ProPhotonix Annual Report 2015

FY2015 Annual Report · ProPhotonix

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Annual Report
2015

About the pictures on the front cover (left to right):

COBRA Cure FX2 UV LED Curing System

The COBRA Cure FX2 is an innovative UV LED Curing system, delivering up to 8.4W/cm2 or 17J/cm2. Its
innovative design incorporates the many benefits of a LED curing systems as well as unique end-user focused
features to guarantee a consistent, reliable cure over the lifetime of the system.

UV LED Flood Light

The UV LED Flood Light is utilized for applications where a wider cure area and higher intensity of light is
required. It is equipped with 144 high power LEDs with integrated reflectors for creating a uniform curing area.
The Flood light produces a curing area of 100 mm x 100 mm with an output of up to 1.6W/cm2 @ a working
distance of 50mm.

COBRA CURE FX1 UV LED Curing System

COBRA Cure FX1 is a compact, fan-cooled UV LED curing system in a scalable form factor that produces a
uniform line with a peak irradiance of 6 W/cm2 and peak energy density (dose) of 5 J/cm2. COBRA Cure FX1
is offered in numerous optical configurations and is available in a range of wavelengths including 365nm,
385nm 395nm and 405nm.

Fiber Coupled Laser Diode Module

The 200mW output power, 405nm, Fiber-Coupled Laser Diode Module (FCLD) was designed for use in large
scale arrays. The outputs from the lasers formed a one dimensional array forming rectangular shaped outputs
(10µm x 5µm) with a pitch of 20µm between each rectangular spot. Due to the high powers involved, the lasers
were placed in a customized water-cooled heat sink to ensure the laser diode, located in the laser module
housing, were maintained to within 1°C to extend the laser modules lifetime. ProPhotonix designed the modules
to be easily replaceable using a simple quick-release system for setting the laser modules in the heat sink and
providing low loss, high environmental protection connectors at the fiber ends.

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

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

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

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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.

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To the Shareholders of ProPhotonix Limited:

2015 Annual Report to Shareholders

We entered 2015 with positive financial movement from the prior year, but also with economic and currency
headwinds. Neither of these challenges abated during the year making continuing financial success all the
more meaningful. 2015 has again been a landmark year in a number of respects – including our first full year
of positive net income since 1994. We have also now
achieved five consecutive half-yearly periods of
positive EBITDA and three consecutive half-yearly
periods of positive operating income. During 2015,
operating income increased 723% and EBITDA
increased 84%. In addition to a continuation of
improving financial results, the ProPhotonix team has been diligently pursuing new customers, new product
and market initiatives, which helps set the stage for 2016.

Operating Income growth 723%
84%
EBITDA growth
Net Income positive
not since 1994
Four provisional/patent applications
Three, three-year customer supply agreements

Financial Progress:
Our financial performance continues to improve. Although revenue fell by 12% during 2015, the year over
year comparatives are significantly impacted by foreign currency conversion rates. While revenue for 2015
was $14.4 million, this would have been $15.8 million
using the same average currency conversion rates in
2014 (2014: $16.4 million). Our margin rate
improved to 41.4% from 39.1% in 2014. The
improvement in the gross margin rate is attributable to
product mix and continuing cost reductions. All of
these factors contributed to the financial improvement
of ProPhotonix and positive net income. The balance
sheet also continued to improve in 2015. Term debt
was reduced by $750,000 in accordance with the
various loan facilities, and the total available credit
from these various loan facilities was $2.0 million as
of December 31, 2015.

Income from Operations

Gross Margin Rate

Net Income (Loss)

Gross Profit

$ 1,168

$ (1,340)

$ 634

$ 280

790

6,425

5,970

$ 14,411

$ 16,431

($000's)

EBITDA

41.4%

39.1%

Sales

2015

2014

During 2015, order bookings declined 2.4% to $15.7 million from 2014, but the book-to-bill ratio increased
to 1.09 (2014: 0.98). However, if you factor in the impact of foreign currency conversion, our order rate for
2015 would have been $17.3 million (a 7.6% improvement), using average 2014 conversion rates. Our order
backlog at December 31, 2015 was $5.6 million.

Customer and Product Development Initiatives:

In addition to the new customer activity in 2015, we entered into three (3) three-year supply agreements with
customers and have received and fulfilled production orders for two of the three agreements beginning in Q4,
2015. We will begin commercial shipments on the third agreement in the first quarter 2016.

During the year, the ProPhotonix engineering team completed the development of several products and
implemented a number of new technology capabilities. We announced eight new manufactured products.
The Company filed four provisional/patent applications in 2015 as a continuation of intellectual property
protection on our unique inventions and solutions.

Over the past two years, I have highlighted the Ultra Violet (UV) LED market as a high potential target
market. We announced the COBRA Cure™ in 2014, and in 2015 we announced the COBRA Cure FX UV

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lamp. These products are ideally suited to a range of UV curing applications, including printing, adhesives,
and coatings. Our UV LED product development plan includes variants of the FX lamp and additional UV
light sources with higher power, configurable interfaces, and advanced sensing capabilities.

