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**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

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**FORM 10-Q**

**QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF**

**THE SECURITIES EXCHANGE ACT OF 1934**

**FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 200****4**

**Commission File Number:  000-****27372**

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| **STOCKERYALE, INC.**
(Exact    name of registrant as specified in its charter)

**Massachusetts**
**04-2114473**
(State    of Incorporation)
(I.R.S.    Employer Identification Number)

**32 Hampshire Road,  Salem, New Hampshire 03079**
    (Address of registrant's principal executive office)

**(603) 893-8778**
    (Registrant's telephone number)
 

 

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

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2 of theExchange Act). o  Yes x  No

As of November 4, 2004,there were 21,570,238 shares of the issuer's common stock outstanding.

 

 

**STOCKERYALE, INC.**

**INDEX TO FORM 10-Q**

 

**PART I - FINANCIAL INFORMATION**       Item 1Financial Statements    Unaudited Condensed Consolidated Balance Sheets      at September 30, 2004 and December 31, 20031   Unaudited Condensed Consolidated Statement      of Operations for the three and nine months ended September 30, 2004 and      2003 2   Unaudited Condensed Consolidated Statement of Cash      Flows for the nine months ended September 30, 2004 and 20033   Notes to Unaudited Condensed Consolidated Financial      Statements 4  Item 2Management's Discussion and Analysis of      Financial Condition and Results of Operations 12 Item 3Quantitative and Qualitative Disclosure About Market Risk         18  Item 4Controls & Procedures18   
**PART II - OTHER INFORMATION**  Item 1Legal Proceedings19  Item 2Changes in Securities 19  Item 3Defaults Upon Senior Securities 19  Item 4Submission of Matters to a Vote of Security Holders19  Item 5Other Information 19  Item 6Exhibits19  Signature (s) 20 i  /  STKR    2004 Form 10-Q  Table of Contents Part I Item 1
ITEM 1.   FINANCIAL STATEMENTS

UNAUDITEDCONDENSED CONSOLIDATED BALANCE SHEETS
**In thousands**           **September 30, 2004**          **December 31, 2003**Assets           ** **** **              Current assets:           ** **** **              Cash and cash      equivalents           **$****1,210**          $ 1,008Accounts receivable,      less reserves of approximately $108 at September 30, 2004 and $103 at      December 31, 2003          ** ****3,444**            2,102Inventories           ** ****3,679**            3,799Prepaid expenses and      other current assets           ** ****452**            188Total current assets                ** ****8,785**            7,097Property, plant and      equipment, net           ** ****19,128**            20,550Goodwill          ** ****2,677**            2,677 Identified intangible      assets, net           ** ****1,224**            1,463Officer note receivable                ** ****-**            263Other long-term assets                ** ****609**            639Total assets           **$****32,423**          $ 32,689Liabilities and      stockholders' equity           ** **** **              Current liabilities:                ** **** **              Current portion of      long-term debt          **$****2,556**          $ 3,365Short-term debt, net of      unamortized discount of $0 at September 30, 2004 and $155 at December 31,      2003          ** ****1,965**            5,091Accounts payable           ** ****2,380**          2,061Accrued expenses           ** ****1,325**            943Short-term portion of      capital lease obligation           ** ****43**            47Total current      liabilities           ** ****8,269**            11,507Long-term debt and      capital lease obligations, net of unamortized discount of $2,156 at      September 30, 2004 and $957 at December 31, 2003 - less current portion          ** ****4,403**            3,934Other    long-term liabilities **17**            17Stockholders' equity:                ** **** **              Common stock, par value      $0.001-shares authorized 100,000,000; Shares issued and outstanding      21,655,107 and 14,791,123 at September 30, 2004 and December 31, 2003,      respectively           ** ****22**            15Paid-in capital           ** ****81,813**            70,948Accumulated other      comprehensive income (loss)          ** ****1,436**            1,340Accumulated deficit                ** ****(63,537)**  (55,072)Total stockholders'      equity           ** ****19,734**            17,231Total liabilities and      stockholders' equity           **$****32,423**          $ 32,689
*Seenotes to unaudited condensed consolidated financial statements.*
 1  /  STKR    2004 Form 10-Q  Table of Contents Part I Item 1
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OFOPERATIONS
**In thousands, except      per share****data**     **Three Months****Nine Months****Ended September    30,****Ended September    30,****2004****2003****2004**          **2003**Net sales           **$****4,852**** **          $ 3,670 
$**13,466**$10,840 Cost of sales   ** ****3,392**** **    2,724 **9,568**          8,159 Gross profit           ** ****1,460**** **            946 **3,898**          2,681 Operating expenses:                ** **** **** **              ** **            Selling expenses           ** ****676**** **            585 **2,076**          2,134 General and      administrative           ** ****1,666**** **            1,009 **4,068**          3,343 Research and      development           ** ****832**** **            831**2,445**          2,647Intangible asset      amortization          ** ****80**** **            80**239**          239 Asset Impairment          ** ****0**** **            605**0**          605Total operating      expenses           ** ****3,254**** **            3,110 **8,828**          8,968 Operating loss           ** ****(****1,794****)**            (2,164 ) **(4,930****)**          (6,287 ) Interest and other      income/(expense)          ** ****(24****)**            15 **  (28****)**            (115 Debt    acquisition and discount amortization expense  **516**   44   **2,957**   132 Interest expense           ** ****196**** **            246**550**          595Loss before income tax      benefit          ** ****(2,530****)**            (2,439 ) **(8,465****)**          (7,129 ) Income tax provision      (benefit)          ** ****0**            14 **0**           (136 Net loss           **$****(2,530****)**          $ (2,453 ) 
$**(8,465****)**          $ (6,993 ) Basic and diluted loss      per share:           ** **** **** **              ** **          Net loss per share                **$****(0.12****)**        $ (0.17 ) 
$**(0.43****)**          $ (0.52 ) Weighted average shares      outstanding:           ** **** **** **              ** **            Basic and diluted                ** ****21,651**** **            14,401 **19,658**13,501  *See notes to  unaudited condensed consolidated financial statements.* 2  /  STKR    2004 Form 10-Q  Table of Contents Part I Item 1
UNAUDITEDCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
**In thousands**
**Nine Months Ended    September 30,**           **2004**          **2003****Operations**                    Net loss           **$****(8,465****)**          $ (6,993 )                     Adjustments to      reconcile net loss to net cash used in operating activities:                     Depreciation and      amortization           **2,379**          2,113 Accretion of original      issue discount          **2,335**** **          -      Asset impairment          **-**          605Loss on disposal of      assets          **24**          -Other changes in assets      and liabilities:                     Accounts receivable,      net           **(1,342****)**          (391 ) Inventories           **120**** **          98 Prepaid expenses and      other current assets           **(1****)**          174      Accounts payable           **319**** **          61  Accrued expenses           **382**          (56 )Other assets and      liabilities           **38**** **          (180 )Net cash used in      operating activities           **(4,211****)**          (4,569 ) **Financing**                    Proceeds from sale of      common stock           **3,143**          1,197 Proceeds from long term      debt **9,550**6,247Principal repayment of      long-term debt           **(7,272****)**          (2,210 )Net repayments      (borrowings) revolving lines of credit          **(406****)**          (3,673 )Restricted cash related      to Merrill Lynch          ** ****-**            2,000 Other**(628****)**(102)Net cash provided by      financing activities           **4,387**          3,459 **Investing**                    Purchases of property,      plant and equipment           **(299****)**            (91)Proceeds from asset      sales          **200**** **          503  Net cash (used in)      provided by investing           **(99****)**          412  Effect of exchange      rates           **125**** **          (34 )     Net change in cash and      equivalents           **202**** **          (732 )    Cash and equivalents,      beginning of year           **1,008**          3,070 Cash and equivalents,      end of year           **$****1,210**          $ 2,338 Supplemental disclosure      of cash flow information:                     Interest paid           **550**          595Conversion of debt to      common stock          **4,202**          - *See notes to  unaudited condensed consolidated financial statements.* 3  /  STKR    2004 Form 10-Q  Table of Contents Part I Item 1 NOTES  TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTSSeptember 30, 2004
(1)ORGANIZATION AND BASIS OF PRESENTATION

