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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2005
Commission File Number: 000-27372
STOCKERYALE, INC.
(Exact name of registrant as specified in its charter)
Massachusetts | 04-2114473 | |
(State of Incorporation ) | (I.R.S. Employer Identification Number) |
32 Hampshire Road, Salem, New Hampshire 03079
(Address of registrant’s principal executive office)
(603) 893-8778
(Registrant’s telephone number)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the 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. x Yes ¨ No
As of May 4, 2005 there were 24,513,316 shares of the issuer’s common stock outstanding.
Transitional Small Business Disclosure Format (Check one): Yes ¨ No x
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INDEX TO FORM 10-QSB
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STOCKERYALE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
March 31, 2005 | December 31 2004 | |||||||
(unaudited) | (audited) | |||||||
In thousands (except share data) | ||||||||
Assets | ||||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | 1,155 | $ | 4,061 | ||||
Accounts receivable less allowances of $103 at March 31, 2005 and $105 at December 31, 2004 | 3,320 | 2,822 | ||||||
Inventories | 3,669 | 3,612 | ||||||
Prepaid expenses and other current assets | 426 | 256 | ||||||
Total current assets | 8,570 | 10,751 | ||||||
Net property, plant and equipment | 18,069 | 18,582 | ||||||
Goodwill | 2,677 | 2,677 | ||||||
Acquired intangible assets, net | 1,064 | 1,144 | ||||||
Other long-term assets | 544 | 624 | ||||||
Total assets | $ | 30,924 | $ | 33,778 | ||||
Current liabilities: | ||||||||
Current portion of long-term debt and capital lease obligations, net of unamortized discount of $1,219 at March 31, 2005 and $1,407 at December 31, 2004 | $ | 2,537 | $ | 1,912 | ||||
Short-term debt | 1,964 | 2,076 | ||||||
Accounts payable | 2,400 | 2,427 | ||||||
Accrued expenses | 1,760 | 2,195 | ||||||
Total current liabilities | 8,661 | 10,016 | ||||||
Long-term debt and capital lease obligations, net of unamortized discount of $484 at March 31, 2005 and $718 at December 31, 2004 | 4,774 | 5,552 | ||||||
Other long-term liabilities | 35 | 35 | ||||||
Commitments and contingencies (Note 17) | ||||||||
Stockholders’ equity: | ||||||||
Common stock, par value $0.001-shares authorized 100,000,000; shares issued and outstanding 24,598,185 and 24,595,536 at March 31, 2005 and December 31, 2004, respectively | 25 | 25 | ||||||
Paid-in capital | 85,451 | 85,448 | ||||||
Accumulated other comprehensive income | 1,891 | 1,866 | ||||||
Accumulated deficit | (69,913 | ) | (67,758 | ) | ||||
Total stockholders’ equity | 17,454 | 19,581 | ||||||
Total liabilities and stockholders’ equity | $ | 30,924 | $ | 33,778 | ||||
See notes to unaudited condensed consolidated financial statements.
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CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
For the Quarter Ended March 31, | ||||||||
2005 | 2004 | |||||||
(Unaudited) In thousands, except loss per share | ||||||||
Revenue | $ | 4,598 | $ | 4,159 | ||||
Cost of sales | 2,961 | 2,922 | ||||||
Gross profit | 1,637 | 1,237 | ||||||
Operating expenses: | ||||||||
Selling | 784 | 695 | ||||||
General and administrative | 1,419 | 1,086 | ||||||
Amortization | 80 | 80 | ||||||
Research and development | 831 | 820 | ||||||
Total operating expenses | 3,114 | 2,681 | ||||||
Loss from operations | (1,477 | ) | (1,444 | ) | ||||
Other income (expense) | 9 | (5 | ) | |||||
Interest expense | 188 | 123 | ||||||
Amortization of debt discount and financing costs | 499 | 730 | ||||||
Loss from operations before income tax | (2,155 | ) | (2,302 | ) | ||||
Income tax provision | — | 3 | ||||||
Net loss | (2,155 | ) | (2,305 | ) | ||||
Basic and diluted net loss per share | $ | (0.09 | ) | $ | (0.14 | ) | ||
Basic and diluted weighted average shares outstanding | 24,596 | 16,636 | ||||||
See notes to unaudited condensed consolidated financial statements.
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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Quarter Ended March 31, | ||||||||
2005 | 2004 | |||||||
(Unaudited) In thousands | ||||||||
Operations | ||||||||
Net loss | $ | (2,155 | ) | $ | (2,305 | ) | ||
Adjustments to reconcile net loss to net cash provided by (used in) operating activities: | ||||||||
Depreciation and amortization | 604 | 550 | ||||||
Accretion of debt discount and financing costs | 499 | 730 | ||||||
Other changes in assets and liabilities: | ||||||||
Accounts receivable | (485 | ) | (408 | ) | ||||
Inventories | (34 | ) | 21 | |||||
Prepaid expenses and other current assets | (173 | ) | (191 | ) | ||||
Accounts payable | (43 | ) | 227 | |||||
Accrued expenses | (427 | ) | 9 | |||||
Other assets and liabilities | (24 | ) | (36 | ) | ||||
Net cash (used in) operations | (2,238 | ) | (1,403 | ) | ||||
Financing | ||||||||
Net proceeds from sale of common stock | 3 | 2,556 | ||||||
Borrowings (repayments) of revolving credit facilities | (112 | ) | — | |||||
Proceeds from long-term debt issuance | — | 3,746 | ||||||
Principal repayment of long-term debt | (592 | ) | (4,875 | ) | ||||
Payment of note receivable | — | 20 | ||||||
Net cash (used in) financing activities | (701 | ) | 1,447 | |||||
Investing | ||||||||
Purchase of property, plant and equipment | (45 | ) | (97 | ) | ||||
Net cash (used for) investing activities | (45 | ) | (97 | ) | ||||
Effect of exchange rate | 78 | 120 | ||||||
Net change in cash and equivalents | (2,906 | ) | 67 | |||||
Cash and equivalents at beginning of the period | 4,061 | 1,008 | ||||||
Cash and equivalents at end of the period | $ | 1,155 | $ | 1,075 | ||||
Supplemental disclosure of cash flow information: | ||||||||
Conversion of notes into common stock | — | 381 | ||||||
Cash paid for interest | 135 | 123 |
See notes to unaudited condensed consolidated financial statements.
