UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-Q





(Mark
One)


x
            QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934




For
the quarterly period ended March 31, 2009




OR




 ̈
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934




For
the transition period from 
to




Commission
file number: 000-27372




StockerYale,
Inc.


(Exact
name of registrant as specified in its charter)









Massachusetts
              04-2114473(State
      or other jurisdiction of
                incorporation
      or organization)
              (I.R.S.
      Employer
                Identification
      No.)




32 Hampshire Road
                Salem, New Hampshire
              03079(Address
      of principal executive offices)
              (Zip
      Code)




Registrant’s
telephone number, including area code: (603) 893-8778





Indicate
by check mark whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.    Yes  x    No   ̈





Indicate by check mark whether the
registrant hassubmitted
electronically and posted on its corporate Web site, if any, every Interactive
Data Filerequired to besubmitted and posted
pursuant to Rule405 of
Regulation S-T (§232.405 of
this chapter) during the preceding 12 months(or for such shorter period
that the registrant was required to submit and post such files). Yes ̈No ̈




Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.





Large accelerated filer   ̈
            Accelerated filer   ̈
            Non-accelerated filer   ̈
            Smaller reporting company  x(Do not
      check if a smaller
              reporting
      company)




Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).    Yes   ̈    No  x




As of
April 21, 2009, there were 44,901,271 shares of the registrant’s common stock
outstanding.










STOCKERYALE,
INC.




INDEX
TO FORM 10-Q




PagePART
      I - FINANCIAL INFORMATIONItem 1
                Financial
      Statements
                3Item 2
                Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                18Item 3
                Quantitative
      and Qualitative Disclosures About Market Risk
                20Item 4
                Controls
      and Procedures
                20PART
      II - OTHER INFORMATIONItem 1
                Legal
      Proceedings
                20Item 1A
                Risk
      Factors
                20Item 5
                Other
      Information
                21Item 6
                Exhibits
                21


2


Item 1.
            Financial
      Statements.




STOCKERYALE,
INC.


CONDENSED
CONSOLIDATED BALANCE SHEETS


In
thousands except share and per share data


Unaudited





March 31,
                                              2009
                                            
                                            
                                            December 31,
                                              2008AssetsCurrent
      assets:Cash
      and cash equivalents
                                            
                                            $
                                            1,199
                                            
                                            
                                            $
                                            1,635Restricted
      cash
                                            
                                            
                                            7
                                            
                                            
                                            
                                            7Accounts
      receivable less allowances of $65 at March 31, 2009 and $115 at
      December 31, 2008
                                            
                                            
                                            3,683
                                            
                                            
                                            
                                            3,859Inventories
                                            
                                            
                                            3,841
                                            
                                            
                                            
                                            3,851Prepaid
      expenses and other current assets
                                            
                                            
                                            485
                                            
                                            
                                            
                                            395Total
      current assets
                                            
                                            
                                            9,215
                                            
                                            
                                            
                                            9,747Net
      property, plant and equipment
                                            
                                            
                                            8,045
                                            
                                            
                                            
                                            8,496Goodwill
                                            
                                            
                                            6,516
                                            
                                            
                                            
                                            6,588Acquired
      intangible assets, net
                                            
                                            
                                            1,745
                                            
                                            
                                            
                                            1,963Other
      long-term assets
                                            
                                            
                                            690
                                            
                                            
                                            
                                            648Total
      assets
                                            
                                            $
                                            26,211
                                            
                                            
                                            $
                                            27,442Liabilities
      and Stockholders’ EquityCurrent
      liabilities:Revolving
      lines of credit
                                            
                                            $
                                            3,767
                                            
                                            
                                            $
                                            4,118Current
      portion of long-term debt, net of unamortized discount of $778 at
      March 31, 2009 and $856 at December 31, 2008
                                            
                                            
                                            4,210
                                            
                                            
                                            
                                            3,869Current
      portion of capital and financing lease obligations
                                            
                                            
                                            570
                                            
                                            
                                            
                                            576Accounts
      payable
                                            
                                            
                                            3,459
                                            
                                            
                                            
                                            3,874Accrued
      expenses
                                            
                                            
                                            3,599
                                            
                                            
                                            
                                            2,496Total
      current liabilities
                                            
                                            
                                            15,605
                                            
                                            
                                            
                                            14,933Long-term
      debt, net of unamortized discount of $491 at March 31, 2009 and $658
      at December 31, 2008
                                            
                                            
                                            5,874
                                            
                                            
                                            
                                            6,372Capital
      and financing lease obligations, net of current portion
                                            
                                            
                                            3,325
                                            
                                            
                                            
                                            3,372Warrant
      liability
                                            
                                            
                                            255
                                            
                                            
                                            
                                            —Deferred
      income taxes, net
                                            
                                            
                                            173
                                            
                                            
                                            
                                            486Total
      liabilities
                                            
                                            
                                            25,232
                                            
                                            
                                            
                                            25,163Stockholders’
      equity:Common
      stock, par value $0.001; shares authorized 100,000,000; 44,901,989 shares
      issued and outstanding at March 31, 2009 and 43,464,413 at
      December 31, 2008
                                            
                                            
                                            45
                                            
                                            
                                            
                                            43Paid-in
      capital
                                            
                                            
                                            102,395
                                            
                                            
                                            
                                            103,270Accumulated
      other comprehensive income
                                            
                                            
                                            2,494
                                            
                                            
                                            
                                            2,518Accumulated
      deficit
                                            
                                            
                                            (103,955
                                            )
                                            
                                            
                                            (103,552
                                            )Total
      stockholders’ equity
                                            
                                            
                                            979
                                            
                                            
                                            
                                            2,279Total
      liabilities and stockholders’ equity
                                            
                                            $
                                            26,211
                                            
                                            
                                            $
                                            27,442




See
notes to unaudited condensed consolidated financial statements.


3




STOCKERYALE,
INC.


CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS


Unaudited




Three Months Ended
                                March 31,2009
                              
                              
                              2008In thousands except per
                                share
      dataRevenue
                              
                              $
                              6,319
                              
                              
                              $
                              8,062Cost
      of sales
                              
                              
                              3,929
                              
                              
                              
                              5,603Gross
      profit
                              
                              
                              2,390
                              
                              
                              
                              2,459Operating
      expenses:Selling
      expenses
                              
                              
                              794
                              
                              
                              
                              1,135General
      and administrative
                              
                              
                              1,575
                              
                              
                              
                              1,761Research
      and development
                              
                              
                              726
                              
                              
                              
                              760Amortization
      of intangibles
                              
                              
                              196
                              
                              
                              
                              330Total
      operating expenses
                              
                              
                              3,291
                              
                              
                              
                              3,986Loss
      from operations
                              
                              
                              (901
                              )
                              
                              
                              (1,527
                              )Other
      expense, net
                              
                              
                              104
                              
                              
                              
                              148Interest
      expense
                              
                              
                              317
                              
                              
                              
                              318Amortization
      of debt discount and financing costs
                              
                              
                              465
                              
                              
                              
                              255Loss
      from continuing operations before income tax benefit
                              
                              
                              (1,787
                              )
                              
                              
                              (2,248
                              )Income
      tax benefit
                              
                              
                              173
                              
                              
                              
                              61Loss
      from continuing operations
                              
                              
                              (1,614
                              )
                              
                              
                              (2,187
                              )Income
      from discontinued operations, net of tax
                              
                              
                              7
                              
                              
                              
                              21Net
      loss
                              
                              $
                              (1,607
                              )
                              
                              $
                              (2,166
                              )Basic
      and diluted net loss per share from continuing operations
                              
                              $
                              (0.04
                              )
                              
                              $
                              (0.06
                              )Basic
      and diluted net loss per share from discontinued
operations
                              
                              $
                              (0.00
                              )
                              
                              $
                              (0.00
                              )Basic
      and diluted net loss per share
                              
                              $
                              (0.04
                              )
                              
                              $
                              (0.06
                              )Basic
      and diluted weighted average shares outstanding
                              
                              
                              42,638
                              
                              
                              
                              36,727




See
notes to unaudited condensed consolidated financial statements.


4


STOCKERYALE,
INC.


CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS


Unaudited





Three Months Ended
                                        March 31,2009
                                      
                                      
                                      2008In
      thousandsOperationsNet
      loss
                                      
                                      $
                                      (1,607
                                      )
                                      
                                      $
                                      (2,166
                                      )Income
      from discontinued operations, net of tax
                                      
                                      
                                      7
                                      
                                      
                                      
                                      21Loss
      from continuing operations
                                      
                                      
                                      (1,614
                                      )
                                      
                                      
                                      (2,187
                                      )Adjustments
      to reconcile net loss to net cash (used in) operating
      activities:Stock
      based compensation
                                      
                                      
                                      243
                                      
                                      
                                      
                                      276Depreciation
      and amortization
                                      
                                      
                                      633
                                      
                                      
                                      
                                      850Amortization
      of debt discount and financing costs
                                      
                                      
                                      465
                                      
                                      
                                      
                                      255Non
      cash interest expense
                                      
                                      
                                      68
                                      
                                      
                                      
                                      72Fair
      value of warrants
                                      
                                      
                                      (36
                                      )
                                      
                                      
                                      —Provision
      for inventories
                                      
                                      
                                      11
                                      
                                      
                                      
                                      11Reduction
      to provision for bad debts
                                      
                                      
                                      (24
                                      )
                                      
                                      
                                      —Deferred
      income taxes
                                      
                                      
                                      (173
                                      )
                                      
                                      
                                      (62
                                      )Other
      change in assets and liabilities:Accounts
      receivable
                                      
                                      
                                      88
                                      
                                      
                                      
                                      (60
                                      )Inventories
                                      
                                      
                                      (94
                                      )
                                      
                                      
                                      (34
                                      )Prepaid
      expenses and other current assets
                                      
                                      
                                      (98
                                      )
                                      
                                      
                                      74Accounts
      payable
                                      
                                      
                                      (350
                                      )
                                      
                                      
                                      488Accrued
      expenses
                                      
                                      
                                      769
                                      
                                      
                                      
                                      (366
                                      )Net
      cash (used in) operating activities
                                      
                                      
                                      (112
                                      )
                                      
                                      
                                      (683
                                      )FinancingNet
      proceeds from sale of common stock
                                      
                                      
                                      9
                                      
                                      
                                      
                                      —Borrowings
      / (Repayments) of revolving credit facilities - U.S.
                                      
                                      
                                      30
                                      
                                      
                                      
                                      461Borrowings
      of revolving credit facilities - U.K.
                                      
                                      
                                      (119
                                      )
                                      
                                      
                                      1,532Principal
      repayment of long-term debt
                                      
                                      
                                      (242
                                      )
                                      
                                      
                                      (481
                                      )Debt
      issuance costs
                                      
                                      
                                      —
                                      
                                      
                                      
                                      (11
                                      )Net
      cash provided by / (used in) financing activities
                                      
                                      
                                      (322
                                      )
                                      
                                      
                                      1,501InvestingPayments
      of financing obligation
                                      
                                      
                                      (82
                                      )
                                      
                                      
                                      (64
                                      )Purchases
      of plant and equipment
                                      
                                      
                                      (30
                                      )
                                      
                                      
                                      (26
                                      )Net
      cash (used in) continuing investing activities
                                      
                                      
                                      (112
                                      )
                                      
                                      
                                      (90
                                      )Net
      cash provided by discontinued operations
                                      
                                      
                                      7
                                      
                                      
                                      
                                      21Net
      cash (used in) investing activities
                                      
                                      
                                      (105
                                      )
                                      
                                      
                                      (69
                                      )Effect
      of exchange rate on cash
                                      
                                      
                                      103
                                      
                                      
                                      
                                      82Net
      change in cash and equivalents
                                      
                                      
                                      (436
                                      )
                                      
                                      
                                      831Cash
      and equivalents, beginning of period
                                      
                                      
                                      1,635
                                      
                                      
                                      
                                      1,577Cash
      and equivalents, end of period
                                      
                                      $
                                      1,199
                                      
                                      
                                      $
                                      2,408Supplemental
      disclosure of cash flow information:Cash
      paid for interest
                                      
                                      $
                                      289
                                      
                                      
                                      $
                                      283Issuance
      of restricted stock
                                      
                                      $
                                      —
                                      
                                      
                                      $
                                      114Issuance
      of common stock to settle liabilities
                                      
                                      $
                                      370
                                      
                                      
                                      $
                                      102Common
      stock issued with financing
                                      
                                      $
                                      —
                                      
                                      
                                      $
                                      51Additional
      discount from extension of warrants
                                      
                                      $
                                      —
                                      
                                      
                                      $
                                      477




See
notes to unaudited condensed consolidated financial statements.


5


STOCKERYALE,
INC.




NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS




(1)
ORGANIZATION AND BASIS OF PRESENTATION




The
accompanying unaudited condensed consolidated financial statements have been
prepared by StockerYale, Inc. (the “Company”) and, in the opinion of management,
reflect all adjustments of a normal recurring nature necessary for a fair
statement of (i) the results of operations for the three month periods
ended March 31, 2009 and 2008, (ii) the financial position at
March 31, 2009 and December 31, 2008, and (iii) the cash flows
for the three month periods ended March 31, 2009 and 2008. These interim
results are not necessarily indicative of results for a full year or any other
interim period.




The
accompanying consolidated financial statements and notes are condensed as
permitted by Form 10-Q and do not contain certain information included in the
annual financial statements and notes of the Company. These statements are
prepared on a going concern basis, which contemplates the realization of assets
and satisfaction of liabilities in the normal course of business. The Company’s
continuation as a going concern is dependent on its ability to generate
sufficient cash flow to meet its obligations on a timely basis through improved
operations and/or additional financing. These unaudited condensed consolidated
financial statements and notes should be read in conjunction with the
consolidated financial statements and notes included in the Company’s Annual
Report on Form 10-K for the year ended December 31, 2008.




The
Company took a number of actions during 2008 and the first quarter of 2009 to
improve its operational efficiency and its overall financial
performance.  In addition, in response to the general economic
slowdown that began in late 2008, management initiated a number of actions to
improve cash flow and liquidity recognizing that the economy could negatively
impact the future performance of the Company.  These actions
include:




·
            Customer-driven
      new product development to provide our customers and potential customers
      with an array of leading edge
products;




·
            Reduction
      in our overall cost structure in a variety of ways
      including:  reduction of work force, salary reductions,
      improvements in supply chain management and material
  costs;




·
            Improvements
      in working capital through focused management of inventory and accounts
      receivable;




·
            Further
      cost reductions, as necessary and able, in order to improve cash
      flow.




We are
considering different ways to raise additional capital including the sale of our
equity securities, offerings of debt securities, or borrowings from financial
institutions. We are in discussions with several potential lenders to refinance
both revolving credit facilities (North America and United Kingdom) as well as
potential lenders to refinance portions of the term debt of the
Company.  However, there can be no assurance that such activities will
result in refinancing.  We have engaged Needham & Company, LLC to
assist us in reviewing and evaluating our financial and strategic
alternatives.




We intend
to pursue various options to finance and fund operations, as necessary, through
the end of 2009. 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 2009, 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.




(2)
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.


6




(3)
RECENT ACCOUNTING PRONOUNCEMENTS




EITF
07-05, Determining Whether an Instrument (or Embedded Feature) Is Indexed to an
Entity's Own Stock





In June
2008, the Emerging Issues Task Force ratified Consensus No. 07-05 Determining
Whether an Instrument (or Embedded Feature) Is Indexed to an Entity's Own Stock
for periods beginning after December 15, 2008. EITF 07-05 applies to any
freestanding financial instrument or embedded features that have the
characteristics of a derivative, as defined by SFAS No. 133, “Accounting
for Derivative Instruments and Hedging Activities,” and to any freestanding
financial instruments that are potentially settled in an entity’s own common
stock.  The Company adopted EITF 07-05 on January 1, 2009 and
determined that certain Warrants, that are contractually indexed to 2,375,000
shares of Common Stock and that were previously treated as stockholders’ equity
under the derivative treatment exemption were no longer eligible for equity
treatment.  These warrants have an exercise price of $1.15 and expire
in October 2016. Effective January 1, 2009 the fair value of these common
stock purchase warrants, which have exercise price reset features, was
reclassified from equity to liability status as if these warrants were treated
as a derivative liability since their date of issue in October, 2006. On
January 1, 2009, the Company reclassified from additional paid-in capital,
as a cumulative effect adjustment, $1.2 million to beginning retained
earnings and $0.3 million to a long-term warrant liability.  The
Company recognized a gain of approximately $36,000 from the change in fair value
of these warrants for the three months ended March 31, 2009.





The
common stock purchase warrants were not issued with the intent of effectively
hedging any future cash flow, fair value of any asset, liability or any net
investment in a foreign operation. The warrants do not qualify for hedge
accounting, and all future changes in the fair value of these warrants will be
recognized currently in earnings until the warrants are exercised or
expire."





