StockerYale Files SEC form 10KSB, Annual Report
Annual Report
Item 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
This section contains statements that are forward-looking. These statements are based on expectations and assumptions that are subject to risks and uncertainties. Actual results could differ materially because of factors discussed in "Risk Factors." Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management's analysis, judgment, belief or expectation only as of the date of issue. We undertake no obligation to publicly revise these forward-looking statements to reflect events or circumstances that arise after the date of issue.
Management intends to employ a series of actions to improve the financial condition of the Company. These initiatives include revenue growth, cost reductions, raising capital, and pursuing appropriate business initiatives which we expect to improve our profitability.
StockerYale continued to introduce new products in 2007 including a line of erbium-doped fibers in our specialty fiber segment, our Lasiris(TM) Hi-Pointing Stability Laser and our COBRA 2 LED linescan illuminator. In addition, our October 2007 acquisition of Spectrode LLC included fiber laser intellectual property that we expect to enhance strategic initiatives in both our specialty optical fiber and laser business units and allow us to pursue applications in the medical and defense industries. We also made key investments last year in medical product research and development to support our strategic move into medical & bio-medical markets. Sales to the medical vertical increased from less than 5% of StockerYale's total revenues in 2006 to approximately 12% in 2007. We expect our medical strategy to be a catalyst for greater revenues across all three product lines in 2008. Medical sales are targeted to grow to approximately 20% of 2008 revenues given existing customer relationships and multiple sales initiatives under way.
We have taken certain actions in 2007 to reduce our overall cost structure and shall continue to implement such actions throughout 2008. In addition, we intend to focus on increasing the pace with which operational improvements are able to improve our financial performance and the consistency of our results. We intend to identify additional opportunities to lower our costs and manage our business more efficiently.
We are considering different ways to raise additional capital including through the sale of our equity securities, through offerings of debt securities, or through borrowings from financial institutions.
StockerYale intends to pursue additional strategic acquisitions consistent with our criteria for attractive and complementary product lines. We believe that the photonics industry contains many opportunities for consolidation, and we will continue to identify and evaluate synergistic businesses that would improve shareholder value. We intend to pursue various options to finance any acquisitions and also to fund operations, as necessary, through the end of 2008. The pursuit of these financings will be opportunistic and we cannot be sure of the timing or terms of any borrowing arrangements or equity offerings, or that we will be able to consummate one or more of these options. If we do not achieve these goals in 2008, we would implement contingency plans for additional cost reductions; however, there is a possibility that we would not have adequate capital to sustain our current operations.
Net revenues in 2007 increased $10.5 million or 54.5% compared to 2006 led by our Photonic Products segment increase over a partial acquisition year of $8.1 million. We also saw an increase in the demand for our optical components of $0.8 million and the remainder came from our illumination segment's LED systems and laser product lines. The optical components segment increased 37.0% in 2007, while the illumination segment saw an increase of 8.9%.
Revenues from our specialty optical fiber and LED systems product lines were lower than, but continued to grow faster than, our laser product line. Specialty optical fiber grew 48% and LED systems grew 34%. Our specialty fiber optic products are being positioned towards medical, industrial and military applications. We recently supplied fiber to gyroscopes used in missile, naval and satellite navigation systems and to Northrop Grumman for use on attack submarine hydrophones.
Gross profit was $9.0 million in 2007, an increase of $2.3 million or 35% compared to $6.7 million in 2006. However, gross profit margin declined to 30% from 35% in 2006 due to foreign exchange, one-time charges, increased operating expenses and the mix of products due to the lower margin distributed and manufactured products of Photonic Products. Product mix accounted for approximately 2.3% of the decrease in gross margin, while foreign currency and one time charges accounted for another 2%.
Operating loss was $6.3 million in 2007 compared to $3.7 million in fiscal year 2006 excluding the impact of amortization expenses. The increased loss results from the decline in gross margin percentage and an increase in operating expenses of 42% to $14.1 million from $9.9 million in 2006, net of non-cash asset amortization expenses. The increase was driven by sales and administrative expenses resulting from the acquisition of Photonic Products, Sarbanes-Oxley compliance costs and other IT expenditures. Operating expenses included approximately $0.4 million non-recurring expenses associated with a reduction in headcount in December 2007 and audit and professional fees relating to the acquisition of Photonic Products earlier in the year.