The interim condensedconsolidated financial statements presented have been prepared by StockerYale,Inc. (the "Company") are unaudited and, in the opinion of management, reflectall adjustments of a normal recurring nature necessary for a fair statement of(a) the results of operations for the nine months ended September 30, 2004 and2003, (b) the financial position at September 30, 2004 and December 31, 2003,and (c) the cash flows for the nine month periods ended September 30, 2004 and2003. These interim results are not necessarily indicative of results for a fullyear or any other interim period.

The accompanying financialstatements and notes are condensed as permitted by Form 10-Q and do not containcertain information included in the annual financial statements and notes of theCompany. The unaudited condensed consolidated financial statements and notesincluded herein should be read in conjunction with the consolidated financialstatements and notes included in the Company's Annual Report on Form 10-K/A forthe year ended December 31, 2003.

The Company has prepared theunaudited condensed financial statements on a going concern basis, whichcontemplates the realization of assets and the satisfaction of liabilities inthe normal course of business. The Company will be required to generatesufficient cash flow to meet its obligations on a timely basis through improvedoperations, refinancing of existing debt and/or additional financing.

Based upon the Company'scurrent forecast for 2004, the Company plans to increase revenues, reduce costsand pursue various options to raise additional funds to finance operations bythe end of 2004. The Company can give no assurances to the timing or terms ofsuch arrangements, assuming it is able to consummate one or more of theseoptions. If the Company is unable to raise sufficient funds through theseoptions by the end of the fourth quarter of 2004, it will need to implementfurther cost reduction strategies, and the Company may not have adequate capitalto sustain its current operations. Financing options in process or underconsideration are the sale of real estate and/or a private placement of equityand/or debt securities. The Company expects to close on some of these financingoptions by the end of 2004.

(2) LOSSPER SHARE

In accordance with Statementof Financial Accounting Standards ("SFAS") No. 128, Earnings per Share, basicand diluted net loss per common share for the three and nine months endedSeptember 30, 2004 and 2003 is calculated by dividing the net loss applicable tocommon stockholders by the weighted average number of common shares outstanding.There were 4,105,863 and 3,191,298 options, 2,738,490 and 19,500 warrants and4,480,063 and 0 shares underlying convertible debt instruments outstanding as ofSeptember 30, 2004 and 2003, respectively, which were not included in thediluted per share calculation because their inclusion would be anti-dilutive.

(3)  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:

(in        thousands) 
         
**September 30, 200****4** 
**December 31, 200****3**Finished goods $ 
805 
$        
992 Work-in-process        
 135  
78 Raw materials  3,677   4,100 Reserve for        obsolescence 
(938)  
        (1,371)$ 
        3,679 
$        
        3,799  4  /  STKR    2004 Form 10-Q      Table of Contents Part I Item 1
Management performs      periodic reviews of inventory to dispose of items not required by their      manufacturing plan and reduces the carrying cost of inventory to the lower      of cost or market.

(4) STOCK BASED      COMPENSATION
The Company accounts        for employee stock options and share awards under the intrinsic-value        method prescribed by Accounting Principles Board Opinion No. 25,        Accounting for Stock Issued to Employees, (APB 25) and various        interpretations. No compensation cost has been recognized for stock        option grants since the options granted to date have exercise prices per        share of not less than the fair value of the Company's stock at the date        of the grant. Had the Company determined the stock-based compensation        expense for the Company's stock options under the provisions of        Statement of Financial Accounting Standards No. 123, Accounting for        Stock Based Compensation, the Company's net loss and net loss per share        based upon the fair value at the grant date for stock options awards        would have increased the loss amounts as indicated below: (in            thousands)**Three Months Ended**
**Nine Months            Ended****September 30,**
**September 30,****200****4****200****3**** ****200****4**
**200****3**Net loss as reported $(2,530)$(2,453)$(8,465)$(6,993)            Additional compensation expense  (1,127) (1,193)(3,080)(3,476)Pro forma  $(3,657) (3,646)$(11,545)(10,469) Net loss per share (basic and              diluted)                     As reported $(0.12)$(0.17)$(0.43)$(0.52)            Pro forma  (0.17) (0.25)(0.59)(0.78) The fair value of        options at the date of grant was estimated using the Black-Scholes        option pricing model with the following assumptions: 
**For the Nine Months            Ended****September  30,****2004****200****3**Volatility 147%            137%Expected option            life-years from vest 5 5 Interest rate (risk            free) 3.29%            2.77%            Dividends --
(5)        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:             (in thousands) 
**Three Months Ended**
**Nine Months Ended**
**September 30,**
**September 30,****200****4****200****3****200****4****2003**Net loss   $ **(2,530****)**  $ (2,453 )            
$ **(8,465****)**
            $(6,993 )             Other comprehensive income (loss):     ** **** **          ** **                 Cumulative translation adjustment     **401**** **    24  **96**1,213 Comprehensive              loss   $  **(2,129****) **  $  (2,429
)  $  **(8,369****)**(5,780) 5  /  STKR                              2004 Form 10-QTable of Contents Part I Item 1
(6) INTANGIBLE ASSETS
Intangible assets        consist primarily of acquired patented technology and trademarks.        Intangible assets are amortized over their estimated useful lives that        range from two to five years. The Company has no intangible assets with        indefinite lives. The Company reviews intangible assets when indications        of potential impairment exist, such as a significant reduction in cash        flows associated with the assets. Intangible assets as of September 30,        2004 and December 31, 2003 are as follows: (in thousands)**September 30,            200****4****December 31,            200****3**Identified            intangible assets  $ 3,549     $ 3,549   Less: accumulated            amortization  $ 2,325    $ 2,086      $ 1,224    $ 1,463   Amortization of        intangible assets was $80,000 and $80,000 for the three months ended        September 30, 2004 and 2003, respectively and $239,000 and $239,000 for        the nine months ended September 30, 2004 and 2003, respectively. As of September 30,        2004, the estimated future amortization expense of intangible assets, in        thousands, is as follows: **200****4****2005****2006****200****7****2008            and            thereafter**
            $
            82
            $
            318
            $
            318
            $
            319
            $
            187 
(7)      ASSET IMPAIRMENT

In the third quarter of      2003, the Company performed an impairment analysis as required by      generally accepted accounting principles, resulting in an impairment      charge of $605,000 related to closing the Company's Maryland specialty      optical fiber facility and the write-off of equipment deposits for the      optical segment of the business.

