ProPhotonix Annual Report 2013

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FY2013 Annual Report · ProPhotonix

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PROPHOTONIX LIMITED
2013 ANNUAL REPORT

Solutions for LEDs

Solutions for Lasers

Corporate

ProPhotonix Limited (IRE)
3020 Euro Business Park
Little Island
Cork, Ireland
+353-21-5001300

ProPhotonix Limited
Sparrow Lane,
Hatfield Broad Oak
Hertfordshire, CM22 7BA UK
+44-1279-717170

ProPhotonix Limited
32 Hampshire Road
Salem, NH 03079
+1-603-893-8778

Business Activities:

ProPhotonix consists of two business units: an LED systems manufacturing business based in Ireland (Cork),
and a laser modules production and laser diode distribution business located in the United Kingdom (Hatfield
Broad Oak). Corporate headquarters and the North American sales activities are based in Salem, New
Hampshire, USA. The fundamental strategy of the Company is growth in revenue through its existing
customers, new customer activity, and new product and market expansion.

ProPhotonix Limited sells its products principally into three markets: industrial, (primarily machine vision
illumination), medical, and homeland security and defense. The Company foresees growth opportunities in all
three markets it serves which are briefly described below:

Industrial (Machine Vision)

Within the industrial market, machine vision is the term used to describe computerized analysis for controlling
manufacturing processes, for example automated inspection. In terms of quality and speed, lighting is often a
critical component in machine vision and the Company manufactures both LED systems and lasers designed
specifically for this market. The recently enhanced 3D Pro Laser line generators and improved LED line light
family specifically address this market.

Medical

The Company has experienced successes in the medical (including dental) market and has gained a foothold in
the market, supplying a variety of applications, with current customers including the world leader in stationary
imaging equipment, a portable x-ray equipment manufacturer, a dental imaging manufacturer and also a pioneer
in the manufacturing of devices offering eye tracking capability utilizing ProPhotonix’s custom infrared LED
arrays. The Company intends to broaden its product marketing effort in the medical field since it offers
significant long-term revenue growth opportunities.

Homeland Security & Defense

LED systems, laser modules and laser diodes are used in a wide variety of applications in the security and
defense fields. The Company currently supplies several defense sighting manufacturers in the US and Europe,
as well as leading manufacturers of Auto Number Plate Recognition systems. This market offers significant
growth opportunities for ProPhotonix over the next several years and the Company is currently marketing its
laser and LED capabilities to additional security and Optical Character Recognition systems companies in this
market space.

Page 2

To the Shareholders of ProPhotonix Limited:

2013 Annual Report to Shareholders

2013 was a year of change and progress for ProPhotonix. Our investments in sales and marketing continue to bear fruit,
as evidenced by our booking and revenue growth, as well as new customer activity. Financially, the Company is
improving and begins 2014 with a solid financial platform for progressive growth. Product development and customer
driven initiatives, which represent the future revenue growth of ProPhotonix, continue at a blistering pace. Our strategy of
growth and prosperity and the path to success are clear. I am pleased with our progress, but certainly not satisfied, as
there is still much to accomplish.

Customer Initiatives:
We made significant progress on many fronts in 2013, driven by improved effectiveness of sales and marketing
throughout the business. The book to bill ratio ended at 1.13 versus 1.08 in 2012, which represented a booking growth
rate of 16.9% year over year. Revenue grew 12.2% over 2012. The revenue growth came from new customer activity
which accounted for $1.5 million of the total $1.7 million revenue increase. Of particular note are the 69% increase in
bookings and 40% growth in revenue in the Americas region. Backlog increased from $5.3 million at December 31, 2012
to $6.9 million at December 31, 2013- a 31% increase.

Financial Progress:
Financial results improved through revenue growth, margin improvement, and lower general and administrative costs.
Gross profit increased by 38.6% from 2012, and the net loss decreased from $2.9 million in 2012 to $571,000(1) in 2013- a
80% improvement. EBITDA dramatically improved from a loss of $2.6 million in 2012 to a loss of $98,000(1) in 2013- a
96% improvement.

Striking improvement is evident in the 2013 second half results as follows:

• Second half revenue grew 16% year over year and 12% sequentially from the first half.
• The second half 2013 operating loss narrowed to $82,000 compared to $517,000(1) in the first half, the result of

significant cost reductions in general and administrative costs.

• Second half net income reflects a profit of $366,000, driven by foreign currency exchange conversions (a non-

cash benefit) of $551,000, versus a net loss of $937,000(1) in the first half.

• The first half EBITDA loss declined from $1.4 million in 2012 to $275,000(1) in 2013, while second half 2013

EBITDA improved from a loss of $1.2 million in 2012 to a PROFIT of $177,000 in 2013.

Even with this great progress, our focus to profitability remains relentless to achieve our intended goals.

The balance sheet also improved in 2013 following the capital restructuring. During 2013, we secured $2.5 million of
additional term debt capacity plus increased our revolving credit facility with Barclays Bank from $1.1 million to $2.3
million. We enter 2014 with $1.8 million of unused and available credit from our various credit facilities.

Product development and market development:
Customer driven product development activity has never been stronger. Customer funded development initiatives
undertaken in 2013 with completion through 2014 amount to approximately $800,000 of order bookings, of which we
expect $700,000 to be recognized revenue in 2014. These potential high volume OEM (custom) applications include
illuminators for the semiconductor, optical sorting, and medical (endoscopy and vascular imagining) markets. We expect
to begin shipping production orders from these projects during 2014. In addition, new projects we take on in 2014 will
have revenue growth opportunities in 2014 and beyond.

1 Excludes $582,000 non-recurring charges in the first half 2013.

Page 3

Internal product development continues apace, with product enhancements and extensions that include:

Structured Light Lasers – 3DPro Family enhanced with adjustable focus capability

LED Line Lights –

3DPro Family to include green (520nm) wavelength
Cobra and Lotus Families extended feature enhancements

New product research and development in 2013 includes a joint cooperation with a local university and research center to
develop capability for a Compact Fiber Coupled High Power UV Laser Light Source. On success, we believe the target
markets for this capability include: commercial printing, UV curing and maskless lithography. We expect to have
demonstrator proto-type units in early 2014 with initial commercial shipments in the second half of 2014. Our technology
roadmap in this area includes: single-mode fiber coupled lasers, multi-spectral beam combiners, multi-channel beam
combiners, and expansion of the multi-mode fiber laser product. Target markets for future systems include sensing, such
as optical sorting, medical, and microscopy applications.

We are constantly on the hunt for emerging and underserved markets where our capabilities may be deployed. The UV
LED market is one such high growth market opportunity. The UV spectrum falls into three ranges (UVC 200-280nm,
UVB 280-315nm, UVA 315-400nm) each having specific application attributes. ProPhotonix currently provides UVA
LED curing lamps to customers for OEM specific applications. New high growth markets for UV LED illuminators
includes disinfection, DNA sequencing, protein analysis, drug discovery, plus the continuing adoption of LEDs for curing
applications. LEDs are ideally suited to this market for cost, efficiency, reliability, and longevity versus traditional
technology. We work with industry leaders in UV epitaxy and are constantly evaluating UV LED technologies. Market
research indicates the market for UV LEDs will grow from $45 million in 2012 to $270 million in 2017 at a CAGR of
43%.2 As our market research evolves, we expect to increase product investments to serve this market.

Strategy – Growth to Prosperity
ProPhotonix’s short-term perspective is governed by three simple goals: sustained positive EBITDA, cash flow, and net
income. We will accomplish these goals through a relentless focus on cost management and most importantly through
revenue growth. We are committed to revenue growth through our existing customer base, but also by winning new
customers. As mentioned above, $1.5 million of the revenue growth in 2013 was from new customers. These new
customers span several markets including: 3D Scanning for 3D printing, Warehouse Robotics, Transport Container
Monitoring and Inspection, Medical Devices, Aeronautics, and Industrial Automation and Inspection. We must build on
the 2013 success, furthering new customer revenue, while growing within our existing customer base by helping them
prosper with products for their applications.

ProPhotonix’s growth in the medium-term will be accomplished with not only new customer wins in our currently served
markets, but also through expansion into new markets and with new products as mentioned above. In addition to the few
important areas where we are focused, we will continuously evaluate additional high growth opportunities.