These
common stock purchase warrants do not trade in an active securities market, and
we estimate the fair value of these warrants using the Black-Scholes option
pricing model using the following assumptions:





March 31,
                        2009
                      
                      
                      January
      1,
                        2009Volatility
                      
                      
                      102.78
                      
                      
                      
                      101.40Expected
      option life
                      
                      
                      10.0
                      
                      
                      
                      10.0Interest
      rate (risk free)
                      
                      
                      2.71
                      %
                      
                      
                      2.46
                      %Dividends
                      
                      
                      0.0
                      
                      
                      
                      0.0




SFAS
161, “Disclosures about Derivative Instruments and Hedging Activities”, an
amendment of FASB Statement No. 133




In March
2008, the FASB issued SFAS No. 161, Disclosures about Derivative
Instruments and Hedging Activities(“SFAS 161”),an amendment of FASB
Statement No. 133, which requires additional disclosures about the
objectives of the derivative instruments and hedging activities, the method of
accounting for such instruments under SFAS No. 133 and its related
interpretations, and a tabular disclosure of the effects of such instruments and
related hedged items on our financial position, financial performance, and cash
flows.. The Company adopted SFAS 161 on January 1, 2009, and the adoption did
not have a material impact on its consolidated financial
statements.




SFAS
160, “Noncontrolling Interests in Consolidated Financial Statements”, an
amendment of ARB 51




In
December 2007, the FASB issued SFAS 160,Noncontrolling Interests in
Consolidated Financial Statements, an amendment of ARB 51,Consolidated Financial
Statements. SFAS 160 provides guidance for the accounting, reporting and
disclosure of noncontrolling interests, also called minority interest. A
minority interest represents the portion of equity (net assets) in a subsidiary
not attributable, directly or indirectly, to a parent. The Company adopted SFAS
160 on January 1, 2009 and the adoption did not have a material impact on
its consolidated financial statements.




SFAS
No. 141(R) “Business Combinations”




In
December 2007, the FASB issued SFAS No. 141(R), Business Combinations,which
replaces SFAS No. 141, Business Combinations.SFAS 141(R) (i) requires the acquiring entity in a business
combination to record all assets acquired and liabilities assumed at their
acquisition-date fair values, (ii) changes the recognition of assets
acquired and liabilities assumed arising from contingencies, (iii) requires
contingent consideration to be recognized at its fair value on the acquisition
date and, for certain arrangements, requires changes in fair value to be
recognized in earnings until settled, (iv) requires companies to revise any
previously issued post-acquisition financial information to reflect any
adjustments as if they had been recorded on the acquisition date,
(v) requires the reversals of valuation allowances related to acquired
deferred tax assets and changes to acquired income tax uncertainties to be
recognized in earnings, and (vi) requires the expensing of
acquisition-related costs as incurred. SFAS 141(R) also requires additional
disclosure of information surrounding a business combination to enhance
financial statement users’ understanding of the nature and financial impact of
the business combination. SFAS 141(R) applies prospectively to business
combinations for which the acquisition date is on or after the beginning of the
first annual reporting period beginning on or after December 15, 2008, with
the exception of accounting for changes in a valuation allowance for acquired
deferred tax assets and the resolution of uncertain tax positions accounted for
under FIN 48, which is effective on January 1, 2009 for all acquisitions.
The Company adopted SFAS 141(R) on January 1, 2009 and it will have an impact on
accounting, but the impact is dependent upon the acquisitions made after
adoption.


7




SFAS
No. 157, Defining Fair Value Measurements, and FASB Staff Position
157-2


In
September 2006, the FASB issued SFAS No. 157, “Fair Value
Measurements” (“SFAS 157”), which defines fair value, establishes a framework
for measuring fair value in GAAP, and expands disclosures about fair value
measurements. SFAS 157 does not require any new fair value measurements, but
provides guidance on how to measure fair value by providing a fair value
hierarchy used to classify the source of the information. In February 2008,
the FASB deferred the effective date of SFAS 157 by one year for certain
non-financial assets and non-financial liabilities, except those that are
recognized or disclosed at fair value in the financial statements on a recurring
basis (at least annually). On January 1, 2008, the Company adopted the
provisions of SFAS 157, except as it applies to those nonfinancial assets and
nonfinancial liabilities for which the effective date has been delayed by one
year, which was adopted on January 1, 2009. The adoption of SFAS 157 did
not have a material effect on our financial position or results of operations.
The Company’s financial instruments consist mainly of cash and cash equivalents,
accounts receivable, short-term debt, accounts payable and long-term debt. The
estimated fair value of these financial instruments 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. As of March 31, 2009, the Company
estimated the fair value of long term fixed rate debt to be approximately
$5,300,000 compared to its carrying value of $6,000,000.





The fair
value hierarchy distinguishes between assumptions based on market data
(observable inputs) and an entity’s own assumptions (unobservable inputs). The
hierarchy consists of three levels:


•
            Level one — Quoted market prices
      in active markets for identical assets or
    liabilities;





•
            Level two — Inputs other than
      level one inputs that are either directly or indirectly observable;
      and





•
            Level three — Unobservable inputs
      developed using estimates and assumptions, which are developed by the
      reporting entity and reflect those assumptions that a market participant
      would use.





Determining
which category an asset or liability falls within the hierarchy requires
significant judgment. The Company evaluates its hierarchy disclosures each
quarter.  Liabilities measured at fair value on a recurring basis are
summarized as follows (unaudited):





In ThousandsMarch 31,Level 1
                  
                  
                  Level 2
                  
                  
                  Level 3
                  
                  
                  2009Fair
      value of warrants
                  
                  $
                  -
                  
                  
                  $
                  255
                  
                  
                  $
                  -
                  
                  
                  $
                  255Total
                  
                  $
                  -
                  
                  
                  $
                  255
                  
                  
                  $
                  -
                  
                  
                  $
                  255




(4) LOSS
PER SHARE




In
accordance with Statement of Financial Accounting Standards (“SFAS”)
No. 128, Earnings per
Share, basic and diluted net loss per common share for the three months
ended March 31, 2009 and 2008, respectively is calculated by dividing the
net loss applicable to common stockholders by the weighted average number of
vested common shares outstanding. There were 5,505,539 options and 8,022,850
warrants outstanding as of March 31, 2009 and 3,943,479 options and
6,443,316 warrants outstanding as of March 31, 2008 which were not included
in the diluted shares calculation because their inclusion would be
anti-dilutive. The Company had 1,273,147 and 2,100,751 shares of unvested
restricted stock outstanding as of March 31, 2009 and March 31, 2008,
respectively. The unvested shares of restricted stock were not included in the
diluted shares calculation as their effect would be anti-dilutive.




(5)
REVENUE RECOGNITION




The
Company recognizes revenue from sales of products and funded research and
development and product development for commercial companies and government
agencies. The Company recognizes revenue in accordance with SEC Staff Accounting
Bulletin No. 101, “Revenue Recognition in Financial
Statements”(“SAB 101”) as updated by Staff Accounting Bulletin (“SAB”)
104, Revenue
Recognition and Emerging Issues Task Force (“EITF”) 00-21, Revenue Arrangements with Multiple
Deliverables.


8




The
Company recognizes revenue from product sales at the time of shipment and when
persuasive evidence of an arrangement exists, performance of the Company’s
obligation is complete, the price to the buyer is fixed or determinable, and
collectability is reasonably assured. The Company’s custom products are 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 FOB shipping point. In certain
limited situations, distributors have the right to return products. Such rights
of return have not precluded revenue recognition because the Company has a long
history with such returns and accordingly is able to estimate a reserve for
their cost.





Revenues
from funded research and development and product development is 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 and collectability is reasonably assured. On fixed-price
contracts, revenue is generally recognized on a percentage-of completion basis
based on proportion of costs incurred to the total estimated costs of the
contract or under the proportional method. Over the course of a fixed-price
contract, the Company routinely evaluates whether revenue and profitability
should be recognized in the current period. The Company estimates the
proportional performance on their fixed-price contracts on a monthly basis
utilizing hours incurred to date as a percentage of total estimated hours to
complete the project. If the Company does not have a sufficient basis to measure
progress toward completion, revenue is recognized upon completion of
performance. This method is used because reasonably dependable estimates of
costs and revenue earned can be made, based on historical experience and
milestones identified in any particular contract. When the current estimates of
total contract revenue and contract costs indicate a loss, a provision for the
entire loss on the contract is recorded.




If a
contract involves the provision of multiple elements and the elements qualify
for separation under EITF 00-21, total estimated contract revenue is allocated
to each element based on the relative fair value of each element provided. The
amount of revenue allocated to each element is limited to the amount that is not
contingent upon the delivery of another element in the future. Revenue is then
recognized for each element as described above.




(6)
WARRANTY




The
Company provides warranties on most of its products for periods of between one
to two years. 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 versus the reserve as a percent of sales. The
Company periodically adjusts the warranty provision based on the actual
experience and for any particular known instances.




