Back to GetFilings.com

FORM 10-K

STOCKERYALE, INC.

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule12b-2, of the Act).  YES  o     NO  x

The registrant's revenues for the fiscal year ended December 31, 2002 were $12,992,000.

The aggregate market value of common stock held by non-affiliates of the registrant as of June 30, 2002 was $15,861,651.

The number of shares outstanding of the registrant's common stock as of February 28, 2003 was 12,696,633.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the definitive Proxy Statement to be delivered to shareholders in connection with the Annual Meeting of Shareholders to be held May 22, 2003 are incorporated by reference into Part III.

StockerYale, Inc.

    FORM 10-K

For the Fiscal Year Ended December 31, 2002

INDEX

This Form 10-K 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.You can identify forward-looking statements by the use of the words "believe," "expect," "anticipate," " intend," "estimate," "assume," and other similar expression which predict or indicate future events and trends and which do not relate to historical matters. The Company's actual results, performance or achievements could differ materially from our expectations expressed or implied by the forward-looking statements sometimes for reasons that are beyond the Company's control. Such reasons include, without limitation: the existence of other suppliers of optical components and illumination products, who may have greater resources than the Company; the risk that the Company's products may infringe patents held by other parties; the uncertainty that the Company's significant investments in R&D will result in products that achieve market acceptance; the Company's ability to attract and maintain key personnel; whether the Company is able to design products to meet the special needs of its customers; and that market conditions could make it more difficult or expensive for the Company to obtain the necessary capital to finance necessary research and development projects, operations as well as its ability to refinance existing debt. Additional factors that might cause such a difference are discussed in the section entitled "Certain Factors Affecting Future Operating Results" beginning on page 20 of this Form 10-K.

ITEM 1.    BUSINESS

GENERAL

StockerYale, Inc. (the Company) 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 for use in a wide range of markets and industries including the machine vision, telecommunications, aerospace, defense and security, utilities, industrial inspection, and medical markets.

 DEVELOPMENTS DURING FISCAL 2002

In 2002, StockerYale adjusted its business plans to a challenging economic environment by significantly reducing its cost structure, curtailing capital expenditures and ceased funding two research and development joint ventures. The key goals were to focus research and development on projects which could produce revenue in the short-term and adjust operating expenses to compensate for a declining revenue plan. As part of that adaptation the Company:

COMPANY HISTORY

StockerYale, Inc. was incorporated on March 27, 1951 under the laws of the Commonwealth of Massachusetts. In December 1995, the Company completed the registration of its Common Stock with the U.S. Securities and Exchange Commission and its stock now trades on the NASDAQ National Market under the trading symbol "STKR".

On May 13, 1998, the Company acquired StockerYale Canada, Inc., formerly known as Lasiris, Inc., a Canadian manufacturer of industrial lasers and other illumination and photonics products. The acquisition of StockerYale Canada provided the Company with the capability to manufacture laser-based illumination products and phase masks, which are used to manufacture fiber Bragg gratings for telecommunication applications.

The Company acquired StockerYale Canada through Lasiris Holdings, Inc., a newly formed New Brunswick corporation ("LHI") and a wholly owned subsidiary of the Company.  StockerYale Canada is operated as a wholly owned Canadian subsidiary of LHI. In connection with this transaction, the former stockholders of StockerYale Canada received shares of capital stock in LHI, which are exchangeable into shares of the Company's common stock on a one-for-one basis at any time at the option of the holder.

In addition to Lasiris Holdings, Inc., the Company has two active subsidiaries. On June 16, 2000, the Company acquired StockerYale (IRL) Ltd., formerly known as CorkOpt Ltd, which is a wholly owned Irish subsidiary and StockerYale Asia PTE Ltd., formerly known as Radiant Asiatec Pte, Ltd., a Singapore corporation that was formed in December 1997 and is an 80% owned subsidiary of the Company. The acquisition of StockerYale (IRL) Ltd. provided the Company with the capability to manufacture and sell light-emitting diodes, or LEDs, for industrial applications. StockerYale Asia PTE Ltd. is the entity through which the Company sells its illumination products in Southeast Asia.

As of February 28, 2003, the authorized capital stock of the Company was 100,000,000 shares of Common Stock of which 12,696,633 shares were issued and outstanding. Additionally, 2,308,981 shares of Common Stock were reserved for issuance upon the exercise of outstanding options or warrants to purchase Common Stock and upon the exchange of 85,290 shares of Lasiris Holdings, which are exchangeable into Company Common Stock on a one-for-one basis.

FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS

The Company operated within two segments, namely illumination 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 communication and sub-component and specialty optical fiber for the telecommunications, aerospace, utility and medical markets.

PRODUCTS

ILLUMINATION PRODUCTS

StockerYale is a leading developer and manufacturer of specialized illumination products for the inspection, machine vision, medical, and military markets and continues to be the only company with design and manufacturing competencies in four illumination disciplines: fiber optic, fluorescent, structured light laser, and light emitting diode (LED) technologies. The Company also differentiates itself from many of its competitors by delivering custom designed lighting solutions that can operate as a stand-alone illumination source or as an integral component of a larger OEM system.

The Company's fiber optic illumination products provide shadow-free, glare-free, cool illumination by way of a halogen light source (i.e., fiber optic illuminator) and the components (i.e., fiber optic light guide) that carry the illumination output to the intended location.

StockerYale manufactures high output, 0.66 and 0.55 numerical aperture (N.A.) glass fiber, in addition to polymer clad fused silica (quartz) fiber that is used in its fiber optic components, providing customers with the lighting solution that best fits their application. StockerYale's illumination fiber is internally produced in its Salem drawing facility rather than outsourced. This ensures that a higher quality of light demanded by increasingly sophisticated imaging systems and advanced quality assurance processes is delivered.

StockerYale has over twenty years experience designing and manufacturing high-quality fluorescent illumination products that are primarily used in microscopy and machine vision applications. The Company's fluorescent illuminators provide the critical lighting needs for a diversity of microscopes and cameras that are widely used for inspection in the semiconductor and disk drive manufacturing industries as well as machine vision applications. StockerYale has the most comprehensive line of fluorescent products available and believes that its Model 9 circular fluorescent microscope illuminator (CFMI) is one of the world's leading microscope illuminators. The Company also custom designs fluorescent illumination systems to meet a customer's exact lighting requirements.

For customers looking for a compact, long lasting illumination source, StockerYale offers LED lighting systems. The Company's patented, state-of-the-art, chip-on-board LED units draw less power and are not subject to the influences of oxidation that other lighting technologies endure, resulting in a life span of over 60,000 hours. Furthermore, because of the intrinsic characteristics of LEDs, which can be engineered into virtually any geometric configuration, StockerYale's LED's are ideal for specialized illumination applications within the semiconductor and electronics and also the medical industries that require the properties and benefits that only this lighting technology can deliver.

StockerYale's Lasiris^TM brand laser pattern projectors are used in the industrial inspection and 3-D machine vision industries and have most recently been introduced into the medical and military industries for specialized applications. The Company's patented optical lens produces a non-Gaussian (evenly illuminated) distinct laser line or a more complex laser light pattern that maintains a consistent intensity along the length and height of the projection. StockerYale's lasers are electrostatic discharge (ESD) protected, feature interchangeable head patterns, and most meet Class II eye safety ratings. By applying nearly 15 years of electro-optic R&D experience, the Company offers custom designed laser pattern projectors that meet even the most stringent requirements.

Lasers can be useful for contour mapping of parts, surface defect detection, depth measurements, guidelines, edges detection, and alignment. For example, in machine vision applications, structured light lasers may be used on systems recording the gap and flushness between car body components. In industrial inspection applications, these products may draw attention to parts that do not conform to specifications, such as defective parts.

OPTICAL COMPONENTS

StockerYale is an independent designer and manufacturer of specialty optical fiber and phase masks that are primarily used by fiber optic sensor, fiber optic gyroscope and telecommunication equipment manufacturers around the world.

Today, the Company is a leading supplier of phase masks, which are high precision phase diffraction gratings used as both a key enabling technology for the production of fiber Bragg gratings (FBGs) and for biomedical applications. FBGs offer a passive fiber-based means of filtering and stabilizing wavelengths to improve the performance of optical components used in various telecommunication and sensor applications. The Company also has the technical expertise and R&D facilities to optimize or custom design a phase mask that supports a special wavelength operation or tailor the mask dimensions to satisfy a customer's specific application.

The phase mask product line is sold by a direct sales force in North America and Europe and through distributor channels in Asia.

StockerYale designs and produces high-quality specialty optical fiber for both industry standard and custom applications.