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NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005
(1) ORGANIZATION AND BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been prepared by StockerYale, Inc. (the “Company”) and, in the opinion of management, reflect all adjustments of a normal recurring nature necessary for a fair statement of (a) the results of operations for the three months ended March 31, 2005 and 2004, (b) the financial position at March 31, 2005 and December 31, 2004, and (c) the cash flows for the three month periods ended March 31, 2005 and 2004. These interim results are not necessarily indicative of results for a full year or any other interim period.
The accompanying consolidated financial statements and notes are condensed as permitted by Form 10-QSB and do not contain certain information included in the annual financial statements and notes of the Company. These unaudited condensed consolidated financial statements and notes should be read in conjunction with the consolidated financial statements and notes included in the Company’s Annual Report on Form 10-KSB for the year ended December 31, 2004.
The Company has prepared these unaudited condensed financial statements on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The Company’s continuation as a going concern is dependent upon its ability to generate sufficient cash flow to meet its obligations on a timely basis through improved operations, refinancing of existing debt and/or additional financing.
The Company’s current forecast for 2005 calls for increased revenues, reduced operating costs, and the pursuit of additional sources of funds to finance operations through the end of 2005. The Company can give no assurances to the timing or terms of such financing arrangements, assuming it is able to consummate one or more funding options. If the Company is unable to raise sufficient funds by the end of the second quarter of 2005, 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/debt securities. The Company expects to close one or more of these financing options in 2005.
(2) LOSS PER SHARE
In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 128,Earnings per Share, basic and diluted net loss per common share for the three months ended March 31, 2005 and 2004 respectively is calculated by dividing the net loss applicable to common stockholders by the weighted average number of vested common shares outstanding. There were 4,345,280 and 3,552,763 options and 3,638,446 warrants and 2,536,000 outstanding as of March 31, 2005 and 2004 respectively which were not included in the diluted share calculation because their inclusion would be anti-dilutive.
(3) INVENTORIES
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:
For the Quarter Ended | ||||||||
(in thousands) | ||||||||
March 31, 2005 | December 31, 2004 | |||||||
Finished goods | $ | 1,197 | $ | 1,351 | ||||
Work-in-process | 415 | 79 | ||||||
Raw materials | 2,773 | 3,276 | ||||||
Reserve for obsolescence | (716 | ) | (1,094 | ) | ||||
Net inventories | $ | 3,669 | $ | 3,612 | ||||
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Management performs periodic reviews of inventory and disposes 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 . Accordingly, 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 SFAS No. 123,Accounting for Stock Based Compensation, and SFAS No. 148,Accounting for Stock-Based Compensation-Transition and Disclosure,the Company’s net loss and net loss per share based upon the fair value at the grant date for stock options awards for the quarter ended in March 31, 2005 and 2004, would have changed the reported amounts as indicated below:
For the Quarter Ended March 31, | ||||||||
(in thousands) | ||||||||
2005 | 2004 | |||||||
Net loss | ||||||||
As reported | $ | (2,155 | ) | $ | (2,305 | ) | ||
Additional compensation expense | (1,354 | ) | (974 | ) | ||||
Pro forma | $ | (3,509 | ) | $ | (3,279 | ) | ||
Net loss per share (basic and diluted) | ||||||||
As reported | $ | (0.09 | ) | $ | (0.14 | ) | ||
Pro forma | (0.14 | ) | (0.20 | ) |
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 Quarter Ended March 31, | ||||||
2005 | 2004 | |||||
Volatility | 122 | % | 140 | % | ||
Expected option life-years from vest | 5 | 5 | ||||
Interest rate (risk free) | 3.72 | % | 2.91 | % | ||
Dividends | None | None |
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(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:
For the Quarter Ended March 31, | ||||||||
2005 | 2004 | |||||||
(in thousands) | ||||||||
Net loss | $ | (2,155 | ) | $ | (2,305 | ) | ||
Other comprehensive income (loss): | ||||||||
Cumulative translation adjustment | 25 | (35 | ) | |||||
Comprehensive loss | $ | (2,130 | ) | $ | (2,340 | ) | ||
(6) INTANGIBLE ASSETS
Intangible assets consist primarily of acquired patented technology and trademarks. Intangible assets are amortized over their estimated useful lives which range from two to five years. The Company has no identified intangible assets with indefinite lives, except for goodwill. The Company reviews intangible assets when indications of potential impairment exist, such as a significant reduction in cash flows associated with the assets. Identified intangible assets with definite lives as of March 31, 2005 and 2004 are as follows:
For the Quarter Ended | ||||||||
March 31, 2004 | December 31, 2004 | |||||||
(in thousands) | ||||||||
Identified intangible assets | $ | 3,549 | $ | 3,549 | ||||
Less: accumulated amortization | (2,485 | ) | (2,405 | ) | ||||
$ | 1,064 | $ | 1,144 | |||||
Amortization of intangible assets was $80,000 for the quarters ended March 31, 2005 and 2004.
As of March 31, the estimated future amortization expense of intangible assets, in thousands, is as follows:
2005 | 2006 | 2007 | 2008 | ||||||
$238 | $ | 318 | $ | 318 | $ | 190 |
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(7) 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.
(8) 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 provides a reserve.
(9) RECENT ACCOUNTING PRONOUNCEMENTS
On December 16, 2004, the Financial Accounting Standards Board (FASB) issued FASB Statement No. 123 (revised 2004) “Share Based Payment” (“SFAS 123R”) which is a revision of Statement No. 123 (“SFAS 123”) “Accounting for Stock Based Compensation.” SFAS 123R supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees” and amends FASB Statement No. 95 “Statement of Cash Flows.” Generally, the approach in SFAS123R is similar to the approach described in SFAS 123. However, SFAS 123R requires that all share-based payments to employees, including grants of stock options, be recognized in the statements of operations, based on their fair values. Pro forma disclosure will no longer be an alternative.
Under SFAS 123R, the Company must determine the appropriate fair value model to be used for valuing share-based payments, the amortization method for compensation cost and the transition method to be used at the date of adoption. The transition alternatives include retrospective and prospective adoption methods. Under the retrospective method, prior periods may be restated based on the amounts previously recognized under SFAS 123 for purposes of pro forma disclosures either for all periods presented or as of the beginning of the year of adoption.
