 31, 2003. The amended agreement also requires a C$10,000,000 net worth as of September 30, 2004 and thereafter. The amended agreement also reduced the reduced the inventory component of the line of credit availability from C$750,000 to C$625,000 and requires the Company to achieve specific net profit targets throughout 2004.
As of September 30, 2004, C$2,500,000 ($1,964,545 US) was outstanding under the line of credit and C$1,262,500 ($ 992,095 US) was outstanding under the term note. As of September 30, 2004, the interest rate on the line of credit and the term note were 6.00% and 6.75%, respectively.
As of September 30, 2004, the Company was in compliance with all provisions of its loan agreements.
(14) OTHER MATTERS
On August 6, 2004 The Company was informed by the staff of the Securities and Exchange Commission (the "SEC") that the SEC is conducting a formal investigation into certain matters relating to the company. The company understands that the SEC's investigation relates to press releases that the company issued on April 19, 2004 and April 21, 2004, and trading in the company's securities on or around the time the press releases were issued. The SEC has not concluded that there has been any wrongdoing, and the company is cooperating fully with the SEC in the conduct of this inquiry.
Part I
Item 2
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND OPERATING RESULTS
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and section 21E of the Securities Exchange Act of 1934. The company's actual results could differ materially from those set forth in the forward-looking statements. When the Company uses words such as "anticipate," "believe," "estimate," "expect," "intend," and other similar expressions, they generally identify forward-looking statements. Forward-looking statements include, for example, statements relating to acquisitions and related financial information, development activities, business strategy and prospects, future capital expenditures, sources and availability of capital, environmental and other regulations and competition. Investors should exercise caution in interpreting and relying on forward-looking statements since they involve known risks, uncertainties and other factors which are, in some cases, beyond the company's control and could materially affect the Company's actual results, performance or achievements. Such factors include, without limitation: market conditions that could make it more difficult or expensive for the Company to obtain the necessary capital to finance its research and development projects, operations, as well as its ability to refinance existing debt; the existence of other independent suppliers of optical fiber, who may have greater resources than the Company; and the uncertainty that the company's significant investments in research and development will not result in products that achieve market acceptance. Additional such factors are discussed in the section entitled "certain factors affecting future operating results" on page 23 of the Company's annual report on form 10-K for the fiscal year ended December 31, 2003.
RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the attached unaudited condensed consolidated financial statements and notes thereto and with our audited financial statements and notes thereto included in the company's Annual Report on Form 10-K/A for the year ended December 31, 2003.
THREE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003
Net Sales
For the quarter ended September 30, net sales increased $1.2 million or 32% from $3.7 million in 2003 to $4.9 million in 2004. Illumination revenues increased $1.2 million or 35% over the comparable period in 2003 representing the majority of the revenue gain. Revenues for the optical components product line were in line with the comparable period in the prior year. Increased shipments of structured lasers for the machine vision sector coupled with continued growth in the LED and machine vision systems sales were the key factors contributing to the strong performance.
Gross Profit
Gross margins improved from $1.0 million, or 26% of sales, in 2003 to $1.5 million or 30% of sales in 2004 as increased sales and lower material and labor costs contributed incremental profits of $0.3 million and $0.2 million, respectively.
Operating Expenses
Overall operating expenses increased $144,000 in the third quarter of 2004 compared to the same period in 2003. Administrative expenses increased $657,000 during this period principally from higher professional fees and severance costs. Selling costs also increased $91,000 due principally to higher commission and travel expenses. Research and development expenses were flat during this period. The remaining change in operating expenses from 2003 to 2004 mainly relates to a $605,000 asset impairment charge recorded in 2003. There was no such charge in 2004. Operating expense comparisons to the third quarter of 2003 include items that were non-recurring in nature. These included approximately $500,000 for professional fees and severance expense recorded in the third quarter of 2004 and the $605,000 asset impairment charge recorded in the third quarter of 2003.
Part I
Item 2
Interest Expense
Interest expense declined $50,000 in the third quarter of fiscal 2004 compared to the comparable period in 2003 due to lower average debt levels.
Provision (Benefit) for Income Taxes
The Company's historical operating losses raise doubt as to the realizability of the deferred tax assets. As a result, management has provided a valuation allowance for the net deferred tax assets that may not be realized.
Net Income (Loss)
Net loss for the three months ended September 30, 2004 increased $0.1 million to $2.5 million compared to a net loss of $2.4 million for the same period in 2003. Non-cash charges for debt amortization of $.5 million more than offset an operating profit improvement of $0.4 million.
NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003
Net Sales
For the nine months ended September 30, net sales increased $2.6 million or 24% from $10.8 million in 2003 to $13.4 million in 2004. Illumination revenues increased $2.7 million or 27% over the comparable period in 2003, which were partially offset by a $100,000 decline in optical component revenues.
Gross Profit
Gross profit improved $1.2 million or 45% in 2004 to $3.9 million or 29% of sales. Increased sales and lower material and labor costs contributed incremental profits of $649,000 and $568,000 respectively.
Operating Expenses
Operating expenses decreased $140,00 for the first nine months of 2004 compared to the same period in 2003. Administrative expenses increased $750,000 during this period principally from higher professional fees. This increase was partially offset by a $202,000 reduction in research and development expenses as the result of lower personnel costs. The remaining change in operating expenses from 2003 to 2004 relates to a $605,000 asset impairment charge recorded in 2003. Operating expense comparisons to the nine months ending September 30, 2003 include items that were non-recurring in nature. These included approximately $500,000 for professional fees and severance expense recorded in the nine months ending September 30, 2004 and the $605,000 asset impairment charge recorded in the nine months ending September 30, 2003.
Interest Expense
Interest expense decreased $ 45,000 in the first nine months of fiscal 2004 compared to 2003 due to lower average debt levels.
Part I
Item 2
Provision (Benefit) for Income Taxes
The Company's historical operating losses raise doubt as to the realizability of the deferred tax assets. As a result, management has provided a valuation allowance for the net deferred tax assets that may not be realized.
Net Income (Loss)
Net loss for the nine months ended September 30, 2004 increased $1.5 million to $8.5 million compared to a net loss of $7.0 million for the same period in 2003, as increased non-cash charges for debt discount and debt acquisition cost amortization of $2.8 million more than offset an operating profit improvement of $1.4 million. A portion of the debt amortization charges related to the prepayment of the company's mortgage debt and conversion of certain convertible notes into common stock. The consolidation program implemented in the second quarter of 2004 is expected to result in a lower overall cost structure with incremental savings commencing in the second half of the year.
LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 2004, the Company was in compliance with all provisions of its loan agreements.
During the first quarter of 2004, the Company raised approximately $2.6 million through the private placement of common stock. In conjunction with the private placement on February 3, 2004 of 2,334,130 shares of common stock, the Company issued warrants to purchase 582,533 shares of common stock at a price of $1.50 per share. Each warrant expires on February 3, 2007. The Company also issued additional investment rights to purchase 582,533 shares of common stock at a price of $1.15 per share. Each additional investment right expires 90 trading days after the effective date of registration. As of September 30, 2004, 313,479 additional investment rights were converted to 313,479 shares and the remainder has expired.
During the second quarter of 2004, the Company raised an additional $5.5 million through the placement of a convertible note. The net proceeds of $5.2 million were used to retire its $3.4 million senior U.S. credit facility with Merrill Lynch Financial Services. The remaining $1.8 million was used for general working capital purposes.
Based upon the Company's current forecast for 2004, the Company plans to increase revenues, reduce costs and pursue various options to raise additional funds to finance operations through the end of 2004. The Company can give no assurances to the timing or terms of such arrangements, assuming it is able to consummate one or more of these options. If the Company is unable to raise sufficient funds through these options by the end of the fourth quarter of 2004, it will need to implement further cost reduction strategies, and the Company may not have adequate capital to sustain its current operations. Financing options in process or under consideration are the sale of real estate and/or a private placement of equity and/or debt securities. The Company expects to close on some of these financing options by the end of 2004.
For the nine months ending September 30, 2004, cash and cash equivalents increased approximately $200,000 from $1.0 million at December 31, 2003 to $1.2 million at September 30, 2004.
Cash used in operating activities was $4.2 million for the period ended September 30, 2004. The change resulted from the net loss of $8.5 million and an increase in working capital of $400,000 offset by $4.7 million of non-cash charges for depreciation and debt amortization expenses.
Cash provided by financing activities during the first nine months of 2004 increased $0.9 million to $4.4 million. Proceeds from the sales of stock and long-term debt of $3.1 and $9.6 million respectively were used to retire $7.3 million in debt and provide additional working capital.
Investing activities used $100,000 cash during the first nine months of 2004, as purchases of $300,000 were offset with $200,000 in proceeds from assets sales.