Warranty
Reserves:




Quarters Ended March 31
                  
                  2009
                  
                  
                  2008In thousandsBalance
      at December 31
                  
                  $
                  253
                  
                  
                  $
                  302Charges
      to costs and expenses
                  
                  
                  23
                  
                  
                  
                  63Account
      write-offs and other deductions
                  
                  
                  (33
                  )
                  
                  
                  (42
                  )Balance
      at March 31
                  
                  $
                  243
                  
                  
                  $
                  323




(7)
INVENTORIES




Inventories
are stated at the lower of cost (first-in, first-out basis) or market and
include materials, labor and overhead. Inventories are as follows:




March 31,
                        2009
                      
                      
                      December 31,
                        2008In
      thousandsFinished
      goods
                      
                      $
                      939
                      
                      
                      $
                      931Work-in-process
                      
                      
                      415
                      
                      
                      
                      369Raw
      materials
                      
                      
                      2,487
                      
                      
                      
                      2,551Net
      inventories
                      
                      $
                      3,841
                      
                      
                      $
                      3,851




9


(8) STOCK
BASED COMPENSATION PLANS AND STOCK-BASED COMPENSATION EXPENSE




The
Company has stock-based compensation plans for its employees, officers, and
directors. The plans permit the grant of a variety of awards with various terms
and prices as determined by the Governance, Nominating and Compensation
Committee (“GNCC”) of the Company’s Board of Directors.  The grants
vest over terms of two to four years and are priced at fair market value or in
certain circumstances 110% of the fair market value, of the common stock on the
date of the grant. The options are generally exercisable after the period
specified in the option agreement, but no option may be exercised after 10 years
from the date of grant.




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. However, there is an exception 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.




Effective
January 1, 2006, the Company adopted the provisions of Statement of
Financial Accounting Standards (“SFAS”) No. 123(R), Share-Based Payment, (“SFAS
123(R)”) and the Securities and Exchange Commission (“SEC”) Staff Accounting
Bulletin No. 107, Share
Based Payments,(“SAB 107”). SFAS 123(R) establishes accounting for
stock-based awards issued for employee services, while SAB107 provides guidance
regarding the interaction of SFAS 123(R) and certain SEC rules and regulations.
Accordingly, stock-based compensation cost is measured at grant date, based on
the fair value of the award, and is recognized as an expense over the employee’s
requisite service period. The Company previously applied Accounting
Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to
Employees, and related Interpretations and provided the required pro
forma disclosures of SFAS No. 123, Accounting for Stock-Based
Compensation (“SFAS 123”). The Company elected to adopt the modified
prospective application method as provided by SFAS 123(R), and, accordingly, the
Company recorded compensation costs as the requisite service was rendered for
the unvested portion of previously issued awards that remain outstanding at the
initial date of adoption and any awards issued, modified, repurchased, or
cancelled after the effective date of SFAS 123(R). Periods prior to adoption
have not been restated.




In March
2005, the SEC issued SAB 107, which provides guidance regarding the interaction
of SFAS 123(R) and certain SEC rules and regulations. The new guidance includes
the SEC’s view on the valuation of share-based payment arrangements for public
companies and clarifies some of SFAS 123(R)’s implementation for registrants.
The Company adopted the provisions of SAB 107 on January 1,
2006.




Stock
Option Awards




The fair
value of each option grant is estimated using the Black-Scholes option pricing
model. The fair value is then amortized on a straight-line basis 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 was calculated based on
the historical volatility of the Company’s stock, at the time of the award. The
average expected option term was estimated at 5 years. The risk-free interest
rate is based on U.S. Treasury zero-coupon issues assumed at the date of grant
and no dividends were assumed in the calculation. The compensation expense
recognized for all equity-based awards is net of estimated forfeitures for the
three months ending March 31, 2009 and 2008. Forfeitures are estimated
based on the historical trends. The fair value of options at the date of grant
was estimated using the Black-Scholes option pricing model. There were 2,577,650
options granted during the three months ended March 31, 2009.




On
January 16, 2009, the GNCC adopted a stock option incentive program for 2009.
The GNCC adopted a policy of granting performance-based options to purchase
shares of the Company’s common stock to various executive officers and key
employees. All options shall vest and become exercisable on the date the Company
publicizes its earnings press release regarding fiscal 2009 results, if the
stated performance goals are met. The Company records the related expense, if
any, over the requisite service period, and assesses the probability of
attaining the performance goals at each reporting date.  If the
performance goals are not met, the options will terminate. Options for a total
of 1,865,000 shares of common stock were granted under this performance-based
program on January 16, 2009.




On
March 17, 2008, the GNCC adopted a stock option incentive program for 2008.
The GNCC adopted a policy of granting performance-based options to purchase
shares of the Company’s common stock to various executive officers and key
employees. All options would vest and become exercisable on the date the Company
publicized its earnings press release regarding fiscal 2008 results, if the
stated performance goals are met. As the performance goals were not met, the
options immediately terminated and the previously accrued compensation cost of
approximately $490,000 was reversed in the fourth quarter of 2008, resulting in
no net compensation recorded in 2008 related to the program. Options to purchase
a total of 1,522,300 shares of common stock were granted under this
performance-based program on March 17, 2008, all of which were forfeited
when the performance goals were not met.


10




The fair
value of options at the date of grant was estimated using the Black-Scholes
option pricing model. The assumptions for grants during the three months ended
March 31, 2009 were as follows:





Three Months Ended
                              March 31,
                              2009Volatility
                            
                            101.40%-102.24%Expected
      option life
                            
                            6.08Interest
      rate (risk free)
                            
                            1.54%
      - 2.49%Dividends
                            
                            NoneWeighted
      average grant date fair value
                            
                            $0.13




A summary
of option activity as of March 31, 2009 and changes during the first
quarter is presented below:




Options
                                Outstanding
                              
                              
                              Weighted
                                Average
                                Exercise Price
                                per
      Share
                              
                              
                              Weighted
                                Average
                                Remaining
                                Contractual Term
                                (in
      Years)
                              
                              
                              Aggregate Intrinsic
                                Value
                                (in thousands)Balance
      at December 31, 2008
                              
                              
                              2,987,889
                              
                              
                              $
                              3.45
                              
                              
                              
                              4.58
                              
                              
                              $
                              -Granted
                              
                              
                              2,577,650
                              
                              
                              
                              0.16
                              
                              
                              
                              —
                              
                              
                              
                              —Exercised
                              
                              
                              —
                              
                              
                              
                              —
                              
                              
                              
                              —
                              
                              
                              
                              —Cancelled
                              
                              
                              (60,000
                              )
                              
                              
                              0.69
                              
                              
                              
                              —
                              
                              
                              
                              —Balance
      at March 31, 2009
                              
                              
                              5,505,539
                              
                              
                              $
                              1.84
                              
                              
                              
                              7.11
                              
                              
                              $
                              1Vested
      and Exercisable at March 31, 2009
                              
                              
                              2,135,617
                              
                              
                              $
                              4.36
                              
                              
                              
                              3.03
                              
                              
                              
                              —




As of
March 31, 2009, there was a total unrecognized compensation cost of
approximately $444,000 related to non-vested stock options outstanding. The cost
is expected to be recognized over the next 1.2 years. There were no options
exercised in the three months ended March 31, 2009.




Restricted
Share Awards (“RSAs”)




The
Company has awarded to a number of employees restricted shares of the Company’s
common stock. The RSAs vest in equal annual installments over a period of four
years. The fair market value of the RSAs is based on the fair market value per
share of the Company’s common stock on the date of grant and is amortized over
the vesting period. During the quarter ended March 31, 2009, there were no
shares of restricted stock issued and 42,747 shares of restricted stock
vested.




A summary
of the status of the Company’s RSAs as of March 31, 2009 and changes during
the first quarter is presented below:




Shares
                            
                            
                            Weighted
                              Average
                              Grant-Date Fair ValueNon-vested
      at December 31, 2008
                            
                            
                            1,368,394
                            
                            
                            $
                            1.17Granted
                            
                            
                            -
                            
                            
                            
                            -.Vested
                            
                            
                            (42,747
                            )
                            
                            
                            0.72Cancelled
                            
                            
                            (52,500
                            )
                            
                            
                            1.36Non-vested
      at March 31, 2009
                            
                            
                            1,273,147
                            
                            
                            $
                            1.18




As of
March 31, 2009, there was a total unrecognized compensation cost of
approximately $1,505,000 related to non-vested RSAs. The Company expects to
recognize the costs over the next 1.9 years.