The prospective method requires that compensation expense be recognized beginning with the effective date, based on the requirements of SFAS 123R, for all share-based payments granted after the effective date, and based on the requirements of SFAS 123, for all awards granted to employees prior to the effective date of SFAS 123R that remain unvested on the effective date.
The provisions of the statement are effective as of the beginning of the first annual reporting period that begins after June 15, 2005. The Company expects to adopt the standard on January 1, 2006. The Company is evaluating the requirements of SFAS 123R and has not determined its method of adoption or the impact on its financial position or the results of operations.
In November 2004, the FASB issued Statement of Financial Accounting Standards No. 151 (“ SFAS 151”), “Inventory Costs, an Amendment of ARB No. 43, Chapter 4.” SFAS 151 clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted material and requires that these items be
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recognized as current period charges. SFAS 151 applies only to inventory costs incurred during periods beginning after the effective date and also requires that the allocation of fixed production overhead to conversion costs be based on the normal capacity of the production facilities. SFAS 151 is effective for the reporting period beginning December 1, 2005. The adoption of SFAS 151 will not have a material impact on our results of operations or financial position.
(10) SEGMENT INFORMATION
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.
The Company operates 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 the telecommunications, defense, and medical markets. 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.
The Corporate assets include cash and cash equivalents, buildings and furniture and fixtures.
Quarter Ended March 31, 2005 | Quarter Ended March 31, 2004 | |||||||||||||||||||||||
Illumination | Optical Components | �� | Total | Illumination | Optical Components | Total | ||||||||||||||||||
Net sales | $ | 4,280 | $ | 318 | $ | 4,598 | $ | 3,915 | $ | 244 | $ | 4,159 | ||||||||||||
Gross margin | 1,515 | 122 | 1,637 | 1,274 | (37 | ) | 1,237 | |||||||||||||||||
Operating loss | (199 | ) | (1,278 | ) | (1,477 | ) | (490 | ) | (954 | ) | (1,444 | ) |
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March 31, 2005 | December 31, 2004 | |||||||||||||||||||||||
Illumination | Optical Components | Corporate | Total | Illumination | Optical Components | Corporate | Total | |||||||||||||||||
Total current assets | $ | 7,232 | $ | 183 | $ | 1,155 | $ | 8,570 | $ | 6,596 | $ | 130 | $ | 4,025 | $ | 10,751 | ||||||||
Property, plant & equipment, net | 7,236 | 587 | 10,246 | 18,069 | 8,162 | 717 | 9,706 | 18,582 | ||||||||||||||||
Intangible assets | 1,065 | — | — | 1,065 | 1,144 | — | — | 1,144 | ||||||||||||||||
Goodwill | 2,677 | — | — | 2,677 | 2,677 | — | — | 2,677 | ||||||||||||||||
Other assets | — | — | 543 | 543 | — | — | 624 | 624 | ||||||||||||||||
$ | 18,210 | $ | 770 | $ | 11,944 | $ | 30,924 | $ | 18,218 | $ | 844 | $ | 14,716 | $ | 33,778 | |||||||||
The Company’s sales by geographic region are denominated in U.S. dollars. These sales are as follows:
Quarter Ended March 31, | ||||||
Sales by region (in thousands) | 2005 | 2004 | ||||
Domestic -United States | $ | 2,549 | $ | 2,396 | ||
Canada | 570 | 416 | ||||
Other | 1,479 | 1,347 | ||||
Total | $ | 4,598 | $ | 4,159 |
(11) DEBT
Debt Compliance
The Company has various debt covenants under its multiple credit facilities and as of March 31, 2005, the Company was in compliance with all covenants. As of December 31, 2004, the Company was not in compliance with certain financial performance covenants with the National Bank of Canada and amended its credit facility and related covenants to bring it into compliance as of December 31, 2004. The amendment, dated March 21, 2005, is described in the following section under Borrowing Agreements.
Laurus Master Fund
The Company has issued four secured notes to Laurus Master Fund, LTD. These notes were issued in September 2003, February 2004, June 2004 and December 2004. Another institutional investor participated in the notes issued
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in June and December 2004. During the second quarter of 2004, the September 2003 note was fully converted into common stock and the February 2004 note was partially converted into common stock. The Company has registered for resale all of the shares of common stock underlying the convertible notes and warrants in registration statements filed on Form S-3. The Company’s accounting methodology for these convertible notes and related transactions along with further details are listed below:
September 2003
On September 24, 2003, the Company issued a Convertible Note to Laurus Master Fund, LTD. The $2,500,000 Convertible Note matures on September 24, 2006, with interest at a rate equal to the Prime Rate plus 3.5%, but in no event less than 7.5%, and provided the holder with the option to convert the loan to common stock at $1.07 per share subject to certain adjustment features. StockerYale had 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 had the right to elect to pay monthly principal amortization in cash at 103% of the principal amount. The Company could have elected to pay both principal amortization and interest in common stock, if the market price of the stock at the time of the payment was 110% of the fixed conversion price. The Company could have elected 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 March 31, 2005, the total value of the note has been converted to 2,337,249 shares of common stock.
February 2004
On February 25, 2004, the Company issued a Convertible Note to Laurus Master Fund, 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 $1.65 per share, 250,000 shares at $1.75 per share and 75,000 shares at $1.95 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 141% 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.
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As of June 30, 2004, Laurus had converted $1,501,500 principal and interest into 1,155,000 shares of common stock.
As of March 31, 2005, $2,498,500 was outstanding under the convertible note of which $790,000 has been classified as short-term debt and $1,282,000 as long-term debt reported net of $426,000 of unamortized debt discount based upon beneficial conversion rights and warrants.
June 2004
On June 10, 2004, the Company issued a Convertible Note to Laurus Master Fund, 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 beneficial 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 March 31, 2005, $4,469,000 was outstanding under the convertible note of which $1,380,000 has been classified as short-term debt and $2,141,000 as long-term debt reported net of $948,000 related to unamortized debt discount based upon beneficial conversion rights and warrants.