In conclusion, I am deeply grateful for the continued support of you, our customers, suppliers and service providers,
investors, and co-workers!

Respectfully submitted,

Tim Losik
President and Chief Executive Officer

2 UV LED Technology & Application Trends Report, Yole Developpement, April 2013.

Page 4

Director Remuneration Report

For the year ended December 31, 2013

Executive Director Compensation - Executive Director Compensation is reviewed by the
Independent Non-Executive Directors.

Executive Director

($)

Bonus ($)

Salary

Pension
($)

Other (1)
($)

Total Cash
Compensation
($)

Options
($)

Total ($)

Total All
Compensation
2013 ($)

Total All
Compensation
2012 ($)

Tim Losik

264,582

5,625

750

270,957

232,311

Total Executive
Compensation

Non-Executive Director

264,582

5,625

750

270,957

232,311

Ray Oglethorpe

Timothy Steel

25,000

3,731

25,000

3,731

Vincent Thompson

25,000

3,731

28,731

24,378

24,738

Mark Weidman

12,500

3,731

16,231

Total Non-Executive
Compensation

Director Share Options:

87,500

14,924

102,424

74,214

Director

Options @
12/31/12

Options
Granted

Options
Forfeited

Options @
12/31/13

Tim Losik

1,400,000

Ray Oglethorpe

995,506

700,000

(11,500)

1,684,006

Timothy Steel

445,433

700,000

1,145,433

Vincent Thompson

445,433

700,000

1,145,433

Mark Weidman

700,000

Total All Directors

3,286,372

2,800,000

(11,500)

6,074,872

(1) Other compensation for the Executive Director is for paid life insurance for the benefit of the director. Other compensation for non-executive directors represents

cash payments expensed in the current year.

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Page 6

ProPhotonix Limited

Consolidated Financial Statements

Years Ended December 31, 2013 and 2012

Page 7

FINANCIAL STATEMENTS

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

Item

Page

Independent Auditor’s Report .......................................................................................................................

Consolidated Balance Sheets as of December 31, 2013 and 2012 ...............................................................

Consolidated Statements of Operations and Comprehensive Loss for the Years Ended December 31,

2013 and 2012 ...........................................................................................................................................

Consolidated Statements of Stockholders’ Equity / (Deficit) for the Years Ended December 31, 2013 and
2012...........................................................................................................................................................

Consolidated Statements of Cash Flows for the Years Ended December 31, 2013 and 2012 .....................

Notes to Consolidated Financial Statements……………………………………………………………….

Page 8

FINANCIAL STATEMENTS

PROPHOTONIX LIMITED

CONSOLIDATED BALANCE SHEETS

($ in thousands except share and per share data)

December 31

2013

2012

Assets
Current assets:
Cash and cash equivalents
Accounts receivable, less allowances of $19 in 2013 and $31 in 2012
Inventories
Prepaid expenses and other current assets

Total current assets
Net property, plant and equipment
Goodwill
Acquired intangible assets, net
Other long-term assets

Total assets

Liabilities and Stockholders’ Equity (Deficit)
Current liabilities:
Revolving credit facility
Current portion of long-term debt
Capital lease obligations
Accounts payable
Accrued expenses

Total current liabilities
Long-term debt, net of current portion
Long-term portion of capital lease obligations
Other long-term liabilities

Total liabilities

Stockholders’ equity (deficit):
Common stock, par value $0.001; shares authorized 150,000,000 at December 31, 2013 and

December 31, 2012; 83,665,402 shares issued and outstanding at December 31, 2013 and
76,059,457 at December 31, 2012

Additional paid-in capital
Accumulated deficit
Accumulated other comprehensive income

Total stockholders’ equity (deficit)

Total liabilities and stockholders’ equity

402
2,559
2,003
220

5,184
303
486
102
354

1,278
2,225
2,033
234

5,770
523
467
218
23

$ 6,429

$ 7,001

1,127
265
10
1,542
1,296

4,240
2,445
-
178

6,863

662
2,387
10
2,000
1,084

6,143
-
10
178

6,331

84
111,302
(111,674)
(146)

76
110,893
(110,521)
222

(434)

670

6,429

7,001

See the notes to consolidated financial statements.

Page 11

PROPHOTONIX LIMITED
Consolidated Statements of Operations and Comprehensive Loss
($ in thousands except share and per share data)

Revenue

Cost of Revenue

Gross Profit

Research & Development Expenses

Selling, General & Administrative Expenses

Amortization of Intangible Assets

Operating Loss

Other Income / (Expense), net

Warrant & Debt Acquisition Expense

Interest Expense

Loss Before Taxes

Tax Benefit

Net Loss

Other Comprehensive Loss:

Foreign currency translation

Total Comprehensive Loss

Years Ended
December 31,

2013

2012

$ 15,599
(9,628)

$ 13,904
(9,597)

5,971

(941)

(6,091)

(120)

(1,181)

295

(103)

(237)

(1,226)

4,307

(922)

(6,403)

(118)

(3,136)

490

(257)

(2,903)

$ (1,153)

$ (2,903)

(368)

(199)

$ ( 1,521)

$ ( 3,102)

Loss Per Share:
Basic and diluted:

Net loss per share

Basic and diluted weighted average shares outstanding

($0.01)

80,496,977

($0.04)

76,059,457

See the notes to consolidated financial statements.

Page 12

PROPHOTONIX LIMITED
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY / (DEFICIT)
(in thousands)

143
(199)
(2,903)

670

169

193

55
(368)
(1,153)

Common Stock

Par
$0.001

Additional
Paid in
Capital

Accumulated
Deficit

Accumulated
Other
Comprehensive
Income

Total
Stockholders’
Equity (Deficit)

76,059

$110,751

(107,618)

421

3,630

143

-
(199)

(2,903)

Balance December 31, 2011
Share based compensation, net
of forfeitures ................
Translation adjustment ......
Net loss ..............................

Balance December 31, 2012

76,059

$110,893

(110,521)

222

Share based compensation, net
of forfeitures ................
Issuance of common stock to
settle liabilities ..............

Issuance of warrants for

financings ......................
Translation adjustment ......
Net loss ..............................

7,606

169

185

(1,153)

-
(368)

Balance December 31, 2013

83,665

$111,302

(111,674)

(146)

(434)

See the notes to consolidated financial statements.

Values may not add due to rounding

Page 13

PROPHOTONIX LIMITED

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

Years Ended December 31

2013

2012

Operating
Net loss
Adjustments to reconcile net loss to net cash used in operating activities:

$ (1,153) $ (2,903)

Stock-based compensation expense
Depreciation and amortization
Foreign exchange (gain) loss
Amortization of debt discount and financing costs
Loss on disposal of assets
Provision for inventories
Provision for bad debts
Other changes in assets and liabilities:

Accounts receivable
Inventories
Prepaid expenses and other current assets
Accounts payable
Accrued expenses
Other assets and liabilities

Net cash used in operating activities

Investing
Purchase of property, plant and equipment

Net cash used in investing activities

Financing
Borrowings of revolving credit facilities, net
Proceeds from issuance of debt
Principal repayment of long-term debt
Debt issuance costs

Net cash provided by (used in) financing activities

Effect of exchange rate on cash

Net change in cash and equivalents
Cash and equivalents at beginning of period

Cash and equivalents at end of period

Supplemental cash flow information:
Cash paid for interest
Common stock issued in connection with financing
Warrants issued in connection with financing

169
332
(408)
96
(7)
120
(12)

143
396
(188)
-
-
75
25

(222)
(8)
20
(518)
171
(9)

199
(372)
57
505
261
21

(1,429)

(1,782)

(17)

438
800
(339)
(398)

501

(876)
1,278

$
$
$

402

263
193
55

(67)

-
-
(889)
-

(889)

(50)

(2,788)
4,066

$
$
$

1,278

228
-
-

See the notes to consolidated financial statements.