(9)
COMPREHENSIVE LOSS




SFAS
No. 130, Reporting
Comprehensive Income,requires disclosure of all components of
comprehensive income (loss) on an annual and interim basis. Comprehensive income
(loss) is defined as the change in equity of a business enterprise during a
period from transactions and other events and circumstances from non-owner
sources. The Company’s total comprehensive loss is as follows:


11





Three
      Months Ended
                                    March 31,2009
                                  
                                  
                                  2008In
      thousandsNet
      loss
                                  
                                  $
                                  (1,607
                                  )
                                  
                                  $
                                  (2,166
                                  )Other
      comprehensive loss:Cumulative
      translation adjustment
                                  
                                  
                                  (24
                                  )
                                  
                                  
                                  (96
                                  )Comprehensive
      loss
                                  
                                  $
                                  (1,631
                                  )
                                  
                                  $
                                  (2,262
                                  )




(10)
INTANGIBLE ASSETS




Intangible
assets consist of trademarks, acquired patents and patented technologies,
distributor and customer relationships and related contracts, trade and brand
names and associated logos, technology design and programs, non-compete
agreements and other intangible assets. There are no intangible assets with
indefinite lives. Acquired patented technologies and trademarks are amortized
over their estimated useful lives of between 3 - 16 years.




Gross
carrying amounts and accumulated amortization of intangible assets were as
follows as of March 31, 2009 for each intangible asset class.




Gross Carrying
                          Amount
                        
                        
                        Accumulated
                          Amortization
                        
                        
                        Carrying Value(in thousands)Acquired
      patents, patented technology and purchased technology
                        
                        $
                        3,360
                        
                        
                        $
                        (3,153
                        )
                        
                        $
                        207Trademarks
                        
                        
                        471
                        
                        
                        
                        (471
                        )
                        
                        
                        —Acquired
      trade name
                        
                        
                        430
                        
                        
                        
                        (130
                        )
                        
                        
                        300Acquired
      customer contracts and relationships
                        
                        
                        1,748
                        
                        
                        
                        (871
                        )
                        
                        
                        877Acquired
      non-compete agreement
                        
                        
                        565
                        
                        
                        
                        (456
                        )
                        
                        
                        109Acquired
      technology design and programs
                        
                        
                        295
                        
                        
                        
                        (89
                        )
                        
                        
                        206Other
                        
                        
                        104
                        
                        
                        
                        (58
                        )
                        
                        
                        46Total
                        
                        $
                        6,973
                        
                        
                        $
                        (5,228
                        )
                        
                        $
                        1,745




Gross
carrying amounts and accumulated amortization of intangible assets were as
follows as of December 31, 2008 for each intangible asset
class.




Gross Carrying
                          Amount
                        
                        
                        Accumulated
                          Amortization
                        
                        
                        Carrying Value(in thousands)Acquired
      patents, patented technology and purchased technology
                        
                        $
                        3,353
                        
                        
                        $
                        (3,123
                        )
                        
                        $
                        230Trademarks
                        
                        
                        471
                        
                        
                        
                        (471
                        )
                        
                        
                        -Acquired
      trade name
                        
                        
                        438
                        
                        
                        
                        (118
                        )
                        
                        
                        320Acquired
      customer contracts and relationships
                        
                        
                        1,779
                        
                        
                        
                        (796
                        )
                        
                        
                        983Acquired
      non-compete agreement
                        
                        
                        576
                        
                        
                        
                        (416
                        )
                        
                        
                        160Acquired
      technology design and programs
                        
                        
                        301
                        
                        
                        
                        (82
                        )
                        
                        
                        219Other
                        
                        
                        104
                        
                        
                        
                        (53
                        )
                        
                        
                        51Total
                        
                        $
                        7,022
                        
                        
                        $
                        (5,059
                        )
                        
                        $
                        1,963




Amortization
of intangible assets was $196,000 for the three months ended March 31, 2009
and $330,000 for the three months ended March 31, 2008.




As of
March 31, 2009, the estimated future amortization expense of intangible
assets, in thousands, is as follows:




Estimated
      Future Expense
                          In
      thousands2009
                        
                        
                        2010
                        
                        
                        2011
                        
                        
                        2012
                        
                        
                        2013
                        
                        
                        2014
      &
                          thereafterAmortization
      expense of intangible assets
                        
                        $
                        530
                        
                        
                        $
                        431
                        
                        
                        $
                        300
                        
                        
                        $
                        167
                        
                        
                        $
                        167
                        
                        
                        $
                        150


12




(11)
DEBT




A summary
of the Debt Obligations of the Company is as follows:


March
      31,
                                        
                                        
                                        December
      31,2009
                                        
                                        
                                        2008In
      thousandsAcquired
      note payable to Barclay’s Bank, maturing on November 16, 2009 and
      having an interest rate of 2.5% above Barclay’s base rate (3.0% at March
      31, 2009)
                                        
                                        $
                                        15
                                        
                                        
                                        $
                                        22Borrowings
      under Revolving Credit facility with Barclay’s Bank Sales Financing with
      an interest rate of 2.55% above Barclay’s base rate (3.05% as of March 31,
      2009)
                                        
                                        
                                        578
                                        
                                        
                                        
                                        710Borrowings
      under Line of Credit Agreement with Laurus Master Fund, Ltd., maturing on
      June 28, 2009, with an interest rate of the prime rate plus 1% (4.25% at
      March 31, 2009)
                                        
                                        
                                        3,189
                                        
                                        
                                        
                                        3,159Notes
      Payable to Laurus Master Fund, Ltd. and affiliates maturing onJune
      30, 2010, with an interest rate of prime plus 2%, and a minimum rate of
      8.0% (8.0% at March 31, 2009), net of unamortized discount of $360 at
      March 31, 2009 and $460 at December 31, 2008
                                        
                                        
                                        2,715
                                        
                                        
                                        
                                        2,690Note
      Payable to an affiliate of Laurus Master Fund, Ltd. maturing onJune
      30, 2010, with an interest rate of 10.5%, net of unamortized discount of
      $64 at March 31, 2009 and $90 at December 31, 2008
                                        
                                        
                                        669
                                        
                                        
                                        
                                        676Senior
      Fixed Rate Secured Bond to a private investor with an interest rate
      of  12%, maturing on July 30, 2011 net of unamortized
      discount of $137 at March 31, 2009 and $166 at December 31,
      2008
                                        
                                        
                                        891
                                        
                                        
                                        
                                        1,028Senior
      Fixed Rate Secured Bond payable to a private investor, maturing on
      October 31, 2011 with an interest rate of 10%, net of unamortized
      discount of $708 at March 31, 2009 and $798 at December 31,
      2008
                                        
                                        
                                        3,394
                                        
                                        
                                        
                                        3,674Bonds
      payable to the stockholders of Photonic Products Ltd. maturing on
      October 31, 2009, with an interest rate of LIBOR plus 1%, (2.21% at
      March 31, 2009)
                                        
                                        
                                        2,400
                                        
                                        
                                        
                                        2,400Sub-total
      debt
                                        
                                        
                                        13,851
                                        
                                        
                                        
                                        14,359Less
      – lines of credit / revolver
                                        
                                        
                                        (3,767
                                        )
                                        
                                        
                                        (3,869
                                        )Less—Current
      portion of long-term debt, net of discount
                                        
                                        
                                        (4,210
                                        )
                                        
                                        
                                        (4,118
                                        )Total
      long-term debt
                                        
                                        $
                                        5,874
                                        
                                        
                                        $
                                        6,372





On
January 13, 2009, a private investor holding a 10% Senior Fixed Rate
Secured Bond issued by StockerYale (UK) Limited, a subsidiary of the Company,
agreed to forego six monthly principal payments due under the Bond from
January 2009 to June 2009 totaling $370,044. In consideration, the Company
agreed to issue to the private investor an aggregate of 1,480,176 shares of the
common stock of the Company.