December 2004
On December 7, 2004 and December 8, 2004, the Company issued secured convertible notes in the aggregate principal amount of $1,000,000 to Laurus Master Fund, LTD and another institutional investor. The notes bear an interest rate of prime plus 2% and provides the holders with the right to convert the notes to common stock at $1.30 per share. The secured convertible note issued to Laurus Master Fund, LTD is secured by a second mortgage on the Company’s Salem, New Hampshire facility. The Company has the right to elect to make the monthly required payments on the secured convertible notes (including principal-and interest) in the form of shares of common stock, determined based on the $1.10 conversion price. The Company also issued to the holders immediately exercisable warrants to purchase an aggregate of 100,000 shares of common stock at $1.38 per share, 66,000 shares of common stock at $1.60 per share, and 24,000 shares of common stock at $1.71 per share. The warrants expire seven years from the date of issuance. The aggregate purchase price of the secured convertible notes and warrants of $1,000,000 was allocated between the secured convertible notes, the common stock conversion option and warrants based upon their relative fair market value. The purchase price assigned to the secured convertible notes, common stock beneficial conversion option and warrants was $585,300, $261,100 and $153,600
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respectively. The difference between the aggregate face amount of the secured convertible notes of $1,000,000 and the aggregate purchase price of the secured convertible notes of $585,300 was recorded as a debt discount and is being amortized over the life of the convertible notes. 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 3.89%; an expected life of seven years; and an expected volatility of 108.29% with no dividend yield.
The Company can elect to pay monthly principal amortization in cash at 101% of the principal amount of the secured convertible notes. The Company may also elect to pay both principal-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 $31,250 per month.
As of March 31, 2005, $1,000,000 was outstanding under the convertible note of which $140,000 has been classified as short-term debt and $530,000 as long-term debt reported net of $330,000 related to unamortized debt discount based upon beneficial conversion rights and warrants.
Each of the convertible notes related to Laurus Master Fund, LTD contain dilution and anti-dilution rights. These rights allow for a reduction in conversion price if subsequent equity-related transactions, such as issuance of convertible debt or sale of common stock, are priced below the conversion prices of existing convertible debt agreements with Laurus Master Fund LTD. On December 8, 2004 Laurus Master Fund, LTD waived all dilution and anti-dilution rights in connection with the convertible note issued on the same date.
National Bank of Canada
The Company has a revolving line of credit and a term note with the National Bank of Canada. The original agreement dated May 26, 2003 was amended in March of 2004 and 2005. The National Bank of Canada credit facility requires the maintenance of certain financial covenants, including working capital, net worth, limitations on capital expenditures, a financial coverage ratio and maximum inventory levels. Details of the amendments are as follows:
On March 19, 2004, the Company entered into an amended agreement with the National Bank of Canada which included 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 required C$10,000,000 net worth as of September 30, 2004 and thereafter. The amended agreement maintained the inventory component of the line of credit availability at C$750,000 and required the Company to achieve specific net profit targets throughout 2004.
On March 22, 2005, the Company entered into another amended agreement with the National Bank of Canada which maintains the line of credit of C$2,500,000 ($2,076,000 US, converted at the March 31, 2005 rate of $.83) and the five-year term note of C$2,000,000 ($1,666,000 US, converted at the March 31, 2005 rate of $.83). The amended agreement reduced the net worth covenant from C$10,000,000 in the prior amended agreement to C$9,250,000 in the March 22, 2005 agreement. The amended agreement also requires the Company to achieve specific net profit targets throughout 2005.
As of March 31, 2005, C$2,376,000 ($1,964,000 US) was outstanding under the line of credit and C$1,147,000 ($948,000 US) was outstanding under the term note. As of March 31, 2005, the interest rate on the line of credit and the term note were 6.00% and 6.75%, respectively and principal payments are C$33,333 a month ($27,333 US).
Merrill Lynch Financial Services
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 in the amended agreement. The amended agreement also increased the interest from LIBOR + 5.5% in the prior agreement to LIBOR + 7.5% in the amended agreement On June 10, 2004, the Company paid in full the credit facility with Merrill Lynch Business Financial Services, including outstanding principal and accrued interest of $3,370,000 and $7,000 respectively, with proceeds from a convertible note.
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(12) SUBSEQUENT EVENTS
Entry into a Material Definitive Agreement-Sale of Building.
On April 15, 2005, the Company entered into a Purchase and Sales Agreement and Deposit Receipt (the “Agreement”) with John F. Alberico (the “Buyer”), dated April 12, 2005, pursuant to which (i) the Company agreed to sell to the Buyer, and the Buyer agreed to purchase from the Company, for $4,572,500 (the “Sale Transaction”) the property owned by the Company and located at 32 Hampshire Road in Salem, New Hampshire (the “Property”) and (ii) the Company agreed to lease from the Buyer approximately 32,000 square feet of the Property for an initial term of ten years with rental rates during such period ranging from approximately $254,400 to $288,640 per year in base rent plus a pro rata share of all operating costs of the Property (the “Lease Transaction”). The Company intends to use the net proceeds from the Sale Transaction to repay in full two outstanding convertible notes issued by the Company.
The carrying value of the land, building and improvements as of March 31, 2005 was $5,174,000.
Although the transactions contemplated by the Agreement are expected to be consummated within 75 days of the date of the Agreement, such transactions are subject to certain closing conditions and there can be no assurance that the transactions will be consummated.
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND OPERATING RESULTS
The following discussion of the consolidated financial condition and results of operations of the Company should be read in conjunction with the unaudited condensed consolidated financial statements and the related notes thereto included elsewhere in this Form 10-QSB. Except for the historical information contained herein, the following discussion, as well as other information in this report, contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and are subject to the “safe harbor” created by those sections. Some of the forward-looking statements can be identified by the use of forward-looking terms such as “believes,” “expects,” “may,” “will,” “should,” “could,” “seek,” “intends,” “plans,” “estimates,” “anticipates” or other comparable terms. Forward-looking statements involve inherent risks and uncertainties. A number of important factors could cause actual results to differ materially from those in the forward-looking statements. We urge you to consider the risks and uncertainties described in “Factors That May Affect Future Results” in this report. We undertake no obligation to update our forward-looking statements to reflect events or circumstances after the date of this report. We caution readers not to place undue reliance upon any such forward-looking statements, which speak only as of the date made.
