**UNITED STATES SECURITIES AND EXCHANGE COMMISSION**

**Washington, D. C. 20549**

 

**FORM 10-K**

 

| **(Mark One)**                                                                                                                                                                                                                                                |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **                                                                                                                                                                                                                                                    |
| **x**                                                                                                                                                                                                                                                         | **ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF  THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                                                                                                                                                          |
| **For the fiscal year ended: December 31, 2007**                                                                                                                                                                                                              |
|                                                                                                                                                                                                                                                          |
| **OR**                                                                                                                                                                                                                                                        |
| ** **                                                                                                                                                                                                                                                    |
| **o**                                                                                                                                                                                                                                                         | **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: 0-11668**                                                                                                                                                                                                                          |

** **

**Photonic Products Group, Inc.**

(Exact name of registrantas specified in its charter)

 

| **New Jersey**                                                |   | **22-2003247**                          |
|---------------------------------------------------------------|--------|-----------------------------------------|
| State or other jurisdiction of incorporation or  organization |   | (I. R. S. Employer  Identification No.) |
| ** **                                                    |   | ** **                              |
| **181 Legrand Avenue, Northvale, NJ**                         |   | **07647**                               |
| (Address of principal executive offices)                      |   | (Zip Code)                              |

Registrant’s telephone number, including areacode 201**-767-1910**

Securities registered pursuant to Section 12(b) of theAct: **None**

 

| ** **               | ** ** | **Name of  each exchange** | ** ** |
|--------------------------|------------|----------------------------|------------|
| **Title of  each class** | ** ** | **on which  registered**   | ** ** |
|                     |       |                       |       |

 

Securities registered pursuant to section 12(g) of theAct:

**Common stock, par value $.01 PerShare**

 

Indicateby check mark if the registrant is a well-known seasoned issuer, as defined in Rule405 of the Securities Act. Yes o.      No ý.

 

Indicateby check mark if the registrant is not required to file reports pursuant toSection 13 or Section 15(d) of the Act.  Yes  o.      No ý.

 

Note — Checking the boxabove will not relieve any registrant required to file reports pursuant toSection 13 or 15(d) of the Exchange Act from their obligations under thoseSections.

 

Indicateby check mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.

 

| ** ** | ** ** |   | Yes | ý | No | o |
|------------|------------|--------|-----|--------|----|---|

 

Indicate by check mark if disclosure of delinquentfilers pursuant to Item 405 of Regulation S-K (§ 229.405 of thischapter) is not contained herein, and will not be contained, to the best ofregistrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or any amendmentto this Form 10-K.  o

 

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, a non-accelerated file, or asmaller reporting company.  Seedefinition of large accelerated filer, accelerated filer and smaller reportingcompany in Rule 12b2 of the Exchange Act. (Check one):

 
| Large accelerated  filer  o |   | Accelerated  filer  o |   | Non-accelerated  filer  o |   | Smaller reporting  company  ý |
|---------------------------------------|--------|---------------------------------|--------|-------------------------------------|--------|-----------------------------------------|

 

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act).

 

| ** ** | ** ** |   | Yes | o | No | ý |
|------------|------------|--------|-----|---|----|--------|

 

State the aggregate market value of the voting andnon-voting common equity held by non-affiliates computed by reference to theprice at which the common equity was last sold, or the average bid and askedprice of such common equity, as of the last business day of the registrant’s mostrecently completed second fiscal quarter. **  $6,565,580**.  (For purposes of determining this amount,only directors, executive officers and 10% or greater shareholders have beendeemed affiliates.)

 

**Note. **If a determination as to whether aparticular person or entity is an affiliate cannot be made without involvingunreasonable effort and expense, the aggregate market value of the common stockheld by non-affiliates may be calculated on the basis of assumptions reasonableunder the circumstances, provided that the assumptions are set forth in thisForm

 

Indicatethe number of shares outstanding of each of the registrant’s classes of commonstock, as of the latest practicable date.

 

**Common Shares outstanding as ofMarch 26, 2008**

**[10,625,738]**

**DocumentsIncorporated by Reference**

 

Portions of theregistrant's definitive proxy statement to be filed not later than 120 daysafter the end of the fiscal year covered by this report are incorporated byreference in Part III.

 

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Photonic Products Group,Inc.

 

INDEX

 
|     |  

  |  

                                                                                                          |   |
|--------------------|----------------|------------------------------------------------------------------------------------------------------------------------|--------|
| **Part I**
   |           |                                                                                                                   |   |
| Item 1.            |           | Business                                                                                                               |   |
|               |           |                                                                                                                   |   |
| Item 1A.           |           | Risk Factors                                                                                                           |   |
|               |           |                                                                                                                   |   |
| Item 1B.           |           | Unresolved  Staff Comments                                                                                             |   |
|               |           |                                                                                                                   |   |
| Item 2.            |           | Properties                                                                                                             |   |
|               |           |                                                                                                                   |   |
| Item 3.            |           | Legal Proceedings                                                                                                      |   |
|               |           |                                                                                                                   |   |
| Item 4.            |           | Submission of  Matters to a Vote of Security Holders                                                                   |   |
|               |           |                                                                                                                   |   |
| **Part II**        |           |                                                                                                                   |   |
|               |           |                                                                                                                   |   |
| Item 5.            |           | Market for  Registrant’s Common Equity and Related Stockholder Matters and Issuer  Purchases of Equity Securities |   |
|               |           |                                                                                                                   |   |
| Item 6.            |           | Selected Financial Data                                                                                                |   |
|               |           |                                                                                                                   |   |
| Item 7.            |           | Management’s  Discussion and Analysis of Financial Condition and Results of Operation                             |   |
|               |           |                                                                                                                   |   |
| Item 7A.           |           | Quantitative  and Qualitative Disclosures about Market Risk                                                            |   |
|               |           |                                                                                                                   |   |
| Item 8.            |           | Financial  Statements and Supplementary Data                                                                           |   |
|               |           |                                                                                                                   |   |
| Item 9.            |           | Changes in and  Disagreements with Accountants on Accounting and Financial Disclosure                                  |   |
|               |           |                                                                                                                   |   |
| Item 9A            |           | Controls and  Procedures                                                                                               |   |
|               |           |                                                                                                                   |   |
| Item 9B            |           | Other Information                                                                                                      |   |
|               |           |                                                                                                                   |   |
| **Part III**       |           |                                                                                                                   |   |
|               |           |                                                                                                                   |   |
| Item 10.           |           | Directors,  Executive Officers and Corporate Governance                                                                |   |
|               |           |                                                                                                                   |   |
| Item 11.           |           | Executive Compensation                                                                                                 |   |
|               |           |                                                                                                                   |   |
| Item 12.           |           | Security Ownership  of Certain Beneficial Owners and Management and Related Stockholder Matters                        |   |
|               |           |                                                                                                                   |   |
| Item 13.           |           | Certain  Relationships and Related Transactions, and Director Independence                                             |   |
|               |           |                                                                                                                   |   |
| Item 14.           |           | Principal  Accounting Fees and Services                                                                                |   |
|               |           |                                                                                                                   |   |
| **Part IV**        |           |                                                                                                                   |   |
|               |           |                                                                                                                   |   |
| Item 15            |           | Exhibits and  Financial Statement Schedules                                                                            |   |
|               |           |                                                                                                                   |   |
| Signatures         |           |

 

2

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#### **PART 1**

#### ** **

**Caution Regarding Forward Looking Statements**

 

This AnnualReport contains forward–looking statements as that term is defined in thefederal securities laws.  The Companywishes to insure that any forward–looking statements are accompanied by meaningfulcautionary statements in order to comply with the terms of the safe harborprovided by the Private Securities Litigation Reform Act of 1995.  The events described in the forward–lookingstatements contained in this Annual Report may not occur.  Generally, these statements relate tobusiness plans or strategies, projected or anticipated benefits or otherconsequences of the Company’s plans or strategies, projected or anticipatedbenefits of acquisitions made by the Company, projections involving anticipatedrevenues, earnings, or other aspects of the Company’s operating results.  The words “may”, “will”, “expect”, “believe”,“anticipate”, “project”, “plan”, “intend”, “estimate”, and “continue”, andtheir opposites and similar expressions are intended to identify forward–lookingstatements.  The Company cautions youthat these statements are not guarantees of future performance or events andare subject to a number of uncertainties, risks, and other influences, many ofwhich are beyond the Company’s control, that may influence the accuracy of thestatements and the projections upon which the statements are based.  Factors which may affect the Company’sresults include, but are not limited to, the risks and uncertainties discussedin Items 1A, 7 and 7A.  Any one or moreof these uncertainties, risks, and other influences could materially affect theCompany’s results of operations and whether forward–looking statements made bythe Company ultimately prove to be accurate. Readers are further cautioned that the Company’s financial results canvary from quarter to quarter, and the financial results for any period may notnecessarily be indicative of future results. The foregoing is not intended to be an exhaustive list of all factorsthat could cause actual results to differ materially from those expressed inforward–looking statements made by the Company. The Company’s actual results, performance and achievements could differmaterially from those expressed or implied in these forward–lookingstatements.  The Company undertakes noobligation to publicly update or revise any forward looking statements, whetherfrom new information, future events, or otherwise.

 

Thefollowing discussion and analysis should be read in conjunction with theCompany’s consolidated financial statements and the notes thereto presentedelsewhere herein.  The discussion ofresults should not be construed to imply any conclusion that such results willnecessarily continue in the future.

 

**Item 1.                 Business**

 

PhotonicProducts Group, Inc. (the “Company” or “PPGI”), incorporated in 1973, develops,manufactures and markets products and services for use in diverse Photonicsindustry sectors via its multiple business units.  Prior to its name change in September, 2003,PPGI was named and did business solely as Inrad, Inc.

 

TheCompany had announced in 2002 that it was implementing its plan to transformthe Company from a single business unit into a portfolio of businesses servingthe Photonics industry.  Companymanagement, the Board of Directors, and shareholders approved the name changein 2003, reinforcing the transformation of the Company’s business model intothat of a portfolio of business units whose branded products conform to theparadigm:  Products Enabling PhotonicsTM.

 

In November2003, the Company concluded its first acquisition, that of the assets andcertain liabilities of Laser Optics, Inc. of Bethel, CT.  Laser Optics, Inc. was a custom optics andoptical coating services provider, in business since 1966.  PPGI integrated the Bethel team and theiroperations into the Company’s Northvale, NJ operations in mid–2004, combiningthem with Inrad’s custom optics and optical coating product lines under theLaser Optics name.

 

In October2004 the Company completed its second acquisition of a complementary businesswith the purchase of 100% of the stock of MRC Precision Metal Optics, Inc. ofSarasota, FL.  MRC Optics, now a wholly–ownedsubsidiary of PPGI, is a fully integrated precision metal optics and diamond–turnedaspheric optics manufacturer, specializing in CNC and single point diamondmachining, optical polishing, plating, beryllium machining, and opto–mechanicalassembly services.

 

PPGI’sbusiness unit products continue, at present, to fall into two productcategories: optical components (including standard and custom opticalcomponents and assemblies, crystals, and crystal components), and laseraccessories (including wavelength conversion products and Pockel’s cells(optical shutters, also known as “Q–switches”) that employ nonlinear crystalsto perform the function of wavelength conversion).  Currently, its optical components productlines and services are brought to market via three PPGI business units: INRAD,Laser Optics, and MRC Optics.  Laseraccessories are brought to market by INRAD.

 

Insummary, the Company is at present an optical component, subassembly, and sub–systemsupplier to major original equipment manufacturers and researchers in thePhotonics industry.  In the future, itsproducts may also include other product categories.

 

Administrative,engineering and manufacturing operations are in a 42,000 square foot buildinglocated in Northvale, New Jersey, about 15 miles northeast of New York City,and in a 25,000 square foot building located in Sarasota, FL.  The headquarters of the Company are locatedwithin its Northvale, NJ facility.

 

Custom opticmanufacturing is a major product area for PPGI. The Company specializes in high–end precision components.  It develops, manufactures and deliversprecision custom optics and thin film optical coating services via its LaserOptics and MRC Precision Optics branded business units.  Glass, metal, and crystal substrates areprocessed using modern manufacturing equipment 

 

3

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andtechniques to prepare and polish substrates, deposit optical thin films, andassemble sub–components, thereby producing optical components used in advancedPhotonic systems.  The majority of customoptical components and optical coating services supplied are used in inspectionand process control systems, in defense and aerospace electro–optical systems,in laser system applications, in industrial scanners, and in medical systemapplications.