(8)      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.

(9)      REVENUE RECOGNITION

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      collectibility is reasonably assured. In certain limited situations,      customers 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 provide a reasonable estimate      for sales returns and allowances.
6 /  STKR                              2004 Form 10-QTable of Contents Part I Item 1
(10)      RECENT ACCOUNTING PRONOUNCEMENTS

In May 2003, the FASB      issued SFAS No. 150, "Accounting for Certain Financial Instruments with      Characteristics of both Liabilities and Equity." This statement      establishes standards for how an issuer classifies and measures certain      financial instruments with characteristics of both liabilities and equity.      It requires that an issuer classify a financial instrument that is within      its scope as a liability (or an asset in some circumstances). Many of      those instruments were previously classified as equity instruments.      Implementation of this statement had no material effect on the company's      financial statements. 

In January 2003 and      December 2003, the Financial Accounting Standards Board (FASB) issued      Interpretation No. 46, Consolidation for Variable Interest Entities (FIN      46) and its revision, FIN 46-R, respectively. FIN 46 and FIN 46-R address      the consolidation of entities whose equity holders have either not      provided sufficient equity at risk to allow the entity to finance its own      activities or do not possess certain characteristics of a controlling      financial interest. FIN 46 and FIN 46-R require the consolidation of these      entities, known as variable interest entities (VIEs), by the primary      beneficiary of the entity. The primary beneficiary is the entity, if any,      that is subject to a majority of the risk of loss from the VIE's      activities, entitled to receive a majority of the VIE's residual returns,      or both. The adoption of FIN 46-R on January 1, 2004 did not have a      material impact on the Company's financial position, results of operations      or cash flows.

(11)      OFFICER NOTE RECEIVABLE

As described in our      annual report on Form 10-K, subsequent to the approval of the Board of      Directors, the Company issued a promissory note to the chairman and chief      executive officer of the Company on May 31, 2002 in the principal amount      of $250,000. The note was payable upon demand and bears an annual interest      rate of 4.5%. On May 7, 2004, the chairman and chief executive officer      paid the Company $266,563, which represented the entire balance of      principal and accrued interest outstanding for such Officer Note.

(12)      SEGMENT INFORMATION

The Company has adopted      the SFAS No. 131, Disclosures About Segments of an Enterprise and Related      information. SFAS No. 131 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.

Prior to January 1,      2002, the Company operated in a single segment. In 2002 the Company began      to operate in two segments, Illumination and Optical Components. 
The illumination        segment develops and manufactures specialized illumination products for        the inspection, machine vision, medical and military markets.        Illumination products are sold both through distributors as well as        directly to original equipment manufacturers (OEM's). The optical        components segment develops and manufactures specialty optical fibers        and phase masks used primarily in sensor, gyroscope and        telecommunication equipment. Optical component products are sold        primarily to original equipment manufacturers (OEM's). 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. The Company's non-allocable 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.  7 /  STKR                              2004 Form 10-QTable of Contents Part I Item 1 The Corporate assets        include cash and cash equivalents, buildings and furniture and fixtures. **Quarter Ended September 30, 2004****Quarter Ended September 30, 200****3****Illumination****Optical Components****Total****Illumination(1)****Optical Components****Total**Net sales $ 4,714$ 138$ 4,852$ 3,486 $ 184 $ 3,670 Gross margin 1,606(146) 1,4601,054 (108 ) 946 Operating loss (457) (1,337) (1,794) (540 ) (1,624 ) (2,164 )     **Nine Months Ended****September 30, 2004****Nine Months Ended September 30, 2003****Illumination****Optical Components****Total****Illumination(1)****Optical Components****Total**Net sales $ 12,761$ 705$ 13,466$ 10,060 $ 780 $ 10,840 Gross margin 4,154(256 ) 3,8983,009 (328 ) 2,681 Operating loss (1,562 ) (3,368 ) (4,930 ) (1,925 ) (4,362 ) (6,287 )     **September 30, 2004****December 31, 2003****Illumination****Optical Components****Corporate****Total****Illumination****Optical Components****Corporate****Total**Total current assets          $ 7,211$ 364$ 1,210$ 8,785$ 5,827$ 425$ 845$ 7,097Property, plant &          equipment 7337,98310,41219,1289787,84711,72520,550Intangible assets 1,224- - 1,2241,463- - 1,463Goodwill 2,677 - - 2,677 2,677 - - 2,677 Other assets 4- 605609--902902$ 11,849$ 8,347$ 12,227$ 32,423$ 10,945$ 8,272$ 13,742$ 32,689
The Company's      geographic sales are denominated in U.S. dollars. These sales are as      follows:  
** Three Months            Ended             September 30,** 
**Nine****Months Ended           September 30,**Sales by            geographic region (in thousands) **2004**** ****2003** **2004** **2003**United States $1,419  $2,202 $6,400  $6,504          Canada  461   331  1,323   976          Europe  1,784   807  3,365   2,384          Asia  1,187   330  2,377   976 Total sales $4,851  $3,670 $13,465  $10,840 8  /  STKR    2004 Form 10-Q      Table of Contents Part I Item 1
(13)    DEBT
**Merrill Lynch      Financial Services**On June 10, 2004, the      Company paid the credit facility in full including outstanding principal      and accrued interest of $3,370,000 and $7,000 respectively, with proceeds      from a convertible note. 
The Company's      obligations under the credit facility were secured by substantially all of      the Company's Salem assets, excluding real property. The facility was also      subject to various financial covenants, including having a minimum net      worth of $10.0 million at all times. The Company was also required to      repay amounts under the credit facility using 100% of the net excess      proceeds, as defined, from the sale of its Salem facility; 80% of net      proceeds from assets sales and 50% of the net proceeds from equity      offerings.