Overview
StockerYale, Inc. is an independent designer and manufacturer of structured light lasers, light emitting diodes (LEDs), fiber optic, and fluorescent illumination technologies as well as specialty optical fiber, phase masks, and advanced optical sub-components. StockerYale’s products are used in a wide range of markets and industries including the machine vision, telecommunications, aerospace, defense and security, utilities, industrial inspection, and medical markets. The Company operates within two segments, namely illumination products and optical components. Illumination products include structured light lasers, specialized fiber optic, fluorescent, and light-emitting diode (LED) products for the machine vision, industrial inspection, and defense and security industries. The optical components segment includes specialty optical fiber and diffractive optics/phase masks for the telecommunications, defense, and medical markets.
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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’ annual report on Form 10-KSB for the year ended December 31, 2004.
The Company’s current forecast for 2005 calls for increased revenues, reduced operating costs, and the pursuit of additional sources of funds to finance operations through the end of 2005. The Company can give no assurances to the timing or terms of such financing arrangements, assuming it is able to consummate one or more funding options. If the Company is unable to raise sufficient funds by the end of the second quarter of 2005, 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/debt securities. The Company expects to close one or more of these financing options in 2005.
FISCAL QUARTERS ENDED MARCH 31, 2005 AND 2004
Net Sales
Revenues for the first quarter of 2005 increased 11% to $4.6 million from those reported in both the first and fourth quarters of 2004. Revenue growth was driven by higher laser and specialty optical fiber shipments. Order bookings increased 12% to $4.8 million in the first quarter 2005 from $4.3 million in the previous quarter reflecting a doubling of specialty fiber orders and improved penetration of lasers into OEM accounts.
Gross Profit
Gross profit for the quarter increased 32% to $1.6 million from the comparable quarter of 2004. The increase in gross profit resulted from the combination of higher sales and a significant improvement in gross margin. The gross margin as a percentage of sales increased from 30% in the first quarter of 2004 to 36% in the first quarter of 2005 as the result of selling higher margin products and material cost reductions.
Operating Expenses
Operating expenses increased 15% to $3.1 million compared to $2.7 million the first quarter of 2004. The increase primarily reflected higher non-recurring legal expenses, which the Company expects to decline significantly in the near future. Research and development expenses of $831,000 reported in the first quarter of 2005 were consistent with the first quarter of 2004 and selling expenses increased 13% to $784,000 were comparable to the first quarter of 2004.
Non-Operating Expenses
Non-operating expenses decreased $0.2 million or 11% principally due to declining non-cash debt acquisition and debt discount amortization expenses. Interest expense increased $0.7 million due to higher debt balances and interest rates.
Net Income (Loss)
The operating loss for the first quarter was $1.5 million versus $1.4 million in the comparable 2004 quarter and down 52% from $2.9 million in the prior quarter, excluding asset impairment charges of $173,000.
Provision (Benefit) for Income Taxes
The Company’s historical operating losses raise doubt as to its ability to realize the benefits of its deferred tax assets. As a result, management has provided a valuation allowance for the net deferred tax assets that may not be realized.
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 2005, the Company was in compliance with all provisions of its loan agreements.
For the quarter ended March 31, 2005, cash decreased $2.1 million. Cash used in operating activities was $2.2 million in the first quarter of fiscal 2005, which primarily resulted from an operating loss of $2.2 million offset by $1.1 million of non-cash charges for depreciation and amortization.
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We have experienced operating losses over the last several years and may continue to incur losses and negative operating cash flows. We cannot predict the size or duration of any future losses. We have historically financed our operations with proceeds from debt financings and the sale of equity securities. The audit report from Vitale, Caturano & Company Ltd., our independent registered public accounting firm, regarding our fiscal year 2004 financial statements contains Vitale Caturano’s opinion that our recurring losses from operations and our need to obtain additional financing raise substantial doubt about our ability to continue as a going concern. We anticipate that we will continue to incur net losses in the future. As a result, we can give no assurance that we will achieve profitability or be capable of sustaining profitable operations. If we are unable to reach and sustain profitability, we risk depleting our working capital balances and our business may not continue as a going concern.
The Company paid $0.7 million in principal payments on the Laurus Fund notes and $0.1 million in other debt obligations.
Investing activities used $0.1 million related to capital expenditures in Montreal and Salem.
FACTORS THAT MAY AFFECT FUTURE RESULTS
We operate in a rapidly changing environment that involves a number of risks, some of which are beyond our control. Forward looking statements in this report and those made from time to time by us through our senior management are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward looking statements concerning the expected future revenues, earnings or financial results or concerning project plans, performance, or development of products and services, as well as other estimates related to future operations are necessarily only estimates of future results and there can be no assurance that actual results will not materially differ from expectations. Forward-looking statements represent management’s current expectations and are inherently uncertain. We do not undertake any obligation to update forward-looking statements. If any of the following risks actually occurs, our financial condition and operating results could be materially adversely affected.
We have a history of losses and may never achieve or sustain profitability and may not continue as a going concern.
We have experienced operating losses over the last several years and may continue to incur losses and negative operating cash flows. We cannot predict the size or duration of any future losses. We have historically financed our operations with proceeds from debt financings and the sale of equity securities. The audit report from Vitale, Caturano & Company Ltd., our independent registered public accounting firm, regarding our fiscal year 2004 financial statements contains Vitale Caturano’s opinion that our recurring losses from operations and our need to obtain additional financing raise substantial doubt about our ability to continue as a going concern. We anticipate that we will continue to incur net losses in the future. As a result, we can give no assurance that we will achieve profitability or be capable of sustaining profitable operations. If we are unable to reach and sustain profitability, we risk depleting our working capital balances and our business may not continue as a going concern.
Our ability to continue as a going concern may be dependent on raising additional capital, which we may not be able to do on favorable terms, or at all.
As of March 31, 2005, we had cash and cash equivalents of approximately $1.2 million. We need to raise additional capital and such capital may not be available on favorable terms or at all. If we do not raise additional capital, our business may not continue as a going concern. We are currently pursuing several financing options, including the possible sale of additional equity securities, debt financings and the sale of real estate. Even if we do find outside funding sources, we may be required to issue securities with greater rights than those currently possessed by holders of our common stock. We may also be required to take other actions that may lessen the value of our common stock or dilute our common stockholders, including borrowing money on terms that are not favorable to us or issuing additional equity securities. If we experience difficulties raising money in the future, our business and liquidity will be materially adversely affected.