 

TheCompany also currently develops, manufactures, and delivers synthetic opticalcrystals, optical crystal components, and laser accessories via its INRADbrand.  It grows synthetic crystals withelectro–optic (EO), non–linear and optical properties for use in both itsstandard products and custom products. The majority of crystals, crystal components and laser accessoriessupplied are used in laser systems, defense EO systems, and in R&Dapplications by researchers within corporations, universities, and nationallaboratories.

 

Thefollowing table summarizes the Company’s product sales by product categoriesduring the past three years. The methodology for categorizing the productscomprising “laser accessories” has been revised to include all non–linear andelectro–optical crystal components. The prior year figures in the followingtable have been revised to reflect this new methodology:

 

| ** **          | ** ** | **Years Ended December 31,** |
|---------------------|------------|------------------------------|
| ** **          | ** ** | **2007**                     | ** ** | **2006** | ** ** | **2005** |
| **Category**        | ** ** | **Sales**                    | ** ** | **%** | ** ** | **Sales** | ** ** | **%** | ** ** | **Sales** | ** ** | **%** |
| Optical  Components |       | $                            | 13,410,000 |   | 89 |   | $ | 12,274,000 |   | 88 |   | $ | 11,798,000 |   | 85 |
| Laser  Accessories  |       | 1,690,000                    |   | 11 |   | 1,647,000 |   | 12 |   | 1,987,000 |   | 15 |
| TOTAL               |       | $                            | 15,100,000 |   | 100 |   | $ | 13,921,000 |   | 100 |   | $ | 13,785,000 |   | 100 |

 

**ProductsManufactured by the Company**

 

**OpticalComponents**

 

a)           Custom Optics and Optical CoatingServices

 

Manufacturing of high–performancecustom optics is at present a major product area for PPGI, and is addressed inthe marketplace by all three business units, but principally via its LaserOptics and its MRC Optics business units.

 

TheLaser Optics business unit was formed in 2003 via the combination of INRAD’sNorthvale, NJ based custom optics and optical coating services operations andthose of the former Laser Optics, Inc. of Bethel, CT.  The Company had been active in the fieldsince 1973, and Laser Optics, Inc. since 1966.

 

Laser Optics producescustom products manufactured to its customer’s requirements.  It specializes in the manufacture of opticalcomponents, optical coatings (ultra–violet wavelengths through infra–redwavelengths) and subassemblies for military, aerospace, process control,photonic instrument, and medical end–use. Planar, prismatic and spherical components are fabricated from glassesof all kinds and crystals of most kinds, including fused silica, quartz, infra–redmaterials (including germanium, zinc selenide and zinc sulfide), calcite,magnesium fluoride and silicon. Component types include mirrors, lenses, prisms, waveplates, polarizingoptics, monochrometers, x–ray mirrors, and cavity optics for lasers.

 

Tomeet performance requirements, most optical components and sub–assembliesrequire thin film coatings on their surfaces. Depending on the design, optical coatings can refract, reflect, ortransmit specific wavelengths.  LaserOptics optical coating specialties include high laser damage resistance,polarizing, high reflective, anti–reflective, infra–red, and coating to complexcustom multi–wavelength requirements on a wide range of substratematerials.  Laser Optics coats mainlycomponents it manufactures, and also customer furnished components.  Coating deposition process technologiesemployed included electron beam, thermal, and ion assist.

 

MRCOptics, established in 1983 is a fully integrated precision metal optics andoptical assembly manufacturer.  TheCompany employs high precision CNC and diamond machining, polishing, plating,beryllium machining, opto–mechanical design, component manufacturing andassembly services in the manufacture of custom optics.  MRC has developed custom processes to supportprototyping through high rate production of large and small metal mirrors,thermally stable optical mirrors, low RMS surface finish polished mirrors,diamond machined precision aspheric and planar mirrors, reflective porro prisms, and arc–second accuracy polygons andmotor assemblies.  Optical platingspecialties include void–free gold and electroless nickel.

 

b)           UV Filter Optical Components

 

The INRAD crystals andcrystal components product lines include crystalline filter materials,including both patented and proprietary materials, that have uniquetransmission and absorption characteristics that enable them to be used incritical applications in defense systems such as missile warning sensors.  Such materials include nickel sulphate, andproprietary materials known in the field as UVC–7 and LAC.

 

4

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**LaserAccessories**

 

PPGIproduces and brings to market crystal–based products that are both used in, andare accessories for, laser systems via its INRAD business unit. These productsinclude wavelength conversion crystals, Pockel’s cells (also known as “Q–switches”),wavelength conversion instruments, and certain other crystal components.

 

a)           CrystalComponents

 

Certainsynthetic crystals, because of their internal structure, have unique optical,non–linear, or electro–optical properties that are essential to application inor with laser systems.  Electro–optic andnonlinear crystal devices can alter the intensity, polarization or wavelengthof a laser beam.  Developing growthprocesses for high quality synthetic crystals and manufacturing and designprocesses for crystal components lies at the heart of the INRAD laser accessoryproduct lines. Other crystal components, both standard and custom, are used inlaser applications research and in commercial laser systems to change thewavelength of laser light.  Syntheticcrystals currently in production include Lithium Niobate, Beta Barium Borate,Alpha Barium Borate, KDP, deuterated KDP and Zinc Germanium Phosphide, amongothers.

 

b)           Pockel’sCells

 

INRADhas developed and manufactures a line of Pockel’s Cells (optical shutters) andassociated electronics, and has been active in this field since 1973.  Pockel’s cells are used in applications thatrequire fast switching of the polarization direction of a beam of light.  These uses include Q–switching of lasercavities (i.e., to generate laser output pulses), coupling light into and outfrom regenerative amplifiers, and light intensity modulation.  These devices are sold on an OEM basis tolaser manufacturers and individually to researchers.

 

INRADPockel’s cell products include the following:

 

·                  Singlecrystal and dual crystal KD*P Pockel’s Cells

 

·                  PKC–21 andPKC–02

 

·                  9 mm through50 mm apertures

 

·                  Singlecrystal Lithium Niobate Pockel’s Cells

 

·                  PLC–01

 

·                  8.5 mmthrough 10.5 mm apertures

 

·                  Singlecrystal and dual crystal BBO Pockel’s Cells

 

·                  PBC–03

 

·                  2.5 mm x 2.5mm through 2.5 mm x 7 mm sizes

 

·                  Electronicdrivers

 

·                  Gimbalmounts

 

c)           HarmonicGeneration Systems

 

PPGIdesigns, manufactures, and brings to market a line of harmonic generation laseraccessories via its INRAD business unit.** **Harmonic generation systems enable the users of lasersto convert the fundamental frequency of the laser to another frequency requiredfor a specific end use.  Harmonicgenerators are currently used in spectroscopy, semiconductor processing,medical lasers, optical data storage and scientific research.

** **

Manycommercial lasers have automatic tuning features, allowing them to produce arange of frequencies.  The INRADAutotracker, when used in conjunction with these lasers, automaticallygenerates tunable ultraviolet light or infrared light for use in spectroscopicapplications.

 

Productsoffered for such nano–second laser systems include the following:

 

·                  AT–III — anAutotracker with servo controlled tuning

 

·                  5–304 —temperature–stabilized crystals

 

·                  Harmonicseparators — for ultra–violet (UV), infra–red (IR), and second frequency mixing(SFM)

 

The Company produces a HarmonicGenerator, the 5–050, for use with ultra–fast lasers having pulse durations inthe femtosecond and picosecond regime. This product is sold on an OEM basis to manufacturers of ultra fastlasers and to researchers in the scientific community.

 

5

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d)           LaserPulse Measurement Instruments

 

TheCompany marketed, through December 31, 2005, a line of Autocorrelators thatmeasure extremely short laser pulses. Autocorrelators are used for measuring laser pulses from ultrafastlasers, with pulse durations in the picosecond and femtosecond ranges.  INRAD had pioneered the design, manufacture,and introduction of autocorrelators as accessories for the emerging field ofultrafast lasers back in 1979.  In 2000,INRAD joined forces with Angewandte Physik & Electronik, GmbH of Berlin,Germany, (A.P.E.) and became the source for supply of products manufactured byA.P.E. to customers in the Americas, Israel, and selected other markets.  Effective January 1, 2006, the Company andA.P.E. ended their alliance in this field. The Company no longer offers Autocorrelators for sale in themarketplace.

 

**Markets**

 

In2007, 2006 and 2005 the Company’s product sales were made to customers in thefollowing market areas:

 

| **Market**                               | ** ** | **2007**                                                                                                                | ** **          | **2006**                             | ** ** | **2005**                                                                         | ** ** |
|------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------|---------------------|--------------------------------------|------------|----------------------------------------------------------------------------------|------------|
| Defense/Aerospace                        |       | $                                                                                                                       | 9,456,000  (63 | )%                                   | $          | 9,048,000   (65                                                        | )%         | $ | 8,352,000   (60 | )% |
| Process control & metrology          |       | 3,760,000  (25                                                                                                     | )%                  | 2,862,000   (20            | )%         |            3,259,000  (24 | )%         |
| Laser systems (non–military)        |       |                  932,000   (6 | )%                  | 1,001,000     (7 | )%         | 1,044,000     (8                                             | )%         |
| Universities & National laboratories |       |                 352,000    (2 | )%                  | 502,000     (4   | )%         | 522,000     (4                                               | )%         |
| Other                                    |       |                 600,000    (4 | )%                  | 508,000     (4   | )%         | 608,000     (4                                               | )%         |
| Total                                    |       | $                                                                                                                       | 15,100,000 (100     | )%                                   | $          | 13,921,000 (100                                                                  | )%         | $ | 13,785,000 (100 | )% |
|                                          |            |                                                                                                                         |                     |                                      |            |                                                                                  |            |  |  |  |  |  |  |

 

Majormarket sectors served by the Company include defense and aerospace, processcontrol & metrology, laser systems (non–military), telecom, universitiesand national laboratories, and various other markets not separatelyclassified.  The “defense and aerospace”area consists of sales to OEM defense electro–optical systems and subsystemsmanufacturers, manufacturers of non–military satellite–based electro–opticalsystems and subsystems, and direct sales to governments where the products havethe same end–use.  The “process controland metrology” area consists of customers who are OEM manufacturers of capitalequipment used in manufacturing process implementation and control, optics–basedmetrology and quality assurance, and inventory and product controlequipment.  Examples of applications forsuch equipment include semiconductor (i.e., chip) fabrication and testing andinventory management and distribution control. The “laser systems” market area consists principally of customers whoare OEM manufacturers of industrial, medical, and R&D lasers.  “Universities and National Laboratories”consists of product sales to researchers at such institutions.  The “Other” category represents sales tomarket areas that, while they may be the object of penetration plans by theCompany, are not currently large enough to list individually (example: bio–medical),and sales through third parties for whom the end–use sector is not known.

 

TheCompany is a provider of optical components, both specialty crystal componentsand high precision custom optical components for customers in the aerospace anddefense electro–optical systems sector. End–use applications include military laser systems, military electro–opticalsystems, satellite–based systems, and missile warning sensors and systems thatprotect aircraft.  The dollar volume ofshipments of product within this sector depends in large measure on the U.S.Defense Department budget and its priorities, that of foreign governments, thetiming of their release of contracts to their prime equipment and systemscontractors, and the timing of competitive awards from this customer communityto the Company.  In the post–9/11 era,government spending priorities for such systems rose and deployment of newsystems was accelerated, as was refurbishment of fielded systems.  The Company’s sales of products to thiscustomer sector continued their upward trend, representing 63% of sales in2007, 65% of sales in 2006 and 60% of sales in 2005.  In dollar terms, sales to customers in thissector increased by 4.5% in 2007 as compared with 2006, and 8.3% in 2006 ascompared with 2005.  The defense andaerospace sector offers continued opportunities for the Company’s capabilitiesin specialty crystal, glass and metal precision optics.

 

Demandin the Process Control and Metrology market sector increased in 2007.  Sales in 2007 represented 25% of totalCompany sales. Sales in 2006 represented 20% of total Company sales, down from24% in 2005.  In dollar terms, 2007 salesto customers in this sector were up 31.4%, while in 2006 sales to this sectorwere down 12% from sales in 2005.  Theoptical and x–ray inspection segment of the semiconductor industry offerscontinued opportunities for the Company’s capabilities in precision optics,crystal products, and monochrometers.