Building On Change:

Strategically, the Company is in transition. Historically, our product development has been customer
directed. This approach has served us well for specific applications and we continue to offer bespoke
product solutions. Over the past two years, we have assessed various markets and product features in order
to develop a product strategy focusing on specific markets to complement our direct customer engagement.
To this end, we are concentrating our engineering talents in a couple of defined market areas that we believe
are poised for fast market expansion.

The first of these is the ultra violet (UV) LED and laser market for various applications including: printing,
curing, 3D printing, bio-luminescence, medical microscopy, and other applications. Market research shows
that the 2014 market size for UV LED applications was approximately $90 million with projected growth to
$500 million by 2019, a compound average annual growth rate of nearly 40% (Yole Developpement, UV
LEDs - Technology, Manufacturing and Application Trends, 2015).

Our other focus is on the continuing market requirement for multi-wavelength devices and systems; both
laser and LED solutions. More and more customers are seeking multi-wavelength solutions requiring
innovative optics, complex electronics, on-board sensing capabilities, and sophisticated software control.
We see obvious opportunities which include a broad range of optical sensing and inspection applications in
microscopy, industrial and security markets. We are in the research and development phase of these
products and expect to announce various laser and LED products in the coming months.

I am happy with our improved financial performance, but we can still do better! We continue to build on the
2015 successes, furthering new customer revenue, while growing within our existing customer base by
helping all customers prosper with ever evolving products for their applications. ProPhotonix’ near-term
perspective has not changed: 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.

In conclusion, I thank you, my co-workers, our customers, suppliers, service providers, and investors for
your continued support!

Respectfully submitted,

Tim Losik
President and Chief Executive Officer

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Director Remuneration Report

For the year ended December 31, 2015

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
2015 ($)

Total All
Compensation
2014 ($)

Tim Losik

300,750

6,000

306,750

52,291

359,041

335,771

Total Executive
Compensation

Non-Executive Director

300,750

6,000

306,750

52,291

359,041

335,771

Ray Oglethorpe

Timothy Steel

25,000

2,968

27,968

28,507

25,000

2,968

27,968

28,507

Vincent Thompson

25,000

2,968

27,968

28,507

Mark Weidman

25,000

2,968

27,968

28,507

Total Non-Executive
Compensation

Director Share Options:

100,000

11,872

111,872

114,028

Director

Options @
12/31/14

Options
Granted

Options
Forfeited

Options @
12/31/15

Tim Losik

4,900,000

Ray Oglethorpe

1,809,006

150,000

1,959,006

Timothy Steel

1,295,433

150,000

1,445,433

Vincent Thompson

1,295,433

150,000

1,445,433

Mark Weidman

850,000

150,000

1,000,000

Total All Directors

10,149,872

600,000

10,749,872

(1) Other compensation for non-executive directors represents cash payments expensed in the current year.

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ProPhotonix Limited

Consolidated Financial Statements

Years Ended December 31, 2015 and 2014

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FINANCIAL STATEMENTS

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

Item

Page

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

Consolidated Balance Sheets as of December 31, 2015 and 2014 ...............................................................

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

2015 and 2014 ...........................................................................................................................................

Consolidated Statements of Stockholders’ Equity (Deficit) for the Years Ended December 31, 2015 and
2014...........................................................................................................................................................

Consolidated Statements of Cash Flows for the Years Ended December 31, 2015 and 2014 .....................

Notes to Consolidated Financial Statements………………………………………………………………. 16

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Independent Auditors’ Report

The Board of Directors
ProPhotonix Limited

Report on the Financial Statements

We have audited the accompanying consolidated financial statements of ProPhotonix Limited and its
subsidiaries, which comprise the consolidated balance sheets as of December 31, 2015 and 2014, and the related
consolidated statements of operations and comprehensive loss, stockholders’ (deficit), and cash flows for the
years then ended, and the related notes to the consolidated financial statements.

This report is made solely to the company’s stockholders, as a body, in accordance with the terms of our
engagement. Our audit work has been undertaken so that we might state to the company’s stockholders those
matters we have been engaged to state to them in this report and for no other purpose. To the fullest extent
permitted by law, we do not accept or assume responsibility to anyone other than the company and the
company’s stockholders, as a body, for our audit work, for this report, or for the opinions we have formed.

Management’s Responsibility for the Financial Statements

Management is responsible for the preparation and fair presentation of these consolidated financial statements
in accordance with U.S. generally accepted accounting principles; this includes the design, implementation, and
maintenance of internal control relevant to the preparation and fair presentation of consolidated financial
statements that are free from material misstatement, whether due to fraud or error.

Auditors’ Responsibility
Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We
conducted our audits in accordance with auditing standards generally accepted in the United States of America.
Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the
consolidated financial statements are free from material misstatement.

An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the
consolidated financial statements. The procedures selected depend on the auditors’ judgment, including the
assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud
or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s
preparation and fair presentation of the consolidated financial statements in order to design audit procedures
that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness
of the entity’s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the
appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by
management, as well as evaluating the overall presentation of the consolidated financial statements.

We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our
audit opinion.