StockerYale's specialty optical fiber fall into five broad categories: rare-earth doped fibers, polarization maintaining fibers, photosensitive fibers, bend insensitive fibers and custom designed fibers. These specialty optical fibers support a diverse range of applications, including erbium-doped fiber amplifiers, (EDFAs), fiber Bragg gratings, (FBGs), high-voltage current sensors, gyroscopes, and other applications related to optical fiber sensors and telecommunications.

StockerYale introduced many new specialty optical fibers in late 2002 including erbium doped fiber, polarization maintaining fiber, cladding mode suppression fiber and select cut-off single mode fiber. The specialty optical fiber is sold by a direct sales force in North America and Europe and through distributor channels in Asia. The Company is focusing a significant amount of its specialty optical fiber development resources outside of the telecommunications market due to a significant downturn in the industry. Many of the products are targeted at the defense sector and oil exploration industries and have longer qualification periods due to the nature of the applications. The Company expects additional opportunities in the telecommunications sectors as existing industry inventories are depleted and when the market returns to more favorable conditions.

SALES DATA

DOMESTIC AND FOREIGN REVENUE

Sales to unaffiliated customers in foreign countries represented 40%, 38% and 40% of net revenues in 2002, 2001and 2000, respectively.

MARKETING AND DISTRIBUTION

The Company's products are sold to over 10,000 customers, primarily in North America, Europe and the Pacific Rim. The Company sells directly to, and works with, a group of approximately 50 distributors and machine vision integrators to sell its specialized illumination products. Optical components are sold directly to OEM customers by the Company's sales organization.

COMPETITION AND COMPETITIVE POSITION

The Company competes with a number of firms in the design and manufacture of its specialized illumination, optical fiber and sub-component products. Some competitors have greater resources than the Company, and as a result, may have competitive advantages in the research and development and sales and distribution.

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.

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.

The Company has developed the in-house capability to draw its own glass fiber in variable dimensions to suit customer needs. Although some of the above-named competitors also have this capability, the Company believes that its proprietary manufacturing techniques result in fiber that has increased reliability. Since mid-1996, the Company has invested in developing its in-house design and research capabilities, including the hiring of personnel trained in optical, chemical, mechanical and electrical engineering and related disciplines, and the purchase of computers and laboratory equipment necessary to support these personnel. Further, the Company has succeeded in designing and developing a complete line of fiber optic lighting products for both the machine vision and microscopy markets.

Over the last eighteen months, the Company completed a program to expand its specialty optical fiber capability to include specialty optical fibers (SOF) for the defense and security, utility and telecommunication industries. The Company made substantial capital investments in plant and equipment in connection with its development of a complete line of specialty optical fibers (SOF). The Company's major competitors in this area include OFS, formally Lucent's Optical Fiber Solutions division, Corning, and 3M. With OFS (now owned by Furukawa), Corning and 3M consuming the majority of their SOF products internally, the Company believes it is positioned to be a leading independent supplier of SOF.

BACKLOG

The Company maintains an inventory of standard materials and components and generally manufactures standard illumination product configurations within one to five days after receipt of a customer order. The optical components and specialty optical products are generally manufactured to specifications of the customer order with a one to four week turnaround between order and shipment. Although such rapid response is, and historically has been, a selling advantage for the Company, some orders are placed for future delivery. At December 31, 2002, the Company had a backlog of orders for future delivery of approximately $2,258,000, compared to approximately $2,858,000 as of December 31, 2001. The principal reason for the backlog decline was a "last-time buy" for a portion of the printer and recorder business which represented approximately $700,000 of the $2,858,000 backlog as of December 31, 2001.

RAW MATERIALS

The raw materials and components used in the Company's products are purchased from a number of different suppliers and are generally available from several sources.

DEPENDENCE ON ONE OR A FEW MAJOR CUSTOMERS

The Company's customer base consists of more than 10,000 customers in various industries worldwide. Sales to the Company's largest single customer represented 16% of the Company's total net sales in fiscal 2002. The Company's top ten customers represented approximately 32% of total net sales in fiscal 2002, 32% in 2001 and 38% in 2000.