 

TheCompany serves the non–military laser industry as an OEM supplier of standardand custom optical components and laser accessories.  Sales in 2007 represented 6% of total saleswhile sales in 2006 were 7%, and in 2005 were 8% of total sales, respectively.  In dollar terms, the sales to this sectordeclined 7% from 2006 sales, reflecting maturation of certain OEM products.Sales in 2006 declined 4% from 2005 levels, reflecting discontinuation of theINRAD/A.P.E. alliance and sales of autocorrellators on December 31, 2005.  Sales to customers in this sector in dollarterms, net of autocorrellator sales, increased between 2005 and 2006.

 

Salesto customers within the University and National Laboratories market sectorrepresented approximately 4% of total revenues in 2007, 2006 and 2005.  Sales to this sector have been in the$500,000 to $700,000 range historically, now representing a smaller percentageof total revenues.

 

Exportsales, primarily to customers in countries within Europe, the Near East andJapan, amounted to 9.5%, 8.7%, and 9.5%, of product sales in 2007, 2006 and2005, respectively.

 

6

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In 2007, two domesticcustomers accounted for 13.5% and 19.0% of sales. Both of these customers areelectro–optical systems divisions of major U.S defense industry corporationswho manufacture systems for U.S. and allied foreign governments. In 2006, threedomestic customers accounted for 15%, 16%, and 11%, of sales.  Two of these three customers are the samecustomers as in 2007. The third customer is also a defense electro–opticalsystems manufacturer.   In 2005, two U.S.customers accounted for 13% and 14%, respectively, of sales.  These two customers were the same customersas in 2007.  In the short–term, the lossof any of these customers would have a significant negative impact on the Companyand its business units.

 

**Long–TermContracts**

 

Certainof the Company’s orders from customers provide for periodic deliveries at fixedprices over a long period of time.  Insuch cases, as in most other cases as well, the Company attempts to obtain firmprice commitments from its suppliers for the materials necessary to fulfill theorder.

 

**Marketing andBusiness Development**

 

TheCompany’s two Northvale, NJ–based business units market their products domesticallythrough their own sales, marketing and customer service teams, led by theCorporate Vice President — Sales and Marketing. The Company’s MRC Optics subsidiary markets its products domesticallythrough a combination of its own sales, marketing and customer service team,led by the Corporate Vice President — Sales and Marketing.

 

Independentsales agents are used in countries in major non–U.S. markets, including Canada,UK, EU, Israel, and Japan.

 

Tradeshow participation, Internet–based marketing and promotion, and internationalsales representative and distributor relationships are coordinated at thecorporate level under the auspices of the corporate Vice President — Marketingand Sales.

 

**Backlog**

 

TheCompany’s order backlog at December 31, 2007 was $9,672,000, essentially all ofwhich is expected to be shipped in 2008. The Company’s order backlog as ofDecember 31, 2006 was $6,969,000. The Company’s order backlog as of December31, 2005 was $7,857,000.

 

**Competition**

 

Withineach product category in which the Company’s business units are active, thereis competition.

 

Changesin the Photonics industry have had an effect on suppliers of customoptics.  As end users have introducedproducts requiring large volumes of optical components, suppliers haveresponded either by staying small and carving out niche product areas or byramping up their own manufacturing capacity and modernizing their manufacturingmethods to meet higher volume production rates. Many custom optics manufacturers lack in–house thin film coatingcapability.  As a result, there are fewerwell–rounded competitors in the custom optics arena, and many are equipped withmodern facilities and manufacturing methods. The Company has and continues to judiciously deploy capital towards modernizingits facilities, and has staffed its manufacturing groups with individuals withcomprehensive experience in manufacturing management, manufacturingengineering, advanced finishing processes and optical coating processes.  The Company competes on the basis ofproviding consistently high quality products delivered on time, developing andmaintaining strong customer relationships, and continuously improving itscapabilities, labor productivity, cost structure, and product cycle times.

 

Competitionfor the Company’s laser accessories is limited, but competitors’ products aregenerally lower priced.  The Company’slaser accessories are considered to be high end and generally offer acombination of features not available elsewhere.  Because of the Company’s in–house crystalgrowth capability, the Company’s staff is knowledgeable about matchingappropriate crystals to given applications for its laser accessories.

 

Forthe crystal product area, price, quality, delivery, and customer service aremarket drivers.  With advancingglobalization, many of the Company’s competitors supplying non–linear opticalcrystals are overseas and can offer significantly reduced pricing for somecrystal species.  Sales in this arena aredeclining, but the Company has been able to retain a base by providing thequality and customer service needed by certain OEM customers not readilyavailable from others, and by offering proprietary crystal components for whichthe Company is either sole source or one of few available sources.  On many occasions, the quality of the crystalcomponent drives the ultimate performance of the component or instrument intowhich it is installed.  Thus, quality andtechnical support are considered to be valuable attributes for a crystalsupplier by some, but not all, OEM customers.

 

Althoughprice is a principal factor in many product categories, competition is alsobased on product design, product performance, customer confidence, quality,delivery, and customer service.  TheCompany is a sole–source supplier of products to several major customers whoare leaders in their industries.  Basedon its performance to date, the Company believes that it can continue tocompete successfully in its niches, although no assurances can be given in thisregard.

 

7

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**Employees**

 

Asof the close of business on December 31, 2007, the Company had 98 full–timeemployees.

 

**Patents andLicenses**

 

TheCompany relies on its manufacturing and technological expertise, rather than onpatents, to maintain its competitive position in the industry.  The Company takes precautionary andprotective measures to safeguard its design and technical and manufacturingdata, and relies on nondisclosure agreements with its employees to protect itsproprietary information.

 

**Regulation**

 

Foreignsales of certain of the Company’s products may require export licenses from theUnited States Department of Commerce or Department of State.  Such licenses are generally available to allbut a limited number of countries and are obtained when necessary.  Company sales in 2007, 2006, and 2005requiring U.S. State Department export approval represented 0.7%, 0.5%, and1.4% of total sales. In all cases the required export approvals were granted.

 

Thereare no other federal regulations or any unusual state regulations that directlyaffect the sale of the Company’s products other than those environmentalcompliance regulations that generally affect companies engaged in manufacturingoperations in New Jersey and Florida.

 

**Item 1A.               RiskFactors**

 

TheCompany cautions investors that its performance (and, therefore, any forwardlooking statement) is subject to risks and uncertainties.  Various important factors, including but notlimited to, the following may cause the Company’s future results to differmaterially from those projected in any forward looking statement.

 

a)           TheCompany faces competition

 

TheCompany encounters substantial competition from other companies positioned toserve the same market sectors that the Company serves.  Some competitors may have financial,technical, capacity, marketing or other resources more extensive than ours, ormay be able to respond more quickly than the Company can to new or emergingtechnologies and other competitive pressures. Some competitors have manufacturing operations in low–cost labor regionssuch as the far–east and eastern–Europe and can offer products at lower pricethan the Company.  The Company may not besuccessful in winning orders against the Company’s present or future competitors,and competition may have a material adverse effect on our business, results ofoperations or financial condition.

 

b)           TheCompany has exposure to Government Markets

 

Salesto customers in the defense industry have increased.  These customers in turn generally contractwith a governmental entity, typically the U.S. government.  Most governmental programs are subject tofunding approval and can be modified or terminated with no warning upon thedetermination of a legislative or administrative body.  The loss or failure to obtain certaincontracts or a loss of a major government customer could have a materialadverse effect on our business, results of operations or financial condition.

 

c)           TheCompany’s revenues are concentrated in its largest customer accounts

 

Forthe year ended December 31, 2007, seven customer accounts represented in theaggregate 68% of total revenues, and three customers represented 42% ofrevenues.  These three customers eachrepresented 19%, 14% and 9.0% of sales, respectively.  Since we are a supplier of custom manufacturedcomponents to OEM customers, the relative size and identity of our largestcustomer accounts changes somewhat from year to year.  In the short term, the loss of any of theselarge customer accounts could have a material adverse effect on business, ourresults of operations, and our financial condition.

 

d)           TheCompany’s business success depends on its ability to recruit and retain keypersonnel

 

The Company depends onthe expertise, experience, and continuing services of certain scientists,engineers, production and management personnel, and on the Company’s ability torecruit additional personnel.  There iscompetition for the services of these personnel, and there is no assurance thatthe Company will be able to retain or attract the personnel necessary for itssuccess, despite the Company’s effort to do so. The loss of the services of the Company’s key personnel could have amaterial adverse affect on its business, on its results of operations, or onits financial condition.

 

e)           TheCompany may not succeed in expanding product lines and markets by acquiringother businesses

 

TheCompany’s business strategy includes expanding its production capacities,product lines and market reach through both internal growth and acquisition ofcomplementary businesses.  The Companymay not succeed in finding or completing acquisitions of such businesses, norcan the Company be assured that it will be able to raise the financial capitalneeded for such acquisitions.  Acquisitionsmay result in substantial per share financial dilution of the Company’s CommonStock from the issuance of equity 

 

8

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securities.  They may also result in the taking on of debtand contingent liabilities, and amortization expenses related to intangibleassets acquired, any of which could have a material adverse affect on theCompany’s business, financial condition or results of operations.  Also, acquired businesses may be experiencingoperating losses.  Any acquisition willinvolve numerous risks, including difficulties in the assimilation of theacquired company’s people, operations and products, uncertainties associatedwith operating in new markets and working with new customers, and the potentialloss of the acquired company’s key employees. To date, the Company has had limited experience in acquiring andintegrating new businesses, having made only two acquisitions, and none since2004.

 

f)           TheCompany depends on, but may not succeed in, developing and acquiring newproducts and processes

 

Inorder to meet the Company’s strategic objectives, the Company needs to continueto develop new processes, to improve existing processes, and to manufacture andmarket new products.  As a result, theCompany may continue to make investments in the future in process developmentand additions to its product portfolio. There can be no assurance that the Company will be able to develop andintroduce new products or enhancements to its existing products and processes ina way that achieves market acceptance or other pertinent targeted results.  The Company also cannot be sure that it willbe successful in acquiring complementary products or technologies or that itwill have the human or financial resources to pursue or succeed in suchactivities.

 

g)           TheCompany may not be able to fully protect its intellectual property

 

TheCompany currently holds one material patent applicable to an important product,but does not in general rely on patents to protect its products or manufacturingprocesses.  The Company generally relieson a combination of trade secret and employee non–competition and nondisclosureagreements to protect its intellectual property rights.  There can be no assurance that the steps theCompany takes will be adequate to prevent misappropriation of the Company’stechnology.  In addition, there can be noassurance that, in the future, third parties will not assert infringementclaims against the Company.  Assertingthe Company’s rights or defending against third–party claims could involvesubstantial expense, thus materially and adversely affecting the Company’sbusiness, results of operations or financial condition.

 

h)           TheCompany incurred a net loss for one of the past three years

 

TheCompany had a net loss of $(11,000) in 2005. Although the Company has been profitable in the last two years, if theCompany were to sustain major future losses, the Company may not be able toobtain the financing that it may require to supply the working capital needs ofits existing operations, or to continue to implement its growth strategy.

 

i)            TheCompany’s stock price may fluctuate widely

 

TheCompany’s stock is thinly traded.  Manyfactors, including, but not limited to, future announcements concerning theCompany, its competitors or customers, as well as quarterly variations inoperating results, announcements of technological innovations, seasonal orother variations in anticipated or actual results of operations, changes inearnings estimates by analysts or reports regarding the Company’s industries inthe financial press or investment advisory publications, could cause the marketprice of the Company’s stock to fluctuate substantially.  In addition, the Company’s stock price may fluctuatewidely for reasons which may be unrelated to operating results.  These fluctuations, as well as generaleconomic, political and market conditions such as recessions, militaryconflicts, or market or market–sector declines, may materially and adverselyaffect the market price of the Company’s Common Stock.  In addition, any information concerning theCompany, including projections of future operating results, appearing ininvestment advisory publications or on–line bulletin boards or otherwiseemanating from a source other than the Company could in the future contributeto volatility in the market price of the Company’s Common Stock.

 

j)            Asgeneral economic conditions deteriorate, the Company’s financial results suffer

 

Significanteconomic downturns or recessions in the United States or Europe could adverselyaffect the Company’s business, by causing a temporary or longer term decline indemand for the Company’s goods and services and thus its revenues.  Additionally, the Company’s revenues andearnings may also be affected by general economic factors, such as excessiveinflation, currency fluctuations and employment levels.