Merrill Lynch Financial Services
On June 10, 2004, the Company paid the credit facility in full including outstanding principal and accrued interest of $3,370,000 and $7,000 respectively, with proceeds from a convertible note.The Company's obligations under the credit facility were secured by substantially all of the Company's Salem assets, excluding real property. The facility was also subject to various financial covenants, including having a minimum net worth of $10.0 million at all times. The Company was also required to repay amounts under the credit facility using 100% of the net excess proceeds, as defined, from the sale of its Salem facility; 80% of net proceeds from assets sales and 50% of the net proceeds from equity offerings.
On March 25, 2004, the Company entered into an amended agreement with Merrill Lynch. The amended agreement changed the maturity date from October 31, 2004 in the prior agreement to June 30, 2004. The amended agreement also increased the interest from LIBOR + 5.5% in the prior agreement to LIBOR + 7.5%.
TJJ Corporation
As of December 31, 2003, the Company had a $4,700,000 term note with TJJ Corporation secured by the Company's Salem headquarters. On February 25, 2004, the Company paid the note in full including outstanding principal and accrued interest of $4,400,000 and $25,000, respectively, with proceeds from a private placement of common stock and convertible notes.
National Bank of Canada
On May 26, 2003, the Company entered into a credit agreement with the National Bank of Canada replacing the facility with Toronto Dominion Bank. The new agreement provided total borrowing availability up to C$4,050,000 ($3,000,000 US), including a line of credit of C$2,500,000 ($1,850,000 US) and a ten-year term note of C$1,550,000 ($1,150,000 US). Initial proceeds were used to pay off the credit agreement with Toronto Dominion Bank.
On August 23, 2003, the Company amended its credit facility with National Bank of Canada to reduce the restricted term deposit from C$1,000,000 ($740,000 US) to C$250,000 ($185,000 US) and reduce the term loan from C$2,300,000 ($1,702,000 US) to C$1,550,000 ($1,147,000 US). The net availability of the term loan remained the same. In addition, the bank added Canadian Provincial Government research and development tax credits as additional eligible accounts receivable, which increased the availability of the revolving credit facility by approximately C$300,000 ($222,000 US). All other terms of the credit facility remained the same, including StockerYale, Inc.'s guarantee to fund StockerYale Canada's deficits if requested by the bank.
On November 20, 2003, the credit facility was amended increasing the interest rate on the line of credit to the Canadian prime rate plus 2.00% and the term note to the Canadian prime rate plus 2.75%.
The National Bank of Canada credit facility requires the following financial covenants, including working capital, net worth, capital expenditures, a financial coverage ratio and maximum inventory levels.
On March 19, 2004, the Company entered into an amended agreement with the National Bank of Canada. The new agreement includes a line of credit of C$2,500,000 ($1,875,000 US) and a five-year term note of C$1,396,000 ($1,050,000 US). The amended agreement reduced the net worth covenant from C$10,800,000 in the May 26, 2003 agreement to C$8,000,000 in the March 19, 2004 agreement as of December 31, 2003. The amended agreement also requires a C$10,000,000 net worth as of September 30, 2004 and thereafter. The amended agreement also reduced the reduced the inventory component of the line of credit availability from C$750,000 to C$625,000 and requires the Company to achieve specific net profit targets throughout 2004.
Part I
Item 2
As of September 30, 2004, C$2,500,000 ($1,964,545 US) was outstanding under the line of credit and C$1,262,500 ($ 992,095 US) was outstanding under the term note. As of September 30, 2004, the interest rate on the line of credit and the term note were 6.00% and 6.75%, respectively.
Laurus Master Funds
As of May 4, 2004, the total value of the note issued on September 24, 2003 had been converted to 2,337,249 shares of common stock that resulted in an incremental non-cash charge related to accelerated amortization of debt discount of $514,000 for the nine months ending September 30, 2004.
On September 24, 2003, the Company issued a Convertible Note to Laurus Master Funds, Ltd. The $2,500,000 Convertible Note matures on September 24, 2006, bears interest at a rate equal to the Prime Rate plus 3.5%, but in no event less than 7.5%, and provides the holder with the option to convert the loan to common stock at $1.07 per share subject to certain adjustment features. StockerYale has the right to elect to make the monthly required payments on the convertible note (comprised of principal amortization and interest) in the form of shares of common stock, determined based on the $1.07 conversion price. The Company also issued to the holder seven-year warrants to purchase shares in the following warrant amounts and exercise prices per share of common stock: 225,000 shares at $1.23 per share, 150,000 shares at $1.34 per share and 100,000 shares at $1.44 per share. The aggregate purchase price of the convertible note and warrants ($2,500,000) was allocated between the note, the common stock conversion option and warrants based upon their relative fair market value. The purchase price assigned to the note, common stock beneficial conversion option and warrants was $1,551,700, $546,650 and $401,650 respectively. The difference between the face amount of the convertible note of $2,500,000 and the aggregate purchase price of the convertible note of $1,551,700 was recorded as a debt discount and is being amortized over the life of the convertible note. The Company used the Black-Scholes Model to calculate the fair value of the warrants. The underlying assumptions included in the Black-Scholes Model were: a risk-free interest rate of 2.7%; an expected life of seven years; and an expected volatility of 114% with no dividend yield.