On March 25, 2004,      the Company entered into an amended agreement with Merrill Lynch. The      amended agreement changed the maturity date from October 31, 2004 in the      prior agreement to June 30, 2004. The amended agreement also increased the      interest from LIBOR + 5.5% in the prior agreement to LIBOR + 7.5%.  **TJJ Corporation**As of December 31,        2003, the Company had a $4,700,000 term note with TJJ Corporation        secured by the Company's Salem headquarters. On February 25, 2004, the        Company paid the note in full including outstanding principal and        accrued interest of $4,400,000 and $25,000, respectively, with proceeds        from a private placement of common stock, convertible notes and        warrants. **Laurus Master        Funds**As of May 4, 2004,        the total value of the note issued on September 24, 2003 had been        converted to 2,337,249 shares of common stock that resulted in an        incremental non-cash charge related to accelerated amortization of debt        discount of $514,000 for the nine months ending September 30, 2004.
On September 24, 2003,      the Company issued a Convertible Note to Laurus Master Funds, Ltd. The      $2,500,000 Convertible Note matures on September 24, 2006, bears interest      at a rate equal to the Prime Rate plus 3.5%, but in no event less than      7.5%, and provides the holder with the option to convert the loan to      common stock at $1.07 per share subject to certain adjustment features.      StockerYale has the right to elect to make the monthly required payments      on the convertible note (comprised of principal amortization and interest)      in the form of shares of common stock, determined based on the $1.07      conversion price. The Company also issued to the holder seven-year      warrants to purchase shares in the following warrant amounts and exercise      prices per share of common stock: 225,000 shares at $1.23 per share,      150,000 shares at $1.34 per share and 100,000 shares at $1.44 per share.      The aggregate purchase price of the convertible note and warrants      ($2,500,000) was allocated between the note, the common stock conversion      option and warrants based upon their relative fair market value. The      purchase price assigned to the note, common stock beneficial conversion      option and warrants was $1,551,700, $546,650 and $401,650 respectively.      The difference between the face amount of the convertible note of      $2,500,000 and the aggregate purchase price of the convertible note of      $1,551,700 was recorded as a debt discount and is being amortized over the      life of the convertible note. The Company used the Black-Scholes Model to      calculate the fair value of the warrants. The underlying assumptions      included in the Black-Scholes Model were: a risk-free interest rate of      2.7%; an expected life of seven years; and an expected volatility of 114%      with no dividend yield.

The Company can elect      to pay monthly principal amortization in cash at 103% of the principal      amount. The Company may also elect to pay both principal amortization and      interest in common stock, if the market price of the stock at the time of      the payment is 110% of the fixed conversion price. The Company may elect      to redeem the principal amount outstanding at 120% within the first year,      115% within the second year and 110% during the third year. The principal      amortization payments began 120 days from the execution of the agreement      at a rate of $78,125 per month. As of September 30, 2004 the note had been      fully converted to common stock. 
9  /  STKR               2004 Form 10-QTable of Contents Part I Items 1, 2
On February 25, 2004,        the Company issued a Convertible Note to Laurus Master Funds, Ltd. The        $4,000,000 Convertible Note matures on February 25, 2007, bears interest        at a rate equal to the Prime Rate plus 2.0 %, but in no event less than        6.0 %, and provides the holder with the option to convert the loan to        common stock at $1.30 per share subject to certain adjustment features.        The Convertible Note is collateralized by a mortgage on the Salem        building. StockerYale has the right to elect to make the monthly        required payments on the convertible note (comprised of principal        amortization and interest) in the form of shares of common stock,        determined based on the $1.30 conversion price. The Company also issued        to the holder seven-year warrants to purchase shares in the following        warrant amounts and exercise prices per share of common stock: 375,000        shares at $1.56 per share, 250,000 shares at $1.75 per share and 75,000        shares at $1.94 per share. The aggregate purchase price of the        convertible note and warrants ($4,000,000) was allocated between the        note, the common stock conversion option and warrants based upon their        relative fair market value. The purchase price assigned to the note,        common stock beneficial conversion option and warrants was $2,319,047,        $988,184 and $692,769 respectively. The difference between the face        amount of the convertible note of $4,000,000 and the aggregate purchase        price of the convertible note of $2,319,047 was recorded as a debt        discount and is being amortized over the life of the convertible note.        The Company used the Black-Scholes Model to calculate the fair value of        the warrants. The underlying assumptions included in the Black-Scholes        Model were: a risk-free interest rate of 3.0%; an expected life of seven        years; and an expected volatility of 140% with no dividend yield. The        Company can elect to pay monthly principal amortization in cash at 101%        of the principal amount. The Company may also elect to pay both        principal amortization and interest in common stock, if the market price        of the stock at the time of the payment is 110% of the fixed conversion        price. The Company may elect to redeem the principal amount outstanding        at 115% within the first year, 110% within the second year and 105%        during the third year. The principal amortization payments began 120        days from the execution of the agreement at a rate of $125,000 per        month. As of September 30, 2004, $1,874,000 was outstanding under the        convertible note and has been classified as long-term debt. The        obligation has been reported net of $683,150 related to unamortized debt        discount based upon beneficial conversion rights and warrants.

As of September 30,        2004, based upon the note issued on February 25, 2004, Laurus had        converted $1,501,500 into 1,155,000 shares of common stock that resulted        in an incremental non-cash charge related to accelerated amortization of        debt discount of $631,000 for the nine months ended September 30, 2004.

On June 10, 2004, the        Company issued a Convertible Note to Laurus Master Funds, LTD and        another institutional investor. The $5,500,000 Convertible Note matures        on June 20, 2007, bears interest at a rate equal to the Prime Rate plus        1.0 %, but in no event less than 5.0 %, and provides the holder with the        option to convert the loan to common stock at $2.15 per share subject to        certain adjustment features. The Convertible Note is collateralized by        U.S. accounts receivable, inventory and equipment and a second mortgage        on the Montreal, Canada building. StockerYale has the right to elect to        make the monthly required payments on the convertible note (comprised of        principal amortization and interest) in the form of shares of common        stock, determined based on the $2.15 conversion price. The Company also        issued to the holders seven-year warrants to purchase an aggregate of        440,000 shares at $3.12 per share The aggregate purchase price of the        convertible note and warrants ($5,500,000) was allocated between the        note, the common stock conversion option and warrants based upon their        relative fair market value. The purchase price assigned to the note,        common stock beneficial conversion option and warrants was $3,646,478,        $1,093,511 and $760,011 respectively. The difference between the face        amount of the convertible note of $5,500,000 and the aggregate purchase        price of the convertible note of $3,646,478 was recorded as a debt        discount and is being amortized over the life of the convertible note.        The Company used the Black-Scholes Model to calculate the fair value of        the warrants. The underlying assumptions included in the Black-Scholes        Model were: a risk-free interest rate of 4.43%; an expected life of        seven years; and an expected volatility of 145.92% with no dividend        yield.