 

k)           Manyof the Company’s customer’s industries are cyclical

 

TheCompany’s business is significantly dependent on the demand its customersexperience for their products.  Many oftheir end users are in industries that historically have experienced a cyclicaldemand for their products.  Theindustries include but are not limited to, the defense electro–optics industryand the manufacturers of process control capital equipment for thesemiconductor tools industry.  As aresult, demand for the Company’s products are subject to cyclical fluctuations,and this could have a material adverse effect on our business, results ofoperations, or financial condition.

 

9

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l)            TheCompany’s operations may be adversely affected if it fails to keep pace withindustry developments

 

TheCompany serves industries and market sectors which will be affected by futuretechnological developments.  Theintroduction of products or processes utilizing new developments could renderthe Company’s existing products or processes obsolete or unmarketable.  The Company’s continued success will dependupon its ability to develop and introduce on a timely and cost–effective basisnew processes, manufacturing capabilities, and products that keep pace withdevelopments and address increasingly sophisticated customer requirements.

 

m)          TheCompany’s manufacturing processes require products from limited sources of supply

 

TheCompany utilizes many relatively uncommon materials and compounds tomanufacture its products.  Examplesinclude optical grade quartz, specialty optical glasses, scarce natural andmanmade crystals, beryllium and its alloys, and high purity chemicalcompounds.  Failure of the Company’ssuppliers to deliver sufficient quantities of these necessary materials on atimely basis, or to deliver contaminated or inferior quality materials, or tomarkedly increase their prices could have an adverse effect on the Company’sbusiness, despite its efforts to secure long term commitments from theCompany’s suppliers.  Adverse resultsmight include reducing the Company’s ability to meet commitments to itscustomers, compromising the Company’s relationship with its customers,adversely affecting the Company’s ability to meet expanding demand for itsproducts, or causing the Company’s financial results to deteriorate.

 

**Item 1B.               UnresolvedStaff Comments**

 

Notapplicable

 

**Item 2.                  Properties**

 

Administrative,engineering and manufacturing operations are housed in a 42,000 square footbuilding located in Northvale, New Jersey and in a 25,000 square foot buildinglocated in Sarasota, FL.  Theheadquarters of the Company are in its Northvale facility.  In September 2006, the Company signed anextension of its Northvale lease until October 31, 2008.  In addition, the Company negotiated an optionfor renewing the lease for two additional two year periods, at fixed terms,through October 31, 2012.

 

PhotonicProducts Group, Inc’s subsidiary, MRC Precision Metal Optics, occupies thespace located in Sarasota, FL pursuant to a net lease expiring on August 31,2008.  MRC Optics has the option ofextending the lease for four additional two year periods through August 31,2016, at fixed terms.

 

Thefacilities are adequate to meet current and future projected productionrequirements.

 

Thetotal rent in 2007 for these leases was approximately $570,000.  The Company also paid real estate taxes andinsurance premiums that totaled approximately $189,000 in 2007.

 

**Item 3.                  LegalProceedings**

 

Thereare no legal proceedings involving the Company as of the date hereof.

 

**Item 4.                  Submissionof Matters to a Vote of Security Holders**

 

None

 

 

10

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**PART II**

 

**Item 5.**                   **Marketfor Registrant’s Common Equity and Related Stockholder Matters**

 

a)           Market Information

 

TheCompany’s Common Stock, with a par value of $0.01 per share, is traded on theOTC Bulletin Board under the symbol PHPG.

 

Thefollowing table sets forth the range of closing prices for the Company’s CommonStock in each fiscal quarter from the quarter ended March 31, 2006 through thequarter ended December 31, 2007, as reported by the National Association ofSecurities Dealers NASDAQ System.  Suchover–the–counter quotations reflect inter–dealer prices, without retail mark–up,mark–down or commission and may not necessarily represent actual transactions.

 

| ** **                        | ** ** | **Price** |
|-----------------------------------|------------|-----------|
| ** **                        | ** ** | **High**  | ** ** | **Low** |
|                              |       |      |   |   |
| Quarter  ended December 31, 2007  |       | 4.49      |   |              2.50 |
|                              |       |      |   |   |
| Quarter  ended September 30, 2007 |       | 2.87      |   | 2.00 |
|                              |       |      |   |   |
| Quarter  ended June 30, 2007      |       | 2.30      |   | 1.55 |
|                              |       |      |   |   |
| Quarter  ended March 31, 2007     |       | 1.75      |   | 1.30 |
|                              |       |      |   |   |
| Quarter  ended December 31, 2006  |       | 1.67      |   | 1.05 |
|                              |       |      |   |   |
| Quarter  ended September 30, 2006 |       | 1.48      |   | 0.86 |
|                              |       |      |   |   |
| Quarter  ended June 30, 2006      |       | 1.89      |   | 1.25 |
|                              |       |      |   |   |
| Quarter  ended March 31, 2006     |       | 1.65      |   | 1.35 |

 

Asof March 26, 2008 the Company’s closing stock price was $ 4.10 per share.

 

b)           Shareholders

 

Asof March 26, 2008, there were approximately 166 shareholders of record ofCommon Stock.  The number of shareholdersof record of common stock was approximated based upon the Shareholders’ Listingprovided by the Company’s Transfer Agent. As of the same date, the Company estimates that there are an additional580 beneficial shareholders.

 

c)           Dividends

 

TheCompany paid an annual dividend of 134,000 shares of Common Stock on its SeriesA and Series B convertible preferred stock which is valued at the closing priceon the dividend date.  The value of thedividend was $238,167 in 2007, $234,500 in 2006, $134,000 in 2005.

 

TheSeries A convertible preferred stock consisting of 500 shares at a stated valueof $1,000 per share and convertible into common shares at the rate of $1.00 pershare was converted into 500,000 common shares of the Company’s stock in April2007.  A total of 2,032 shares of theSeries B convertible preferred stock consisting of 2,082 shares at a statedvalue of $1,000 per share and convertible into common shares at the rate of$2.50 per share were converted in October and November of 2007.  The remaining 50 shares of Series B preferredstock were redeemed by the Company for a cash payment of $50,000 and an accruedstock dividend of 1,332 common shares.  Accordingly,there will be no further dividend payments by the Company on the former SeriesA or B convertible preferred stock in 2008 or subsequent years.

 

TheCompany historically has not paid cash dividends.  Payment of cash dividends is at thediscretion of the Company’s Board of Directors and depends, among otherfactors, upon the earnings, capital requirements, operations and financialcondition of the Company.  The Companydoes not anticipate paying cash dividends in the immediate future.

 

d)           Recent Sales of UnregisteredSecurities

 

Therewere no sales of unregistered securities during 2007.

 

11

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**Item 6.                   Selected Financial Data**

 

Thefollowing data is qualified in its entirety by the financial statementspresented elsewhere in this Annual Report on Form 10–K.

 

| ** **                                           | ** ** | ** ** | **As of December 31, or**           | ** ** | ** ** |
|------------------------------------------------------|------------|------------|-------------------------------------|------------|------------|
| ** **                                           | ** ** | ** ** | **For the Year Ended December 31,** | ** ** | ** ** |
| ** **                                           | ** ** | **2007**   | **2006**                            | ** ** | **2005**   | ** ** | **2004** | ** ** | **2003** |
|                                                 |       |       |                                |       |       |   |   |   |   |   |   |   |   |   |
| Revenues                                             |       | $          | 15,099,878                          | $          | 13,921,127 |   | $ | 13,785,057 |   | $ | 9,221,857 |   | $ | 5,388,184 |
|                                                 |       |       |                                |       |       |   |   |   |   |
| Net income  (loss)                                   |       | 1,880,081  | 772,266                             |       | (11,398)   |   | (672,937) |   | (1,777,309) |
|                                                 |       |       |                                |       |       |   |   |   |   |
| Net income (loss) applicable to common  shareholders |       | $          | 1,641,914                           | $          | 537,766    |   | $ | (145,398) |   | $ | (837,757) |   | $ | (1,830,909) |
|                                                 |       |       |                                |       |       |   |   |   |   |
| Earnings per  share                                  |       |       |                                |       |       |   |   |   |   |
| Basic earnings (loss) per share                      |       | 0.19       | 0.07                                |       | (0.02)     |   | (0.15) |   | (0.35) |
| Diluted earnings (loss) per share                    |       | 0.13       | 0.06                                |       | (0.02)     |   | (0.15) |   | (0.35) |
|                                                 |       |       |                                |       |       |   |   |   |   |
| Weighted  average shares                             |       |       |                                |       |       |   |   |   |   |
| Basic                                                |       | 8,609,822  | 7,572,637                           |       | 7,218,244  |   | 5,710,354 |   | 5,287,849 |
| Diluted                                              |       | 13,777,114 | 11,915,090                          |       | 7,218,244  |   | 5,710,354 |   | 5,287,849 |
|                                                 |       |       |                                |       |       |   |   |   |   |
| Common stock dividends on Preferred shares           |       | 238,167    | 234,500                             |       | 134,000    |   | 164,820 |   | 53,600 |
| Total assets                                         |       | 16,077,947 | 15,316,260                          |       | 13,481,021 |   | 13,526,634 |   | 8,851,121 |
| Long–term  obligations                          |       | 2,990,730  | 6,299,767                           |       | 5,963,411  |   | 6,459,088 |   | 4,405,576 |
| Shareholders’  equity                           |       | 7,712,799  | 5,236,703                           |       | 3,929,407  |   | 3,965,129 |   | 3,284,439 |
|                                                      |            |            |                                     |            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

TheCompany completed the acquisition of the stock of MRC Precision Metal Optics,Inc. in mid–October 2004.  Also, theCompany completed the acquisition of Laser Optics, Inc.’s assets andliabilities at the end of November 2003. The comparability of information in the selected financial data providedfor 2007, 2006 and 2005, above, is aided by details provided in the managementdiscussion, which attribute certain portions of revenue growth to these twoacquisitions.

 

**Item 7.                   Management’s Discussionand Analysis of Financial Condition and Results of Operation**

 

Critical Accounting Policies

 

TheCompany’s significant accounting polices are described in Note 1 of theConsolidated Financial Statements, that were prepared in accordance withaccounting principles generally accepted in the United States of America.  In preparing the Company’s financialstatements, the Company made estimates and judgments that affect the results ofits operations and the value of assets and liabilities the Companyreports.  The Company’s actual resultsmay differ from these estimates.

 

TheCompany believes that the following summarizes critical accounting polices thatrequire significant judgments and estimates in the preparation of the Company’sconsolidated financial statements.

 

Revenue Recognition

 

TheCompany records revenue when a product is shipped.  Losses on contracts are recorded whenidentified.  The Company, from time totime, may recognize revenue using the percentage of completion method forcertain long term manufacturing projects. No revenues in 2007 were accounted for using the percentage ofcompletion method.

 

Accounts Receivable

 

Accountsreceivable are stated at the historical carrying amount, net of write–offs andallowances.  The Company establishes anallowance for doubtful accounts based on estimates as to the collectibility ofaccounts receivable.  Managementspecifically analyzes past–due accounts receivable balances and, additionally,considers bad debts history, customer credit–worthiness, current economictrends and changes in customer payment terms when evaluating the adequacy ofthe allowance for doubtful accounts. Uncollectible accounts receivable are written–off when it is determinedthat the balance will not be collected. Historically, the Company hasexperienced very few instances of uncollectible receivables.  For each of the past three years, theCompany’s allowance for doubtful accounts has remained fixed at $15,000.

 

12

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Inventory

 

Inventoriesare stated at the lower of cost (first–in, first–out method) or market.  Cost includes material, labor and overhead.

 

TheCompany records a reserve for slow moving inventory as a charge againstearnings for all products identified as surplus, slow moving ordiscontinued.  Excess work–in–processcosts are charged against earnings whenever estimated costs–of–completionexceed unbilled revenues.

 

Acquired Goodwill and Intangible assets

 

Intangibleassets with finite lives are amortized on a straight–line basis over theassets’ estimated useful life up to 14 years. The Company periodically evaluates on an annual basis, or morefrequently when conditions require, whether events or circumstances haveoccurred indicating the carrying amount of intangible assets may not berecoverable.  When factors indicate thatintangible assets should be evaluated for possible impairment, the Company usesan estimate of the associated undiscounted future cash flows compared to therelated carrying amount of assets to determine if an impairment loss should berecognized.