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Opinion

In our opinion, the consolidated financial statements referred to above present fairly in all material respects, the
financial position of ProPhotonix Limited and its subsidiaries as of December 31, 2015 and 2014, and the
results of their operations and their cash flows for the years then ended in accordance with U.S. generally
accepted accounting principles.

KPMG LLP

Cambridge
United Kingdom
March 22, 2016

Page 11

FINANCIAL STATEMENTS

PROPHOTONIX LIMITED

CONSOLIDATED BALANCE SHEETS

($ in thousands except share and per share data)

December 31

2015

2014

Assets
Current assets:
Cash and cash equivalents
Accounts receivable, less allowances of $21 in 2015 and $20 in 2014
Inventories
Prepaid expenses and other current assets

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

Total assets

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

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

Total liabilities

434
2,751
1,550
140

4,875
132
385
81

331
2,606
1,686
180

4,803
184
429
36

$ 5,473

$ 5,452

1,334
966
1,260
1,035

4,595
508
178

5,281

1,128
668
1,463
965

4,224
1,585
178

5,987

Stockholders’ Equity / (Deficit):
Common stock, par value $0.001; shares authorized 250,000,000 at December 31, 2015 and at

December 31, 2014; 83,665,402 shares issued and outstanding at December 31, 2015 and at
December 31, 2014
Additional paid-in capital
Accumulated deficit
Accumulated other comprehensive income

Total stockholders’ equity / (deficit)

Total liabilities and stockholders’ equity

84
111,860
(112,734)
982

84
111,583
(113,014)
812

192

(535)

5,473

5,452

See the notes to consolidated financial statements.

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PROPHOTONIX LIMITED
Consolidated Statements of Operations and Comprehensive Income (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 Income

Other Income, net

Foreign Currency Translation Losses

Warrant & Debt Acquisition Expense

Interest Expense

Income (Loss) Before Taxes

Income Taxes

Net Income (Loss)

Other Comprehensive Income:

Foreign currency translation

Total Comprehensive Income / (Loss)

Income (Loss) Per Share:
Basic and diluted:

Net Income (loss) per share

Basic and diluted weighted average shares outstanding

Years Ended
December 31,

2015

2014

$ 14,411
(8,441)

$ 16,431
(10,006)

5,970

(654)
(4,526)
-

790

131

(259)

(158)

(224)

280

6,425

(879)
(5,350)
(100)

(1,031)

(198)

(300)

(1,340)

$ 280

$ ( 1,340)

170

$ 450

958

$ ( 382)

$0.003

83,665,402

($0.016)

83,665,402

See the notes to consolidated financial statements.

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

Common Stock

Par
$0.001

Additional
Paid in
Capital

Accumulated
Deficit

Accumulated
Other
Comprehensive
Income

Total
Stockholders’
Equity (Deficit)

83,665

$111,302

(111,674)

(146)

(434)

-
-
-

280
-
-

-
-
(1,340)

-
958
-

280
958
(1,340)

Balance December 31, 2013
Share based compensation, net
of forfeitures ................
Translation adjustment .....
Net Loss ............................

Balance December 31, 2014

83,665

$111,583

(113,014)

812

(535)

Share based compensation, net
of forfeitures ................
Translation adjustment .....
Net Income .......................

-
-
-

277
-
-

-
-
280

-
170
-

Balance December 31, 2015

83,665

$111,860

(112,734)

982

277
170
280

192

See the notes to consolidated financial statements.

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PROPHOTONIX LIMITED

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

Years Ended December 31

2015

2014

Cash flows from operating activities
Net income (loss)
Adjustments to reconcile net loss to net cash used in operating activities:

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 provided by 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

Net cash (used in) provided by 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

$ 280

$ (1,340)

277
101
(51)
130
-
95
4

280
258
1,066
186
4
55
5

(362)
(127)
22
(58)
136
(47)

(395)
38
23
100
(248)
(2)

400

(77)

(64)

312
-
(750)

144
175
(292)

(438)

218

(64)

103
331

$ 434

224

(71)
402

331

303

See the notes to consolidated financial statements.

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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 manufacturer of laser modules and a distributor of laser diodes 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 traded on the London Stock Exchange, plc
(AIM listing), under the trading symbol “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 year ended December 31, 2015, the Company
recorded a net income of $280,000, and during the year ended December 31, 2014, the Company recorded a net
loss of $1,340,000. Net cash flow from operating activities for the same time periods were $400,000 and
$30,000, 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. The Company believes that
it has adequate available working capital to continue to trade for at least the next twelve months from the
issuance of these financial statements.

(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The accompanying consolidated financial statements are prepared in conformity with U.S. 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 (UK) Ltd., which owns 100% of ProPhotonix
Limited, a U.K. subsidiary, and ProPhotonix Holdings, Inc., which 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.

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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 also covers most of the larger customers at the ProPhotonix
(IRL) Limited subsidiary, and 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 to costs and expenses ...................................................................
Account write-offs and other deductions...................................................

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

2015
2014
In thousands

20 $
6
(5)

21 $

19
3
(2)

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.

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

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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 the asset is determined not to be recoverable,
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.

INCOME (LOSS) PER SHARE

The Company calculates basic and diluted net income (loss) per common share by dividing the net income

(loss) applicable to common stockholders by the weighted average number of common shares outstanding.