The Company can elect        to pay monthly principal amortization in cash at 101% of the principal        amount. The Company may also elect to pay both principal amortization        and interest in common stock, if the market price of the stock at the        time of the payment is 110% of the fixed conversion price. The Company        may elect to redeem the principal amount outstanding at 115% within the        first year, 110% within the second year and 105% during the third year.        The principal amortization payments begin 120 days from the execution of        the agreement at a rate of $171,875 per month. As of September 30, 2004,        $5,500,000 was outstanding under the Convertible Note of which        $2,062,500 has been classified as short-term debt and $1,964,800 has        been classified as long-term debt. The obligation has been reported net        of $1,473,312 related to unamortized debt discount based upon beneficial        conversion rights and warrants.  10  /  STKR                          2004 Form 10-QTable of Contents Part I Item 2**National Bank of        Canada**On May 26, 2003, the        Company entered into a credit agreement with the National Bank of Canada        replacing the facility with Toronto Dominion Bank. The new agreement        provided total borrowing availability up to C$4,050,000 ($3,000,000 US),        including a line of credit of C$2,500,000 ($1,850,000 US) and a ten-year        term note of C$1,550,000 ($1,150,000 US). Initial proceeds were used to        pay off the credit agreement with Toronto Dominion Bank.
On August 23, 2003, the      Company amended its credit facility with National Bank of Canada to reduce      the restricted term deposit from C$1,000,000 ($740,000 US) to C$250,000      ($185,000 US) and reduce the term loan from C$2,300,000 ($1,702,000 US) to      C$1,550,000 ($1,147,000 US). The net availability of the term loan      remained the same. In addition, the bank added Canadian Provincial      Government research and development tax credits as additional eligible      accounts receivable, which increased the availability of the revolving      credit facility by approximately C$300,000 ($222,000 US). All other terms      of the credit facility remained the same, including StockerYale, Inc.'s      guarantee to fund StockerYale Canada's deficits if requested by the bank.      

On November 20, 2003,      the credit facility was amended increasing the interest rate on the line      of credit to the Canadian prime rate plus 2.00% and the term note to the      Canadian prime rate plus 2.75%.      The National Bank of Canada credit facility requires the following      financial covenants, including working capital, net worth, capital      expenditures, a financial coverage ratio and maximum inventory levels.

On March 19, 2004, the      Company entered into an amended agreement with the National Bank of      Canada. The new agreement includes a line of credit of C$2,500,000      ($1,875,000 US) and a five-year term note of C$1,396,000 ($1,050,000 US).      The amended agreement reduced the net worth covenant from C$10,800,000 in      the May 26, 2003 agreement to C$8,000,000 in the March 19, 2004 agreement      as of December 31, 2003. The amended agreement also requires a      C$10,000,000 net worth as of September 30, 2004 and thereafter. The      amended agreement also reduced the reduced the inventory component of the      line of credit availability from C$750,000 to C$625,000 and requires the      Company to achieve specific net profit targets throughout 2004.

As of September 30,      2004, C$2,500,000 ($1,964,545 US) was outstanding under the line of credit      and C$1,262,500 ($ 992,095 US) was outstanding under the term note. As of      September 30, 2004, the interest rate on the line of credit and the term      note were 6.00% and 6.75%, respectively.

As of September 30,      2004, the Company was in compliance with all provisions of its loan      agreements.

(14)      OTHER MATTERS

On August 6, 2004 The      Company was informed by the staff of the Securities and Exchange      Commission (the "SEC") that the SEC is conducting a formal investigation      into certain matters relating to the company. The company understands that      the SEC's investigation relates to press releases that the company issued      on April 19, 2004 and April 21, 2004, and trading in the company's      securities on or around the time the press releases were issued. The SEC      has not concluded that there has been any wrongdoing, and the company is      cooperating fully with the SEC in the conduct of this inquiry.
11  /  STKR                          2004 Form 10-QTable of Contents Part I Item 2
Item      2.     MANAGEMENT'S DISCUSSION AND      ANALYSIS OF FINANCIAL CONDITION AND OPERATING RESULTS

***This Quarterly Report      on Form 10-Q contains forward-looking statements within the meaning of      Section 27A of the Securities Act of 1933 and section 21E of the      Securities Exchange Act of 1934. The company's actual results could differ      materially from those set forth in the forward-looking statements. When      the Company uses words such as "anticipate," "believe," "estimate,"      "expect," "intend," and other similar expressions, they generally identify      forward-looking statements. Forward-looking statements include, for      example, statements relating to acquisitions and related financial      information, development activities, business strategy and prospects,      future capital expenditures, sources and availability of capital,      environmental and other regulations and competition. Investors should      exercise caution in interpreting and relying on forward-looking statements      since they involve known risks, uncertainties and other factors which are,      in some cases, beyond the company's control and could materially affect      the Company's actual results, performance or achievements. Such factors      include, without limitation: market conditions that could make it more      difficult or expensive for the Company to obtain the necessary capital to      finance its research and development projects, operations, as well as its      ability to refinance existing debt; the existence of other independent      suppliers of optical fiber, who may have greater resources than the      Company; and the uncertainty that the company's significant investments in      research and development will not result in products that achieve market      acceptance. Additional such factors are discussed in the section entitled      "certain factors affecting future operating results" on page 23 of the      Company's annual report on form 10-K for the fiscal year ended December      31, 2003.***

      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/A for the year ended December 31, 2003.

THREE      MONTHS ENDED SEPTEMBER 30, 2004 AND 2003

Net Sales

For the quarter ended      September 30, net sales increased $1.2 million or 32% from $3.7 million in      2003 to $4.9 million in 2004. Illumination revenues increased $1.2 million      or 35% over the comparable period in 2003 representing the majority of the      revenue gain. Revenues for the optical components product line were in      line with the comparable period in the prior year. Increased shipments of      structured lasers for the machine vision sector coupled with continued      growth in the LED and machine vision systems sales were the key factors      contributing to the strong performance.

Gross Profit

Gross margins improved      from $1.0 million, or 26% of sales, in 2003 to $1.5 million or 30% of      sales in 2004 as increased sales and lower material and labor costs      contributed incremental profits of $0.3 million and $0.2 million,      respectively.

Operating Expenses

Overall operating      expenses increased $144,000 in the third quarter of 2004 compared to the      same period in 2003. Administrative expenses increased $657,000 during      this period principally from higher professional fees and severance costs.      Selling costs also increased $91,000 due principally to higher commission      and travel expenses. Research and development expenses were flat during      this period. The remaining change in operating expenses from 2003 to 2004      mainly relates to a $605,000 asset impairment charge recorded in 2003.      There was no such charge in 2004. Operating expense comparisons to the      third quarter of 2003 include items that were non-recurring in nature.      These included approximately $500,000 for professional fees and severance      expense recorded in the third quarter of 2004 and the $605,000 asset      impairment charge recorded in the third quarter of 2003.
12  /  STKR                          2004 Form 10-QTable of Contents Part I Item 2
Interest Expense

Interest expense          declined $50,000 in the third quarter of fiscal 2004 compared to the          comparable period in 2003 due to lower average debt levels.