PATENTS AND TRADEMARKS

The Company holds patents in the United States and Ireland and has filed additional patent applications in the United States, Canada, Europe and Japan. StockerYale (IRL), Ltd holds a patent on a method for attaching semiconductor chips and has applied for two patents in the United States, Canada and Europe on new LED ring light and line light technologies. StockerYale Canada holds exclusive rights to three patents in the United States and one patent in Canada through licensing agreements. A wholly-owned subsidiary of the Company, Innovative Specialty Optical Fiber Components LLC, has applied for a patent in the United States on a fiber optic technology for depolarizing light. A 49% owned joint venture of the Company, Optune Technologies, Inc. has applied for two patents in the United States on a tunable optical filter for optical communications.

The Company has four patents relating to fundamental technological devices and methodologies used to achieve low-cost fluorescent light dimming; these patents expire on August 18, 2009, August 24, 2010, September 6, 2011 and September 13, 2011. StockerYale Canada's material patents consist of four patents for lenses, which expire on May 2, 2006, November 27, 2007, June 4, 2013 and December 15, 2015. The Company believes that patents are an effective way of protecting its competitive technological advantages, and considers its patents to be a strong deterrent against unauthorized manufacture, use and sale of its products and key product attributes. There can be no assurance, however, that a patent will be issued with respect to the Company's pending patent applications or whether the Company's patents or license rights will provide meaningful protection for the Company.

The Company also relies upon trade secret protection for its confidential and proprietary information. There can be no assurance that others will not independently develop substantially equivalent proprietary information and techniques, or otherwise gain access to and use or disclose the Company's trade secrets or that the Company can meaningfully protect its trade secrets.

The Company holds rights in certain trademarks to protect its brand name recognition in various markets. Because of the Company's long history and reputation for designing and manufacturing high quality products, trademark protection enhances the Company's position in the market.

Although the Company believes that its products and other proprietary rights do not infringe the proprietary rights of third parties, there can be no guarantee that infringement claims will not be asserted against the Company in the future or that any such claims will not require the Company to enter into royalty arrangements or result in costly litigation.

RESEARCH AND DEVELOPMENT

The Company intends to continue to invest significant amounts in research and development for new products and for enhancements to existing products. Research and development expenditures for the Company were $6,203,000 or 48% of net sales in 2002 and $5,465,000 or 35% of net sales in 2001. The increase was primarily a result of the strategic decision to focus on the development of the Company's optical communication sub-component product line.

On-going research and development expenses were greatly reduced in the second half of 2002 and as of February 28, 2003, the Company employed 55 full-time scientists and engineers compared to 85 as of February 28, 2002. Outside firms and consultants are selectively engaged to develop or assist with the development of new products when opportunities exist.

COMPLIANCE WITH ENVIRONMENTAL LAWS

The Company is subject to evolving Federal, state and local environmental laws and regulations. Compliance with such laws and regulations in the past has had no material effect on the capital expenditures, earnings or competitive position of the Company. The Company believes that it complies in all material respects with existing environmental laws and regulations applicable to it. However, the Company's Salem, New Hampshire headquarters are currently the subject of environmental testing and monitoring relating to soil and groundwater contamination that occurred under prior ownership. The costs incurred to date for such testing and for remediation planning have been paid by third parties. The Company believes that the costs of any required remediation will be covered by an environmental indemnity obtained from the seller, John Hancock Mutual Life Insurance Company. In addition, it is management's understanding that in April 1996, the Massachusetts Department of Environmental Protection circulated notices to parties identified as "potentially responsible parties" with respect to the Company's Salem, New Hampshire headquarters. The Company did not receive such notice. Compliance with environmental laws and regulations in the future may require additional capital expenditures, and the Company expects that in the foreseeable future such capital expenditures will be financed by cash flow from operations.

EMPLOYEES

As of February 28, 2003, the Company employed approximately 175 people, of whom six were part‑time employees. None of the Company's employees are represented by a labor union and the Company believes that it has good relations with its employees.

ITEM 2.     PROPERTIES

The Company conducts its business at two Company owned facilities and in two leased facilities. The Company's headquarters are located in a 95,000 square foot facility in Salem, New Hampshire, which also houses research and development, manufacturing, sales and distribution capacities for the Company's specialized lighting and specialty optical fiber products. In December 2000, the Company purchased a 65,000 square foot building and property located in Dollard-des-Ormeaux, Quebec for research and development, manufacturing and sales and distribution by its Canadian subsidiary, StockerYale Canada. StockerYale Asia Pte, Ltd. operates out of an approximately 2,733 square foot leased office space in Singapore. StockerYale (IRL), Ltd leases approximately 5,500 square feet in Cork, Ireland.