As of December 31, 2015, 22,965,040 shares underlying options and 8,026,067 shares underlying warrants
would have been included in the calculation of diluted shares. However, as the exercise price exceeded the
market price on December 31, 2015, none of these have been included in the calculation of earnings per share.

As of December 31, 2014, 22,365,040 shares underlying options and 8,577,567 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 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 upon completion of performance, subject to any project management assessments as to the
status of work performed.

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
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.

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

WARRANTY

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Company adjusts annually the warranty provision based on actual experience and for any particular known
instances.

Warranty Reserves:

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

In thousands
146
109
(121)

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

134

146
36
(36)

146

Years Ended December 31,

2015

2014

The Company expenses advertising costs as incurred. Advertising expenses for the years ended 2015 and

2014 were approximately $81,000 and $82,000, 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
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, 2015 or 2014.

Page 19

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
the
permit
Remuneration Committee of the Company’s Board of Directors. Generally the grants vest over terms of one 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 2015, the Company recognized approximately $277,000 of stock-based compensation related to
options, all of which was charged to general and administrative expense. During 2014, the Company recognized
approximately $280,000 of stock-based compensation related to options, all of which was charged to 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.

During 2014, the Company implemented the 2014 stock incentive plan, which is described in Note 11.

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 deficit (accumulated other comprehensive income) in the
accompanying consolidated balance sheets.

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

Page 20

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.

At December 31, 2015, the Company estimated the fair value of long term fixed rate debt to be

approximately $1,849,000 compared to its carrying value of $1,783,000.

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 2015 or 2014. The Company had no customer that accounted for 10% of the outstanding
accounts receivable balance at December 31, 2015 and had one customer that accounted for 10% of the
outstanding accounts receivable balance at December 31, 2014. The Company maintains its cash and cash
equivalents in bank deposit accounts, which at times may exceed insured limits. At December 31, 2015, the
amount in excess of governmental insurance protection was approximately $0.3 million, measured across all
entities and jurisdictions. At December 31, 2014, the amount in excess of governmental insurance protection
was approximately $0.2 million. The Company believes it is not exposed to any significant credit risk on cash
and cash equivalents.

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 August 2014, the FASB updated the Accounting Standards Codification and amended Subtopic 205-
40, Presentation of Financial Statement – Going Concern. This amended guidance requires that in connection
with preparing financial statements for each annual and interim reporting period, an entity’s management
should evaluate whether there are conditions or events, considered in the aggregate, that raise substantial doubt
about the entity’s ability to continue as a going concern within one year after the date that the financial
statements are issued (or within one year after the date that the financial statements are available to be issued
when applicable).

Page 21

Management’s evaluation should be based on relevant conditions and events that are known and reasonably
knowable at the date that the financial statements are issued (or at the date that the financial statements are
available to be issued when applicable).

Substantial doubt about an entity’s ability to continue as a going concern exists when relevant conditions and
events, considered in the aggregate, indicate that it is probable that the entity will be unable to meet its
obligations as they become due within one year after the date that the financial statements are issued (or
available to be issued). The term probable is used consistently with its use in Topic 450, Contingencies.

When management identifies conditions or events that raise substantial doubt about an entity’s ability to
continue as a going concern, management should consider whether its plans that are intended to mitigate those
relevant conditions or events will alleviate the substantial doubt. The mitigating effect of the management’s
plans should be considered only to the extent that (1) it is probable that the plans will be effectively
implemented and, if so (2) it is probable that the plans will mitigate the conditions or events that raise
substantial doubt about the entity’s ability to continue as a going concern.

If conditions or events raise substantial doubt about an entity’s ability to continue as a going concern, but the
substantial doubt is alleviated as a result of consideration of management’s plans, the entity should disclose
information that enables users of the financial statements to understand all of the following:

a. Principal conditions or events that raised substantial doubt about the entity’s ability to continue as a

going concern (before consideration of management’s plans)

b. Management’s evaluation of the significance of those conditions or events in relation to the entity’s

ability to meet its obligations

c. Management’s plans that alleviated substantial doubt about the entity’s ability to continue as a going

concern.

If conditions or events raise substantial doubt about an entity’s ability to continue as a going concern, and
substantial doubt is not alleviated after consideration of management’s plans, an entity should include a
statement in the footnotes indicating that there is substantial doubt about the entity’s ability to continue as a
going concern within one year after the date that the financial statements are issued (or available to be issued).
Additionally, the entity should disclose information that enables users of the financial statements to understand
all of the following:

a. Principal conditions or events that raise substantial doubt about the entity’s ability to continue as a

going concern

b. Management’s evaluation of the significance of those conditions or events in relation to the entity’s

ability to meet its obligations

c. Management’s plans that are intended to mitigate the conditions or events that raise substantial doubt

about the entity’s ability to continue as a going concern.

The amendments are effective for the annual period ending after December 15, 2016, and for annual periods
and interim periods thereafter. Early application is permitted. The Company will evaluate this reporting
requirement and adopt with the year beginning January 1, 2016. However the adoption of these requirements is
not expected to have a significant impact on the Company’s financial statements.