Provision (Benefit)          for Income Taxes

 The Company's          historical operating losses raise doubt as to the realizability of the          deferred tax assets. As a result, management has provided a valuation          allowance for the net deferred tax assets that may not be realized.

Net Income (Loss)

 Net loss for the            three months ended September 30, 2004 increased $0.1 million to $2.5            million compared to a net loss of $2.4 million for the same period            in 2003. Non-cash charges for debt amortization of $.5 million more            than offset an operating profit improvement of $0.4 million.

NINE MONTHS ENDED            SEPTEMBER 30, 2004 AND 2003

Net Sales

For the nine            months ended September 30, net sales increased $2.6 million or 24%            from $10.8 million in 2003 to $13.4 million in 2004. Illumination            revenues increased $2.7 million or 27% over the comparable period in            2003, which were partially offset by a $100,000 decline in optical            component revenues.

Gross Profit

Gross profit            improved $1.2 million or 45% in 2004 to $3.9 million or 29% of            sales. Increased sales and lower material and labor costs            contributed incremental profits of $649,000 and $568,000            respectively.
Operating Expenses

Operating expenses          decreased $140,00 for the first nine months of 2004 compared to the          same period in 2003. Administrative expenses increased $750,000 during          this period principally from higher professional fees. This increase          was partially offset by a $202,000 reduction in research and          development expenses as the result of lower personnel costs. The          remaining change in operating expenses from 2003 to 2004 relates to a          $605,000 asset impairment charge recorded in 2003. Operating expense          comparisons to the nine months ending September 30, 2003 include items          that were non-recurring in nature. These included approximately          $500,000 for professional fees and severance expense recorded in the          nine months ending September 30, 2004 and the $605,000 asset          impairment charge recorded in the nine months ending September 30,          2003.

Interest Expense

Interest expense          decreased $ 45,000 in the first nine months of fiscal 2004 compared to          2003 due to lower average debt levels.  13  /  STKR    2004 Form 10-Q      Table of Contents Part I Item 2
Provision (Benefit)          for Income Taxes

The Company's          historical operating losses raise doubt as to the realizability of the          deferred tax assets. As a result, management has provided a valuation          allowance for the net deferred tax assets that may not be realized.

Net Income (Loss)

Net loss for the          nine months ended September 30, 2004 increased $1.5 million to $8.5          million compared to a net loss of $7.0 million for the same period in          2003, as increased non-cash charges for debt discount and debt          acquisition cost amortization of $2.8 million more than offset an          operating profit improvement of $1.4 million. A portion of the debt          amortization charges related to the prepayment of the company's          mortgage debt and conversion of certain convertible notes into common          stock. The consolidation program implemented in the second quarter of          2004 is expected to result in a lower overall cost structure with          incremental savings commencing in the second half of the year.

LIQUIDITY AND            CAPITAL RESOURCES

As of September            30, 2004, the Company was in compliance with all provisions of its            loan agreements.

During the first            quarter of 2004, the Company raised approximately $2.6 million            through the private placement of common stock. In conjunction with            the private placement on February 3, 2004 of 2,334,130 shares of            common stock, the Company issued warrants to purchase 582,533 shares            of common stock at a price of $1.50 per share. Each warrant expires            on February 3, 2007. The Company also issued additional investment            rights to purchase 582,533 shares of common stock at a price of            $1.15 per share. Each additional investment right expires 90 trading            days after the effective date of registration. As of September 30,            2004, 313,479 additional investment rights were converted to 313,479            shares and the remainder has expired.

During the second            quarter of 2004, the Company raised an additional $5.5 million            through the placement of a convertible note. The net proceeds of            $5.2 million were used to retire its $3.4 million senior U.S. credit            facility with Merrill Lynch Financial Services. The remaining $1.8            million was used for general working capital purposes.

Based upon the            Company's current forecast for 2004, the Company plans to increase            revenues, reduce costs and pursue various options to raise            additional funds to finance operations through the end of 2004. The            Company can give no assurances to the timing or terms of such            arrangements, assuming it is able to consummate one or more of these            options. If the Company is unable to raise sufficient funds through            these options by the end of the fourth quarter of 2004, it will need            to implement further cost reduction strategies, and the Company may            not have adequate capital to sustain its current operations.            Financing options in process or under consideration are the sale of            real estate and/or a private placement of equity and/or debt            securities. The Company expects to close on some of these financing            options by the end of 2004.

For the nine            months ending September 30, 2004, cash and cash equivalents            increased approximately $200,000 from $1.0 million at December 31,            2003 to $1.2 million at September 30, 2004. 

Cash used in            operating activities was $4.2 million for the period ended September            30, 2004. The change resulted from the net loss of $8.5 million and            an increase in working capital of $400,000 offset by $4.7 million of            non-cash charges for depreciation and debt amortization expenses.

Cash provided by            financing activities during the first nine months of 2004 increased            $0.9 million to $4.4 million. Proceeds from the sales of stock and            long-term debt of $3.1 and $9.6 million respectively were used to            retire $7.3 million in debt and provide additional working capital.

Investing            activities used $100,000 cash during the first nine months of 2004,            as purchases of $300,000 were offset with $200,000 in proceeds from            assets sales. 14  /  STKR                          2004 Form 10-QTable of Contents Part I Item 2**Merrill        Lynch Financial Services**On June 10, 2004, the        Company paid the credit facility in full including outstanding principal        and accrued interest of $3,370,000 and $7,000 respectively, with        proceeds from a convertible note. 
The Company's        obligations under the credit facility were secured by substantially all        of the Company's Salem assets, excluding real property. The facility was        also subject to various financial covenants, including having a minimum        net worth of $10.0 million at all times. The Company was also required        to repay amounts under the credit facility using 100% of the net excess        proceeds, as defined, from the sale of its Salem facility; 80% of net        proceeds from assets sales and 50% of the net proceeds from equity        offerings.
On March 25, 2004, the      Company entered into an amended agreement with Merrill Lynch. The amended      agreement changed the maturity date from October 31, 2004 in the prior      agreement to June 30, 2004. The amended agreement also increased the      interest from LIBOR + 5.5% in the prior agreement to LIBOR + 7.5%. 
**TJJ        Corporation**As of December 31,        2003, the Company had a $4,700,000 term note with TJJ Corporation        secured by the Company's Salem headquarters. On February 25, 2004, the        Company paid the note in full including outstanding principal and        accrued interest of $4,400,000 and $25,000, respectively, with proceeds        from a private placement of common stock and convertible notes.
 **National Bank of        Canada**On May 26, 2003, the Company entered into a        credit agreement with the National Bank of Canada replacing the facility        with Toronto Dominion Bank. The new agreement provided total borrowing        availability up to C$4,050,000 ($3,000,000 US), including a line of        credit of C$2,500,000 ($1,850,000 US) and a ten-year term note of        C$1,550,000 ($1,150,000 US). Initial proceeds were used to pay off the        credit agreement with Toronto Dominion Bank.
On      August 23, 2003, the Company amended its credit facility with National      Bank of Canada to reduce the restricted term deposit from C$1,000,000      ($740,000 US) to C$250,000 ($185,000 US) and reduce the term loan from      C$2,300,000 ($1,702,000 US) to C$1,550,000 ($1,147,000 US). The net      availability of the term loan remained the same. In addition, the bank      added Canadian Provincial Government research and development tax credits      as additional eligible accounts receivable, which increased the      availability of the revolving credit facility by approximately C$300,000      ($222,000 US). All other terms of the credit facility remained the same,      including StockerYale, Inc.'s guarantee to fund StockerYale Canada's      deficits if requested by the bank. 