 

Goodwilland intangible assets not subject to amortization are tested in December ofeach year for impairment, or more frequently if events and circumstancesindicate that the assets might have become impaired.  An impairment loss is recognized to theextent that the carrying amount exceeds the asset’s fair value.

 

## Share–based compensation

 

EffectiveJanuary 1, 2006, the Company adopted the recognition and measurement provisionsof Statement of Financial Accounting Standards ("SFAS") No. 123(revised 2004), Share–Based Payment ("SFAS 123(R)"), which replacesSFAS No. 123, Accounting for Stock–Based Compensation, and supersedes AccountingPrinciples Board Opinion ("APB") No. 25, Accounting for Stock Issuedto Employees, and related interpretations.

 

SFAS123 (R) requires compensation costs related to share–based paymenttransactions, including employee stock options, to be recognized in thefinancial statements.  In addition, theCompany adheres to the guidance set forth within Securities and ExchangeCommission ("SEC") Staff Accounting Bulletin ("SAB") No.107, which provides the Staff's views regarding the interaction between SFASNo. 123(R) and certain SEC rules and regulations and provides interpretationswith respect to the valuation of share–based payments for public companies.

 

Priorto January 1, 2006, the Company accounted for similar transactions inaccordance with APB No. 25 which employed the intrinsic value method ofmeasuring compensation cost. Accordingly, compensation expense was not recognized for fixed stockoptions if the exercise price of the option equaled or exceeded the fair valueof the underlying stock at the grant date.

 

WhileSFAS No. 123 encouraged recognition of the fair value of all stock–based awardson the date of grant as expense over the vesting period, companies werepermitted to continue to apply the intrinsic value–based method of accountingprescribed by APB No. 25 and disclose certain pro–forma amounts as if the fairvalue approach of SFAS No. 123 had been applied.  In December 2002, SFAS No. 148, Accountingfor Stock–Based Compensation–Transition and Disclosure, an amendment of SFASNo. 123, was issued, which, in addition to providing alternative methods oftransition for a voluntary change to the fair value method of accounting forstock–based employee compensation, required more prominent pro–formadisclosures in both the annual and interim financial statements.  The Company complied with these disclosurerequirements for all applicable periods prior to January 1, 2006.

 

Inadopting SFAS 123(R), the Company applied the modified prospective approach totransition.  Under the modifiedprospective approach, the provisions of SFAS 123 (R) are to be applied to newawards and to awards modified, repurchased, or cancelled after the requiredeffective date.  Additionally,compensation cost for the portion of awards for which the requisite service hasnot been rendered that are outstanding as of the required effective date shallbe recognized as the requisite service is rendered on or after the requiredeffective date.  The compensation costfor that portion of awards shall be based on the grant–date fair value of thoseawards as calculated for either recognition or pro–forma disclosures under SFAS123.

 

**Results ofOperations**

 

Thefollowing table summarizes the Company’s product sales by product categoriesduring the past three years:

 

| ** **          | ** ** | **Years Ended December 31,** |
|---------------------|------------|------------------------------|
| ** **          | ** ** | **2007**                     | ** ** | **2006** | ** ** | **2005** |
| **Category**        | ** ** | **Sales**                    | ** ** | **%** | ** ** | **Sales** | ** ** | **%** | ** ** | **Sales** | ** ** | **%** |
| Optical  Components |       | $                            | 13,410,000 |   | 89 |   | $ | 12,274,000 |   | 89 |   | $ | 11,798,000 |   | 85 |
| Laser  Accessories  |       | 1,690,000                    |   | 11 |   | 1,647,000 |   | 12 |   | 1,987,000 |   | 15 |
| TOTAL               |       | $                            | 15,100,000 |   | 100 |   | $ | 13,921,000 |   | 100 |   | $ | 13,785,000 |   | 100 |

 

Thefollowing table sets forth, for the past three years, the percentagerelationship of statement of operations categories to total revenues.

 

13

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| ** **                                    | ** ** | **Years ended December 31,** | ** ** |
|-----------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                    | ** ** | **2007**                                    | ** ** | **2006** | ** ** | **2005** | ** ** |
| Revenues:                                     |       |                                        |       |   |   |   |   |
| Product sales                                 |       | 100.0                                       | %          | 100.0 | % | 100.0 | % |
| Costs and  expenses:                          |       |                                        |       |   |   |   |   |
| Cost of goods sold                            |       | 60.5                                        | %          | 67.4 | % | 72.2 | % |
| Gross profit margin                           |       | 39.5                                        | %          | 32.6 | % | 27.8 | % |
| Selling,  general and administrative expenses |       | 23.6                                        | %          | 26.1 | % | 25.0 | % |
| Internal  research and development            |       | 0.0                                         | %          | 0.0 | % | 0.1 | % |
| Profit from  operations                       |       | 15.9                                        | %          | 6.6 | % | 2.6 | % |
| Net income  (loss)                            |       | 12.5                                        | %          | 5.5 | % | (0.1 | )% |

 

**Revenues**

 

Totalrevenues were approximately $15,100,000, $13,921,000, and $13,785,000 in 2007,2006 and 2005, respectively, reflecting the consolidated results from all threepresent business units. Revenues increased by 8.5% in 2007, while revenues wereapproximately equal in 2006 and 2005.

 

Examiningthese results by customer industry sector:

 

Salesto the Defense/Aerospace sector continued their upward trend in 2007,increasing by 4.5% in dollar terms to $9,456,000 in 2007 compared to 2006, andrepresenting 63% of total Company revenues. In 2006, sales to the sector were$9,048,000, or 65% of total sales and up 8.3% compared to $8,352,000 or 60% oftotal sales in 2005.  Increased militaryspending on electro–optical systems and R&D in the post–9/11 era combinedwith strategic re–positioning by the Company has boosted demand for theCompany’s services in manufacturing custom products for its OEM customers.

 

Revenuesfrom customers in the Process Control and Metrology (i.e. semiconductor tools,instruments, inventory management equipment) sector in 2007 increased by 31.4%to $3,760,000, reflecting the addition of a large new OEM account. Sales intothis sector in 2006 decreased 12% from sales in 2005, to $2,862,000 from$3,259,000.  The sales decline in 2006was due to reduced demand from two major OEM customers.  The optical and x–ray inspection segment ofthe semiconductor industry offers continued opportunities for the Company’scapabilities in precision optics, crystal products, and X–raymonochrometers.  Sales to this sectoraccounted for 25%, 20%, and 24% of total sales in 2007, 2006, and 2005,respectively.

 

Revenuesdecreased in the non–military Laser Systems sector by 6.9% to $932,000 in 2007reflecting maturation of certain OEM products. This followed the sales declineof 4.1% in 2006, from 2005 levels, reflecting discontinuation of the INRAD/A.P.E.alliance and cessation of sales of autocorrellators on December 31, 2005.  Sales to customers in this sector in dollarterms, net of autocorrellator sales, increased between 2005 and 2006.  Sales to this sector accounted for 6%, 7%, and8% of total sales in 2007, 2006, and 2006, respectively.

 

Salesto customers within the University and National Laboratories market sectorrepresented 2.3% of total revenues in 2007, 3.6% in 2006 and 3.8% in 2005.  In dollar terms, sales to this sector havebeen slowly trending downward, reflecting commoditization of certain crystalcomponent categories, internet buying by University researchers from Asiansources, and maturation of certain legacy instruments. Sales to this sector indollar terms net of autocorrellator sales to researchers increased between 2005and 2006, but then fell between 2006 and 2007.

 

Salesto customers in “Other” (i.e. non–separately classified) sectors were $600,000in 2007, $508,000 in 2006, and $608,000 in 2005.  Sales in these sectors have accounted for approximately4% of total sales in each of the past three years.

 

Totalnew orders booked in 2007 were $17,802,000, up approximately 34.0% from neworders of $13,269,000 in 2006. The increase in bookings was for opticalcomponents, especially in our Laser Optics and MRC Optics business units. Orderintake from one large INRAD and one large Laser Optics OEM customer in theDefense/Aerospace sector increased significantly in 2007 from 2006. One largenew Defense/Aerospace OEM was added in 2007, while orders from another declinedby 50% as their program’s demands declined. Additionally, a large new OEM customer in the Process Control andMetrology sector was added in 2007.  Neworders in 2006 had decreased by approximately 13% from orders of $15,308,000 in2005.

 

TheCompany’s backlog of product orders as of December 31, 2007 wasapproximately $9,672,000, up 38.4% from $6,969,000 in 2006.  The Company’s end of year backlog in 2005 was$7,857,000.

 

**Cost of GoodsSold and Gross Profit Margin**

 

As apercentage of its consolidated sales, cost of goods sold was 60.5%, 67.4%, and72.2%, for the years ended December 31, 2007, 2006 and 2005,respectively.  Gross profit margin as apercentage of sales was 39.5%, 32.6%, and 27.8%, for the same periods,respectively.

 

14

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Theaggregate cost of goods sold percentage metric and its complement, the grossprofit margin percentage metric, improved with increasing sales levels, asfixed costs represent a major component of our total cost structure.  These metrics improve, as well, withdecreasing cost of material and outside services as a percentage of sales,increasing labor productivity, and decreasing fixed expenses.  In 2007, the cost of goods sold declined(i.e. improved) as a percentage of sales, from 2006 levels, continuing its yearto year improvement over the past three years. In dollar terms, cost of goods soldwas $9,141,000 compared with $9,377,000 in 2006, down 2.5%, while revenuesincreased 8.5%.  The reduction in thecost of goods sold percentage in 2007 was primarily a reflection of lowermaterial costs as a percentage of revenues in 2007, and increased laborproductivity on higher sales volume, while other manufacturing expenses as apercentage of sales improved by approximately 6% , reflecting continual expensecontrol vigilance.

 

Materialcosts as a percentage of revenues decreased by approximately 19% in comparisonto the prior year, caused principally by an increase in shipments in the secondhalf of custom products with customer furnished materials which carry norelated material costs in cost–of–goods sold. The lower material cost as a percentage of revenues in 2007 should notbe viewed as a trend; rather it reflects the impact of a one–time contractualarrangement with an OEM customer for the second half of 2007 and the firstquarter of 2008.  Total labor costs in2007 were down 4.2% on the higher sales volume, resulting in a laborproductivity improvement of 12%.

 

Grossmargin in 2007 continued its three year upward trend to $5,959,000 or 39.5%,compared with a gross margin of $4,544,000 or 32.6% in the comparable period of2006, and gross margin of $3,829,000, or 27.8% in 2005. These improvementsreflect the positive factors discussed above.

 

**Selling, General and Administrative Expenses**

 

Selling,general and administrative expenses as a percentage of sales were 23.6%, 26.1%,and 25.0% in 2007, 2006, and 2005, respectively.

 

Selling,general and administrative expenses in 2007 decreased in dollar terms fromthose in 2006 by $66,000, or 1.8%, while sales increased by 8.5%, resulting ina decrease in the 2007 SG&A cost as a percentage of sales. SG&Aexpenses in 2006 had increased in dollar terms from those in 2005 by $177,000,or 5.1%, while sales increased by 1.0%, resulting in the increase in the 2006SG&A cost as a percentage of sales. The increase in SG&A expenditures in 2006 compared with 2005resulted in large measure from non–recurring expenses that were incurred inconnection with the investigation into misappropriation of Company funds forpersonal use by its former CFO, as we reported in our Form 8–K filed on June26, 2006, and the resolution of this matter. These included additional costs for legal advice, forensic consulting,temporary accounting assistance, and special meetings of the Audit Committee ofthe Board of Directors.  Increasedexpenses also resulted from recruitment costs incurred in connection with theCompany’s search for its new CFO and assistant controller, and higher legal andaccounting expenses related to day–to–day corporate matters. The Company didnot incur expenses of this nature in 2007, resulting in the decrease in overallSG&A expenses in the year just ended.

 

**OperatingIncome**

 

Operatingincome in 2007 was $2,397,000, or 15.9% of sales, and in dollar terms up$1,481,000 or 161% from the prior year. This compares favorably with a profitof $917,000, or 6.6% of sales in 2006, (up 156% over 2005), and operatingincome of $358,000, or 2.6% of sales in 2005.

 

Management’sefforts to increase profitability from operations through 2007 have beenfocused on increasing the Company’s top line, and on improving productivitythroughout its operations.  These year–over–yearimprovements in operating profit dollars have been a direct result of the successto date of these efforts.