In May 2014, the FASB amended the Accounting Standards Codification and created a new Topic 606,
Revenue from Contracts with Customers. The new guidance establishes a single comprehensive contract-based
model for entities to use in accounting for revenue arising from contracts with customers. The new model
significantly changes existing GAAP, requires substantial judgment in its application, and will generally require
Page 22

companies to make more disclosures about revenue. The core principle of the amendment is that an entity
recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects
the consideration to which the entity expects to be entitled in exchange for those goods or services. In applying
the new guidance, an entity will (1) identify the contract(s) with a customer; (2) identify the performance
obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to the contract’s
performance obligations; and (5) recognize revenue when (or as) the entity satisfies a performance obligation.
The new standard provides for two alternative implementation methods. The first is to apply the new standard
retrospectively to each prior reporting period presented. This method does allow the use of certain practical
expedients. The second method is to apply the new standard retrospectively in the year of initial adoption and
record a cumulative effect adjustment for the impact of adjusting contracts open at the date of adoption. Under
this transition method, we would apply this guidance retrospectively only to contracts that are not completed
contracts at the date of initial application. We would then recognize the cumulative effect of initially applying
the standard as an adjustment to the opening balance of retained earnings. This method also requires us to
disclose comparative information for the year of adoption.

In August, 2015, the FASB issued AS 2015-14, which deferred the effective date of this guidance to the year
beginning after December 15, 2017.

We will adopt the FASB’s amended guidance for our year beginning January 1, 2017; early adoption is not
permitted. We are currently evaluating the new guidance and have not determined the impact this standard may
have on our financial statements nor have we decided upon the method of adoption.

In April, 2015, the FASB issued ASU 2015-03, Simplifying the Presentation of Debt Issuance Costs,
with amendments to Subtopic 835-30. Section 3 amends paragraphs 835-30-45-1 through 45-1A, 835-30-45-3
through 45-4, and 835-30-55-8, with a link to transition paragraph 835-30-65-1, as follows:

Interest—Imputation of Interest

Other Presentation Matters

a. 835-30-45-1 The guidance in this Section does not apply to the amortization of premium and
discount of assets and liabilities that are reported at fair value and the debt issuance costs of
liabilities that are reported at fair value.

b. 835-30-45-1A The discount or premium resulting from the determination of present value in cash or
noncash transactions is not an asset or liability separable from the note that gives rise to it.
Therefore, the discount or premium shall be reported in the balance sheet as a direct deduction from
or addition to the face amount of the note. Similarly, debt issuance costs related to a note shall be
reported in the balance sheet as a direct deduction from the face amount of that note. The discount,
premium, or debt issuance costs shall not be classified as a deferred charge or deferred credit.

c. 835-30-45-2 The description of the note shall include the effective interest rate. The face amount

shall also be disclosed in the financial statements or in the notes to the statements.

d. 835-30-45-3 Amortization of discount or premium shall be reported as interest expense in the case of
liabilities or as interest income in the case of assets. Amortization of debt issuance costs also shall be
reported as interest expense.

The Company has adopted this revised guidance and includes it in the presentation of the balance sheet and in
FN 8.

Page 23

(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 .............................................................................

2015

2014

In thousands

$ 369
252
929

$ 1,550

$ 327
226
1,133

$ 1,686

Management performs quarterly reviews of inventory and either reserves or disposes of items not required

by their manufacturing plan, as well as 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 ......................................................

2015

2014

In thousands

253
407
1,511
399

$ 276
413
1,668
410

$ 2,570
(2,438)

$ 2,767
(2,583)

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

$ 132

$ 184

Depreciation expense from operations was approximately $101,000 and $158,000 in the years ended

December 31, 2015 and 2014, respectively.

(6) GOODWILL

The Company uses a three-step approach to a goodwill impairment test. First, ASU 2011-08 allows
entities 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 unit’s 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 units and implied fair value of goodwill, the impairment
analysis is highly sensitive to actual versus forecast results. Finally, if the estimated value is less than the
carrying value, an impairment loss is recognized for any excess of the carrying amount of the reporting unit’s
goodwill over the implied fair value of that goodwill.

Page 24

In connection with the annual impairment test of goodwill, performed at the end of the fourth quarter 2015,

and at the end of the fourth quarter 2014, the Company concluded that no impairment existed.

The changes in the carrying amount of goodwill for the years ended December 31, 2015 and 2014 were as

follows:

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

$ 429
(44)

$ 486
(57)

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

$ 385

$ 429

December 31, 2015

December 31, 2014

( In thousands)

The Company operates in two reporting units: LED’s (light emitting diode systems) and Laser &

Diodes. Goodwill as of December 31, 2015 and 2014 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 2015. 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, 2015 for each intangible asset class.

Gross
Carrying
Amount

Accumulated
Amortization
(in thousands)

Net Balances

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

1,850
313
102
$ 2,265 $

(1,850)
(313)
(102)
(2,265)

-
-
-
-

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

December 31, 2014 for each intangible asset class.