On      November 20, 2003, the credit facility was amended increasing the interest      rate on the line of credit to the Canadian prime rate plus 2.00% and the      term note to the Canadian prime rate plus 2.75%.      The National Bank of Canada credit facility requires the following      financial covenants, including working capital, net worth, capital      expenditures, a financial coverage ratio and maximum inventory levels.

On      March 19, 2004, the Company entered into an amended agreement with the      National Bank of Canada. The new agreement includes a line of credit of      C$2,500,000 ($1,875,000 US) and a five-year term note of C$1,396,000      ($1,050,000 US). The amended agreement reduced the net worth covenant from      C$10,800,000 in the May 26, 2003 agreement to C$8,000,000 in the March 19,      2004 agreement as of December 31, 2003. The amended agreement also      requires a C$10,000,000 net worth as of September 30, 2004 and thereafter.      The amended agreement also reduced the reduced the inventory component of      the line of credit availability from C$750,000 to C$625,000 and requires      the Company to achieve specific net profit targets throughout 2004.
15  /  STKR                          2004 Form 10-QTable of Contents Part I Item 2
As of      September 30, 2004, C$2,500,000 ($1,964,545 US) was outstanding under the      line of credit and C$1,262,500 ($ 992,095 US) was outstanding under the      term note. As of September 30, 2004, the interest rate on the line of      credit and the term note were 6.00% and 6.75%, respectively.
**Laurus Master        Funds**As of May 4, 2004,        the total value of the note issued on September 24, 2003 had been        converted to 2,337,249 shares of common stock that resulted in an        incremental non-cash charge related to accelerated amortization of debt        discount of $514,000 for the nine months ending September 30, 2004.
On September 24, 2003,      the Company issued a Convertible Note to Laurus Master Funds, Ltd. The      $2,500,000 Convertible Note matures on September 24, 2006, bears interest      at a rate equal to the Prime Rate plus 3.5%, but in no event less than      7.5%, and provides the holder with the option to convert the loan to      common stock at $1.07 per share subject to certain adjustment features.      StockerYale has the right to elect to make the monthly required payments      on the convertible note (comprised of principal amortization and interest)      in the form of shares of common stock, determined based on the $1.07      conversion price. The Company also issued to the holder seven-year      warrants to purchase shares in the following warrant amounts and exercise      prices per share of common stock: 225,000 shares at $1.23 per share,      150,000 shares at $1.34 per share and 100,000 shares at $1.44 per share.      The aggregate purchase price of the convertible note and warrants      ($2,500,000) was allocated between the note, the common stock conversion      option and warrants based upon their relative fair market value. The      purchase price assigned to the note, common stock beneficial conversion      option and warrants was $1,551,700, $546,650 and $401,650 respectively.      The difference between the face amount of the convertible note of      $2,500,000 and the aggregate purchase price of the convertible note of      $1,551,700 was recorded as a debt discount and is being amortized over the      life of the convertible note. The Company used the Black-Scholes Model to      calculate the fair value of the warrants. The underlying assumptions      included in the Black-Scholes Model were: a risk-free interest rate of      2.7%; an expected life of seven years; and an expected volatility of 114%      with no dividend yield.

The Company can elect      to pay monthly principal amortization in cash at 103% of the principal      amount. The Company may also elect to pay both principal amortization and      interest in common stock, if the market price of the stock at the time of      the payment is 110% of the fixed conversion price. The Company may elect      to redeem the principal amount outstanding at 120% within the first year,      115% within the second year and 110% during the third year. The principal      amortization payments begin 120 days from the execution of the agreement      at a rate of $78,125 per month. As of September 30, 2004 the note had been      fully converted to common stock. 
16  /  STKR                          2004 Form 10-QTable of Contents Part I Item 2
On February 25, 2004,      the Company issued a Convertible Note to Laurus Master Funds, Ltd. The      $4,000,000 Convertible Note matures on February 25, 2007, bears interest      at a rate equal to the Prime Rate plus 2.0 %, but in no event less than      6.0 %, and provides the holder with the option to convert the loan to      common stock at $1.30 per share subject to certain adjustment features.      The Convertible Note is collateralized by a mortgage on the Salem      building. StockerYale has the right to elect to make the monthly required      payments on the convertible note (comprised of principal amortization and      interest) in the form of shares of common stock, determined based on the      $1.30 conversion price. The Company also issued to the holder seven-year      warrants to purchase shares in the following warrant amounts and exercise      prices per share of common stock: 375,000 shares at $1.56 per share,      250,000 shares at $1.75 per share and 75,000 shares at $1.94 per share.      The aggregate purchase price of the convertible note and warrants      ($4,000,000) was allocated between the note, the common stock conversion      option and warrants based upon their relative fair market value. The      purchase price assigned to the note, common stock beneficial conversion      option and warrants was $2,319,047, $988,184 and $692,769 respectively.      The difference between the face amount of the convertible note of      $4,000,000 and the aggregate purchase price of the convertible note of      $2,319,047 was recorded as a debt discount and is being amortized over the      life of the convertible note. The Company used the Black-Scholes Model to      calculate the fair value of the warrants. The underlying assumptions      included in the Black-Scholes Model were: a risk-free interest rate of      3.0%; an expected life of seven years; and an expected volatility of 140%      with no dividend yield. The Company can elect to pay monthly principal      amortization in cash at 101% of the principal amount. The Company may also      elect to pay both principal amortization and interest in common stock, if      the market price of the stock at the time of the payment is 110% of the      fixed conversion price. The Company may elect to redeem the principal      amount outstanding at 115% within the first year, 110% within the second      year and 105% during the third year. The principal amortization payments      began 120 days from the execution of the agreement at a rate of $125,000      per month. As of September 30, 2004, $1,874,000 was outstanding under the      convertible note and has been classified as long-term debt. The obligation      has been reported net of $683,150 related to unamortized debt discount      based upon beneficial conversion rights and warrants.

As of September 30,      2004, based upon the note issued on February 25, 2004, Laurus had      converted $1,501,500 into 1,155,000 shares of common stock that resulted      in an incremental non-cash charge related to accelerated amortization of      debt discount of $631,000 for the nine months ended September 30, 2004.