The Company can elect to pay monthly principal amortization in cash at 103% of the principal amount. The Company may also elect to pay both principal amortization and interest in common stock, if the market price of the stock at the time of the payment is 110% of the fixed conversion price. The Company may elect to redeem the principal amount outstanding at 120% within the first year, 115% within the second year and 110% during the third year. The principal amortization payments begin 120 days from the execution of the agreement at a rate of $78,125 per month. As of September 30, 2004 the note had been fully converted to common stock.
Part I
Item 2
On February 25, 2004, the Company issued a Convertible Note to Laurus Master Funds, Ltd. The $4,000,000 Convertible Note matures on February 25, 2007, bears interest at a rate equal to the Prime Rate plus 2.0 %, but in no event less than 6.0 %, and provides the holder with the option to convert the loan to common stock at $1.30 per share subject to certain adjustment features. The Convertible Note is collateralized by a mortgage on the Salem building. StockerYale has the right to elect to make the monthly required payments on the convertible note (comprised of principal amortization and interest) in the form of shares of common stock, determined based on the $1.30 conversion price. The Company also issued to the holder seven-year warrants to purchase shares in the following warrant amounts and exercise prices per share of common stock: 375,000 shares at $1.56 per share, 250,000 shares at $1.75 per share and 75,000 shares at $1.94 per share. The aggregate purchase price of the convertible note and warrants ($4,000,000) was allocated between the note, the common stock conversion option and warrants based upon their relative fair market value. The purchase price assigned to the note, common stock beneficial conversion option and warrants was $2,319,047, $988,184 and $692,769 respectively. The difference between the face amount of the convertible note of $4,000,000 and the aggregate purchase price of the convertible note of $2,319,047 was recorded as a debt discount and is being amortized over the life of the convertible note. The Company used the Black-Scholes Model to calculate the fair value of the warrants. The underlying assumptions included in the Black-Scholes Model were: a risk-free interest rate of 3.0%; an expected life of seven years; and an expected volatility of 140% with no dividend yield. The Company can elect to pay monthly principal amortization in cash at 101% of the principal amount. The Company may also elect to pay both principal amortization and interest in common stock, if the market price of the stock at the time of the payment is 110% of the fixed conversion price. The Company may elect to redeem the principal amount outstanding at 115% within the first year, 110% within the second year and 105% during the third year. The principal amortization payments began 120 days from the execution of the agreement at a rate of $125,000 per month. As of September 30, 2004, $1,874,000 was outstanding under the convertible note and has been classified as long-term debt. The obligation has been reported net of $683,150 related to unamortized debt discount based upon beneficial conversion rights and warrants.
As of September 30, 2004, based upon the note issued on February 25, 2004, Laurus had converted $1,501,500 into 1,155,000 shares of common stock that resulted in an incremental non-cash charge related to accelerated amortization of debt discount of $631,000 for the nine months ended September 30, 2004.
On June 10, 2004, the Company issued a Convertible Note to Laurus Master Funds, LTD and another institutional investor. The $5,500,000 Convertible Note matures on June 20, 2007, bears interest at a rate equal to the Prime Rate plus 1.0%, but in no event less than 5.0%, and provides the holder with the option to convert the loan to common stock at $2.15 per share subject to certain adjustment features. The Convertible Note is collateralized by U.S. accounts receivable, inventory and equipment and a second mortgage on the Montreal, Canada building. StockerYale has the right to elect to make the monthly required payments on the convertible note (comprised of principal amortization and interest) in the form of shares of common stock, determined based on the $2.15 conversion price. The Company also issued to the holders seven-year warrants to purchase an aggregate of 440,000 shares at $3.12 per share The aggregate purchase price of the convertible note and warrants ($5,500,000) was allocated between the note, the common stock conversion option and warrants based upon their relative fair market value. The purchase price assigned to the note, common stock beneficial conversion option and warrants was $3,646,478, $1,093,511 and $760,011 respectively. The difference between the face amount of the convertible note of $5,500,000 and the aggregate purchase price of the convertible note of $3,646,478 was recorded as a debt discount and is being amortized over the life of the convertible note. The Company used the Black-Scholes Model to calculate the fair value of the warrants. The underlying assumptions included in the Black-Scholes Model were: a risk-free interest rate of 4.43%; an expected life of seven years; and an expected volatility of 145.92% with no dividend yield.