The Company's Salem facility is owned by the Company subject to a mortgage granted to TJJ Corporation, which secures obligations of the Company to such party. The Company's Canadian facility in Dollard-des-Ormeaux is owned by the Company subject to a mortgage granted to Toronto Dominion Bank, which secures obligations of the Company to such party. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS-Liquidity and Capital Resources."

The Company's facilities are generally operated on the basis of one shift per day, five days per week. Management considers the facilities to be in generally good condition, to be adequately maintained and insured, and sufficient to satisfy the Company's needs for the foreseeable future.

ITEM 3.     LEGAL PROCEEDINGS

At times 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.

ITEM 4.    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

There were no matters submitted to a vote of stockholders during the fourth quarter of fiscal 2002.

ITEM 5.     MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS

In connection with entering into a Term Note secured by its Salem facility with TJJ Corporation, on December 27, 2002, the Company issued warrants to purchase 250,000 shares of its common stock at an exercise price of $1.35 per share, which expire December 27, 2007. The Company did not engage an underwriter or agent in connection with this transaction. The issuance of the warrants was exempt for registration pursuant to Section 4(2) of the Securities Act of 1933, as amended.

ITEM 6.     SELECTED FINANCIAL DATA

The following selected consolidated financial data are derived from the Company's audited consolidated financial statements. The data should be read in conjunction with the related notes and other information included herein.

RESULTS OF OPERATIONS FOR 2002 AND 2001

Management Discussion and Analysis contains statements that are forward-looking. These statements are based on expectations and assumptions that are subject to risks and uncertainties. Actual results could differ materially because of factors discussed in "Certain Factors Affecting Future Operating Results." As further discussed in the following Liquidity and Capital Resources section, the Company is experiencing liquidity problems and is in default of its loan agreements.

 NET SALES

Net sales were $13.0 million in 2002 compared to $15.6 million in 2001, a decrease of 17% or $2.6 million.

Net sales from the Company's specialized illumination products were $10.9 million in 2002 compared to $10.8 million in 2001, an increase of $0.1 million or 1%. Sales of fluorescent and fiber optic illumination products manufactured in the Company's Salem facility declined $0.6 million or 14% primarily due to a reduction in demand as a result of a general slow down in the semiconductor, disk drive inspection and electronic assembly markets. Sales of laser illumination products manufactured in the Company's Montreal facility increased $0.7 million or 14% as new products and new applications, especially in the defense industry gained acceptance. Sales from its Irish and Singapore subsidiaries in 2002 were level with 2001. The majority of the Company's sales of specialized illumination products are made for companies in industries who use specialized lighting for industrial inspection and machine vision applications; however, the Company recently made significant inroads in the military and medical markets.

Net sales from the Company's optical fiber and sub-component products were $1.1 million in 2002 compared to $3.6 million in 2001, a decrease of $2.5 million or 67%. A sharp decline in phase masks, which are principally sold to the telecommunications industry, accounted for 95% of the revenue decline in this product line. Revenue from our printer and recorder product line declined from $1.2 million in 2001 to $1.0 million in 2002. A portion of this product line was transferred to an outside distributor on consignment in the fourth quarter of 2002. The Company will be reimbursed beginning in 2003 for inventory transferred to this distributor plus a 5% royalty on future revenues.

COST OF SALES

Cost of sales was $11.2 million in 2002 compared to $11.3 million in 2001, a decrease of 1.3% or $0.1 million. The decrease in cost of sales resulted primarily from a sharp reduction in material cost related to the decline in phase mask revenue, which was offset by higher manufacturing overhead costs and increased obsolete inventory charges related to the printer and recorder product line.

GROSS PROFIT

Approximately $1.2 million of the $2.5 million gross profit decline was a result of the reduced phase mask revenue. The remaining $1.3 million erosion was the result of increased obsolete inventory costs related to the printer and recorder product line and increased depreciation and incremental overhead costs associated with the fiber and optical component product lines in both Salem and Montreal.

OPERATING EXPENSES

Operating expenses decreased $1.3 million from $18.4 million in 2001 to $17.1 million in 2002.