 

**Other Incomeand Expenses**

 

TheCompany incurred interest expense at fixed rates on a $1,700,000 secured note,three subordinated convertible notes totaling $5,200,000, certain equipmentleases, and other notes related to its acquisition of MRC Optics and LaserOptics, Inc.  Net interest in 2007declined to $261,000 from $402,000 in 2006 and $505,000 in 2005.  The reduction in net interest expensereflects both the positive impact of interest income earned on this year’s highercash balances and the continued reduction in higher rate long term notes andcapital lease balances due to both scheduled amortization and acceleratedprincipal re–payments.  In particular,interest income was $163,000, $52,000 and $3,000 in 2007, 2006 and 2005,respectively while interest expense was $424,000 in 2007, compared to $454,000in 2006 and $508,000 in 2005.  TheCompany’s focus on pro–actively reducing debt levels resulted in a decrease ofapproximately $1,844,000 in debt principal during the year.

 

In2006, the Company received an insurance settlement for $300,000 from a claimunder its employee dishonesty insurance policy and the Company reported therecovery as other income (expense) for the period.  These proceeds were largely offset by theadditional general and administrative costs related to the investigation of theemployee involved and costs associated with remediation of the Company’sinternal controls.

 

TheCompany also incurred costs of $13,000 during 2006 to liquidate liabilities forproperty tax and unemployment and disability tax that were incurred as part ofits acquisition in December 2003 of the assets and certain liabilities of theformer Laser Optics, Inc.

 

15

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**IncomeTaxes**

 

In 2007,the Company recorded income tax expense in the amount of $250,000 afterutilizing net operating losses of approximately $2,700,000 to offset federaltaxes payable.  In 2006, the Companyrecorded income tax expense of $21,000 after utilizing net operating losses of approximately$1,400,000 to offset federal income tax payable and $678,000 against stateincome tax payable.  There was no incometax expense recorded by the Company in 2005.

 

**Net Income**

 

Netincome in 2007 was $1,880,000, in dollar terms up 144% from the prior year.This compares favorably with net income of $772,000 in 2006, and a loss of$(11,000) in 2005.

 

**Net Income(Loss) Applicable to Common Shareholders and Earnings per Common Share**

 

Net income(loss) applicable to common shareholders, is arrived at after deducting thevalue of the stock dividends issued by the Company to the holders of its SeriesA and Series B convertible preferred stock. In April of 2007, 2006, and 2005, theCompany distributed common stock dividends valued at $238,200, $234,500, and$134,000, respectively to the holders of its Series A and B convertiblepreferred stock.  The dividend value iscalculated by reference to the market price of the common shares on thedividend distribution date.  The numberof common shares issued in settlement of the dividend is determined based onthe coupon rate of the preferred shares, the total shares outstanding, and theconversion price of each series of preferred shares.

 

In2007, all of the shares of the Series A convertible preferred stock andapproximately 98% of the shares of the Series B convertible preferred stockwere converted by the preferred shareholders into 812,800 shares of theCompany’s common stock.  The stock of theremaining holder of 50 shares of Series B convertible preferred stock wereredeemed by the Company on the payment of $50,000, the liquidation value, plusan accrued stock dividend of $5,000. Accordingly, common stock dividends on these preferred shares will nolonger be payable after 2007.

 

Netincome applicable to common shareholders in 2007 was $1,642,000, or $0.19 pershare basic and $0.13 per share diluted. This compares favorably with a netincome applicable to common shareholders for the same period in 2006 of$538,000, and earnings per share of $0.07, basic and $0.06 diluted. In 2005,the Company had a net loss applicable to common shareholders of $(145,000), or$(0.02) per share basic and diluted.

 

**Liquidity andCapital Resources**

 

TheCompany’s primary source of cash in recent years has been from operating cashflows.  Other sources of cash includeproceeds received from the exercise of stock options, short–term borrowing, andissuance of common stock.  The Company’smajor uses of cash in the past three years have been for capital expendituresand for repayment and servicing of outstanding debt.  Supplemental information pertaining to oursource and use of cash is presented below:

 

| **Selected Sources (uses) of cash  ($ thousands)**                             | ** ** | **Years ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                          | ** ** | **2007**                                    | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net cash  provided by operations                                                    |       | $                                           | 3,001      |   | $ | 2,672 |   | $ | 360 |   |
|                                                                                |       |                                        |       |   |   |   |   |
| Net Proceeds  from issuance of common stock, exercise of stock options and warrants |       | 395                                         |       | 113 |   | (19 | ) |
|                                                                                |       |                                        |       |   |   |   |   |
| Capital  Expenditures                                                               |       | (247                                        | )          | (987 | ) | (454 | ) |
| Principal  payments on lease obligations                                            |       | (196                                        | )          | (250 | ) | (221 | ) |
| Net  borrowing (payment) on debt obligations                                        |       | (1,647                                      | )          | 373 |   | (167 | ) |
|                                                                                     |            |                                             |            |  |  |  |  |  |  |  |

 

In2007, the Company deployed excess cash into accelerating repayment of debt, andfocused on retiring its convertible preferred shares. This initiative wasundertaken to strengthen its balance sheet, and to have a positive impact onthe Company’s financial position, financial flexibility, and financial results.

 

InFebruary 2006, a major shareholder and debt holder, Clarex Limited (“Clarex”)had provided the Company with $700,000 in financing to fund the acquisition ofcertain capital assets required for expanded capabilities to meet customerdemand.  The terms called for repaymentof the Company’s Promissory note in equal monthly installments, includinginterest & principal, commencing 

 

16

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March 2006,until maturity in March 2013.  The Notehad an annual interest rate of 6.75%. In December 2007, the Company repaid theoutstanding balance of $554,600 principal and $1,740 interest, retiring thisnote.

 

In2002, the Company received $1,000,000 in proceeds from the issuance of aSubordinated Convertible Promissory Note to Clarex.  The note, originally due inJanuary 2006, was in 2007 extended to December 31, 2008 and bears aninterest rate of 6%.  Interest accruesyearly and along with principal may be converted into Common Stock,(and/or securities convertible into common shares).  The note is convertible into 1,000,000 Unitsconsisting of 1,000,000 shares of Common Stock and Warrants.  The warrants have an expiration date ofAugust 2009 and allow the holder to acquire 750,000 shares of Common Stock at aprice of $1.35 per share.  In January2008, the maturity date of the note was extended to April 1, 2009.

 

InJune of 2003, the Company paid off existing debt with the proceeds of a$1,700,000 Secured Promissory Note held by Clarex. The note was secured by allassets of the Company.  The note was fora period of 18 months at an interest rate of 6% per annum.  The Company’s Board of Directors approved theissuance of 200,000 warrants to the holder, as a fee for the issuance of theNote.  In 2004, the Company approved theissuance of 200,000 additional warrants to Clarex for extending the maturity ofthe note an additional 36 months. The warrants are exercisable at $0.425 pershare and $1.08 per share, respectively, and expire on March 31, 2008 andMay 18, 2008.  The note was extendedagain, to December 31, 2008, without issuance of warrants or any otherfurther consideration.  On January 29,2008, the Board of Directors authorized the repayment in full of thisoutstanding note including accrued interest of $477,444. Repayment was made inFebruary 2008.  With the retirement ofthis Senior Secured note, the Company has no general liens against its assets,except for specific liens related to outstanding capital leases.  On March 27, 2008, Clarex Limited notifiedthe Company that they had elected to exercise the 200,000 warrants expiring onMarch 31, 2008.  The Company expects the200,000 common shares resulting from this exercise will be issued on or aboutMarch 31, 2008.

 

ASubordinated Convertible Promissory Note for $1,500,000 originally due inJanuary 2006, was in 2007 extended to December 31, 2008 and bears aninterest rate of 6%.  Interest accruesyearly and along with principal may be converted into Common Stock, and/orsecurities convertible into Common Stock. The note is convertible into 1,500,000 Units consisting of 1,500,000shares of Common Stock and Warrants to acquire 1,125,000 shares of Common stockat a price of $1.35 per share up to August 2009.  The Holder of the Note is a major shareholderof the Company.  The proceeds from theNote were used in the Company’s acquisition program. The maturity date of thenote was extended in January 2008 to a maturity date of April 1, 2009.

 

In 2004, the Company received $1,000,000 inproceeds from the issuance of a Subordinated Convertible Promissory Note.  The note had an interest rate of 6% and wasinitially due on March 31, 2007, but its term was extended in early 2007 to March31, 2008.  Interest accrued yearly andalong with principal was convertible into Common Stock, (and/or securitiesconvertible into common shares).  Thenote was convertible into 1,000,000 Units consisting of 1,000,000 shares ofCommon Stock and Warrants, exercisable through July 2009, to acquire 750,000shares of Common Stock at a price of $1.35 per share.  The note holder was a major shareholder ofthe Company. On June 28,2007, the Company accelerated payment of $500,000 on the outstanding balance ofthis note, and subsequently, on September 17, 2007, the Company paid the remainingoutstanding balance of principal and interest on this note, in full, in theamount of $697,000, consisting of $500,000 in remaining principal and $197,000in accrued interest.

 

During2004, the Company entered into an agreement with an investment banking firm toraise equity via a private placement of the Company’s common stock.  In July 2004 the Company issued1,581,000 Units consisting of 1,581,000 shares and warrants, exercisablethrough August 2009, to acquire an additional 1,185,750 shares at $1.35 pershare.  In addition, 276,675 Warrantswere issued to Casimir Capital, LP, who was the placement agent for the privateplacement.  Casimir Capital earnedcommissions of $142,391 as the underwriter of this private placement.  This private placement resulted in netproceeds to the Company of approximately $1,173,000.  The funds were utilized in the furtherance tothe company’s M&A program, capital equipment purchases and to meet generalworking capital requirements.  The issuedshares and shares underlying warrants were subsequently registered under an S–1Registration filing.

 

On April 16, 2007, the Company called for the full redemptionof its $500,000 Series A 10% Convertible Preferred Stock (the “Series A”).  On April 30, 2007, Clarex Limited, the holderof all the shares of the Series A, notified the Company that it had decided toconvert all 500 preferred shares into 500,000 shares of the Company’s commonstock, in accordance with the Series A agreement.

 

On October 25, 2007, two principal holders, two outsideDirectors, and the Company’s CEO, notified the Company they were exercisingtheir right to convert their shares of the Company’s $2,082,000 Series B 10%Convertible Preferred Stock (the “Series B”) into common stock at the specifiedconversion price of $2.50 per share.  Inthe aggregate, these holder’s shares of the Series B represented 1,560 shares or75% of the total of 2,082 issued and outstanding Series B shares. Subsequently,on October 29, the Company issued a call for the redemption of the remainingbalance of 522 issued and outstanding Series B shares on November 29,2007.  The 10 holders of these shares hadthe option of converting their shares into common stock prior to the redemptiondate. Nine holders elected to convert, and the remaining holder elected to thepreferred shares for cash and a final stock dividend accrued to the redemptiondate. In all, the Series B was converted into 812,800 shares of common stockthrough conversion, and through redemption into a cash payment of $50,000 andan accrued final stock dividend of 1,332 shares of common stock.

 

Capital expenditures, including internallabor and overhead charges, for the years ended December 31, 2007, 2006and 2005 were approximately $247,000, $987,000, and $454,000,respectively.  In 2007, capitalexpenditures were primarily for replacement or refurbishment of manufacturingequipment and facility heating and ventilating equipment at the end of itsuseful life.  Capital 

 

17

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expendituresin 2006 and 2005 were used for the acquisition of manufacturing and testequipment and the build–up of tooling for new customer requirements.  In 2006, the major portion of capitaladditions represented a major purchase of manufacturing equipment required inthe performance of certain specific contracts and to provide an increasedcapability and a stronger competitive position for the Company in highprecision spherical and aspherical lens production.

 

During 2007, proceeds from the exercise ofstock options were $445,000, with 651,100 stock options exercised at a weightedaverage exercise price of approximately $0.68 per share and converted into anequivalent number of shares of the Company’s common stock. By comparison, inthe 2006, proceeds from the exercise of stock options were $113,000 with145,000 stock options exercised at a weighted average exercise price of $0.78each and converted an equivalent number of shares of common stock.

 

For2007, cash and cash equivalents increased by $1,318,000 to $4,396,000, afternet cash outlays for debt repayments and redemptions of $1,697,000. In 2006,cash and cash equivalents increased by $1,922,000, including net borrowing of$373,000.