The Company can elect to pay monthly principal amortization in cash at 101% of the principal amount. The Company may also elect to pay both principal amortization and interest in common stock, if the market price of the stock at the time of the payment is 110% of the fixed conversion price. The Company may elect to redeem the principal amount outstanding at 115% within the first year, 110% within the second year and 105% during the third year. The principal amortization payments began 120 days from the execution of the agreement at a rate of $171,875 per month. As of September 30, 2004, $5,500,000 was outstanding under the Convertible Note of which $2,062,500 has been classified as short-term debt and $1,964,800 has been classified as long-term debt. The obligation has been reported net of $1,473,312 related to unamortized debt discount based upon beneficial conversion rights and warrants.
Part I
Items 2 - 4
CRITICAL ACCOUNTING POLICIES, COMMITMENTS AND CERTAIN OTHER MATTERS
The Company considered the disclosure requirements of FR-60 regarding critical accounting policies and FR-61 regarding liquidity and capital resources, certain trading activities and related party/certain other disclosures, and concluded that nothing materially changed during the quarter that would warrant further disclosure under these releases.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
FOREIGN CURRENCY EXCHANGE RISK
Management has determined that all of the Company's foreign subsidiaries operate primarily in local currencies that represent the functional currencies of the subsidiaries. All assets and liabilities of foreign subsidiaries are translated into U.S. dollars using the exchange rate prevailing at the balance sheet date, while income and expense accounts are translated at average exchange rates during the year. As such, the Company's operating results are affected by fluctuations in the value of the U.S. dollar as compared to currencies in foreign countries, as a result of the Company's transactions in these foreign markets. The Company does not operate a hedging program to mitigate the effect of a significant rapid change in the value of the Canadian Dollar or Euro as compared to the U.S. dollar. If such a change did occur, the Company would have to take into account a currency exchange gain or loss in the amount of the change in the U.S. dollar denominated balance of the amounts outstanding at the time of such change. While the Company does not believe such a gain or loss is likely, and would not likely be material, there can be no assurance that such a loss would not have an adverse material effect on the Company's results of operations or financial condition.
INTEREST RATE RISK
The Company is exposed to market risk from changes in interest rates, which may adversely affect its financial position, results of operations and cash flows. In seeking to minimize the risks from interest rate fluctuations, the Company manages exposures through its regular operating and financing activities. The Company is exposed to interest rate risk primarily through its borrowings under its $3.9 million CDN credit facility with the National Bank of Canada with line of credit and term note interest rates of 2.0% and 2.75% over the Canadian prime rate respectively. As of September 30, 2004 the fair market value of the Company's outstanding line of credit and term note approximates its carrying value due to the short-term maturities and variable interest rates. A 1% change in interest rates could increase or decrease interest expense by approximately $30,000 on an annual basis.
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures.
As required by Rule 13a-15 under the Securities Exchange Act of 1934, as of the end of the period covered by this report, the Company carried out an evaluation under the supervision and with the participation of the Company's management, including the Company's Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission's rules and forms. In connection with the new rules, we currently are in the process of further reviewing and documenting our disclosure controls and procedures, including our internal controls and procedures for financial reporting, and may from time to time make changes aimed at enhancing their effectiveness and to ensure that our systems evolve with our business.
(b) Changes in internal controls
None
Item 1. LEGAL PROCEEDINGS
Not applicable.
Item 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Not applicable.
Item 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY
Not applicable.
Item 5. OTHER INFORMATION
Not applicable.
Item 6. EXHIBITS
(a) The following is a complete list of exhibits filed as part of this Form 10-Q:
Exhibit Number Description
31.1 CEO Certification
31.2 CFO Certification
32.1 CEO Certification
32.2 CFO Certification
Part II
Item 6
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| StockerYale, Inc. | |
| |
| |
| November 15, 2004 | /s/ Mark W. Blodgett |
| Mark W. Blodgett, |
| Chairman and Chief Executive Officer |
| |
| November 15, 2004 | /s/ Richard P. Lindsay |
| Richard P. Lindsay |
| Chief Financial Officer and Treasurer |
| |
| 20 / STKR | END | 2004 Form 10-Q |