13


Laurus
Master Fund
  Line of Credit
Agreement:
  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 a
previously outstanding credit facility between the Company and a bank.
Additional amounts borrowed under the line of credit from time to time may be
used for the Company’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 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 million limited to qualifying receivables and
inventories as defined in the agreement.
  The
Company began making monthly payments to Laurus of accrued interest only on
August 1, 2006. The outstanding principal under the revolver accrues
interest at an annual rate of 1% above the prime rate. The interest rate was
4.25% as of March 31, 2009. The Company may elect to prepay the revolver 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.
  In 2006,
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.
 On
March 31, 2008, Laurus granted the Company the ability to borrow up to
$500,000 over the limit defined by qualified receivables and inventory for one
year, expiring March 31, 2009. In consideration, the Company issued and
sold to
 Laurus
100,000 shares of its common stock at a per share purchase price of $.01, for an
aggregate purchase price of $1,000, and extended the term of all outstanding
warrants issued to Laurus for an additional 5 years. The Company recorded debt
acquisition costs relating to the line of credit for cash fees paid of
approximately $21,000 and an additional amount as debt acquisition costs of
approximately $528,000 representing the fair market value of the stock issued
and the warrant modification. The debt acquisition charges are being amortized
over the one year life of the over advance agreement. The Company used the
Black-Scholes model to calculate the impact of the warrant modification. There
were a total of 1,820,000 warrants modified. The factors used were as follows:
(i) warrant exercise prices ranged from $0.80 to $3.12, (ii) the
expected term ranged from 2.5 to 9 years, (iii) volatility rates ranged
from 73.79% to 98.55%, (iv) the risk free interest rates ranged from 1.62%
to 3.45% and (v) no dividends were assumed. The value of the warrant
modifications was calculated at approximately $477,000. The fair value of the
common stock was approximately $51,000. On April 16, 2009, the Company and
Laurus entered into an agreement, effective March 31, 2009, to extend the
overadvance by amending the note.  The amendment grants a risk
premium, payable in cash, to Laurus of $200,000 on June 30, 2010 if the
obligations under the note are paid in full and the Note terminated and
cancelled on or before May 15, 2009. If the obligations under the note are paid
after May 15, 2009, the cash due for the risk premium will be $400,000. The
Company has evaluated the likelihood of meeting the first date of May 15, 2009,
and concluded that it should accrue the maximum fee of $400,000 as a liability,
with an offset to deferred debt acquisition costs on the balance sheet as of
March 31, 2009.  This $400,000 will be expensed over the three month
period of the extension.
 
 There was
$3,189,324 outstanding under the line of credit as of March 31, 2009, which
includes the $500,000 overadvance, and was classified as lines of
credit/revolver and $3,159,324 outstanding as of December 31, 2008, which
includes the $500,000 over draft, and was classified as revolving lines of
credit. The credit line availability at March 31, 2009 was approximately
$127,000.
  Barclay’s
Bank, PLC
  On
February 6, 2008, the Company’s Photonic Products subsidiary entered into a
Confidential Invoice Discounting Agreement with Barclay’s Bank Sales Financing
(“Barclay’s”). Under the Discounting Agreement, a three-year revolving line of
credit was established. The Discounting Agreement provides for a revolving line
of credit not to exceed an aggregate principal amount of £700,000 ($1,400,000)
and grants a security interest in and lien upon all of Photonic Products’ trade
receivables in favor of Barclay’s.
  14
  The
facility requires the maintenance of certain financial covenants including
annual sales and minimum tangible net worth. The Company was not in compliance
at March 31, 2009. Barclay’s also reserves the right to review the facility in
the event of losses in any 3-month rolling period. The outstanding principal
under the note accrues interest at an annual rate of 2.55% above Barclay’s base
rate. The interest rate was 3.05% as of March 31, 2009. The Company may elect to
prepay amounts due under the facility at any time, in whole or in part, without
penalty or premium upon 3 months notice.
  The
amount outstanding under the facility was $577,816 as of March 31, 2009 and
$710,000 as of December 31, 2008, all of which was classified as short term debt
under revolving lines of credit. During the fourth quarter 2008, the Company was
notified that Barclay’s will no longer continue to provide credit under the
Discounting Agreement.  The Company has been working with Barclay’s
and other lenders to provide a transition of the lending
arrangement.
 
 (12)
DISCONTINUED OPERATIONS
  During
2005, the Company’s management and the Board of Directors made a decision to
discontinue its Singapore operation as well as its fiber optic illumination and
galvanometer businesses.
  During
2006, the Company completed the divestitures of these three businesses in
exchange for aggregate consideration of up to $525,000 in cash and notes
receivable and a 5% royalty on future sales of a specific product royalty up to
a maximum of $35,000.
  Amounts
recorded as income from discontinued operations for the quarters ended March 31,
2009 and 2008, primarily resulted from additional cash consideration received
under certain notes receivable.
  (13)
COMMITMENTS AND CONTINGENCIES
  Lease
obligation treated as financing
  On December 30, 2005, the Company
closed a sale-leaseback transaction on the Company’s Salem, New Hampshire
headquarters with 55 Heritage LLC. The terms of the Real Estate Purchase
Agreement dated November 29, 2005, as amended on December 22, 2005,
between the Company and the buyer were that (i) the Company agreed to sell
the property to the buyer for $4,700,000, and (ii) the Company agreed to
lease from the buyer (a) approximately 32,000 square feet of the property
for an initial term of five years with a rental rate during such period of
$192,000 per year in base rent and (b) approximately 63,000 square feet of
the property for an initial term of five years with rental rates ranging from
approximately $220,500 to $315,000 per year in base rent, plus a pro rata share
of all operating costs of the property. The Company plans to sublease all or
part of the 63,000 square feet block of space. At the time an opportunity arises
to enter into a sublease agreement with a third party, either (i) the
Company will enter into a sublease with that party or (ii) the buyer will
enter into a direct lease with them. The lease agreement grants the Company the
option to extend the initial term for a period of five years. Because the
transaction did not qualify as a sale for Generally Accepted Accounting
Principles (GAAP) reporting purposes under SFAS 66,Accounting for
Sales of Real Estateand
SFAS 98,Accounting for
Leases,the net proceeds
were classified as a financing lease obligation. This was primarily due to the
terms of the lease agreement. Accordingly, the Company continues to carry the
value of the building on its balance sheet and record depreciation expense until
the criteria to record a sale are met. The Company continues to account for the
financing lease in accordance with the provisions of SFAS
98.
  During
the quarter ended March 31, 2009, the Company recorded $68,000 as non-cash
interest expense and $14,000 as a decrease of the lease obligation due to a
reduction in the deposit amount left with the landlord of $29,000 during the
first quarter of 2009.
  At
March 31, 2009, $3,655,000 was recorded on the balance sheet as a financing
lease obligation, which was classified as $444,000 short-term obligation and
$3,211,000 long-term obligation, and has been reported net of a $128,500
deposit. The net book value of the building at March 31, 2009 was approximately
$3,335,000.
  At
December 31, 2008, $3,669,000 was recorded on the balance sheet as a
financing lease obligation, which has been classified as $444,000 short-term
obligation and $3,225,000 long-term obligation, and has been reported net of a
$157,500 deposit. The net book value of the building at December 31, 2008 was
approximately $3,410,000.
  15
  Other
obligations
  The
Company’s Canadian subsidiary, StockerYale Canada Inc., conducts research and
development, manufacturing, sales and administration from a property located at
275 Kesmark Street, Montreal, Quebec, Canada. StockerYale Canada leases
approximately 60,000 square feet of the Montreal property for an initial term of
ten years ending December 2015. The rent during the ten-year term ranges from
approximately Cdn $416,031 to Cdn $469,521 per year plus all operating costs.
StockerYale Canada has an option to extend the initial term of the lease for an
additional term of five years. StockerYale Canada sub-leases portions of the
facility.
  (14)
SEGMENT INFORMATION
  SFAS
No. 131 (“SFAS 131”), Disclosures about Segments of an
Enterprise and Related information, requires financial and supplementary
information to be disclosed on an annual and interim basis of each reportable
segment of an enterprise. SFAS No. 131 also establishes standards for
related disclosures about product and services, geographic areas and major
customers. Operating segments are identified as components of an enterprise
about which separate discrete financial information is available for evaluation
by the chief decision-making group, in making decisions how to allocate
resources and assess performance. The Company’s chief decision-maker is the
Chief Executive Officer. The Company’s accounting policies and method of
presentation for segments is consistent with that used throughout the
consolidated financial statements.
  The
Company operates in three segments: lasers, Photonic Products, and optical
components.  In the laser segment, the Company acts as an independent
designer and manufacturer of LasirisTM brand
lasers and light emitting diode (“LED”) systems for the inspection, machine
vision, medical and military markets. The Photonic Products segment distributes
laser diodes and designs and manufactures custom laser diodes modules for
industrial, commercial and medical applications. In its optical component
segment, the Company develops and manufactures specialty optical fiber,
fiber-based assemblies and diffractive optics such as phase masks used primarily
in the telecommunications, defense, and medical markets by original equipment
manufacturers. 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 loss for each segment includes selling,
research and development and expenses directly attributable to the segment. In
addition, the operating loss includes amortization of acquired intangible
assets, including any impairment of these assets and of goodwill. Certain of the
Company’s indirect overhead costs, which include corporate general and
administrative expenses, are allocated between the segments based upon an
estimate of costs associated with each segment. Segment assets include accounts
receivable, inventory, machinery and equipment, goodwill and intangible assets
directly associated with the product line segment.
  All
revenues and costs associated with our discontinued businesses have been
eliminated from segment reporting, so that the net effect is to report from
continuing operations only.
  Three
      months Ended March 31, 2009
                          