Other expense in 2007 increased $1.22 million or 82.0% compared to 2006. The increase results from additional interest expense and non-cash amortization of deferred financing cost and discount expenses associated with the financing of our Photonics Products acquisition and other new debt. Interest expense increased $531,000 directly attributable to increased borrowings in 2007 and late 2006.
We have recorded a valuation allowance against our net deferred tax assets after concluding that it is more likely than not that we will not be able to use those deferred tax assets. In 2007, the Company recorded an income tax benefit related to losses of one of its non-U.S. based subsidiaries.
We tested our assets for impairment during the fourth quarter as part of our budget process. We did not record any asset impairment charges in 2006 or 2007. We test for impairments using the methodology prescribed by SFAS 144 and SFAS 142 and described under "Critical Accounting Policies." There were no significant asset disposals in 2006 or 2007.
The current ratio (the ratio of current assets to short term liabilities) as of December 31, 2007 was 1.3, a slight increase from the December 31, 2006 current ratio of 1.15. Our December 31, 2007 cash balance of $1.6 million was $0.2 million higher than our cash balance on December 31, 2006.
We used $4.0 million of cash for operating activities during 2007 compared to $1.4 million in 2006 primarily from an operating loss of $8.9 million offset partially by $5.4 million of non-cash charges for depreciation, amortization, and stock-based compensation. Total financing activities conducted during 2007 contributed $4.5 million in cash from net proceeds from the sale of common stock ($3.5 million) and from net proceeds from the issuance of a note ($2.3 million). We made principal payments of debt of $2.7 million. Investing activities for 2007 were $0.7 million mainly for the acquisition of equipment.
Significant items contributing to the increase in working capital included an increase in receivables balances consistent with the increase in revenues.
On January 26, 2007, we entered into a Securities Purchase Agreement with Smithfield Fiduciary LLC, under which we sold and issued for an aggregate purchase price of $2.3 million to Smithfield Fiduciary LLC 2,000,000 shares of our common stock at a per share purchase price of $1.15 (a discount to the 30 day trading average) and a 10-year warrant to purchase 1,000,000 shares of common stock at an exercise price of $1.72 per share.
On September 25, 2007, a private investor exercised warrants for the purchase of 1,140,741 shares of the Company's common stock at an average per share exercise price of $1.08 per share, or approximately $1,227,000.
On December 28, 2007, the Company issued amended and restated secured term notes to Laurus Master Fund, Ltd. and its assignees, PSource Structured Debt Limited and Valens U.S. SPV I. Under the note issued to Valens, the Company borrowed an additional $1.0 million from Valens at an annual interest rate of 10.5%. The notes amended and restated secured term notes dated December 30, 2005 and June 19, 2007 and reduced the monthly principal payments of the Company by $50,000.
We are using the proceeds from these transactions for general working capital, investments in our information technology infrastructure and accelerated operational improvements.
We are considering different ways to raise additional capital including through the sale of our equity securities, through offerings of debt securities or through borrowings from financial institutions. The pursuit of these financings will be opportunistic and we cannot be sure of the timing or terms of any borrowing arrangements or equity offerings, or that we will be able to consummate one or more of these options.
The Company had no debt covenants at December 31, 2007.
Photonic Products Ltd.
On October 31, 2006, as part of the consideration paid for the acquisition of Photonic Products Ltd., StockerYale (UK) Ltd., a wholly owned subsidiary of the Company, issued bonds to each of the stockholders of Photonic Products Ltd. with an aggregate initial principal amount equal to $2.4 million. The outstanding principal under the bonds issued to the stockholders of Photonic Products Ltd. accrues interest at an annual rate of 1% above the LIBOR rate as determined on the first business day of each month. StockerYale (UK) Ltd. may elect to prepay the bonds at any time, in whole or in part, without penalty or premium. If the stockholders of Photonic Products Ltd. breach any representation, warranty, covenant or agreement made in the acquisition agreement, StockerYale (UK) Ltd. or the Company may make a claim and the amounts outstanding under the bonds will be reduced by an amount equal to any damages, claims, demands, losses, expenses, costs, obligations and liabilities reasonably and foreseeably arising to the Company and/or StockerYale (UK) Ltd. If StockerYale
(UK) Ltd. fails to make any payments under the bonds, the stockholders of Photonic Products Ltd. will then have the right to require payment from the Company in the form of newly issued shares of the Company's common stock. All unpaid principal plus accrued but unpaid interest under the bonds is due and payable on October 31, 2009.
As of December 31, 2007 and 2006, $2.4 million was outstanding under the bonds issued to the stockholders of Photonic Products Ltd.