Securities we issue to fund our operations could dilute or otherwise adversely affect our shareholders.
We will likely need to raise additional funds through public or private debt or equity financings to fund our operations. If we raise funds by issuing equity securities, the percentage ownership of current shareholders will be
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reduced. If we raise funds by issuing debt securities, we may be required to agree to covenants that substantially restrict our ability to operate our business. We may not obtain sufficient financing on terms that are favorable to investors or us. We may delay, limit or eliminate some or all of our proposed operations if adequate funds are not available.
In addition, upon issuance of the shares of common stock upon exercise of outstanding warrants, the percentage ownership of current shareholders will be diluted substantially.
We may be unable to fund the initiatives required to achieve our business strategy.
In 2002, we began to focus our resources on opportunities that would result in near-term revenue and simultaneously reduced our operating expenses by 40% on an annualized basis. In 2003 and 2004, we continued to reduce costs and we are currently evaluating the restructuring of our product lines. While we believe these efforts will assist us in improving our financial condition, we can give no assurances as to whether our cost reduction and product restructuring efforts will be successful. If our cost reduction strategies are unsuccessful, we may be unable to fund our operations.
We could be subject to fines, penalties or other sanctions as a result of an investigation of us and of Mark W. Blodgett, our President, Chairman and Chief Executive Officer, by the Securities and Exchange Commission.
On November 9, 2004, we received a “Wells Notice” from the Staff of the Securities and Exchange Commission (“SEC”) relating to disclosures contained in press releases that we issued on April 19, 2004 and April 21, 2004. The Wells Notice states that the Staff of the SEC intends to recommend that a civil action be brought against us and Mark W. Blodgett, our President, Chairman and Chief Executive Officer, alleging violations of Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5. We have been cooperating in the Staff’s investigation, and on December 10, 2004 we responded to the Staff’s recommendation, in which we vigorously defended our actions.
We cannot predict the scope, timing or outcome of the SEC investigation or any civil actions that may be brought against us as a result. The SEC investigation may result in the imposition of significant fines, penalties and sanctions, which could have a material adverse effect on our business, including on our ability to obtain additional financing, our stock price and on our ability to attract or retain key employees and customers. We cannot predict what impact, if any, these matters may have on our business, financial condition, results of operations and cash flow.
The unpredictability of our quarterly results may cause the trading price of our common stock to fluctuate or decline.
Our operating results have varied on a quarterly basis during our operating history and are likely to continue to vary significantly from quarter-to-quarter and period-to-period as a result of a number of factors, many of which are outside of our control and any one of which may cause our stock price to fluctuate.
Such factors include the implementation of our new business strategy, which makes prediction of future revenues difficult. Our ability to accurately forecast revenues from sales of our products is further limited by the development and sales cycles related to our products, which make it difficult to predict the quarter in which sales will occur. In addition, our expense levels are based, in part, on our expectations regarding future revenues, and our expenses are generally fixed, particularly in the short term. We may be unable to adjust spending in a timely manner to compensate for any unexpected revenue shortfall. Any significant shortfall of revenues in relation to our expectations could cause significant declines in our quarterly operating results.
Due to the above factors, we believe that quarter-to-quarter or period-to-period comparisons of our operating results may not be a good indicator of our future performance. Our operating results for any particular quarter may fall short of our expectations or those of stockholders or securities analysts. In this event, the trading price of our common stock would likely fall.
An impairment of goodwill and/or long-lived assets could affect net income.
We record goodwill on our balance sheet as a result of business combinations consummated in prior years. We have also made a significant investment in long-lived assets. In accordance with applicable accounting standards, we periodically assess the value of both goodwill and long-lived assets in light of current circumstances to determine
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whether impairment has occurred. If an impairment should occur, we would reduce the carrying amount to our fair market value and record an amount of that reduction as a non-cash charge to income, which could adversely affect our net income reported in that quarter in accordance with generally accepted accounting principles. We recorded a $1,905,000 impairment charge in 2003 and $173,000 in 2004. We cannot definitively determine whether impairment will occur in the future, and if impairment does occur, what the timing or the extent of any such impairment would be.
Failure to comply with credit facility covenants may result in an acceleration of substantial indebtedness.
Our financing agreements with National Bank of Canada and Laurus Master require us to comply with various financial and other operating covenants. If we breach our financing agreements with National Bank of Canada and Laurus Master Fund, a default could result. A default, if not waived, could result in, among other things, all or a portion of our outstanding amounts becoming due and payable on an accelerated basis, which would adversely affect our liquidity and our ability to manage our business.
Our stock price has been volatile and may fluctuate in the future.
Our Common Stock has experienced significant price and volume fluctuations in recent years. Since January 2002, our common stock has closed as low as $.52 per share and as high as $11.06 per share. These fluctuations often have no direct relationship to our operating performance. The market price for our common stock may continue to be subject to wide fluctuations in response to a variety of factors, some of which are beyond our control. Some of these factors include:
• | our performance and prospects; |
• | sales by selling shareholders of shares issued and issuable in connection with our private placements in 2003 and 2004; |
• | changes in earnings estimates or buy/sell recommendations by analysts; |
• | general financial and other market conditions; and |
• | domestic and international economic conditions. |
In addition, some companies that have experienced volatility in the market price of their stock have been the subject of securities class action litigation or other litigation or investigations. In light of the fluctuations in our stock price, it is possible that we may be the subject of securities class action litigation in the future. Such litigation often results in substantial costs and a diversion of management’s attention and resources and could harm our business, prospects, results of operations, or financial condition.
The loss of key personnel or the inability to recruit additional personnel may harm our business.
Our success depends to a significant extent on the continued service of our executive officers, our senior and middle management and our technical and research personnel. In particular, the loss of Mark W. Blodgett, our President, Chairman and Chief Executive Officer, or other key personnel, could harm us significantly. Hiring qualified management and technical personnel will be difficult due to the limited number of qualified professionals in the work force in general and the intense competition for these types of employees. The loss of key management personnel or an inability to attract and retain sufficient numbers of qualified management personnel could materially and adversely affect our business, results of operations, financial condition or future prospects.