Page 14

PROPHOTONIX LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(1) ORGANIZATION AND BASIS OF PRESENTATION

ProPhotonix Limited (also referred to in this document as “ProPhotonix”, “we”, or the “Company”)
operates in two segments: as an independent designer and manufacturer of LED systems through ProPhotonix
(IRL) Limited; and as a distributor of laser diodes and manufacturer of laser modules through ProPhotonix
Limited, a U.K. subsidiary. The operating units are ProPhotonix (IRL) Limited based in Cork, Ireland,
ProPhotonix Limited, a U.K. subsidiary based near Stansted, United Kingdom and ProPhotonix Limited, based
in Salem, New Hampshire, U.S.A. The Company’s products serve a wide range of applications and industries
including machine vision and industrial inspection, biomedical, defense and security, and other commercial
applications.

ProPhotonix Limited was incorporated on March 27, 1951 in the Commonwealth of Massachusetts and
is currently incorporated in the state of Delaware. The common stock of the Company now trades on the OTC
Market in the U.S. under the trading symbol “STKR” and is also on the London Stock Exchange, plc (AIM
listing), under the trading symbols “PPIR” and “PPIX”.

The accompanying consolidated financial statements have been prepared on a going concern basis, which
contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. As
shown in the consolidated financial statements, during the years ended December 31, 2013 and 2012, the
Company recorded net losses of $1,153,000 and $2,903,000, respectively. Net use of cash flow for operating
activities from continuing operations for the same time periods were $1,429,000 and $1,782,000, respectively.
The consolidated financial statements do not include any adjustments relating to the recoverability and
classification of recorded asset amounts or the amounts and classification of liabilities that might be necessary
should the Company be unable to continue as a going concern. On June 20, 2013, the Company entered into
an amendment with the PPI Bond bondholder who waived any and all events of default and amended the terms
of the PPI Bond. The amendment restructures the existing Bond as described in Note 8. Also on June 20, 2013,
the Company entered into a term note agreement with the holder of the PPI Bond allowing for an additional
$1,000,000 of available funds as described in Note 8. Under the terms of this note, the Company must use 50%
of any amounts advanced to make additional principal payments under the PPI Bond. Finally, on June 20,
2013, the Company entered into a term note agreement with a Lender, affiliated with the Company CEO, for
$2.0 million of available funds as described in Note 8. On November 29, 2013, the Company entered into an
amendment with Barclays bank that increased the maximum line of credit from £650,000 to £1,400,000, as
described in Note 8. The Company believes with this loan capacity that it has adequate available working
capital to continue to trade for at least the next twelve months from the approval of these financial statements.

(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The accompanying consolidated financial statements are prepared in conformity with Generally Accepted
Accounting Principles (“U.S. GAAP”) and reflect the application of the Company’s most significant accounting
policies as described in this note and elsewhere in the accompanying consolidated financial statements and
notes.

PRINCIPLES OF CONSOLIDATION

The accompanying consolidated financial statements include the accounts of the Company and its wholly
owned subsidiaries, ProPhotonix (IRL) Limited, StockerYale Waterloo Acquisition Inc., StockerYale (UK)
Ltd., which owns 100% of ProPhotonix Limited, a U.K. subsidiary, and ProPhotonix Holdings, Inc., which

Page 15

holds all of the outstanding shares of StockerYale Canada. All intercompany balances and transactions have
been eliminated.

CASH AND CASH EQUIVALENTS

The Company considers cash equivalents to consist of highly liquid investments with original maturities of

three months or less when purchased.

ACCOUNTS RECEIVABLE

The Company reviews the financial condition of new customers prior to granting credit. After completing
the credit review, the Company establishes a credit line for each customer. Periodically, the Company reviews
the credit line for major customers and adjusts the credit limit based upon an updated financial condition of the
customer, historical sales and payment information and expected future sales. The Company has a large number
of customers; therefore, material credit risk is limited.

The Company periodically reviews the collectability of its accounts receivable. Provisions are established
for accounts that are potentially uncollectible. The Company also has accounts receivables insurance at
ProPhotonix Limited, a U.K. subsidiary, which allows the Company to submit a claim on overdue receivables in
excess of 60 days past invoice due date. Determining adequate reserves for accounts receivable requires
management’s judgment. Conditions impacting the collectability of the Company’s receivables could change
causing actual write-offs to be materially different than the reserved balances.

Changes in the allowance for doubtful accounts were as follows:

Years Ended December 31

Balance at beginning of period .................................................................
Charges (recoveries) to costs and expenses ..............................................
Account write-offs and other deductions ..................................................

2012
2013
In thousands
31 $

(10)
(2)

13
25
(7)

Balance at end of period ............................................................................

19 $

INVENTORY

The Company values inventories at the lower of cost or market using the first in, first-out (“FIFO”)
method. The Company periodically reviews the quantities of inventory on hand and compares these amounts to
the expected usage for each particular product or product line. The Company records as a charge to cost of sales
any amounts required to reduce the carrying value amount of the inventory to market. Actual results could be
different from management’s estimates and assumptions.

INTANGIBLE ASSETS

The Company’s intangible assets consist of goodwill, trademarks, acquired patents and patented
technologies, distributor and customer relationships and related contracts, technology design and programs,
non-compete agreements and other intangible assets which, except for goodwill, are being amortized over their
useful lives. Goodwill is tested for impairment on an annual basis, and between annual tests when indicators of
impairment are present, and written down when and if impaired. The Company has elected the end of the
fourth quarter to complete its annual goodwill impairment test.

Page 16

LONG-LIVED ASSETS

The Company reviews the recoverability of its long-lived assets including property, plant and equipment
and amortizing intangible assets when events or changes in circumstances occur that indicate that the carrying
value of the assets may not be recoverable. This review is based on the Company’s ability to recover the
carrying value of the assets from expected undiscounted future cash flows. If impairment is indicated, the
Company measures the loss based on the difference between the carrying value and fair value of the asset using
various valuation techniques including discounted cash flows. If an impairment loss exists, the amount of the
loss will be recorded in the consolidated statements of operations. It is possible that future events or
circumstances could cause these estimates to change.

LOSS PER SHARE

The Company calculates basic and diluted net loss per common share by dividing the net loss applicable to

common stockholders by the weighted average number of common shares outstanding.

As of December 31, 2013, 12,615,690 shares underlying options and 8,582,567 shares underlying warrants

were excluded from the calculation of diluted shares, as their effects were anti-dilutive.

As of December 31, 2012, 9,355,890 shares underlying options and 7,809,567 shares underlying warrants

were excluded from the calculation of diluted shares, as their effects were anti-dilutive.

REVENUE RECOGNITION

The Company recognizes revenue from product sales at the time of shipment and when persuasive
evidence of an arrangement exists, performance of our obligation is complete, the price to the buyer is fixed or
determinable, and collectability is reasonably assured. Custom products are designed and supplied to original
equipment manufacturers and produced in accordance with a customer-approved design. Custom product
revenue is recognized when the criteria for acceptance has been met. Title to the product generally passes upon
shipment, as products are generally shipped free on board (FOB) at shipping point. In certain limited situations,
distributors may have the right to return products. Such rights of return may preclude the Company from
recognizing revenue until the return period has ended.

Revenues from funded research and development and product development are recognized based on
contractual arrangements, which may be based on cost reimbursement or fixed fee-for-service models. Revenue
from reimbursement contracts is recognized as services are performed. On fixed-price contracts, revenue is
generally recognized on a percentage of completion basis based on proportion of costs incurred to the total
estimated costs of the contract. Over the course of a fixed-price contract, the Company routinely evaluates
whether revenue and profitability should be recognized in the current period. The Company estimates the
proportional performance on their fixed-price contracts on a monthly basis utilizing hours incurred to date as a
percentage of total estimated hours to complete the project. If the Company does not have a sufficient basis to
measure progress toward completion, revenue is recognized upon completion of performance, subject to any
project management assessments as to the status of work performed. When the current estimates of total
contract revenue and contract costs indicate a loss, a provision for the entire loss on the contract is recorded.

For those arrangements that include multiple deliverables, the Company first determines whether each
service or deliverable meets the separation criteria of FASB ASC 605-25, Revenue Recognition—Multiple-
Element Arrangements. In general, a deliverable (or a group of deliverables) meets the separation criteria if the
deliverable has stand-alone value to the customer and, if the arrangement includes a general right of return
related to the delivered item, that delivery or performance of the undelivered item(s) is considered probable and
is substantially in control of the Company. Each deliverable that meets the separation criteria is considered a
Page 17

separate ‘‘unit of accounting”. After the arrangement consideration has been allocated to each unit of
accounting, the Company applies the appropriate revenue recognition method for each unit of accounting based
on the nature of the arrangement and the services included in each unit of accounting. All deliverables that do
not meet the separation criteria of FASB ASC 605-25 are combined into one unit of accounting, and the most
appropriate revenue recognition method is applied.