Laurus Master Fund
Line of Credit Agreement:
On June 28, 2006, the Company entered into a Security and Purchase Agreement with Laurus Master Fund, Ltd (Laurus). Under the Security and Purchase Agreement, a three-year revolving line of credit was established. The proceeds from this line of credit were used to pay in full the outstanding amount under the credit facility between StockerYale Canada, Inc. and National Bank of Canada as described below. Additional amounts borrowed under the line of credit from time to time may be used for the Company's and StockerYale Canada Inc.'s working capital needs. The Security and Purchase Agreement provides for a revolving line of credit not to exceed an aggregate principal amount of $4.0 million and grants a security interest in and lien upon all of the Company's assets in favor of Laurus. The Company may borrow a total amount at any given time up to $4.0 million, limited to qualifying receivables and inventories as defined.
The Company began making monthly payments to Laurus of accrued interest only on August 1, 2006. The outstanding principal under the note accrues interest at an annual rate of 1% above the prime rate. The interest rate was 8.25% as of December 31, 2007. The Company may elect to prepay the note at any time, in whole or in part, without penalty or premium. All unpaid principal plus accrued but unpaid interest is due and payable on June 28, 2009.
Also under the terms of this Security and Purchase Agreement and in consideration of the line of credit, the Company issued and sold to Laurus 642,857 shares of its common stock at a per share purchase price of $.001, for an aggregate purchase price of $643. The Company recorded debt acquisition costs relating to the line of credit for cash fees paid of $209,487 and an additional amount as debt acquisition costs of $757,925 representing the fair market value of the stock issued. The debt acquisition charges are being amortized over the life of the line of credit using the effective interest method.
At December 31, 2007, $2,838,000 was outstanding under the line of credit, which has been classified as long-term debt. Credit line availability at December 31, 2007 was approximately $100,000.
In addition, the Company entered into a Registration Rights Agreement under which it agreed to register for resale within 60 days the shares of common stock issued and sold to Laurus. On July 21, 2006 the Company filed a registration statement on Form S-3 (declared effective on August 25, 2006) with the SEC for the resale of the shares.
Term Note:
On December 30, 2005, under the terms of a Securities Purchase Agreement, the Company issued a secured term note in the aggregate principal amount of $4.0 million to Laurus. The note was originally due on December 30, 2008 and is collateralized by U.S. accounts receivable, inventory and equipment, and a second security interest in accounts receivable, inventory and equipment in Montreal, Canada. The Company began making monthly payments of principal and interest on the note on April 1, 2006. The outstanding principal on the note accrues interest at an annual rate of 2% above the prime rate, subject to a minimum annual interest rate of 8% (subject to certain adjustments). The Company could elect to prepay the note provided that (i) if prepayment occurred during the first year of the date of issuance, the Company would pay a 15% prepayment penalty, (ii) if
prepayment occurred during the second year of the date of issuance, the Company would pay a 10% prepayment penalty, and (iii) if prepayment occurred during the third year of the date of issuance, the Company would pay a 5% prepayment penalty.
Also, under the terms of the Securities Purchase Agreement, the Company sold and issued to Laurus an aggregate of 750,000 shares of common stock of the Company at a per share purchase price of $.001, for an aggregate purchase price of $750, related to the prepayment of certain convertible notes. The Company recorded debt acquisition costs of $102,650 and a debt discount of $720,000 representing the fair market value of the stock issued. The debt acquisition and debt discount charges were being amortized over the life of the note using the effective interest method.
The Company has registered for resale under the Securities Act of 1933, as required by the agreement, the shares of common stock sold and issued to Laurus by filing a registration statement on Form S-3 on January 27, 2006, which was declared effective on February 14, 2006. Because of certain provisions contained in the agreement, the Company initially classified the amounts allocated to the common stock as a liability. This amount was reclassified to equity on February 14, 2006 when the shares were registered. The Company reclassified the market value of the stock on this date of $660,000 as equity and recorded a $60,000 gain to other income (expense).