Page 25

Gross
Carrying
Amount

Accumulated
Amortization
(in thousands)

Net Balances

1,942
329
107
$ 2,378

(1,942)
(329)
(107)
(2,378)

-
-
-
-

Actual Expense

2014

2015

In thousands

Amortization expense of

$ 100
intangible assets ...............................

(8) DEBT

Years Ended December 31

Senior Fixed Rate Secured Bond (“PPI Bond”) to a private
investor, maturing on June 30, 2017 with an interest rate of 8%,
December 31, 2015 and at December 31, 2014.

Principal Amount

Senior Fixed Rate Secured Bond to a private investor, maturing
on June 20, 2017, with an interest rate of 12.25%, at December
31, 2015 and at December 31, 2014.

Senior Fixed Rate Secured Bond to a private investor, maturing
on June 20, 2017, with an interest rate of 12.25%, at December
31, 2015 and at December 31, 2014

Less: Unamortized
discount and debt
issuance costs
Long-term debt less
unamortized discount and
debt issuance costs
Principal Amount

Less: Unamortized
discount and debt
issuance costs
Long-term debt less
unamortized discount and
debt issuance costs

2015(1)

2014

In thousands

$902

$1.434

$ (33)

$ (88)

$869

$1,346

$213

$334

$ (10)

$ (28)

$203

$306

$426

$669

$ (24)

$ (67)

$402

$602

Page 26

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, 2015 and at December 31, 2014 (3.0%
as of December 31, 2015 and at December 31, 2014).

Total All Debt

Principal Amount

$1.334

$1,140

Less: Unamortized
discount and debt
issuance costs
Long-term debt less
unamortized discount and
debt issuance costs
Principal Amount
Less: Unamortized
discount and debt
issuance costs
Long-term debt less
unamortized discount and
debt issuance costs

$ -

$ (12)

$1,334

$1,128

$2.875
$ (67)

$3,577
$ (196)

$2,808

$3,381

(1) As of December 31, 2015, the Company had approximately $ 2,027,000 available under the various
borrowing facilities.

BORROWING AGREEMENTS

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 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 ($61,486) from July 1, 2015 through June 30,
2017*

Page 27

(g) One-time fee of €31,413 ($34,259) 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 have been made
within 45 days of the end of such calendar quarter, or as agreed to by the lender.

At December 31, 2015, $901,876 remained outstanding under the note, which has been classified as
$589,189 current portion of long term debt and $312,687 long term debt and reported net of $9,458 of
unamortized debt discount, which has been reported as $8,506 short-term and $952 as long-term and reported
net of unamortized debt acquisition costs of $23,048, which have been reported as $20,729 short-term and
$2,320 as long-term.

At December 31, 2014, $1,433,877 remained outstanding under the note, which has been classified as
$420,992 current portion of long term debt and $1,012,885 long term debt and reported net of $25,648 of
unamortized debt discount, which has been reported as $16,190 short-term and $9,458 as long-term and
reported net of unamortized debt acquisition costs of $62,503, which have been reported as $39,455 short-term
and $23,048 as long-term.

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 June 30, 2014
36 months (July 1, 2014 through June 20, 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 June, 2017.

At December 31, 2015, $212,775 remained outstanding under the note, which has been classified as
$137,487 current portion of long-term debt and $75,288 as long term debt and reported net of unamortized debt
acquisition costs of $10,034, which have been reported as $9,051 short-term and $984 as long-term. As of
December 31, 2015, the Company had net available funding of $305,000.

At December 31, 2014, $334,486 remained outstanding under the note, which has been classified as
$121,711 current portion of long-term debt and $212,775 as long term debt and reported net of unamortized
debt acquisition costs of $28,529, which have been reported as $18,495 short-term and $10,034 as long-term.
As of December 31, 2014, the Company had net available funding of $305,000.

Page 28

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 June 30, 2014
36 months (July 1, 2014 through June 20, 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
June, 2017.

At December 31, 2015, $425,551 remained outstanding under the note, which has been classified as
$274,974 current portion of long-term debt and $150,577 as long term debt and reported net of unamortized
debt acquisition costs of $23,622, which have been reported as $21,306 short-term and $2,316 as long-term.
As of December 31, 2015, the Company had $1,220,000 available under this borrowing facility.

At December 31, 2014, $668,973 remained outstanding under the note, which has been classified as
$243,422 current portion of long-term debt and $425,551 as long term debt and reported net of unamortized
debt acquisition costs of $67,161, which have been reported as $43,539 short-term and $23,622 as long-term
As of December 31, 2014, the Company had $1,220,000 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, later
reduced to £650,000, and grants a security interest in and lien upon all of ProPhotonix Limited, a U.K.
subsidiary, trade receivables in favor of Barclays. The 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 was
fully amortized over the two year amendment period to November, 2015.

On February 10, 2016, the Company entered into an amendment to the revolving credit facility to (i)
increase the line from £1,400,000 to £1,500,000; (ii) to reduce the discount rate from 2.50% plus Barclays base
rate to 2.00% plus Barclays base rate and service charges (iii) increase the early payment ceiling from 80% to
85% and extended the minimum period of this amendment to 12 months through February 10, 2017.