WARRANTY

The Company provides standard warranties for most products for periods up to one year. The warranty is
limited to the cost of the product and the Company will repair or replace the product as required. The Company
monitors the actual warranty repair costs and trends in relation to the reserve as a percent of sales. The
Company adjusts annually the warranty provision based on actual experience and for any particular known
instances.

Warranty Reserves:

Balance at beginning of period ....................................................
Charges (recoveries) to costs and expenses .................................
Account write-offs and other deductions .....................................

In thousands
164
(4)
(14)

Balance at end of period ......................................................

146

159
18
(13)

164

Years Ended December 31,
2012

2013

The Company expenses advertising costs as incurred. Advertising expenses for the years ended 2013 and

2012 were approximately $181,000 and $250,000, respectively.

ADVERTISING EXPENSE

PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment are valued at the lower of cost or estimated carrying values. The Company
provides for depreciation on a straight-line basis over the assets estimated useful lives or capital lease terms, if
shorter. The following table summarizes the estimated useful lives by asset classification:

Asset Classification
Building and building improvements ................................... Term of the lease or 10-40 years
Computer equipment ............................................................
Machinery and equipment ....................................................
Furniture and fixtures ...........................................................

3 to 5 years
5 to 10 years
3 to 10 years

Estimated Useful Life

Maintenance and repairs are expensed as incurred.

INCOME TAXES

The Company accounts for income taxes under the asset and liability method. Under this method the
Company recognizes deferred tax assets and liabilities for the expected future tax consequences of events that
have been recognized in the financial statements or tax returns. Deferred tax assets and liabilities are determined

Page 18

based on the difference between the financial reporting and tax basis of the assets and liabilities using tax rates
expected to be in place when the differences reverse. Valuation allowances are established when necessary to
reduce deferred tax assets to the amount that is more likely than not to be realized. The Company recognizes
the tax benefit of tax positions to the extent that the benefit will more likely than not be realized. The
determination as to whether the tax benefit will more likely than not be realized is based upon the technical
merits of the tax position as well as consideration of the available facts and circumstances. With respect to any
uncertain tax positions, the Company records interest and penalties, if any, as a component of income tax
expense. It did not have any interest and penalties related to uncertain tax positions during the years ended
December 31, 2013 or 2012.

STOCK-BASED COMPENSATION

the grant of a variety of awards with various

The Company has stock-based compensation plans for its employees, officers, and directors. The plans
permit
the
Remuneration Committee of the Company’s Board of Directors (“GNRC”). Generally the grants vest over
terms of two to four years and are priced at fair market value, or in certain circumstances 110% of the fair
market value, of the common stock on the date of the grant. The options are generally exercisable after the
period or periods specified in the option agreement, but no option may be exercised after 10 years from the date
of grant.

terms and prices as determined by

Additionally, in the case of incentive stock options, the exercise price may not be less than 100% of the
fair market value of the Company’s common stock on the date of grant, except in the case of a grant to an
employee who owns or controls more than 10% of the combined voting power of all classes of the Company’s
stock or the stock of any parent or subsidiary. In that case, the exercise price shall not be less than 110% of the
fair market value on the date of grant. In the case of non-qualified stock options, the exercise price shall not be
less than 85% of the fair market value of the Company’s common stock on the date of grant, except in the case
of a grant to an independent director; in which case the exercise price shall be equal to fair market value
determined by reference to market quotations on the date of grant.

During 2013, the Company recognized approximately $169,000 of stock-based compensation related to
restricted stock and options, all of which was charged to selling, general and administrative expense. During
2012, the Company recognized approximately $143,000 of stock-based compensation related to restricted stock
and options, all of which was charged to selling, general and administrative expense.

Stock Option Awards—The fair value of each option grant is estimated using the Black-Scholes option
pricing model. The fair value is then expensed ratably over the requisite service periods of the awards, which is
generally the vesting period. Use of a valuation model requires management to make certain assumptions with
respect to selected model inputs. Expected volatility is calculated based on the historical volatility of the
Company’s stock at the time of the award. The average expected option term is based on historical trends. The
risk-free interest rate is based on U.S. Treasury zero-coupon issues assumed at the date of grant and generally
no dividends are assumed in the calculation. The compensation expense recognized for all equity-based awards
is net of estimated forfeitures. Forfeitures are estimated based on the historical trends.

Restricted Share Awards— The Company periodically awards restricted shares of common stock to
employees. The awards vest in equal annual installments over a period of four years, assuming continued
employment, with some exceptions. The fair market value of the award at the time of the grant is amortized
over the vesting period. The fair value of the awards is based on the fair market value of the Company’s
common stock on the date of issue, which is the closing market price on the date of the award. During 2013 and
2012, the Company did not grant any shares of restricted stock.

Page 19

TRANSLATION OF FOREIGN CURRENCIES

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 our transactions in these foreign markets. For foreign subsidiaries,
whose functional currency is not the U.S. dollar, assets and liabilities are translated using the foreign exchange
rates prevailing at the balance sheet date, and income and expense accounts using average exchange rates for
the period. Cumulative transaction gains or losses from the translation into the Company’s reporting currency
are included as a separate component of stockholder’s equity (accumulated other comprehensive loss) in the
accompanying consolidated balance sheets.

Management has determined the functional currency of StockerYale (UK) Ltd, and ProPhotonix Limited, a
U.K. subsidiary, is the euro. The functional currency of ProPhotonix (IRL) Limited is the euro, while the
functional currency of ProPhotonix Limited U.S.A. is the U.S. dollar.

Foreign currency transaction losses from continuing operations recorded in the statements of operations as

other income (expense), net were approximately $178,000 and $471,000 for 2013 and 2012, respectively.

FAIR VALUES OF FINANCIAL INSTRUMENTS

The Company’s financial instruments consist mainly of cash and cash equivalents, accounts receivable,
revolving credit facility, accounts payable and long-term debt. The estimated fair value of these financial
instruments, with the exception of fixed rate long-term debt, approximates their carrying value due to the short-
term maturity of certain instruments and the variable interest rates associated with certain instruments, which
have the effect of re-pricing such instruments regularly.

December 31, 2013, the Company estimated the fair value of long term fixed rate debt to be approximately

$4,433,000 compared to its carrying value of $4,072,000.

CONCENTRATION OF CREDIT RISK

Financial instruments that potentially subject the Company to concentrations of credit risk consist
principally of trade receivables. The risk is limited due to the relatively large number of customers composing
the Company’s customer base and their dispersion across many industries and geographic areas within the
United States, Canada, United Kingdom, Europe and Asia. The Company performs ongoing credit evaluations
of existing customers’ financial condition. The Company believes that its concentrated credit risk is limited to
only a small number of customers. The Company had no customer accounting for 10% or more of consolidated
revenues in either 2013 or 2012. The Company had one customer that accounted for 10% of the outstanding
accounts receivable balance at December 31, 2013 and 2012. The Company maintains its cash and cash
equivalents in bank deposit accounts, which at times may exceed insured limits. At December 31, 2013, the
amount in excess of governmental insurance protection was approximately $0.4 million, measured across all
entities and jurisdictions. At December 31, 2012, the amount in excess of governmental insurance protection
was approximately $1.0 million. The Company believes it is not exposed to any significant credit risk on cash
and cash equivalents.

Page 20

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.

(3) RECENT ACCOUNTING PRONOUNCEMENTS

The Company has reviewed recently issued accounting pronouncements to determine the impact that
these pronouncements are expected to have on the financial statements when adopted in future periods. In
March, 2013, the Financial Accounting Standards Board (“FASB”) issued authoritative guidance on accounting
for the cumulative translation adjustment upon de-recognition of certain subsidiaries or groups of assets within
a foreign entity or of an investment in a foreign entity. This guidance requires that the cumulative translation
adjustment should be released into net income only if the sale or transfer results in the complete or substantially
complete liquidation of the foreign entity in which the subsidiary or group of assets had resided. The adoption
of this guidance did not have an impact on our consolidated financial position, results of operation or cash
flows.