Amendments to the Term Note and Security Purchase Agreement:
On June 19, 2007, the Company and Laurus entered into a Note Amendment Agreement to the December 2005 secured term note. The amendment extended the maturity date of the December 30, 2005 note, as described above, from December 30, 2008 to June 30, 2010. In connection with the amendment, the Company entered into a Securities Purchase Agreement with Laurus under which the Company borrowed $2,318,180 and issued a Secured Term Note to Laurus. The note is due on June 30, 2010. The Company agreed to make monthly payments of principal and interest on the note beginning on July 1, 2007. The outstanding principal on the note accrues interest at an annual rate of 2% above the prime rate, subject to a minimum annual interest rate of 8% (subject to certain adjustments). The Company may elect to prepay the note provided that (i) if such prepayment occurs during the first year of the date of issuance, the Company shall pay a 15% prepayment penalty, (ii) if such prepayment occurs during the second year of the date of issuance, the Company shall pay a 10% prepayment penalty and (iii) if such prepayment occurs during the third year of the date of issuance, the Company shall pay a 5% prepayment penalty. Laurus holds a security interest in certain assets of the Company. The monthly principal payment on the revised combined note is $125,000. The interest rate is prime plus 2% and was 9.25% as of December 31, 2007.
Under the Securities Purchase Agreement, the Company sold and issued to Laurus an aggregate of 300,000 shares of common stock of the Company at a per share purchase price of $.01, for an aggregate purchase price of $3,000. The Company will use the net proceeds from the Securities Purchase Agreement for general corporate purposes. In conjunction with the 300,000 shares of common stock issued to Laurus, the Company recorded a debt discount of approximately $362,000, which represented the approximate fair value of the stock as of the date of issuance.
The amended agreement resulted in an extinguishment of debt under EITF 96-19, Debtor's Accounting for a Modification or Exchange of Debt Instrument. As a result, the Company accelerated the existing debt discount and financing costs associated with the original note and certain other costs paid with the financing totaling approximately $290,000 in June 2007.
The Company and Laurus also entered into a Registration Rights Agreement on June 19, 2007, under which the Company agreed to file a registration statement with the SEC to register the shares of common stock for resale within 135 days under the Securities Act of 1933, as amended which has been since extended until May 9, 2008.
On December 28, 2007, the Company issued amended and restated secured term notes to Laurus and its assignees, PSource Structured Debt Limited and Valens U.S. SPV I, under which the Company borrowed an additional $1.0 million from Valens. The notes amended and restated the secured term notes dated December 30, 2005 and June 19, 2007. The terms of the note issued to Valens are the same as the note issued to Laurus on June 19, 2007. The $1.0 million portion of the Valens note will accrue interest at an annual rate of 10.5%. The notes reduced the monthly principal payments of the Company by $50,000. Laurus, PSource and Valens rights under the notes are secured by a security interest in certain assets of the Company.
In connection with the notes, on December 28, 2007, the Company and Laurus and its assignees entered into amendments to the (i) Securities Purchase Agreement, dated as of December 30, 2005 and (ii) Securities Purchase Agreement, dated as of June 19, 2007 (together, the "Amendments"). Under the Amendments, the Company sold and issued (i) to PSource an aggregate of 75,000 shares of common stock of the Company at a per share purchase price of $.01, for an aggregate purchase price of $750 and (ii) to Valens an aggregate of 300,000 shares of common stock of the Company at a per share purchase price of $.01, for an aggregate purchase price of $3,000. The Company will use the net proceeds from the Amendments for general corporate purposes. The Company recorded debt acquisition costs of $99,569 and an additional debt discount of $515,740 representing the fair market value of the stock issued. The debt acquisition and debt discount charges are being amortized over the life of the note using the effective interest. In addition, as required under EITF 96-019, we expensed approximately $12,000 of the acquisition related costs to the income statement directly, rather than amortizing this amount over the life of the note.
The Company also entered into Registration Rights Agreements with each of PSource and Valens on December 28, 2007, under which the Company agreed to register the shares of common stock for resale under the Securities Act of 1933, as amended, by May 9, 2008.
At December 31, 2007, $4,750,000 was outstanding under the combined notes, which has been classified as $1,256,546 short-term debt and $3,492,087 long term debt and reported net of $509,875 of unamortized debt discount, which has been classified as $261,502 short term and $248,373 long term.
At December 31, 2006, $2,909,092 was outstanding under the December 30, 2005 note, which has been classified as $1,454,546 short-term debt and $1,454,546 long term debt and reported net of $316,164 of unamortized debt discount, which has been classified as $240,761 short term and $75,403 long term.
Private Investor Notes and Bond
On August 16, 2007, the Eureka Interactive Fund Ltd. (Eureka) agreed to transfer the promissory notes and bonds listed below, as well as all of the unexercised warrants previously issued to Eureka, to a private investor.