Selling expenses declined $1.0 million or 22% from $4.5 million in 2001 to $3.5 million in 2002. Salaries and fringe benefits remained level despite a 20% reduction in year-end headcount between fiscal 2001 and 2002 as increased staffing in the second half of 2001 was offset by reduced personnel in the second half of 2002. Commission expenses and bad debt expenses declined approximately $0.4 million due to lower revenues and tighter credit controls. Travel and trade show expenses declined approximately $0.2 million as the Company reduced staff and the number of events attended. The remaining $0.4 million in savings was realized through reduced administrative sales support cost, including: postage, telephone, office supplies, and recruiting costs.

Research and development expenses increased $0.7 million or 13% from $5.5 million in 2001 to $6.2 million in 2002. Salaries and fringe benefits increased $0.3 million or 12% as the cost reductions implemented in the second half of 2002 only partially offset the ramp up of staff in the second half of 2001 that continued through the second quarter of 2002. Depreciation expense increased $0.6 million as the equipment investments made in 2001 became operational in 2002.

General and administrative expenses declined $2.3 million or 30% from $7.8 million in 2001 to $5.5 million in 2002. Salaries and fringe benefit costs declined $0.7 million as a result of reduced headcount and salary reductions for both senior and middle management. Professional fees were reduced $0.5 million as the Company undertook a large portion of services previously outsourced. Travel expenses declined $0.3 million as a result of reduced staff and the use of alternative methods to conduct business with investors, customers, and vendors. Reduced support expenses, including training and recruiting, office supplies, and investor relations materials represented the majority of the remaining savings.

Management reviewed the requirements of SFAS No. 144, Accounting for the Impairment or Disposal of Long-lived Assets, which became effective for financial statements issued for the fiscal years beginning after December 15, 2001. Based upon this review and analysis, the Company recorded a $1.6 million asset impairment charge primarily related to a reduction in the carrying value of internal and joint venture research and development projects in Montreal.

The Company terminated further capital expenditures on an internally developed capital project in the second quarter of 2002. At the time, the Company was considering selling the equipment to a third party, based upon the third party receiving funding to purchase the equipment. The Company was informed in the fourth quarter of 2002 that the third party was not successful in obtaining the funding and therefore the Company recorded an impairment charge in the fourth quarter of 2002.

The Company ceased funding a joint venture in the second quarter of 2002. At the time, the joint venture was soliciting additional funding from several venture capital firms. The joint venture was informed in the fourth quarter of 2002 that these venture capitalists were not interested in providing additional funding to the joint venture and therefore the Company recorded an impairment charge in the fourth quarter of 2002.

INTEREST AND OTHER INCOME

Interest and other income was $142,000 in 2002 compared to $441,000 in 2001. Interest and other income was comprised primarily of $103,000 of interest income for 2002.

INTEREST EXPENSE

Interest expense was $417,000 in 2002 compared to $757,000 in 2001 as lower interest rates offset a higher level of borrowings.

PROVISION (BENEFIT) FOR INCOME TAXES

The Company has not recorded an income tax benefit during 2002. The Company has recorded a valuation allowance against its net deferred tax assets after concluding that it is more likely than not that such deferred tax assets will not be recoverable.

RESULTS OF OPERATIONS FOR 2001 AND 2000

NET SALES

Net sales were $15.6 million in 2001 compared to $18.4 million in 2000, a decrease of 15% or $2.8 million. 

Net sales from the Company's specialized illumination products were $10.8 million in 2001 compared to $13.6 million in 2000, a decrease of 21% or $2.8 million. The decrease was primarily caused by a reduction in demand due to a general slow down in the semi-conductor, disk drive inspection and electronic assembly markets. The majority of the Company's sales of specialized illumination products are made to companies in industries who use specialized lighting for industrial inspection and machine vision applications.

Net sales from the Company's optical sub-component products were $3.6 million in 2001 compared to $3.0 million in 2000, an increase of 21% or $0.6 million. Net sales from the Company's other products, largely printers and recorders, decreased from $1.8 million in 2000 to $1.2 million in 2001.

COST OF SALES

Cost of sales were $11.3 million in 2001 compared to $11.5 million in 2000, a decrease of 1% or $157,000. The decrease in cost of sales resulted primarily from the decrease in net sales.

GROSS PROFIT

Gross profit was $4.3 million or 28% in 2001 compared to $6.9 million or 38% in 2000. Gross margin declined primarily due to unabsorbed fixed overhead costs related to the decrease in revenue in the illumination business as well as increased depreciation and incremental management costs related to the implementation of specialty optical fiber and optical components manufacturing capacity in anticipation of revenues in 2002. The Company also recorded a charge of approximately $0.4 million related to inventory obsolescence related to its printer and recorder product line.