                          
                          Three months
      Ended March 31, 2008In
      thousands
                          
                          
                          In
      thousandsLasers
                          
                          
                          Photonic
                            Products
                          
                          
                          Optical
                            Components
                          
                          
                          Total
                          
                          
                          Lasers
                          
                          
                          Photonic
                            Products
                          
                          
                          Optical
                            Components
                          
                          
                          TotalNet
      sales
                          
                          $
                          3,487
                          
                          
                          $
                          1,864
                          
                          
                          $
                          968
                          
                          
                          $
                          6,319
                          
                          
                          $
                          4,115
                          
                          
                          $
                          3,033
                          
                          
                          $
                          914
                          
                          
                          $
                          8,062Gross
      margin
                          
                          
                          1,520
                          
                          
                          
                          490
                          
                          
                          
                          380
                          
                          
                          
                          2,390
                          
                          
                          
                          1,385
                          
                          
                          
                          787
                          
                          
                          
                          287
                          
                          
                          
                          2,459Operating
      loss
                          
                          
                          (582
                          )
                          
                          
                          (202
                          )
                          
                          
                          (117
                          )
                          
                          
                          (901
                          )
                          
                          
                          (945
                          )
                          
                          
                          (288
                          )
                          
                          
                          (294
                          )
                          
                          
                          (1,527
                          )
  16
 
 March 31,
      2009
                        In
      thousands
                      
                      
                      December 31,
      2008
                        In
      thousandsLasers
                      
                      
                      Photonic
                        Products
                      
                      
                      Optical
                        Components
                      
                      
                      Corporate
                      
                      
                      Total
                      
                      
                      Lasers
                      
                      
                      Photonic
                        Products
                      
                      
                      Optical
                        Components
                      
                      
                      Corporate
                      
                      
                      TotalTotal
      current assets
                      
                      $
                      5,229
                      
                      
                      $
                      2,038
                      
                      
                      $
                      760
                      
                      
                      $
                      1,188
                      
                      
                      $
                      9,215
                      
                      
                      $
                      5,532
                      
                      
                      $
                      2,049
                      
                      
                      $
                      544
                      
                      
                      $
                      1,622
                      
                      
                      $
                      9,747Property,
      plant & equipment, net
                      
                      $
                      2,009
                      
                      
                      $
                      446
                      
                      
                      $
                      2,101
                      
                      
                      $
                      3,489
                      
                      
                      $
                      8,045
                      
                      
                      $
                      2,271
                      
                      
                      $
                      480
                      
                      
                      $
                      2,167
                      
                      
                      $
                      3,578
                      
                      
                      $
                      8,496Acquired
      intangible assets, net
                      
                      $
                      72
                      
                      
                      $
                      1,537
                      
                      
                      $
                      136
                      
                      
                      
                      —
                      
                      
                      $
                      1,745
                      
                      
                      $
                      70
                      
                      
                      $
                      1,735
                      
                      
                      $
                      158
                      
                      
                      
                      —
                      
                      
                      $
                      1,963Goodwill
                      
                      $
                      2,677
                      
                      
                      $
                      3,831
                      
                      
                      $
                      8
                      
                      
                      
                      —
                      
                      
                      $
                      6,516
                      
                      
                      $
                      2,677
                      
                      
                      $
                      3,903
                      
                      
                      
                      8
                      
                      
                      
                      —
                      
                      
                      $
                      6,588Other
      long-term assets
                      
                      $
                      208
                      
                      
                      $
                      -
                      
                      
                      $
                      -
                      
                      
                      $
                      482
                      
                      
                      $
                      690
                      
                      
                      $
                      213
                      
                      
                      
                      133
                      
                      
                      
                      —
                      
                      
                      $
                      302
                      
                      
                      $
                      648Total
                      
                      $
                      10,195
                      
                      
                      $
                      7,852
                      
                      
                      $
                      3,005
                      
                      
                      $
                      5,159
                      
                      
                      $
                      26,211
                      
                      
                      $
                      10,763
                      
                      
                      $
                      8,300
                      
                      
                      $
                      2,877
                      
                      
                      $
                      5,502
                      
                      
                      $
                      27,442
  The
Company’s sales by geographic region are denominated in U.S. dollars. These
sales are as follows:
  Sales
      by region
                                
                                Three months Ended
                                  March 31,
                                  In
      thousands2009
                                
                                
                                2008Domestic
      – United States
                                
                                $
                                3,272
                                
                                
                                $
                                3,657Canada
                                
                                
                                429
                                
                                
                                
                                567Europe
                                
                                
                                2,280
                                
                                
                                
                                2,870Asia
                                
                                
                                187
                                
                                
                                
                                867Rest
      of world
                                
                                
                                151
                                
                                
                                
                                101Total
                                
                                $
                                6,319
                                
                                
                                $
                                8,062
  17
  (15)
SUBSEQUENT EVENTS
 
 On April
6, 2009 the Company announced that it notified the Nasdaq Stock Market LLC of
its intent to voluntarily delist its common stock, ticker symbol “STKR”, from the
Nasdaq Capital Market. The Company filed a Form 25 relating to the delisting of
its common stock on April 16, 2009 with the SEC and Nasdaq and the delisting and
the last day of trading of its common stock on the Nasdaq Capital Market was
April 24, 2009. The Company’s common stock began trading on the OTC Bulletin
Board on April 27, 2009 under the ticker symbol “STKR.OB.”.
 