Our common stock price may be negatively impacted if it is delisted from the NASDAQ National Market.
Our common stock is currently listed for trading on the NASDAQ National Market. We must continue to satisfy NASDAQ’s continued listing requirements, including a minimum bid price for our common stock of $1.00 per share, or risk delisting which would have an adverse affect on our business.
On September 17, 2003, we received a delisting notice from NASDAQ stating that if we did not meet the $1.00 minimum bid price for ten consecutive days, our common stock would be delisted from the NASDAQ National Market as of September 26, 2003. On September 23, 2003, we received a notice from NASDAQ that it had rescinded its letter of September 17, 2003 and that we had regained compliance with Marketplace Rule 4450(a)(5) regarding the $1.00 per share minimum bid price requirement.
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Although we regained compliance with the $1.00 per share minimum bid pricing requirement, there have subsequently been times that we have not complied with the requirement; however we have not received any further delisting notices from NASDAQ, even though stock price is again below $1.00 per share. A delisting of our common stock from the NASDAQ National Market could materially reduce the liquidity of our common stock and result in a corresponding material reduction in the price of our common stock. In addition, any such delisting could harm our ability to raise capital through alternative financing sources on terms acceptable to us, or at all, and may result in the potential loss of confidence by investors, suppliers, customers and employees.
A small number of affiliated stockholders control more than 10% of our stock.
Our executive officers and directors as a group own or control approximately sixteen percent (16%) of our common stock. Accordingly, these shareholders, if they act together, will be able to influence our management and affairs and all matters requiring shareholder approval, including the election of directors and approval of significant corporate transactions. In addition, this concentration of ownership may have the effect of delaying or preventing a change in control of our company and might adversely affect the market price of our common stock.
We depend on a limited number of suppliers and may not be able to ship products on time if we are unable to obtain an adequate supply of raw materials and equipment on a timely basis.
We depend on a limited number of suppliers for raw materials and equipment used to manufacture our products. We depend on our suppliers to supply critical components in adequate quantities, consistent quality and at reasonable costs. If our suppliers are unable to meet our demand for critical components at reasonable costs, and if we are unable to obtain an alternative source, or the price for an alternative source is prohibitive, our ability to maintain timely and cost-effective production of our products would be harmed. We generally rely on purchase orders rather than long-term agreements with our suppliers; therefore, our suppliers may stop supplying materials and equipment to us at any time. If we are unable to obtain components in adequate quantities we may incur delays in shipment or be unable to meet demand for our products, which could harm our revenues and damage our relationships with customers and prospective customers.
We have many competitors in our field and our technologies may not remain competitive.
We participate in a rapidly evolving field in which technological developments are expected to continue at a rapid pace. We have many competitors in the United States and abroad, including various fiber optic component manufacturers, universities and other private and public research institutions. The Company has five primary competitors in the fiber optic illumination market. The most established segment of this market relates to illumination for microscopes. Within that market, Volpi Manufacturing USA, Inc. and Dolan-Jenner Industries, Inc. compete directly with the Company’s products. Both of these companies have been producing fiber optic products for more than thirty years and offer a complete line of fiber optic illumination systems for microscopy applications. A third company, Cuda Products, Inc., also supplies fiber optic lighting for microscopy; however, its primary market is medical. The value-oriented segment of the microscopy market is dominated by Chiu Technical Corp, which offers an inexpensive, “no-frills”, fiber optic lighting system. A newer segment in the fiber optic lighting market relates to automated imaging and inspection equipment for machine vision. Schott-Fostec, Inc. is the leading provider of fiber optic lighting for the machine vision industry. In the industrial fluorescent lighting market, the Company has two primary competitors. MicroLite markets a product similar in appearance to the Company’s circular fluorescent microscope illuminator. Techni-Quip Corporation offers industrial fluorescent lighting as part of its product line but as a whole, its lighting product line is limited and represents a small percentage of that company’s total business
Our major competitors in the specialty fiber optic market segment are Furukawa OFS, Fiberforce, and Corning. In the laser market, we compete against Power Technology, Inc. in the United States, Schafter GMBH and Kirchoff GMBH in Europe and several other smaller laser manufacturers.
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Our success depends upon our ability to develop and maintain a competitive position in the product categories and technologies on which we focus. To be successful in the illumination and optical components industries, we will need to keep pace with rapid changes in technology, customer expectations, new product introductions by competitors and evolving industry standards, any of which could render our existing products obsolete if we fail to respond in a timely manner. We could experience delays in introduction of new products. If others develop innovative proprietary illumination products or optical components that are superior to ours, or if we fail to accurately anticipate technology and market trends and respond on a timely basis with our own innovations, our competitive position may be harmed and we may not achieve sufficient growth in our revenues to attain or sustain profitability.
Many of our competitors have greater capabilities and experience and greater financial, marketing and operational resources than us. Competition is intense and is expected to increase as new products enter the market and new technologies become available. To the extent that competition in our markets intensifies, we may be required to reduce our prices in order to remain competitive. If we do not compete effectively, or if we reduce our prices without making commensurate reductions in our costs, our revenues and profitability, and our future prospects for success, may be harmed.
Our customers are not obligated to buy material amounts of our products and may cancel or defer purchases on short notice.
Our customers typically purchase our products under individual purchase orders rather than pursuant to long-term contracts or contracts with minimum purchase requirements. Therefore, our customers may cancel, reduce or defer purchases on short notice without significant penalty. Accordingly, sales in a particular period are difficult to predict. Decreases in purchases, cancellations of purchase orders or deferrals of purchases may have a material adverse effect on us, particularly if we do not anticipate them. There can be no assurance that our revenue from key customers will not decline in future periods.
We are subject to risks of operating internationally.