OPERATING EXPENSES

Operating expenses increased $10.3 million from $8.1 million in 2000 to $18.4 million 2001. The increase is directly related to the Company's new business strategy to invest in the optical components market.

Research and development expenses rose $4.2 million from $1.3 million in 2000 to $5.5 million in 2001. Salaries and benefits increased $2.7 million as the scientific and engineering staff evolved from 24 at December 31, 2000 to 85 at December 31, 2001. The increase in professional staff completed the Company's substantial intellectual capital investment in the optical components and specialty optical fiber markets. Prototype material expenses and higher depreciation costs accounted for $1.1 million of the higher research and development expenses.

Selling expenses increased $2.3 million as a result of staff doubling from 12 to 24 representing a $1.0 million growth in salaries, benefits, commissions and traveling expenses. In addition, advertising, promotion and trade show costs increased from $0.4 million to $1.0 million. The majority of these higher expenses were in support of the Company's strategic initiative into the specialty optical fiber market.

General and administrative expenses more than doubled from $3.6 million in 2000 to $7.8 million in 2001. Salaries and associated costs, including benefit and travel expenses, rose $0.9 million as headcount grew from 27 to 35. Occupancy and professional fees rose $1.6 million while Information Technology costs increased $0.5 million. The full year impact of the June 2001 acquisition of CorkOpt Ltd. also represented a $0.5 million increase in general and administrative expenses. The Company believes these incremental costs were necessary to provide the infrastructure to support the new complexity of the Company.

The increase in operating expenses in 2001 versus 2000 was based upon a strategic decision of the Company to invest in the optical component and specialty optical fiber markets.

INTEREST AND OTHER INCOME

Interest and other income was $441,000 in 2001 compared to $394,000 in 2000. Interest and other income were comprised primarily of $425,000 of interest income for 2001.

INTEREST EXPENSE

Interest expense was $757,000 in 2001 compared to $475,000 in 2000. The increase in interest expense resulted primarily from an increase in borrowings to fund working capital.

PROVISION (BENEFIT) FOR INCOME TAXES

The tax benefit recorded in 2001 relates primarily to net operating losses ($465,000) and research and development tax credits ($236,000) being benefited in the Canadian tax jurisdiction. In accordance with the provisions of Statement of Financial Accounting Standards (SFAS) No. 109, Accounting for Income Taxes, the deferred tax assets were recognized up to the amount offsetting deferred tax liabilities in the applicable tax jurisdiction.

LIQUIDITY AND CAPITAL RESOURCES

As of December 31, 2002, the Company was out of compliance with the financial covenants of the Toronto Dominion Credit Agreement and as a result triggered the cross default provisions of all other borrowing agreements as described under Borrowing Agreements.

Three years ago the Company made a strategic decision to utilize its optics and manufacturing expertise in phase masks and fiber optic illumination to expand into specialty optical fiber and optical components. This was based on high growth expectations for the telecommunications infrastructure in order to facilitate the rapid growth in Internet traffic. Given management's expectations of the optical component industry's rapid growth and the communications industry's growing demand for advanced telecommunications equipment, the Company over the following three years invested significant equity capital in plant and equipment, research and development and commercialization expenses.

However, as the original equipment manufacturers (OEMs) in the telecommunication sector continued to curtail purchases in the first half of 2002, the Company realized that while the telecom equipment market still offered long-term growth potential, near-term revenue opportunities for optical components would be adversely affected. This change in market conditions required the Company to significantly modify its expectations for specialty fiber and component revenue in the foreseeable future.

In May of 2002, the Company began to significantly reduce its overall operating expenses, and most importantly, its investment in research and development expenses related to optical components. The Company ceased funding two joint ventures and reduced its headcount in research and development, as well as selling and general and administration expenses.

Since the Company has not been immune to the difficulties of raising capital in the current equity markets, it shifted its short-term goals to financing operations based upon a revised business plan. The Company leveraged its asset investments in both real estate and equipment to obtain debt financing rather than issuing additional equity capital to support its short-term cash requirements.

Over the past year, the Company has significantly reduced its cash requirements by adjusting its operating expenses to a reduced revenue forecast. Incremental capital expenditures have been eliminated. The Company closely monitors its on-going cash requirements and is prepared to implement additional cost reductions as necessary.