 

Asummary of the Company’s contractual cash obligations at December 31, 2007is as follows:

 

| **Contractual Obligations**             | ** ** | **Total**  | ** ** | **Less than  1 Year** | ** ** | **1–3 Years** | ** ** | **3–5 Years** | ** ** | **Greater  Than 5  Years** |
|----------------------------------------------|------------|------------|------------|---------------------------------|------------|-------------------------|------------|-------------------------|------------|---------------------------------|
| Secured note payable  (1)               |       | $1,700,000 |       | $1,700,000                      |       | $—                 |       | $—                 |       | $—                         |
| Convertible notes payable                    |       | 2,500,000  |       | —                          |       | 2,500,000               |       | —                  |       | —                          |
| Notes payable–other, including interest |       | 703,306    |       | 30,110                          |       | 173,477                 |       | 46,128                  |       | 453,591                         |
| Operating leases (2)                         |       | 388,536    |       | 388,536                         |       | —                  |       | —                  |       | —                          |
| Capital leases, including interest           |       | 49,144     |       | 49,144                          |       | —                  |       | —                  |       | —                          |
| Employment Contracts                         |       |       | 208,000    |                            |       | 208,000                 |       |                    | —     |                            |   | — |   |   | — |
| Total contractual cash obligations           |       | $5,548,986 |       | $2,375,790                      |       | $2,673,477              |       | $46,128                 |       | $453,591                        |
|                                              |            |            |            |                                 |            |                         |            |                         |            |                                 |  |  |  |  |  |

 

(1)   InMarch 2008, the Company repaid the $1,700,000 secured note payable along withaccrued interest of $471,855.

(2)  Excludesall future lease renewal options available to Company and which have not yetbeen exercised.

 

**Overview ofFinancial Condition**

 

Asshown in the accompanying financial statements, the Company reported net incomeof $1,880,000 in 2007, $772,000 in fiscal year 2006 and a loss of approximately($11,000) in 2005.  During 2007, 2006 and2005, the Company’s working capital requirements were provided by positive cashflow from its operations.

 

Netcash provided by operations was $3,001,000 in 2007, $2,672,000 in 2006, and$360,000 in 2005.  The significantlyhigher operating cash flows for 2007 and 2006 as compared with 2005 resultedfrom significantly increased net income in 2007 as compared with 2006, and in2006 both from the higher level of customer advances received during 2006 oncertain long term contracts and the significantly higher net income as comparedwith 2005.

 

TheCompany continues to seek new opportunities to increase sales and minimize expensesand cash requirements, in order to improve future operating results and cashflows.

 

TheCompany’s management expects that future cash flow from operations and itsexisting cash reserves will provide adequate liquidity for the Company’soperations and working capital requirements in 2008.

 

TheCompany assesses merger and acquisition opportunities from time to time.  No assurances can be given that the Companywill be able to identify and acquire appropriate targets for acquisition ormerger, or to raise the capital required for any such transactions.

 

**Item 7A.                 Quantitative and QualitativeDisclosures about Market Risk**

 

TheCompany believes that it has limited exposure to changes in interest rates frominvestments in certain money market accounts. The Company does not utilize derivative instruments or other market risksensitive instruments to manage exposure to interest rate changes.

 

**Item 8.                    Financial Statements andSupplementary Data**

 

Thefinancial statements and supplementary financial information required to befiled under this Item are presented commencing on page 23 of the Annual Reporton Form 10–K, and are incorporated herein by reference.

 

**Item 9.                    Changes In andDisagreements with Accountants on Accounting and Financial Disclosure**

 

None

 

18

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**Item 9A.                 Controlsand Procedures**

 

**a)  Evaluation of Disclosure Controls andProcedures**

 

The Company’s management, including the Chief Executive Officer andChief Financial Officer, has evaluated the effectiveness of the design andoperation of the Company’s disclosure controls and procedures (as defined inExchange Act Rules 13a–15(e) and 15d–15(e)) as of the end of the period coveredby this Annual Report on Form 10–K. Based upon that evaluation, the Company’s ChiefExecutive Officer and Chief Financial Officer have concluded that thedisclosure controls and procedures as of December 31, 2007 are effective toensure that information required to be disclosed in the reports the Companyfiles or submits under the Exchange Act is recorded, processed, summarized andreported within the time periods specified in the SEC’s rules and forms andthat such information is accumulated and communicated to the Company'smanagement, including the Chief Executive Officer and Chief Financial Officer,to allow timely decisions regarding disclosure.

 

**b) Management’s Annual Report on Internal Control over FinancialReporting**

 

Our management is responsible forestablishing and maintaining an adequate system of internal control over financial reporting. Our internalcontrol over financial reporting includes those policies and procedures that:

 
|   | · | pertain to the maintenance of records that,  in reasonable detail, accurately and fairly reflect the transactions and  dispositions of our assets;                                                                                                                                                                                                 |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                               |
|   | · | provide reasonable assurance that  transactions are recorded as necessary to permit preparation of our financial  statements in accordance with generally accepted accounting principles in the  United States, and that our receipts and expenditures are being made only in  accordance with authorizations of our management and directors; and |
|   |   |                                                                                                                                                                                                                                                                                                                                               |
|   | · | provide reasonable assurance regarding  prevention or timely detection of unauthorized acquisition, use or  disposition of our assets that could have a material effect on the financial  statements.                                                                                                                                              |

 

Dueto its inherent limitations, internal control over financial reporting may notprevent or detect misstatements. Projections of any evaluation of effectivenessto future periods are subject to the risk that controls may become inadequatebecause of changes in conditions, or that the degree of compliance with the policiesor procedures may deteriorate. All internal control systems, no matter how welldesigned, have inherent limitations. Therefore, even those systems determinedto be effective can provide only reasonable assurance with respect to financialstatement preparation and presentation. Because of the inherent limitations ofinternal control, there is a risk that material misstatements may not beprevented or detected on a timely basis by internal control over financialreporting. However, these inherent limitations are known features of thefinancial reporting process. Therefore, it is possible to design into theprocess safeguards to reduce, though not eliminate, this risk.

 

Our management assessed the effectiveness of our system of internalcontrol over financial reporting as of December 31, 2007. In making thisassessment, management used the framework in *InternalControl*—*Integrated Framework* issued by theCommittee of Sponsoring Organizations of the Treadway Commission (“COSO”).Based on our assessment and the criteria set forth by COSO, management believesthat the Company did maintain effective internal control over financialreporting as of December 31, 2007.

 

Our annual report on Form 10–K does not include an attestation reportof the Company’s registered public accounting firm regarding internal controlover financial reporting.  Management’sreport was not subject to attestation by the Company’s registered publicaccounting firm pursuant to temporary rules of the Securities and ExchangeCommission that permit the Company to provide only management’s report in thisannual report.

 

There have been no significantchanges in the Company’s internal control over financial reporting identifiedin connection with the evaluation that occurred during the Company’s lastfiscal quarter that have materially affected, or that are reasonably likely tomaterially affect, the Company’s internal controls over financial reporting.

 

**Item 9B**                                                      **Other Information**

 

None.

 

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**PART III**

 
| **Item 10.** | **Directors and Executive Officers of the Registrant and Corporate  Governance**                                                                           |
|--------------|------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **   | ** **                                                                                                                                                 |
| ** **   | The  information required under this item is incorporated by reference to the  Company’s Proxy Statement for the 2008 Annual Meeting of Stockholders. |

 
| **Item 11.** | **Executive Compensation**                                                                                                                                 |
|--------------|------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **   | ** **                                                                                                                                                 |
| ** **   | The  information required under this item is incorporated by reference to the  Company’s Proxy Statement for the 2008 Annual Meeting of Stockholders. |

 
| **Item 12.** | **Security Ownership of Certain Beneficial Owners and Management**                                                                                         |
|--------------|------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **   | ** **                                                                                                                                                 |
| ** **   | The  information required under this item is incorporated by reference to the  Company’s Proxy Statement for the 2008 Annual Meeting of Stockholders. |

 
| **Item 13.** | **Certain Relationships and Related Transactions**                                                                                                         |
|--------------|------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **   | ** **                                                                                                                                                 |
| ** **   | The  information required under this item is incorporated by reference to the  Company’s Proxy Statement for the 2008 Annual Meeting of Stockholders. |

 
| **Item 14.** | **Principal Accounting Fees and Services**                                                                                                                 |
|--------------|------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **   | ** **                                                                                                                                                 |
| ** **   | The  information required under this item is incorporated by reference to the  Company’s Proxy Statement for the 2008 Annual Meeting of Stockholders. |

 

 

 

 

 

 

 

 

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**PART IV**

 
| **Item 15.** | **Exhibits  and Financial Statement Schedules** |
|--------------|-------------------------------------------------|

 
| **(a) (1)** | **Financial Statements.**                                                                                        |
|-------------|------------------------------------------------------------------------------------------------------------------|
| ** **  | ** **                                                                                                       |
| ** **  | Reference is made to the  Index to Financial Statements and Financial Statement Schedule commencing on page  23. |

 
| **(a) (2)** | **Financial Statement Schedule.**                                                                                                                                                                                                                                                                                                                                                                  |
|-------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **  | ** **                                                                                                                                                                                                                                                                                                                                                                                         |
| ** **  | Reference is made to the  Index to Financial Statements and Financial Statement Schedule on  Page 23.   All other schedules  have been omitted because the required information is not present or is not  present in amounts sufficient to require submission of the schedule, or  because the information required is included in the Financial Statements or  Notes thereto. |