We distribute and sell some of our products internationally, and our success depends in part on our ability to manage our international operations. Sales outside the United States accounted for 36% of our total revenue for the fiscal year ended December 31, 2004. We are subject to risks associated with operating in foreign countries, including:
• | foreign currency risks; |
• | costs of customizing products for foreign countries; |
• | imposition of limitations on conversion of foreign currencies into dollars; |
• | remittance of dividends and other payments by foreign subsidiaries; |
• | imposition or increase of withholding and other taxes on remittances and other payments on foreign subsidiaries; |
• | hyperinflation and imposition or increase of investment and other restrictions by foreign governments; |
• | compliance with multiple, conflicting and changing governmental laws and regulations; |
• | longer sales cycles and problems collecting accounts receivable; |
• | labor practices, difficulties in staffing and managing foreign operations, political instability and potentially adverse tax consequence; and |
• | import and export restrictions and tariffs. |
If we are unable to manage these risks, we may face significant liability, our international sales may decline and our financial results may be adversely affected.
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Our products could contain defects, which could result in reduced sales of those products or in claims against us.
Despite testing by our customers, and us errors have been found and may be found in the future in our existing or future products. These defects may cause us to incur significant warranty, support and repair costs, divert the attention of our technical personnel from our product development efforts and harm our relationship with our customers. Defects, integration issues or other performance problems in our illumination and optical products could result in personal injury or financial or other damages to our customers or could damage market acceptance of our products. Our customers could also seek damages from us for their losses. A product liability claim brought against us, even if unsuccessful, would likely be time consuming and costly to defend.
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 C$2.5million line of credit and C$2.0 million term note with the National Bank of Canada with interest rates of 6.0% and 6.75%. As of March 31, 2005, the fair market value of the Company’s outstanding debt approximates its carrying value due to the short-term maturities and variable interest rates.
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures.
As required by new Rule 13a-15 under the Securities Exchange Act of 1934, within the 90 days prior to the date of 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.
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(b) Changes in internal controls
There was no change in our internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act) that occurred during the fiscal quarter to which this report relates that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
On November 9, 2004, we received a “Wells Notice” from the Staff of the Securities and Exchange Commission (“SEC”) relating to disclosures contained in press releases that we issued on April 19, 2004 and April 21, 2004. The Wells Notice states that the Staff of the SEC intends to recommend that a civil action be brought against us and Mark W. Blodgett, our President, Chairman and Chief Executive Officer, alleging violations of Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. We have been cooperating in the Staff’s investigation, and on December 10, 2004 we responded to the Staff’s recommendation, in which we vigorously defended our actions.
We cannot predict the scope, timing or outcome of the SEC investigation or any civil actions that may be brought against us as a result. The SEC investigation may result in the imposition of significant fines, penalties and sanctions, which could have a material adverse effect on our business, including on our ability to obtain additional financing, our stock price and on our ability to attract or retain key employees and customers. We cannot predict what impact, if any, these matters may have on our business, financial condition, results of operations and cash flow.
The company may be involved in disputes and/or litigation with respect to its products and operations in its normal course of business. The company does not believe that the ultimate impact of the resolution of such matters would have a material adverse effect on the company’s financial condition or results of operations. The company is not currently involved in any legal proceedings.
During the quarter ended March 31, 2005, we made no material changes to the procedures by which shareholders may recommend nominees to our Board of Directors, as described in our most recent proxy statement.
StockerYale, Inc. (the “Company”) and one of its subsidiaries, StockerYale Canada, Inc. (the “Subsidiary”), entered into an Offer of Financing (the “2005 Agreement”) with the National Bank of Canada (the “Bank”) on March 22, 2005. The 2005 Agreement amends that certain Offer of Financing among the same parties dated March 19, 2004 in its entirety. For purposes of the following, all amounts reported in U.S. currency have been converted from Canadian currency at the March 31, 2005 rate of C$.83 per U.S. dollar.
Under the 2005 Agreement, the Bank will continue to extend a credit facility in the amount of C$2,500,000 (US$2,076,000) to the Subsidiary with a variable rate of interest on the amounts advanced to the Subsidiary under such facility at the Canadian prime rate plus 2%. The Bank renewed the existing term loan to the Subsidiary in the amount of approximately C$1,166,666. This term loan bears interest on a variable basis at the Canadian prime rate plus 2.75% and will expire on June 26, 2008. Pursuant to the 2005 Agreement, the Bank agreed to increase the existing term loan to $2,000,000 (US$1,666,000) and to extend the term of such loan should the Company achieve certain specified financial targets, among other things.
Under the 2005 Agreement, as partial security for the existing credit facility and the existing term loan, the Company renewed its obligation to fund the Subsidiary’s deficits if requested to do so by the Bank and agreed to subordinate to the Bank its advances made to the Subsidiary.
Under the 2005 Agreement, the Subsidiary agreed to maintain net worth greater than or equal to C$9,250,000 as of the end of each fiscal quarter, from and after December 31, 2004. In addition to agreeing to limit its capital expenditures to a maximum of C$75,000 from and after January 1, 2005 as well as limiting its inventory levels, the Subsidiary also agreed to maintain certain ratios involving working capital, net worth and minimum coverage as of the end of each fiscal quarter from and after December 31, 2004 for the duration of the 2005 Agreement, with the exception of the minimum coverage ratio, which is in effect from and after December 31, 2005.
(a) The following is a complete list of exhibits filed as part of this Form 10-QSB:
Exhibit | Description | |
10.1 | Purchase and Sales Agreement and Deposit Receipt between the Company and John F. Alberico, dated April 12, 2005, is incorporated herein by reference to Exhibit 99.1 of the Company’s Current Report on Form 8-K filed on April 18, 2005 (File No. 000-27372). | |
10.2* | Offer of Financing among Bank of Canada, StockerYale Canada, Inc. and the Company dated March 22, 2005. | |
31.1* | Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
31.2* | Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
32.1* | Certification of the Chief Executive Officer pursuant to Rule 13a-14(b) and Rule 15d-14(b) of the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
32.2* | Certification of the Chief Financial Officer pursuant to Rule 13a-14(b) and Rule 15d-14(b) of the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
*Filed herewith. |
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In accordance with the requirements of the Securities Exchange Act of 1934, the Registrant caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
STOCKERYALE, INC. | ||||
Date: May 16, 2005 | By: | /s/ MARK W. BLODGETT | ||
Mark W. Blodgett President, Chief Executive Officer and Chairman of the Board | ||||
Date: May 16, 2005 | By: | /s/ RICHARD P. LINDSAY | ||
Richard P. Lindsay Executive Vice President and Chief Financial Officer |
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