(4) INVENTORIES

Inventories are stated at the lower of cost (first-in, first-out basis) or market when applicable and include

materials, labor and overhead. Inventories are as follows:

Years Ended December 31

Finished goods .....................................................................................
Work in-process ...................................................................................
Raw materials .......................................................................................

Net inventories .............................................................................

2013

2012

In thousands

$ 403
218
1,382

$ 460
176
1,397

$ 2,003

$ 2,033

Management performs quarterly 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.

(5) PROPERTY, PLANT AND EQUIPMENT

Major classes of property, plant and equipment were as follows:

Years Ended December 31

Buildings and building improvements ...........................................
Computer equipment .....................................................................
Machinery and equipment .............................................................
Furniture and fixtures ....................................................................

Property, plant and equipment ...............................................
Less accumulated depreciation ......................................................

Net property, plant and equipment ........................................

2013

2012

In thousands

301
437
1,843
523

290
427
1,785
703

$ 3,104
(2,801)

$ 3,205
(2,682)

$ 303

$ 523

Page 21

Depreciation expense from continuing operations was approximately $212,000 and $278,000 in the years

ended December 31, 2013 and 2012, respectively.

(6) GOODWILL

The Company uses a three-step approach to a goodwill impairment test. First, ASU 2011-08 allows
entities with the option to first use an assessment of qualitative factors to determine whether the existence of
events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting
unit is less than its carrying amount. If a conclusion is reached that reporting unit fair value is not more likely
than not below carrying value, no further impairment testing is necessary. If further testing is necessary, the
second step is to estimate the fair value of its reporting units by using forecasts of discounted cash flows and
compare that value to the carrying value which requires that certain assumptions and estimates be made
regarding industry economic factors and future profitability of reporting units to assess the need for an
impairment charge. The methodology the Company uses to allocate certain corporate expenses is based on each
segments use of services and/or direct benefit to its employees. While the Company believes it has made
reasonable estimates and assumptions to calculate the fair value of the reporting segments and implied fair value
of goodwill, the impairment analysis is highly sensitive to actual versus forecast results. If the estimated value
is less than the carrying value the Company moves to the third step of the impairment test to determine if
goodwill is impaired.

In connection with the annual fair value test of goodwill, performed at the end of the fourth quarter 2013,

and at the end of the fourth quarter 2012, the Company concluded that no impairment existed.

The changes in the carrying amount of goodwill for the years ended December 31, 2013 and 2012 was as

follows:

Beginning of the year ..................................................
Effect of exchange rate ...............................................

$ 467
19

$ 458
9

End of year ..................................................................

$ 486

$ 467

December 31, 2013 December 31, 2012
( In thousands)

Goodwill as of December 31, 2013 and 2012 relates to the LED reporting unit.

(7) INTANGIBLE ASSETS

Intangible assets consist of distributor and customer relationships and related contracts, technology design
and programs, and other intangible assets. There are no intangible assets with indefinite lives. There were no
intangible assets acquired in 2013. Intangible assets and their respective useful lives are as follows:

Acquired customer contracts and relationships
Acquired technology design and programs
Other

Useful Life

5 – 8 Years
8 Years
3 – 7 Years

Gross carrying amounts and accumulated amortization of intangible assets were as follows as of

December 31, 2013 for each intangible asset class.

Page 22

Gross
Carrying
Amount

Accumulated
Amortization
(in thousands)

Net Balances

Acquired customer contracts and relationships .........................
Acquired technology design and programs ................................
Other ..........................................................................................
Total ...................................................................................

2,062
349
114
$ 2,525 $

(2,011)
(298)
(114)
(2,423)

51
51
-
102

Gross carrying amounts and accumulated amortization of intangible assets were as follows as of

December 31, 2012 for each intangible asset class.

Gross
Carrying
Amount

Accumulated
Amortization
(in thousands)

Net Balances

2,061
349
114
$ 2,524 $

(1,935)
(257)
(114)
(2,306)

126
92
-
218

Actual Expense Estimated Future Expense
2014
2012

2013

Amortization expense of

intangible assets ..................... $ 118 $ 120 $ 102

In thousands

(8) DEBT

Years Ended December 31

Bonds payable to the former stockholders of Photonic

Products Ltd. maturing on December 31, 2012 (see notes
below relative to a default), with an interest rate of 11%,
at December 31, 2013 and at December 31, 2012. ..............

Senior Fixed Rate Secured Bond (“PPI Bond”) to a private
investor, maturing on June 30, 2017 with an interest rate
of 8%, net of unamortized debt discount of $45,000 at
December 31, 2013 and with an interest rate of 8%, with
no unamortized debt discount at December 31, 2012..........

2013(1)

2012

In thousands

243

$ 1,750

$ 2,144

Page 23

Years Ended December 31

Senior Fixed Rate Secured Bond to a private investor, maturing

on May 19, 2017, with an interest rate of 12.25%, at
December 31, 2013 …………………………………….

Senior Fixed Rate Secured Bond to a private investor, maturing

on May 19, 2017, with an interest rate of 12.25%, at
December 31, 2013 …………………………………….

Borrowings under Revolving Credit facility with Barclays Bank Sales

Financing with an interest rate of 2.50% above Barclay’s base rate at
December 31, 2013 and 2.65% above Barclay’s base rate at December 31,
2012 (3.0% as of December 31, 2013 and 3.15% as of December 31,
2012). ............................................................................................................

2013(1)

2012

In thousands

320

640

1,127

662

Sub-total debt ....................................................................................

Less – revolving credit facility ………………………………………..
Less—Current portion of long-term debt .................................

3,837
(1,127)
(265)

3,049
(662)
(2,387)

Total long-term debt .........................................................................

$ 2,445

(1)

As of December 31, 2013, the Company had approximately $ 1,759,000 available under the various
borrowing facilities.

Photonic Products Ltd.

BORROWING AGREEMENTS

StockerYale (UK) Ltd., a wholly owned subsidiary of the Company, issued bonds to each of the former
stockholders of Photonic Products Ltd. with an aggregate initial principal amount equal to $2,400,000 (Photonic
Bonds).

In 2010, the Company and the holders of the Photonic Bonds entered into Deeds of Variation of the
Photonic Bonds. The Photonic Bonds were amended to pay the outstanding balance as of October 31, 2010
monthly over the period from November 30, 2010 through November 30, 2012 at the rate of $50,000 principal
plus simple interest (at 11% per annum). On December 31, 2012, the remaining balance (approximately
$243,000) of the Photonic Bonds was to have been paid in full.

The original key repayment terms of the Photonic Bonds, under this amendment, were as follows:

(a) Principal as of December 10, 2010:
(b) Interest Rate:
(c) Repayment term:
(d) Monthly principal:
(e) Balloon payment:

$1,443,000
11% per annum, payable monthly
October 31, 2010 to November 30, 2012
$50,000
$243,000 due December 31, 2012

Page 24

As of December 31, 2012, $243,000 was outstanding under the bonds issued to the stockholders of
Photonic Products Ltd., which was classified as current portion of long-term debt. The bonds were not paid in
full on December 31, 2012 as required by the Bond agreement. However, on April 30, 2013, the bonds were
paid in full satisfaction of the outstanding amount.

Private Investor Notes and Bond

ProPhotonix (IRL) Limited Senior Fixed Rate Secured Bond

On July 24, 2008, ProPhotonix (IRL) Limited issued a three-year 12% Senior Fixed Rate Secured Bond
(“PPI Bond”), as amended at various times, to a bondholder in the original principal amount of €935,000
($1,472,905 at July 24, 2008) secured by all of the assets of ProPhotonix (IRL) Limited. On June 9, 2009, the
bondholder loaned the company an additional $500,000 payable over the remaining term of the original loan, at
the same fixed 12% interest rate. Also on June 9, 2009, the Company and bondholder consolidated $1.0 million
of other bonds between the Company and bondholder to the PPI Bond.