On June 10, 2004, the      Company issued a Convertible Note to Laurus Master Funds, LTD and another      institutional investor. The $5,500,000 Convertible Note matures on June      20, 2007, bears interest at a rate equal to the Prime Rate plus 1.0%, but      in no event less than 5.0%, and provides the holder with the option to      convert the loan to common stock at $2.15 per share subject to certain      adjustment features. The Convertible Note is collateralized by U.S.      accounts receivable, inventory and equipment and a second mortgage on the      Montreal, Canada building. StockerYale has the right to elect to make the      monthly required payments on the convertible note (comprised of principal      amortization and interest) in the form of shares of common stock,      determined based on the $2.15 conversion price. The Company also issued to      the holders seven-year warrants to purchase an aggregate of 440,000 shares      at $3.12 per share The aggregate purchase price of the convertible note      and warrants ($5,500,000) was allocated between the note, the common stock      conversion option and warrants based upon their relative fair market      value. The purchase price assigned to the note, common stock beneficial      conversion option and warrants was $3,646,478, $1,093,511 and $760,011      respectively. The difference between the face amount of the convertible      note of $5,500,000 and the aggregate purchase price of the convertible      note of $3,646,478 was recorded as a debt discount and is being amortized      over the life of the convertible note. The Company used the Black-Scholes      Model to calculate the fair value of the warrants. The underlying      assumptions included in the Black-Scholes Model were: a risk-free interest      rate of 4.43%; an expected life of seven years; and an expected volatility      of 145.92% with no dividend yield.

The Company can elect      to pay monthly principal amortization in cash at 101% of the principal      amount. The Company may also elect to pay both principal amortization and      interest in common stock, if the market price of the stock at the time of      the payment is 110% of the fixed conversion price. The Company may elect      to redeem the principal amount outstanding at 115% within the first year,      110% within the second year and 105% during the third year. The principal      amortization payments began 120 days from the execution of the agreement      at a rate of $171,875 per month. As of September 30, 2004, $5,500,000 was      outstanding under the Convertible Note of which $2,062,500 has been      classified as short-term debt and $1,964,800 has been classified as      long-term debt. The obligation has been reported net of $1,473,312 related      to unamortized debt discount based upon beneficial conversion rights and      warrants.
17  /  STKR                          2004 Form 10-QTable of Contents Part I Items 2 - 4
      CRITICAL ACCOUNTING POLICIES, COMMITMENTS AND CERTAIN OTHER MATTERS

The Company considered      the disclosure requirements of FR-60 regarding critical accounting      policies and FR-61 regarding liquidity and capital resources, certain      trading activities and related party/certain other disclosures, and      concluded that nothing materially changed during the quarter that would      warrant further disclosure under these releases.

ITEM      3.    QUANTITATIVE AND QUALITATIVE DISCLOSURE      ABOUT MARKET RISK

      FOREIGN CURRENCY EXCHANGE RISK

Management has      determined that all of the Company's foreign subsidiaries operate      primarily in local currencies that represent the functional currencies of      the subsidiaries. All assets and liabilities of foreign subsidiaries are      translated into U.S. dollars using the exchange rate prevailing at the      balance sheet date, while income and expense accounts are translated at      average exchange rates during the year. As such, the Company's operating      results are affected by fluctuations in the value of the U.S. dollar as      compared to currencies in foreign countries, as a result of the Company's      transactions in these foreign markets. The Company does not operate a      hedging program to mitigate the effect of a significant rapid change in      the value of the Canadian Dollar or Euro as compared to the U.S. dollar.      If such a change did occur, the Company would have to take into account a      currency exchange gain or loss in the amount of the change in the U.S.      dollar denominated balance of the amounts outstanding at the time of such      change. While the Company does not believe such a gain or loss is likely,      and would not likely be material, there can be no assurance that such a      loss would not have an adverse material effect on the Company's results of      operations or financial condition.

INTEREST RATE RISK

The Company is exposed      to market risk from changes in interest rates, which may adversely affect      its financial position, results of operations and cash flows. In seeking      to minimize the risks from interest rate fluctuations, the Company manages      exposures through its regular operating and financing activities. The      Company is exposed to interest rate risk primarily through its borrowings      under its $3.9 million CDN credit facility with the National Bank of      Canada with line of credit and term note interest rates of 2.0% and 2.75%      over the Canadian prime rate respectively. As of September 30, 2004 the      fair market value of the Company's outstanding line of credit and term      note approximates its carrying value due to the short-term maturities and      variable interest rates. A 1% change in interest rates could increase or      decrease interest expense by approximately $30,000 on an annual basis.

ITEM 4.         CONTROLS AND PROCEDURES

(a) Evaluation of      disclosure controls and procedures.

As required by Rule      13a-15 under the Securities Exchange Act of 1934, as of the end of the      period covered by this report, the Company carried out an evaluation under      the supervision and with the participation of the Company's management,      including the Company's Chief Executive Officer and Chief Financial      Officer, of the effectiveness of the design and operation of the Company's      disclosure controls and procedures. Based upon that evaluation, the Chief      Executive Officer and Chief Financial Officer concluded that the Company's      disclosure controls and procedures are effective to ensure that      information required to be disclosed by the Company in the reports it      files or submits under the Exchange Act is recorded, processed, summarized      and reported, within the time periods specified in the Securities and      Exchange Commission's rules and forms. In connection with the new rules,      we currently are in the process of further reviewing and documenting our      disclosure controls and procedures, including our internal controls and      procedures for financial reporting, and may from time to time make changes      aimed at enhancing their effectiveness and to ensure that our systems      evolve with our business.

(b) Changes in internal      controls

None
18  /  STKR                          2004 Form 10-QTable of Contents Part II Items 1 - 6
Item      1.     LEGAL PROCEEDINGS

Not applicable.

Item      2.    CHANGES IN SECURITIES AND USE OF PROCEEDS

Not applicable.

Item      3.    DEFAULTS UPON SENIOR SECURITIES

Not applicable.

Item      4.    SUBMISSION OF MATTERS TO A VOTE OF SECURITY

Not applicable.

        Item 5.    OTHER INFORMATION

Not applicable.

        Item 6.    EXHIBITS

(a)  The        following is a complete list of exhibits filed as part of this Form        10-Q: Exhibit Number               Description31.1                        CEO Certification31.2                        CFO Certification32.1                        CEO Certification32.2                        CFO Certification 19  /  STKR                          2004 Form 10-QTable of Contents Part II Item  6
SIGNATURES

Pursuant to the      requirements of the Securities Exchange Act of 1934, the registrant has      duly caused this report to be signed on its behalf by the undersigned,      thereunto duly authorized.
          StockerYale, Inc.                                 November 15, 2004/s/ Mark W.          Blodgett Mark W. Blodgett,          Chairman and Chief          Executive Officer   November 15, 2004          /s/ Richard P.          LindsayRichard P. LindsayChief Financial          Officer and Treasurer             20  /  STKR             END              2004 Form 10-Q |
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