On May 12, 2005, the Company issued a note to Eureka Interactive Fund, Ltd. The $1.5 million note was initially due and payable in full on September 12, 2005. The note accrues interest on the outstanding principal balance at the rate of 10% per year, payable on the last day of each month. The Company also issued to Eureka five-year common stock warrants to purchase 250,000 shares at an exercise price per share of $0.90. The aggregate purchase price of the note and warrants ($1.5 million) was allocated between the note and warrants based upon their relative fair market value. The difference between the face amount of the note of $1,500,000 and the aggregate purchase price of the note of $1,341,362 was recorded as a debt discount of $158,638 and is being amortized over the life of the note. The Company used the Black-Scholes Model to calculate the fair value of the warrants. The underlying assumptions included in the Black-Scholes Model were: a risk-free interest rate of 3.87%, an expected life of five years and an expected volatility of 116% with no dividend yield. These warrants were exercised during the quarter ended September 30, 2007.
On August 26, 2005, the Company entered into an amendment to the note in which the maturity date of the note was extended to December 31, 2005. On December 15, 2005, the maturity date of the note was extended to
January 15, 2007. The note accrues interest on the outstanding principal balance at the rate of 10% per year. The aggregate outstanding principal amount of the note and accrued interest was payable in equal installments of $50,000 on the 15th day of each month, with the entire balance of unpaid principal and interest previously due on January 15, 2007. As a part of the December 15, 2005 agreement, the Company issued to the holder additional five-year common stock warrants to purchase 150,000 shares at an exercise price per share of $0.90. An additional debt discount was recorded in the amount of $90,149 and is being amortized over the life of the note. The Company used the Black-Scholes Model to calculate the fair value of the warrants. The underlying assumptions included in the Black-Scholes Model were: a risk-free interest rate of 4.40%, an expected life of five years and an expected volatility of 92% with no dividend yield. These warrants were exercised during the quarter ended September 30, 2007.
On December 27, 2006, the Company entered into Amendment No. 3 to the note. The amendment extended the maturity date of the note from January 15, 2007 to January 15, 2008. The aggregate outstanding principal amount of the note as of the date of the amendment along with accrued interest is payable in equal installments of $50,000 on the 15th day of each month beginning on January 15, 2007 and continuing until March 15, 2007, and in equal installments of $100,000 on the 15th day of each month beginning on April 15, 2007 and continuing until December 15, 2007. The entire balance of unpaid principal and interest thereafter was paid on January 15, 2008.
At December 31, 2007, $34,796 was outstanding under the note, which has been classified as short-term debt.
At December 31, 2006, $1,021,415 was outstanding under the note, which has been classified as $988,618 short-term debt and $34,796 long-term debt and reported net of $5,138 of unamortized debt discount.
On September 25, 2007, the same private investor exercised additional warrants for the purchase of 740,741 shares of the Company's common stock at an average per share price of $1.17 per share, or approximately $867,000.
Photonic Products Ltd., Financing
On October 31, 2006, StockerYale (UK) Ltd. issued a 10% Senior Fixed Rate Secured Bond to Eureka in the original principal amount of $4,750,000. The bond is due on October 31, 2011. StockerYale (UK) Ltd. agreed to make payments of principal and interest over the term; however, during the first twelve months of the term of the bond, only accrued interest will be required to be paid (no payments of principal will be required) and an amount equal to 50% of the original principal sum of $4,750,000 will be paid on October 31, 2011. The outstanding principal on the bond accrues interest at an annual rate of 10%. StockerYale (UK) Ltd. may prepay the bond at any time, in whole or in part, without penalty or premium. The bond is secured by all of the equity interests of Photonic Products Ltd. owned by the Company and StockerYale (UK) Ltd. as stated in the Charge Over Shares by and among the Company, StockerYale (UK) Ltd. and Eureka, which was entered into in connection with the financing. The Company used the net proceeds to make the cash payment for the acquisition of Photonic Products Ltd. The remaining proceeds were used for transaction fees and working capital.
In connection with the issuance of the bond on October 31, 2006, the Company issued a Common Stock Purchase Warrant to Eureka to purchase 2,375,000 shares of its common stock for a purchase price of $1.15 per share. The warrant expires on the tenth anniversary of the date of issuance. If StockerYale (UK) Ltd. prepays all amounts outstanding under the bond prior to the third anniversary of the date of issuance, then the number of shares of the Company's common stock . . .
Full Filing can be found at http://www.sec.gov/Archives/edgar/data/94538/000119312508071207/d10ksb.htm