On December 10, 2010, the Company and the bondholder entered into an amendment of the PPI Bond,
such that interest only was paid monthly on the outstanding balance through June 30, 2012 and thereafter equal
monthly payments of principal and interest over the three year period July 1, 2012 through June 30, 2015. The
Company also paid a restructuring fee of $50,000 to the bondholder. The key repayment terms of the PPI Bond,
under the December, 2010 amendment, were:

(a) Principal as of December 10, 2010:
(b) Interest Rate:
(c) Interest payments only:
(d) Principal Repayment term:
(e) Monthly principal and interest:

€1,972,523 ($2,614,000)
8% per annum
through June 30, 2012
36 months (July 31, 2012 through June 30, 2015)
€61,812 ($82,000)

On June 20, 2013 the bondholder entered into an amendment and waiver agreement with the Company
waiving all events of default from inception of the bond through the date of the amendment. In addition, the
bondholder also agreed to amend the terms of the bond as follows:

(a) Convert € 144,324 ($193,132) of the balance of the bond into common stock of the Company with a
subsequent transfer of such common stock to the Term Loan holder, described below as part of the Term
Loan provided to the Company

(b) Issue 1,900,000 warrants over common stock of the Company exercisable at a price of $0.03 per share
through June 20, 2023 as described in Note 10. The fair value of these warrants of $55,185 was
deducted from the carrying value of the bond and is being amortized over the remaining term of the PPI
Bond

€ 1,426,540 ($1,909,281)

(d) Interest Rate:

8% per annum

(e) Interest payments only:

June 30, 2013 through June 30, 2014

(f) Principal Repayment:

€15,000 per month plus interest July 1, 2014 through June 30,
2015, thereafter principal and interest monthly €56,378 ($75,456) from July 1, 2015 through June 30,
2017*

Page 25

(g) One-time fee of €31,413 ($42,043) payable on June 30, 2017. This fee is being accrued ratably over the
life of the loan, payable in June, 2017. In addition, the Company recorded debt acquisition costs of
$134,484 which is being amortized over the life of the amended term note.

∗

In addition to the terms above, the bondholder will be entitled to accelerated principal payments, on a
quarterly basis, equal to 30% of Free Cash Flow (defined as earnings before interest, taxes, depreciation,
and amortization (EBITDA) minus debt repaid and interest paid, minus capital expenditures not
financed, and minus taxes paid, each during such calendar quarter). Such payments shall be made within
45 days of the end of such calendar quarter.

At December 31, 2013, $1,794,702 remained outstanding under the note, which has been classified as
$123,912 current portion of long term debt and $1,670,790 long term debt and reported net of $44,857 of
unamortized debt discount, which has been reported as $19,209 as short-term and $25,648 as long-term.

At December 31, 2012, $2,143,803 was outstanding under the bond all of which was classified as
current portion of long-term debt. The Company was in default in respect of its repayment obligations under the
bond at December 31, 2012.

Term Notes:

PPI Bond Holder

On June 20, 2013, the Company entered into a Term Loan agreement with the PPI Bond holder to provide

up to $1.0 million of loan availability subject to certain terms as follows:

(a) Available Loan (subject to (b) below):
(b) 50% of each advance shall be used to repay amounts owed under the PPI Bond

$1.0 million

(d) Interest payments only:
(e) Principal Repayment term:

12.25% per annum

June 30, 2013 through May 31, 2014
36 months (June 1, 2014 through May 19, 2017)

The Company recorded debt acquisition costs of $70,437 which is being amortized over the life of the term
note. In addition, the Company is accruing a back-end fee of $15,000 ratably over the life of the loan, payable
in May, 2017.

At December 31, 2013, $320,000 remained outstanding under the note, which has been classified as
$53,415 current portion of long-term debt and $266,585 as long term debt. As of December 31, 2013, the
Company had $680,000 available under this borrowing facility. Given the requirement to apply 50% of
advances under this facility against the outstanding balance of the PPI Bond, this gives net available funding of
$340,000.

Page 26

Tiger Investments 1 LLC

On June 20, 2013, the Company entered into a Term Loan agreement with a Lender, which is owned
and controlled by the wife of Tim Losik, Patricia Losik. As Mr. Losik is a director and the Chief Executive of
the Company, the entry into the Loan Facility constitutes a “related party transaction” for the purposes of AIM
Rule 13.

The Term Loan provides availability to the Company of up to $2.0 million during the term of the Loan,

as follows, subject to certain restrictions:

(a) Available Loan:

(b) Interest Rate:

$2.0 million

12.25% per annum

June 30, 2013 through May 19, 2014
36 months (June 1, 2014 through May 19, 2017)

The Company recorded debt acquisition costs of $165,817 which is being amortized over the life of the
term note. In addition, the Company is accruing a back-end fee of $60,000 over the life of the loan, payable in
May, 2017.

At December 31, 2013, $640,000 remained outstanding under the note, which has been classified as
$106,830 current portion of long-term debt and $533,170 as long term debt. As of December 31, 2013, the
Company had $1,360,000 available under this borrowing facility.

Barclays Bank, PLC

On February 6, 2008, ProPhotonix Limited, a U.K. subsidiary, entered into a Confidential Invoice
Discounting Agreement, as amended at various times, with Barclays Bank Sales Financing (“Barclays”). Under
the Discounting Agreement, a three-year revolving line of credit was established. The Discounting Agreement
originally provided for a revolving line of credit not to exceed an aggregate principal amount of £700,000
($1,132,000), later reduced to £650,000 ($1,051,000), and grants a security interest in and lien upon all of
ProPhotonix Limited, a U.K. subsidiary, trade receivables in favor of Barclays. The Company originally could
borrow a total amount at any given time up to (cid:2)700,000, limited to qualifying receivables as defined. The
facility requires the maintenance of certain financial covenants including a minimum tangible net worth.

On November 29, 2013, the Company entered into an amendment to the revolving credit facility to (i)
increase the line from £650,000 to £1,400,000; (ii) to reduce the discount rate from 2.65% plus Barclays base
rate to 2.50% plus Barclays base rate and service charges and extended the minimum period of this amendment
to 24 months through November 29, 2015. The Company recorded debt acquisition costs of $27,172 which is
being amortized over the two year amendment period.

The amount outstanding under the facility was $1,127,000 as of December 31, 2013 and $662,000 as of
December 31, 2012, all of which was classified as a short term debt under revolving credit facility. As of
December 31, 2013, the Company had approximately $59,000 available under this facility.

(9) TAXES

The Company had deferred tax assets, before considering the full valuation allowance, totaling
approximately $27.3 million as of December 31, 2013 and approximately $27.7 million as of December 31,
2012. Realization of the deferred tax assets is dependent upon the Company’s ability to generate sufficient
future taxable income and, if necessary, execution of tax planning strategies.

Page 27

The Company’s historical operating losses raise considerable doubt as to when, if ever, any of the deferred
tax assets will be realized. As a result, management has provided a valuation allowance for the net deferred tax
assets. In the event management determines that sufficient future taxable income may be generated in
subsequent periods and the previously recorded valuation allowance is no longer needed, the Company will
decrease the valuation allowance by providing an income tax benefit in the period that such a determination is
made. Because of its historical operating losses, the Company has not been subject to income taxes since 1996.

The Company is subject to taxation in the U.S., Canada, the United Kingdom, Ireland and various states
and local jurisdictions. As a result of the Company’s tax loss position, the tax years 2000 through 2013 remain
open to examination by the federal and most state tax authorities. In addition, the tax years 2007 through 2013
are open to examination in foreign jurisdictions. As of December 31, 2013, the Company did not have any tax
examinations in process. On March 21, 2014, the Company was notified by the Internal Revenue Service of its
intent to audit the tax year 2012.

The significant items comprising the deferred tax asset and liability at December 31, 2013 and 2012 are as
follows:

Years Ended December 31,

2013

2012

In Thousands

Net operating loss carry forwards ...............................................
Foreign net operating loss carry forwards ...................................
R&D tax credit ............................................................................
Other ............................................................................................
Valuation allowance ....................................................................
Total .......................................................................................