Based upon our current forecast for 2003, the Company is pursuing various options to raise additional funds to finance operations through the end of 2003. 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 second quarter of 2003, 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 include: a new Canadian bank revolving credit facility that would refinance the existing Toronto Dominion facility, a Canadian government development loan, sale of real estate and/or a private placement of equity/debt securities. The Company expects to close several of these financing options by the end of the second quarter of 2003.

Historically, the Company has financed operations through private equity placements, third-party credit facilities and cash from operations. During the year ended December 31, 2002, the Company completed a private placement transaction selling an aggregate of 1,242,600 shares of common stock resulting in net proceeds of approximately $9.7 million. In addition, the Company obtained additional funding of $6.6 million primarily through the proceeds from the TJJ Note of $4.0 million and utilization of $3.4 million from the Merrill Lynch credit facility. This was partially offset by the repayment of the $1.2 million mortgage note with Granite Bank. The Company has used the proceeds from the private placement and bank debt primarily to fund operating losses, capital expenditures and for general working capital purposes. As of December 31, 2002, unrestricted cash and cash equivalents were $3.1 million.

Cash used in operating activities was $12.8 million in 2002, as a result of a net loss of $15.5 million and a decrease in accounts payable of $1.7 million partially offset by depreciation and amortization of $2.7 million, a decrease in inventories of $0.7 million and an asset impairment charge of $0.9 million. Cash used in investing activities was $1.8 million principally due to an increase in property, plant and equipment of $1.5 million. Included in property, plant and equipment was approximately $0.5 million of fixed assets purchased from CIENA Corporation in the second quarter of 2002. Cash provided by financing activities was $16 million in 2002 principally as a result of the Company's sale of common stock through a private placement transaction with net proceeds of $9.7 million as well as an increase in net proceeds from bank debt of $6.4 million.

BORROWING AGREEMENTS

On December 27, 2002, the Company entered into a second amendment of the credit agreement, which decreased the borrowing availability to $6,000,000 by decreasing the line of credit to $2,500,000 and maintaining the revolver at $3,500,000. The line of credit is subject to review and renewal as of July 31, 2003. As of December 31, 2002, $2,886,995 was outstanding under the reducing revolver and $3,500,000 was outstanding under the line of credit. The outstanding principal balance of all advances under this credit facility bears interest at 2.5% over the one month LIBOR rate. As of December 31, 2002 the interest rate was approximately 3.9%. The Company's obligations under this credit facility are secured by substantially all the Company's Salem assets, excluding real property, plus a pledge of restricted cash in the amount of $2,000,000. In addition, the Company is required to maintain a $7.8 million tangible net worth. The Company was not in compliance with all provisions of the credit agreement due to cross default provisions related to the Toronto Dominion Bank credit facility. The reducing revolver is a seven-year loan with monthly principal and interest payments.

The Company's headquarters in Salem, New Hampshire was subject to a mortgage and note issued to Granite Bank on August 26, 1996 (the "Granite Note"). The Granite Note, in an initial principal amount of $1,500,000 was due August 29, 2011. The Granite Note bore interest at a rate of 5.75% per annum and was reviewed annually in August. The principal and interest were repayable in 180 equal monthly installments. In accordance with the terms of the Granite Note, the Company could prepay amounts outstanding there under, in whole or in part, at any time without premium or penalty. As of December 31, 2002, the Granite note was paid in full from the proceeds of the TJJ Corporation Term Note.

However, the long-term portion of debt outstanding to TJJ Corporation of $4,000,000 and Toronto Dominion Bank of $1,555,000 as of December 31, 2002 has been reclassified from long-term to short-term debt due to cross default provisions in the debt covenants with both institutions. Although Toronto Dominion Bank has extended repayment  until May 31, 2003, under SFAS No. 78, Classification of Obligations that are Callable by the Creditor, the Company is required to reclassify all long-term obligations as current.

Therefore, all long-term obligations due both TJJ Corporation and Toronto Dominion Bank are considered current liabilities as of December 31, 2002. The cross default covenants will be cured upon the closing of the National Bank of Canada credit facility, which will replace the entire Toronto Dominion Bank credit facility (see Note 22 for additional information). Subsequent to the replacement of the Toronto Dominion Bank credit facility with the new National Bank of Canada credit facility, the Company expect