Page 29

The amount outstanding under the facility was $1,334,000 as of December 31, 2015 and $1,140,000 as
of December 31, 2014 and reported net of unamortized debt acquisition costs of $12,454, all of which was
classified as a short term debt under revolving credit facility. As of December 31, 2015, the Company had
approximately $502,000 available under this facility.

(9) TAXES

The Company had deferred tax assets, before considering the full valuation allowance, totaling
approximately $26.9 million as of December 31, 2015 and approximately $27.1 million as of December 31,
2014. 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.

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 2001 through 2015 remain
open to examination by the federal and most state tax authorities. In addition, the tax years 2008 through 2015
are open to examination in foreign jurisdictions.

The following is a reconciliation of the federal income tax provision calculated at the statutory rate of 34%

to the recorded amount:

Years Ended December 31,
Income (Loss) before taxes ................................................................
Reconciliation
Applicable statutory federal income tax benefit ................................
Foreign tax rate differential ...............................................................
Non deductible items .........................................................................
Valuation allowance ..........................................................................

2015

2014

In thousands

280

$ (1,340)

95
(38)
33
(90)

(456)
230
38
126

Net income tax provision ...........................................................

Page 30

The significant items comprising the deferred tax asset and liability at December 31, 2015 and 2014 are as
follows:

Years Ended December 31,

2015

2014

In Thousands

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

$ 25,092
1,477
525
313
(27,407)
$ -

$ 25,160
1,602
525
278
(27,565)
$ -

As of December 31, 2015, the Company had United States federal net operating loss carry forwards
(NOLs) of approximately $62.1 million (2014: $62.2 million) available to offset future taxable income, if any.
These carry forwards expire through 2034 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, 2015, the Company also has Canadian
federal NOLs of approximately $1.2 million (2014: $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. At December 31, 2015, the Company also has a United Kingdom NOL of
approximately $4.4 million (2014: $4.6 million). At December 31, 2015, the Company also has an Ireland NOL
of approximately $2.3 million (2014: $2.6 million). The total valuation allowance against deferred tax assets
decreased by $0.2 million (2014: decreased by $0.3 million).

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, 2015 and 2014, 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.

Page 31

(10) UNREGISTERED SALES OF EQUITY SECURITIES AND WARRANTS

Warrants

As of December 31, 2015, there were 8,026,067 common shares outstanding warrants with the following

exercise prices and expiration dates:

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

8,026,067

Exercise Price

Expiration Date

$1.15 –$3.12
$0.80 –$1.72
$0.45 –$0.60
$0.10 –$0.10
$0.03

2016
2017
2018
2019
2023

On June 9, 2014, the Company implemented the creation of a 2014 stock incentive plan.

(11) STOCK OPTION PLANS

New remuneration policy for senior management
Summary
In order to incentivize the achievement of its objectives, the Company has implemented a new remuneration
policy for its senior management with the following elements:

 A one-off substantial performance based option grant to key senior management at market value
 No further grants intended to said senior management through the end of the three-year measurement period
 Cliff vesting on December 31, 2016 at different levels dependent on achievement against the performance

target (zero below 50% up to 100% vesting at 90% attainment)

 10 year option term

Performance measure - The performance measure is the driving factor behind the new policy. Broadly, the
target is EBITDA equal to 90% of the term debt and lease principal payments, and all interest payments, which
are due during the performance period. Such payments would, on the basis of current obligations, amount to
approximately $3.0 million in total. Achievement of this objective will result in full vesting. The committee
and board believe that achievement of the objective will result in the creation of significant stockholder value.

Under the Company’s 2014 Stock Incentive Plan (the 2014 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 10,200,000 shares of the Company’s common stock were initially
reserved for issuance under the 2014 Plan. In addition, there is an annual increase to the number of shares
reserved for issuance under the 2014 Plan equal to the lesser of (i) 2,000,000 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.

As of December 31, 2015, there were 3,400,000 shares available to be issued from this plan.

Page 32

In May, 2014, the Board of Directors approved the Seventh Amended and Restated Policy Regarding
Compensation of Independent Directors, (i) cash compensation is $25,000 per annum paid in arrears each
quarter in installments of $6,250; and (ii) options to purchase 150,000 shares of the Company’s common stock,
$.001 par value per share (the “Common Stock”), such that each Independent Director who is serving as
director of the Company on the date of each annual meeting of stockholders (or special meeting in lieu thereof)
beginning with the 2014 annual meeting, shall automatically be granted on such day an option (the “Option
Award”) entitling the recipient to acquire 150,000 shares of Common Stock, pursuant to the Company’s 2014
Stock Incentive plan for 2015 & the 2007 Stock Incentive Plan (the “Plan”) for 2014.

In May 2007, the Company adopted the 2007 Stock Option and Incentive Plan (the 2007 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 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, 2015.
There is no intrinsic value on the options outstanding, and exercisable, at December 31, 2015. The intrinsic
value on the options outstanding, and exercisable, at December 31, 2014 is approximately $8,000.