$ 25,010
1,611
525
124
(27,270)
$ -

$ 25,080
1,693
525
406
(27,704)
$ -

As of December 31, 2013, the Company had United States federal net operating loss carry forwards
(NOLs) of approximately $62.5 million (2012: $62.7 million) available to offset future taxable income, if any.
These carry forwards expire through 2033 and are subject to review and possible adjustment by the Internal
Revenue Service. The Company may be subject to limitations under Section 382 of the Internal Revenue
Service Code as a result of changes in ownership. The Company’s historical operating losses raise considerable
doubt as to when, if ever, any of the deferred tax assets will be realized. As a result, management has provided a
full valuation allowance for the net deferred tax assets. At December 31, 2013, the Company also has Canadian
federal NOLs of approximately $1.5 million (2012: $1.5 million) available to offset future taxable income, if
any. These carry forwards expire through 2031 and are subject to review and possible adjustment by the
Canadian Revenue Agency. The Company may be subject to limitations of the use of the Canadian NOLs as a
result of changes in ownership. The Company’s historical operating losses raise considerable doubt as to when,
if ever, any of the deferred tax assets will be realized. As a result, management has provided a full valuation
allowance for the net deferred tax assets. At December 31, 2013, the Company also has a United Kingdom
NOL of approximately $4.6 million (2012: $4.5 million) for which management has provided a full valuation
allowance against. The total valuation allowance against deferred tax assets has decreased by $0.1 million
(2012: decreased by $2.0 million). At December 31, 2013, the Company also has an Ireland NOL of
approximately $2.3 million (2012: $1.5 million) for which management has provided a full valuation allowance
against. The total valuation allowance against deferred tax assets decreased by $0.4 million (2012: decreased
by $2.0 million).

Page 28

The Company must determine whether it is more-likely-than-not that a tax position will be sustained upon
examination, including resolution of any related appeals or litigation processes, based on the technical merits of
the position. A tax position that meets the more-likely-than-not threshold is then measured to determine the
amount of benefit to recognize in the financial statements. As of December 31, 2013 and 2012, the Company
has cumulatively recorded long-term liabilities of $178,000 and $178,000 respectively, relative to the sale of its
North American operations to Coherent, Inc. This represents the only significant uncertain tax position of the
Company.

(10) UNREGISTERED SALES OF EQUITY SECURITIES AND WARRANTS

On June 20, 2013, €144,324 ($193,132) of the PPI Bond (Note 8) was converted in exchange for
7,605,946 shares of common stock of the Company; such shares were issued to the Term Loan holder in partial
consideration relating to securing the Term Loan. Also on June 20, 2013, the Company issued a Warrant in
partial consideration for the Term Loan issued by the PPI Bond holder, described in Note 8. The Warrant for
1,900,000 shares of common stock of the Company is exercisable at a price of $0.03 per share through June 20,
2023.

Warrants

As of December 31, 2013, there were 8,582,567 common shares outstanding warrants with the following

exercise prices and expiration dates:

Number of Common Shares
Warrants
5,000
551,500
3,570,000
1,150,000
906,067
500,000
1,900,000

8,582,567

Exercise Price

Expiration Date

$0.50
$0.32 –$1.44
$1.15 –$3.12
$0.80 –$1.72
$0.45 –$0.60
$0.10 –$0.10
$0.03

2014
2015
2016
2017
2018
2019
2023

(11) STOCK OPTION PLANS

Under the Company’s 2007 Stock Incentive Plan (the 2007 Plan), the Company may issue options,
restricted stock, restricted stock units and other stock-based awards to its employees, officers, directors,
consultants and advisors. An aggregate of 5,300,000 shares of the Company’s common stock were initially
reserved for issuance under the 2007 Plan. In addition, there is an annual increase to the number of shares
reserved for issuance under the 2007 Plan equal to the lesser of (i) 1,000,000 shares of common stock, (ii) 5%
of the outstanding shares of common stock of the Company, or (iii) an amount determined by the Board of
Directors of the Company. On April 17, 2012, the Board of Directors approved amendments No. 2 and No. 3 to
the 2007 Stock Incentive Plan. Amendment No. 2 provided for various administrative matters and updated the
definition of “exercise price”. Amendment No. 3 increased the stock available for Awards to 11,300,000
shares of common stock; plus an annual increase to be added on the first day of each of the Company’s fiscal
years during the period beginning in fiscal year 2013 and ending on the second day of fiscal year 2017 equal to
the lesser of (i) 2,000,000 shares of common stock, (ii) 5% of the outstanding shares on such date, or (iii) an
amount determined by the Board. Also, this amendment provides that the per participant limit increased to 2

Page 29

million shares per calendar year. As of December 31, 2013, there were 13,300,000 shares reserved for
issuance and there were 11,300,000 shares reserved at December 31, 2012. The Company had 55,544 shares
available under the plan for future grants of options and restricted shares December 31, 2013.

In May, 2012, the Board of Directors approved the Third Amended and Restated Policy Regarding
Compensation of Independent Directors, (i) cash compensation is increased from $15,000 to $25,000 per annum
paid in arrears each quarter; (ii) the number of shares for the option grant for 2012 only shall be calculated as
follows: the lesser of 250,000 option shares or the non-cash component of compensation ($25,000) divided by
the mid market price as quoted on LSE – AIM on the date of grant as converted into USD at the closing foreign
currency exchange rate. Also, in accordance with the foregoing calculation the 2012 annual stock option grants
to non-employee Directors of the Company (the “Annual Grants”) to be issued as of the date of this meeting
(the “Option Date”) shall each be for an option to purchase up to 250,000 shares at a per share exercise price of
$0.0924, and that such options shall vest and become exercisable as to 25% of the original number of shares
subject to each option on each of the first, second, third and fourth anniversaries of the Option Date, until fully
vested on the fourth anniversary of the Option Date.

In May 2004, the Company adopted the 2004 Stock Option and Incentive Plan (the 2004 Option Plan) for
the purpose of issuing both Incentive Options and Nonqualified Options to officers, employees and directors of
the company. No further grants are allowed under this plan.

In May 2000, the Company adopted the 2000 Stock Option and Incentive Plan for the purpose of issuing
both Incentive Options and Nonqualified Options to officers, employees and directors of the Company. No
further grants are allowed under this plan.

The following table summarizes information about the stock options outstanding as of December 31, 2013.

There is no intrinsic value on the options outstanding at December 31, 2013 or December 31, 2012.

During 2013 and 2012, the Remuneration Committee approved various qualified and non-qualified stock option
awards to purchase shares of the Company’s common stock to various officers, directors and employees. There
were 3,500,000 options granted during the year ended December 31, 2013 and 3,085,000 options were granted
during the year ended December 31, 2012. These options vest over either a two year or a four year anniversary
of the grant date, provided that the recipient continues to serve the Company in that capacity until each such
vesting. The weighted average assumptions for grants during the years ended December 31, 2013 and
December 31, 2012 used in the Black-Scholes option pricing model were as follows:

Volatility………………………………………..
Expected option life……………………………
Interest rate (risk free)………………………….
Dividends……………………………………….
Weighted average grant date fair value………...

Twelve months Ended
December 31,
2013

224.1%
4.5 years
1.19%
$0
$0.02

Twelve months Ended
December 31,
2012

188.7%-189.6%
4.3 years
0.62%-0.93%
$0
$0.10

Page 30

Weighted
Average
Remaining
Contractual
Term
(in Years)
7.70

Options
Outstanding
6,567,940
3,085,000
-
( 297,050)

Weighted
Average
Exercise Price
per Share ($)
0.33
0.10
-
2.55

Balance at December 31, 2011 .......................
Granted ....................................................
Exercised .................................................
Cancelled .................................................

Balance at December 31, 2012 .......................

9,355,890

0.19

7.70

Vested and Exercisable at December 31,

2012 .............................................................

9,135,139

0.19

7.67

Balance at December 31, 2012 .......................
Granted ....................................................
Exercised .................................................
Cancelled .................................................

Balance at December 31, 2013 .......................

9,355,890
3,500,000
-
( 240,200)

12,615,690

Vested and Exercisable at December 31,

2013 .............................................................

5,519,840

0.19
0.02
-
0.92

0.13

0.20

6.70

7.63

6.24

Vested and Expected to Vest at December
31, 2013 ...................................................