 Item 2.  Management’s
Discussion and Analysis of Financial Condition and Results of
Operations.
  The
following discussion of the consolidated financial condition and results of
operations of the Company should be read in conjunction with the unaudited
condensed consolidated financial statements and the related notes thereto
included elsewhere in this Form 10-Q. Except for the historical information
contained herein, the following discussion, as well as other information in this
report, contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E
of the Securities Exchange Act of 1934, as amended, and is subject to the “safe
harbor” created by those sections. Some of the forward-looking statements can be
identified by the use of forward-looking terms such as “believes,” “expects,”
“may,” “will,” “should,” “could,” “seek,” “intends,” “plans,” “estimates,”
“anticipates” or other comparable terms. Forward-looking statements involve
inherent risks and uncertainties. A number of important factors could cause
actual results to differ materially from those in the forward-looking
statements. We urge you to consider the risks and uncertainties described in
“Risk Factors” in this report and in our annual report on Form 10-K for the year
ended December 31, 2008. We undertake no obligation to update our
forward-looking statements to reflect events or circumstances after the date of
this report. We caution readers not to place undue reliance upon any such
forward-looking statements, which speak only as of the date made.
  Overview
  StockerYale,
Inc. is an independent designer and manufacturer of structured light lasers, LED
systems, and specialty optical fibers and phase masks for industry-leading
original equipment manufacturers (OEMs), as well as a distributor of visible,
infrared and blue violet laser diodes. Our illumination products include the
Lasiris and Photonic Products brands of laser diode modules, diodes, and LED
systems for the machine vision, industrial inspection, defense and security,
biomedical and medical markets. Our products are sold to over 1,500 customers,
primarily in North America, Europe and the Pacific Rim. We sell directly to, and
work with, a group of distributors and machine vision integrators to sell their
specialized illumination products.
  RESULTS
OF OPERATIONS
  The
following discussion should be read in conjunction with the attached unaudited
condensed consolidated financial statements and notes thereto and with our
audited financial statements and notes thereto included in the Company’s annual
report on Form 10-K for the year ended December 31, 2008.
  We are a
leader in the design, development and manufacturing of low power laser modules
and related optics.  In addition, we distribute laser diodes for
leading diode manufacturers, and develop and manufacturer LED systems and
specialty optical fiber (SOF). Since 1990, we have grown through internal
expansion and through strategic acquisitions of technology and complimentary
businesses. StockerYale is recognized as the only photonics company that
possesses the design and manufacturing know-how in four different photonic
technologies: diode-based lasers, LEDs, specialty optical fiber and diffractive
optics. We also distribute laser diodes through our Photonic Products
subsidiary. Our products serve a wide range of applications and industries
including machine vision and industrial inspection, biomedical and medical,
defense and security, and other commercial applications. Our advanced
technologies are driven by a deep understanding of the needs of our customers
and the industries in which they work.
  Management
took a number of actions during 2008 and the first quarter of 2009 to improve
the Company’s operational efficiency and to improve its overall financial
performance.  In addition, in response to the general economic
slowdown that began in late 2008, management initiated a number of actions to
improve cash flow and liquidity recognizing that the economy could negatively
impact the future performance of the Company.  These actions
include:
  ·
              Customer-driven
      new product development to provide our customers and potential customers
      with an array of leading edge
products;
  ·
              Reduction
      of our overall cost structure in a variety of ways
      including:  reduction of work force, salary reductions,
      improvements in supply chain management and material
  costs;
  18
  ·
              Improvements
      in working capital through focused management of inventory and accounts
      receivable;
  ·
              Further
      cost reductions, as necessary and able, in order to improve cash
      flow.
  We are
considering different ways to raise additional capital including the sale of our
equity securities, offerings of debt securities, or borrowings from financial
institutions. We are in discussions with several potential lenders to refinance
both revolving credit facilities (North America and United Kingdom) as well as
potential lenders to refinance portions of the term debt of the
Company.  However, there can be no assurance that such activities will
result in refinancing.  We have engaged Needham & Company, LLC to
assist us in reviewing and evaluating our financial and strategic
alternatives.
  OPERATING
RESULTS OF CALENDAR QUARTERS ENDED MARCH 31, 2009 AND 2008
  Net
Sales
  Net sales
were $6.3 million for the three months ended March 31, 2009, a 22% decrease
versus $8.1 million for the first quarter of 2008. The decrease in sales was
mainly due to a $1.2 million decrease in the Photonic Products segment, of which
$0.5 million was due to the impact of foreign currency exchange, and on lower
laser segment sales of approximately $0.5 million. Optical sales, including
specialty optical fiber and fiber assemblies, increased 6% to $1.0
million.
  Gross
Profit
  Gross
profit was $2.4 million for the three months ended March 31, 2009,
essentially flat compared to the first quarter of 2008. During the three months
ended March 31, 2009, gross margin was 38% compared with 31% in the first
quarter of 2008, due to product mix, improved productivity and the effects of
foreign currency exchange.
  Operating
Expenses
  Operating
expenses totaled $3.3 million for the first quarter of 2009, decreasing 17%
versus $4.0 million in the first quarter of 2008. The decrease in operating
expenses over the first quarter of 2008 was primarily due to the cost savings
programs, including headcount and salary reductions as well as a favorable
impact of $0.5 million in foreign currency exchange rates. Non-cash
amortization of intangible assets decreased to $196,000 versus $330,000 for the
first quarter of 2008. Sales and marketing expenses decreased by
approximately $340,000, or 30%, partially due to the favorable changes in the
foreign currency exchange of approximately $200,000, but also due to the cost
savings programs, including headcount and salary reductions. Research and
development expenses were slightly lower by $34,000 at
$726,000.  General and administrative expense decreased 11%, or
$186,000, due to cost savings programs, including headcount and salary
reductions.
  Operating
loss was $0.9 million compared with operating losses of $1.5 million for the
first quarter of 2008. Operating losses were favorably impacted by cost
savings programs, including headcount and salary reductions as well as foreign
currency exchange gains of approximately $900,000 on a year-over-year
basis.
  Non-Operating
Expenses
  Other
expenses, which are comprised primarily of non-cash debt discount and financing
costs, increased by 23% to $886,000 for the three months ended March 31,
2009, versus the $721,000 in the three months ended March 31,
2008.
  Net
Loss
  Net loss
including discontinued operations was $1.6 million or $0.04 per share. This
compares to net loss of $2.2 million or $0.06 per share for the first quarter of
2008.
  Benefit
for Income Taxes
  Our
historical operating losses raise doubt about our ability to realize the
benefits of our deferred tax assets. As a result, we provide a valuation
allowance for the net deferred tax assets that may not be realized. We recorded
a deferred tax benefit of approximately $173,000 in the period ended
March 31, 2009, related to one of our non-U.S. based
subsidiaries.  We recorded a deferred tax benefit of approximately
$62,000 in the period ended March 31, 2008, related to one of our non-U.S. based
subsidiaries.
  19
  LIQUIDITY
AND CAPITAL RESOURCES
  Our cash
balance decreased to $1.1 million at March 31, 2009 from $1.6 million at
December 31, 2008 primarily as a result of the principal and interest
payments and payments against revolving lines of credit. During the first
quarter ended, March 31, 2009, our overall borrowings decreased by
approximately $0.4 million.
  As of
March 31, 2009, our net accounts receivable balance was $3.7 million
compared to $3.9 million at year end. Our days sales outstanding increased from
50 days at December 31, 2008 to 53 days at March 31,
2009.
  Inventories
were essentially flat.
  Capital
spending for the quarter ending March 31, 2009 was $30,000. The Company has
no material contingent capital expenditure commitments as of March 31, 2009
but has plans to purchase approximately $455,000 of capital items between
April 1, 2009 and December 31, 2009, of which we expect approximately
$70,000 to be financed through capital leases.
  As of
March 31, 2009, the Company may not have sufficient liquidity and working
capital to meet its ongoing operating obligations. Management is continuing its
efforts to raise additional capital so that the Company can meet its obligations
and sustain operations through the sale of its equity securities, through
offerings of debt securities, or through borrowings from financial
institutions.  We are in discussions with several potential lenders to
refinance both revolving credit facilities (North America and United Kingdom) as
well as potential lenders to refinance portions of the term debt of the
Company.  However, there can be no assurance that such activities will
result in refinancing.
  OFF-BALANCE
SHEET ARRANGEMENTS
  We have
no significant off-balance sheet arrangements, including derivative instruments
that have or are reasonably likely to have a current or future material effect
on our financial condition, changes in financial condition, revenues or
expenses, results of operations, liquidity, capital expenditures or capital
resources.
  Item
      3.
                Quantitative
      and Qualitative Disclosures About Market
Risk.
  Not
required.
  Item
      4.
                Controls
      and Procedures.
  Evaluation
of disclosure controls and procedures.
  Our Chief
Executive Officer and Chief Financial Officer have evaluated the effectiveness
of our disclosure controls and procedures as of March 31, 2009. Based on
that evaluation, our Chief Executive Officer and Chief Financial Officer have
concluded that, as of March 31, 2009, our disclosure controls and procedures
were effective in ensuring that the information we are required to disclose in
the reports we file or submit under the Securities Exchange Act of 1934 is
recorded, processed, summarized and reported on a timely basis, and that this
information is accumulated and communicated to management as appropriate to
allow timely decisions regarding required disclosures.
  Changes
in Internal Control Over Financial Reporting
  There was no change in our internal
control over financial reporting during the quarter ended March 31, 2009, that
materially affected, or is reasonably likely to materially affect, our internal
control over financial reporting.
  PART
II: OTHER INFORMATION
  Item 1.
              Legal
      Proceedings.
  From time
to time, we may become involved in litigation relating to claims arising out of
operations in the normal course of business, which we consider routine and
incidental to our business. We currently are not a party to any legal
proceedings, the adverse outcome of which, in management’s opinion, would have a
material adverse effect on our business, results of operation or financial
condition.
  Item 1A.
              Risk
      Factors.
  During
the period covered by this Form 10-Q, there have not been any material changes
from the risk factors previously disclosed in the “Risk Factors” of our annual
report on Form 10-K, for the fiscal year ended December 31, 2008. In
addition to the other information set forth in this report, you should carefully
consider the factors discussed in our annual report on Form 10-K, which could
materially affect our business, financial condition or future results. The risks
described in our annual report on Form 10-K are not the only risks facing the
Company. Additional risks and uncertainties not currently known to us or that we
currently deem to be immaterial also may materially adversely affect our
business, financial condition and/or operating results.
  20
  Item
      5.
              Other
      Information.
  During
the quarter ended March 31, 2009, we made no material changes to the
procedures by which shareholders may recommend nominees to our Board of
Directors, as described in our most recent proxy statement.
  Item 6.
              Exhibits.
  The
Exhibits listed in the Exhibit Index immediately preceding such Exhibits are
filed with, or incorporated by reference in, this report.
  21
  SIGNATURES
  In
accordance with the requirements of the Securities Exchange Act of 1934, the
Registrant caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
  STOCKERYALE, INC.Date:
      May 8, 2009
                By:
                /s/
      MARK W. BLODGETTMark
      W. BlodgettPresident,
      Chief Executive Officer and Chairman of the BoardDate:
      May 8, 2009
                By:
                /s/
      TIMOTHY P. LOSIKTimothy
      P. LosikChief
      Operating Officer and Chief Financial
Officer
  22
  EXHIBIT
INDEX
  Exhibit
                          Number
                        
                        Description10.1
                        
                        Amendment,
      dated as of March 31, 2009, by and among StockerYale, Inc., LV
      Administrative Services, Inc. and Valens U.S. SPV I, LLC is incorporated
      herein by reference to Exhibit 10.1 of the Registrant’s Current Report on
      Form 8-K filed on April 21, 2009 (File No.000-27372).31.1
                        
                        Certification
      of Chief Executive Officer pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.31.2
                        
                        Certification
      of Chief Financial Officer pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.32.1
                        
                        Certification
      of the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as
      Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
      2002.32.2
                        
                        Certification
      of the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as
      Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
      2002.
  23