During 2015 and 2014, 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 600,000 options granted during the year ended December 31, 2015 and there were 10,500,000 options
granted during the year ended December 31, 2014. These options vest over a one year, three 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, 2015
and December 31, 2014 used in the Black-Scholes option pricing model were as follows:

Twelve months Ended
December 31,
2015

Twelve months Ended
December 31,
2014

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

226.2%
7.75 years
2.01%
$0
$0.0314

237.58%
5.1 years
1.71%
$0
$0.0366

Page 33

Balance at December 31, 2013 ............................
Granted ........................................................
Exercised .....................................................
Cancelled .....................................................

Balance at December 31, 2014 ............................

Vested and Exercisable at December 31, 2014 ...

Balance at December 31, 2014 ............................
Granted ........................................................
Exercised .....................................................
Cancelled .....................................................

Balance at December 31, 2015 ............................

Options
Outstanding
12,615,690
10,500,000
-
(750,650)

22,365,040

8,175,238

22,365,040
600,000
-
-

22,965,040

Vested and Exercisable at December 31, 2015 ...

12,045,040

Vested and Expected to Vest at December

Weighted
Average
Exercise Price
per Share ($)
0.13
0.04
-
0.56

0.07

0.11

0.07
0.03
-
-

0.07

0.09

Weighted
Average
Remaining
Contractual
Term
(in Years)
7.63

7.97

6.32

7.97

7.03

5.90

31, 2015 ...................................................... 22,561,632

0.07

6.99

Range of
Exercise Prices
$ 0.02 – 0.99

Options
Outstanding
22,965,040

Weighted
Average
Contractual
Life (years)
7.0

Weighted
Average
Exercise
Price

0.07

Options
Exercisable
12,045,040 $

Weighted
Average
Exercise
Price

0.09

At December 31, 2015, there was approximately $164,000 of total unrecognized compensation cost related to
stock options granted (2014: $419,000). The cost is expected to be recognized over the next 1.02 years. Total
stock option expense recorded in 2015 and 2014 was approximately $277,000 and $280,000, respectively.
There were no options exercised during 2015 and 2014.

(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, 2015 and
2014, there were no shares issued under the Stock Purchase Plan.

Page 34

(13) EMPLOYEE DEFINED CONTRIBUTION PLANS

On January 17, 1994, the Company established the ProPhotonix Limited 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 $25,000 in the year ended December 31, 2015 and
$27,000 in the year ended December 31, 2014. The Company incurred costs of approximately $2,000 in 2015
and approximately $1,200 in 2014 to administer the Plan. Approximately $15,000 of the $27,000 contributed
by the Company was non cash, as the Company was allowed to offset these payments from the forfeitures
remaining in the account, and as allowed by 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 $46,000 in each of the years
ended December 31, 2015 and 2014. 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 $28,000 and $32,000 in the years ended December 31, 2015 and 2014, 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. The lease is still under re-negotiation, however, the
rent and service charges are now €72,000 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.

The Company utilizes, or has assumed, capital leases to finance purchases of equipment or vehicles. At
December 31, 2015 and at December 31, 2014, these capital leases were paid in full. 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, 2015 and December 31, 2014,

is as follows:

Assets under capital lease ...........................................................
Less—accumulated depreciation ................................................

2015
$ 565,000
(559,000)

2014
$ 594,000
(582,000)

Assets under capital lease, net ....................................................

$ 6,000

$ 12,000

Page 35

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

Due by period

2016

2017

2018

2020

2019
in thousands

Total

Debt obligations ......................................
$ 966 $ 508 $
Revolving credit facility .........................
1,334
Operating lease obligations .....................
78

-
-

- $

-
-

$ 2,378 $ 508 $

- $

-
$
-
-

$1,474
1,334
78

$2,886

The Company expensed approximately $217,000 and $241,000 in rent for the years ended December 31, 2015
and 2014, 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, defense and medical applications. The
policies relating to segments are the same as the Company’s corporate policies.

The Company evaluates performance and allocates resources based on revenues and operating income
(loss). The operating profit / (loss) for each segment includes selling, research and development and expenses
directly attributable to the segment. In addition, the operating profit / (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.

Page 36

2015

2014

(In thousands)

Years Ended December 31
Revenues:

$ 6,578
7,833

$ 7,111
9,320

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

14,411

16,431

Gross profit:

$ 3,136
2,834

$ 3,288
3,137

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

5,970

6,425

Operating profit (loss):

$ 502
288

$ 126
(30)

Total operating profit ...................................................................................

790

Years Ended December 31
Current assets:

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

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

Property, plant & equipment:

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

Goodwill:

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

Other assets:

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

2015

2014

(In thousands)

1,659
2,729
487

4,875

50
73
9

132

385
—
—

385

76
—
5

2,201
2,222
380

4,803

64
116
4

184

429
—
—

429

30
—
6

Page 37

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 ........................................................................

2015

2014

(In thousands)

2,170
2,802
501

5,473

4,865
1,048
6,703
1,795

2,797
2,265
390

5,452

4,724
419
8,531
2,757

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

14,411

16,431

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 ......................................................................................................................

9
435
72

516

4
545
64

613

2015

2014

(In thousands)

(17) SUBSEQUENT EVENTS

The Company has evaluated subsequent events through March 21, 2016, 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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