12,372,730

0.13

7.58

Range of
Exercise Prices
$ 0.02 – 0.99
1.00 – 1.99
2.00 – 3.99

$ 0.02 – 3.99

Options
Outstanding
12,335,290
215,400
65,000

12,615,690

Weighted
Average
Contractual
Life (years)
7.8
0.6
0.4

7.6

Weighted
Average
Exercise
Price

0.10
1.22
2.06

0.13

Options
Exercisable
5,239,440
215,400
65,000

5,519,840

Weighted
Average
Exercise
Price

0.14
1.22
2.06

0.20

At December 31, 2013, there was approximately $330,000 of total unrecognized compensation cost related to
stock options granted. The cost is expected to be recognized over the next 1.50 years. Total stock option
expense recorded in 2013 and 2012 was approximately $169,000 and $142,000, respectively. There were no
options exercised during 2013 and 2012.

Restricted Share Awards (“RSAs”)

The Company has awarded to a number of employees restricted shares of the Company’s common
stock. The RSAs vest in equal annual installments over a period of four years. The fair market value of the
RSAs is based on the fair market value per share of the Company’s common stock on the date of grant and is
amortized over the vesting period.

Page 31

As of December 31, 2013, there was no unrecognized compensation cost related to non-vested RSAs.
Total expense recorded in the nine months ended December 31, 2013 and 2012 was approximately $0 and
$1,000, respectively.

(12) EMPLOYEE STOCK PURCHASE PLAN

In May 2000, the Company adopted the 2000 Employee Stock Purchase Plan (the Stock Purchase Plan),
which permits the eligible employees of the Company and its subsidiaries to purchase shares of the Company’s
common stock, at a discount, through regular monthly payroll deductions of up to 10% of their pre-tax gross
salary. Subject to adjustment for stock splits, stock dividends and similar events, a maximum of 300,000 shares
of common stock may be issued under the Stock Purchase Plan. During the years ended December 31, 2013 and
2012, there were no shares issued under the Stock Purchase Plan.

(13) EMPLOYEE DEFINED CONTRIBUTION PLANS

On January 17, 1994, the Company established the StockerYale, Inc. 401(k) Plan (the Plan). Under the
Plan, employees are allowed to make pre-tax retirement contributions. In addition, the Company may make
matching contributions, not to exceed 100% of the employee contributions, and profit sharing contributions at
its discretion. The Company made matching contributions of $33,000 in the year ended December 31, 2013 and
$31,000 in the year ended December 31, 2012. The Company incurred costs of approximately $1,100 in 2013
and approximately $1,700 in 2012 to administer the Plan.

The Company also has voluntary contribution pension schemes in Ireland and in the United Kingdom. In
the United Kingdom, the Company contributes a maximum of 3% of the participating employee salaries, with
one exception, where the maximum contribution is 10%. The plan is voluntary, with plan administration costs
coming out of the plan itself. The Company made contributions of approximately $44,000 and $41,000 in the
years ended December 31, 2013 and 2012, respectively. In Ireland, the Company also has a voluntary plan that
matches contributions for those participating employees with minimum of 6 months of service. After two years
of service, the Company will match up to a maximum of 5% of salary. The Company made contributions of
approximately $20,000 and $22,000 in the years ended December 31, 2013 and 2012, respectively. Plan
administration costs come out of the plan itself.

Other obligations and contingent liabilities

(14) COMMITMENTS AND CONTINGENCIES

The Company leases approximately 3,600 square feet for its corporate headquarters and sales office in
Salem, New Hampshire. The term of the lease requires monthly tenant at-will payments with a 90 day
termination notice. Base rent is $2,550 per month plus the tenant’s share of expenses.

ProPhotonix (IRL) Limited leases approximately 10,000 square feet for its operations in Cork, Ireland. The
original five year lease term ended on August 22, 2013 with rent and service charges of €102,000 per year. The
lease is still under re-negotiation, however, the rent and service charges are now €77,000 per year.

ProPhotonix Limited, a U.K. subsidiary, leases approximately 13,000 square feet of space in Hatfield
Broad Oak, Hertfordshire, U.K. The original lease had a term of nine years ending September 29, 2013 at
£87,000 per year, at which time the Company renegotiated the lease for an additional 3 years. Rent charges are
£70,000 per year under the renegotiated terms of the lease.

Page 32

The Company utilizes, or has assumed, capital leases to finance purchases of equipment or vehicles. There
was approximately $10,000 and $22,000 payable in principal and interest under these leases at December 31,
2013 and December 31, 2012, respectively. The Company records depreciation expense on assets acquired
under a capital lease in the consolidated statement of operations.

The net book value of assets acquired under capital leases at December 31, 2013 and December 31, 2012,

is as follows:

2013
Assets under capital lease ............................................... $ 631,000
Less—accumulated depreciation ....................................

(606,000)

2012
$ 621,000
(574,000)

Assets under capital lease, net ........................................ $ 25,000

$ 47,000

Scheduled future maturities of debt, and operating lease obligations for the next five years:

Due by period

2014

2015

2016

2018

2017
in thousands

Total

Debt obligations ..................... $ 275 $ 774 $ 1,106 $ 565
Operating lease obligations ....

149

115

—

$ 424 $ 889 $ 1,193 $ 565

$2,720
351

$3,071

The Company expensed approximately $269,000 and $293,000 in rent for the years ended December 31, 2013
and 2012, respectively.

(15) LEGAL PROCEEDINGS

The Company is party to various legal proceedings generally incidental to its business. Although the
disposition of any legal proceedings cannot be determined with certainty, it is the Company’s opinion that any
pending or threatened litigation will not have a material adverse effect on the Company’s results of operations,
cash flow or financial condition.

(16) SEGMENT INFORMATION

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’s accounting policies and method of presentation for segments is consistent with that used throughout
the consolidated financial statements.

The Company operates in two segments: LED’s (light emitting diode systems) and Laser & Diodes. In
the LED segment, the Company designs and manufactures LED systems for the inspection, machine vision,
medical and military markets. The Laser & Diodes segment distributes laser diodes and designs and
manufactures custom laser diodes modules for industrial, commercial and medical applications. The policies
relating to segments are the same as the Company’s corporate policies.

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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. Certain of the Company’s indirect 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.

2013

2012

(In thousands)

Years Ended December 31
Revenues:

$ 6,599
9,000

$ 6,023
7,881

Total revenues .............................................................................................

15,599

13,904

Gross profit:

$ 2,947
3,024

$ 2,103
2,204

Total gross profit .........................................................................................

5,971

4,307

Operating (loss)

$ (806)
(375)

$ (1,831)
(1,305)

Total operating (loss) ...................................................................................

(1,181)

(3,136)

Years Ended December 31
Current assets:

LEDs ...........................................................................................................
Laser & diodes ............................................................................................
Corporate .....................................................................................................

Total current assets ......................................................................................

Property, plant & equipment:

Total property, plant & equipment ..............................................................

Intangible assets:

Total intangible assets .................................................................................

Goodwill:

Corporate .....................................................................................................

Total goodwill .............................................................................................

2013

2012

(In thousands)

1,984
2,737
463

5,184

179
120
4

303

—
102
—

102

486

—
—

486

2,107
2,257
1,406

5,770

275
225
23

523

—
218
—

218

467
—

—

467

Page 34

Other assets:

Total other assets .........................................................................................

28
—
326

354

18
—
5

Years Ended December 31
Total assets:

Total assets ..................................................................................................

Revenues by geographic area:

United States ...............................................................................................
Canada, Mexico & So. America ..................................................................
Europe .........................................................................................................
Asia & the rest of the world ........................................................................

2013

2012

(In thousands)

2,677
2,959
793

6,429

4,585
274
8,148
2,592

2,867
2,700
1,434

7,001

3,507
257
7,756
2,384

Total ......................................................................................................................

15,599

13,904

The Company’s long-lived assets consist of property, plant and equipment, goodwill and intangible assets located in the

following geographic locations:

Years Ended December 31
Long-lived assets by geographic area:

United States and North America ................................................................
Europe ..........................................................................................................
UK ...............................................................................................................

Total ......................................................................................................................

4
666
222

892

23
742
443

1,208

2013

2012

(In thousands)

(17) SUBSEQUENT EVENTS

The Company has evaluated subsequent events through April 22, 2014, the date which the financial statements
were available to be issued, and there were no additional events that impacted these financial statements or
required additional disclosure to the financial statements.

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