 
| **(a) (3)** | **Exhibits.** |
|------------------|---------------|

 
| **Exhibit  No.** | ** ** | **Description of Exhibit**                                                                                                                                                                                                                                                                                          |
|------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.1              |       | Stock  Purchase Agreement between Photonic Products Group, Inc., MRC Precision  Metal Optics and Frank E. Montone (incorporated by reference to  Exhibit 2.1 to the Company’s Current Report on Form 8-K filed with  the Securities and Exchange Commission on October 25, 2004) |
|             |       |                                                                                                                                                                                                                                                                                                                |
| 3.1              |       | Restated  Certificate of Incorporation of Photonics Products Group, Inc.  (incorporated by reference to Exhibit 3.1 to the Company’s Registration  Statement on Form S-1 filed with the Securities and Exchange Commission  on August 25, 2004)                                            |
|             |       |                                                                                                                                                                                                                                                                                                                |
| 3.2              |       | By-Laws  of Photonic Products Group, Inc. (incorporated by reference to  Exhibit 3.2 to the Company’s Registration Statement on Form S-1  filed with the Securities and Exchange Commission on August 25, 2004)                                                                            |
|             |       |                                                                                                                                                                                                                                                                                                                |
| 4.1              |       | Specimen  Common Stock Certificate (incorporated by reference to Exhibit 4.1 to  the Company’s Registration Statement on Form S-1 filed with the  Securities and Exchange Commission on August 25, 2004)                                                                                        |
|             |       |                                                                                                                                                                                                                                                                                                                |
| 4.2              |       | Form of  Warrants issued pursuant to June 2004 Private Placement (incorporated by  reference to Exhibit 4.2 to the Company’s Registration Statement on  Form S-1 filed with the Securities and Exchange Commission on  August 25, 2004)                                               |
|             |       |                                                                                                                                                                                                                                                                                                                |
| 4.3              |       | Form of  Placement Agent Warrants issued pursuant to June 2004 Private Placement  (incorporated by reference to Exhibit 4.3 to the Company’s Registration  Statement on Form S-1 filed with the Securities and Exchange Commission  on August 25, 2004)                               |
|             |       |                                                                                                                                                                                                                                                                                                                |
| 4.4              |       | Promissory  Note Dated June 30, 2003 held by Clarex, Ltd. (incorporated by reference  to Exhibit 4.4 to the Company’s Registration Statement on Form S-1  filed with the Securities and Exchange Commission on August 25, 2004)                                                            |
|             |       |                                                                                                                                                                                                                                                                                                                |
| 4.5              |       | Subordinated  Convertible Promissory Note dated April 1, 2004 held by Clarex, Ltd.  (incorporated by reference to Exhibit 4.5 to the Company’s Registration  Statement on Form S-1 filed with the Securities and Exchange Commission  on August 25, 2004)                                  |
|             |       |                                                                                                                                                                                                                                                                                                                |
| 4.6              |       | Subordinated  Convertible Promissory Note dated October 31, 2003 held by Clarex, Ltd.  (incorporated by reference to Exhibit 4.6 to the Company’s Registration  Statement on Form S-1 filed with the Securities and Exchange Commission  on August 25, 2004)                               |
|             |       |                                                                                                                                                                                                                                                                                                                |
| 4.7              |       | Subordinated  Convertible Promissory Note dated December 31, 2002 held by Welland,  Ltd. (incorporated by reference to Exhibit 4.7 to the Company’s  Registration Statement on Form S-1 filed with the Securities and  Exchange Commission on August 25, 2004)                             |
|             |       |                                                                                                                                                                                                                                                                                                                |
| 4.8              |       | Warrant  dated March 31, 2004 issued to Clarex, Ltd. (incorporated by reference  to Exhibit 10.2 to the Company’s Registration Statement on Form S-1  filed with the Securities and Exchange Commission on August 25, 2004)                                                                |
|             |       |                                                                                                                                                                                                                                                                                                                |
| 4.9              |       | Warrant  dated May 19, 2004 issued to Clarex, Ltd. (incorporated by reference to  Exhibit 10.3 to the Company’s Registration Statement on Form S-1  filed with the Securities and Exchange Commission on August 25, 2004)                                                                  |
|             |       |                                                                                                                                                                                                                                                                                                                |
| 4.10             |       | Extension  of Promissory Note dated February 15, 2008 originally issued to Clarex, Ltd.  on October 31, 2003                                                                                                                                                                                                        |
|             |       |                                                                                                                                                                                                                                                                                                                |
| 4.11             |       | Extension  of Promissory Note dated February 15, 2008 originally issued to Welland, Ltd.  on December 31, 2002                                                                                                                                                                                                      |
|             |       |                                                                                                                                                                                                                                                                                                                |
| 10.1             |       | 2000  Equity Compensation Program (incorporated by reference to Exhibit 10.1  to the Company’s Registration Statement on Form S-1 filed with the  Securities and Exchange Commission on August 25, 2004)                                                                                        |
|             |       |                                                                                                                                                                                                                                                                                                                |
| 10.2             |       | Daniel  Lehrfeld Employment Contract, dated October 20, 1999 (incorporated by  reference to Exhibit 10.4 to the Company’s Registration Statement on  Form S-1 filed with the Securities and Exchange Commission on August 25,  2004)                                                       |
|             |       |                                                                                                                                                                                                                                                                                                                |
| 14.1             |       | Code  of Ethics (incorporated by reference to the Company’s Annual Report on  Form 10-K filed with the Securities and Exchange Commission on March 31,  2006)                                                                                                                                             |
|             |       |                                                                                                                                                                                                                                                                                                                |
| 21.1             |       | List  of Subsidiaries (incorporated by reference to the Company’s Annual Report on  Form 10-K filed with the Securities and Exchange Commission on March 31,  2006)                                                                                                                                       |
|             |       |                                                                                                                                                                                                                                                                                                                |
| 23.1             |       | Consent  of Holtz Rubenstein Reminick LLP Independent Registered Public Accounting  Firm                                                                                                                                                                                                                            |
|             |       |                                                                                                                                                                                                                                                                                                                |
| 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 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 Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                                                                                                                       |

 

21

----

 

**SIGNATURES**

 

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of1934, the registrant has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized.

 

|   | PHOTONIC  PRODUCTS GROUP, INC. |
|--------|-------------------------------------|
|   |                                |
|   |                                |   |
|   | By:                                 | /s/ Daniel Lehrfeld |
|   |                                | Daniel Lehrfeld |
|   |                                | Chief Executive Officer |
|   |                                |   |
|   |                                |   |
|   | Dated:                              | March 28, 2008 |

 

Pursuant to the requirements of the Securities Exchange Act of 1934,this report has been signed below by the following persons on behalf of theregistrant and in the capacities and on the dates indicated.

 

| **Signature**            | ** ** | **Title**                               | ** ** | **Date**       |
|--------------------------|------------|-----------------------------------------|------------|----------------|
|                     |       |                                    |       |           |
|                     |       |                                    |       |           |
| /s/ John C. Rich         |       | Chairman of the Board                   |       | March 28, 2008 |
| John C. Rich             |       | of Directors                            |       |           |
|                     |       |                                    |       |           |
|                     |       |                                    |       |           |
| /s/ Daniel Lehrfeld      |       | President, Chief                        |       | March 28, 2008 |
| Daniel Lehrfeld          |       | Executive Officer                       |       |           |
|                     |       | and Director                            |       |           |
|                     |       |                                    |       |           |
|                     |       |                                    |       |           |
| /s/ Luke P. LaValle, Jr. |       | Director                                |       | March 28, 2008 |
| Luke P. LaValle, Jr.     |       |                                    |       |           |
|                     |       |                                    |       |           |
|                     |       |                                    |       |           |
| /s/ Thomas H. Lenagh     |       | Director                                |       | March 28, 2008 |
| Thomas H. Lenagh         |       |                                    |       |           |
|                     |       |                                    |       |           |
|                     |       |                                    |       |           |
| /s/ Jan M. Winston       |       | Director                                |       | March 28, 2008 |
| Jan M. Winston           |       |                                    |       |           |
|                     |       |                                    |       |           |
|                     |       |                                    |       |           |
| /s/ William J. Foote     |       | Vice-President, Chief Financial Officer |       | March 28, 2008 |
| William J. Foote         |       | and Secretary                           |       |           |

 

 

22

----

 

**PHOTONICPRODUCTS GROUP, INC. AND SUBSIDIARIES**

 

**REPORTON AUDITS OF CONSOLIDATED FINANCIAL STATEMENTS**

 

**THREEYEARS ENDED DECEMBER 31, 2007**

 

**CONTENTS**

 
| Report of Independent  Registered Public Accounting Firm                                               |   |
|--------------------------------------------------------------------------------------------------------|--------|
|                                                                                                   |   |
| Consolidated balance  sheets as of December 31, 2007 and 2006                                     |   |
|                                                                                                   |   |
| Consolidated statements  of operations for the three years ended December 31, 2007                |   |
|                                                                                                   |   |
| Consolidated statements  of shareholders’ equity for the three years ended December 31, 2007 |   |
|                                                                                                   |   |
| Consolidated statements  of cash flows for the three years ended December 31, 2007                |   |
|                                                                                                   |   |
| Notes to consolidated  financial statements                                                            |   |
|                                                                                                   |   |
| Report of Independent  Registered Public Accounting Firm on Supplemental Information                   |   |
|                                                                                                   |   |
| Schedule II — Valuation  and Qualifying Accounts                                                  |   |

 

23

----

 

 

**Report of Independent Registered Public AccountingFirm**

 

Board of Directors and Shareholders

Photonic Products Group, Inc.

and Subsidiaries

Northvale, New Jersey

 

We have audited theaccompanying consolidated balance sheets of Photonic Products Group, Inc.and Subsidiaries as of December 31, 2007 and 2006, and the relatedconsolidated statements of operations, shareholders’ equity and cash flows forthe three years ended December 31, 2007. These consolidated financialstatements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these consolidated financialstatements based on our audits.

 

We conducted our audits in accordance with the standards ofthe Public Company Accounting Oversight Board (United States). Those standardsrequire that we plan and perform the audits to obtain reasonable assuranceabout whether the consolidated financial statements are free of materialmisstatement. TheCompany is not required to have, nor were we engaged to perform, an audit ofits internal control over financial reporting. Our audits includedconsideration of internal control over financial reporting as a basis fordesigning audit procedures that are appropriate in the circumstances, but notfor the purpose of expressing an opinion on the effectiveness of the Company’sinternal control over financial reporting. Accordingly, we express no suchopinion. An audit includes examining on a test basis, evidence supporting theamounts and disclosures in the consolidated financial statements. An audit alsoincludes assessing the accounting principles used and significant estimatesmade by management, as well as, evaluating the overall consolidated financialstatement presentation. We believe that our audits provide a reasonable basisfor our opinion.

 

Inour opinion, the consolidated financial statements referred to above presentfairly, in all material respects, the financial position of Photonic ProductsGroup, Inc. and Subsidiaries as of December 31, 2007 and 2006, andthe results of their operations and their cash flows for the three years thenended, in conformity with accounting principles generally accepted in theUnited States of America.

 

/s/HOLTZRUBENSTEIN REMINICK LLP

 

Melville,New York

March 21,2008

 

 

24

----

 

**PHOTONICPRODUCTS GROUP, INC AND SUBSIDIARIES**

 

**CONSOLIDATED BALANCE SHEETS**

 
| ** **                                                                                                                                                                                  | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                  | ** ** | **2007**              | ** ** | **2006** | ** ** |
| **Assets**                                                                                                                                                                                  | ** ** | ** **            | ** ** | ** ** | ** ** |
| **Current assets:**                                                                                                                                                                         | ** ** | ** **            | ** ** | ** ** | ** ** |
| Cash and cash equivalents                                                                                                                                                                   |       | $                     | 4,395,945  |   | $ | 3,078,052 |   |
| Accounts receivable (after allowance for doubtful accounts of $15,000  in 2007 and 2006)                                                                                                    |       | 2,181,859             |       | 2,396,486 |   |
| Inventories                                                                                                                                                                                 |       | 2,931,080             |       | 2,336,033 |   |
| Other current assets                                                                                                                                                                        |       | 164,065               |       | 176,587 |   |
| **Total Current Assets**                                                                                                                                                                    |       | 9,672,949             |       | 7,987,158 |   |
| **Plant and equipment:**                                                                                                                                                                    | ** ** | ** **            | ** ** | ** ** | ** ** |
| Plant and equipment at cost                                                                                                                                                                 |       | 13,690,229            |       | 13,459,212 |   |
| Less: Accumulated depreciation and amortization                                                                                                                                             |       | (10,189,853           | )          | (9,164,031 | ) |
| Total plant and equipment                                                                                                                                                                   |       | 3,500,376             |       | 4,295,181 |   |
| **Precious Metals**                                                                                                                                                                         |       | 112,851               |       | 130,732 |   |
| **Goodwill**                                                                                                                                                                                |       | 1,869,646             |       | 1,869,646 |   |
| **Intangible Assets, net of  accumulated amortization**                                                                                                                                     |       | 830,144               |       | 908,708 |   |
| **Other Assets**                                                                                                                                                                            |       | 91,981                |       | 124,835 |   |
| **Total Assets**                                                                                                                                                                            |       | $                     | 16,077,947 |   | $ | 15,316,260 |   |
|                                                                                                                                                                                        |       |                  |       |   |   |
| **Liabilities and Shareholders’  Equity**                                                                                                                                              | ** ** | ** **            | ** ** | ** ** | ** ** |
| **Current Liabilities:**                                                                                                                                                                    | ** ** | ** **            | ** ** | ** ** | ** ** |
|                                                                                                                                                                                        |       |                  |       |   |   |
| Current portion of notes payable -other                                                                                                                                                     |       | $                     | 14,814     |   | $ | 100,079 |   |
| Accounts payable and accrued liabilities                                                                                                                                                    |       | 2,741,966             |       | 2,495,398 |   |
| Customer advances                                                                                                                                                                           |       | 870,550               |       | 987,963 |   |
| Current obligations under capital leases                                                                                                                                                    |       | 47,088                |       | 196,350 |   |
| Related party secured note due within one year                                                                                                                                              |       | 1,700,000             |       | — |   |
| **Total Current Liabilities**                                                                                                                                                               |       | 5,374,418             |       | 3,779,790 |   |
|                                                                                                                                                                                        |       |                  |       |   |   |
| **Related Party Convertible and  Secured Notes Payable**                                                                                                                                    |       | 2,500,000             |       | 5,200,000 |   |
| **Notes Payable — Other, net of  current portion**                                                                                                                                     |       | 490,730               |       | 1,052,680 |   |
| **Capital Lease Obligations, Net  of current portion**                                                                                                                                      |       | —                |       | 47,087 |   |
| **Total Liabilities**                                                                                                                                                                       |       | 8,365,148             |       | 10,079,557 |   |
|                                                                                                                                                                                        |       |                  |       |   |   |
| **Commitments and Contingencies**                                                                                                                                                           |       | —                |       | — |   |
|                                                                                                                                                                                        |       |                  |       |   |   |
| **Shareholders’ equity:**                                                                                                                                                              | ** ** | ** **            | ** ** | ** ** | ** ** |
| 10% convertible preferred stock, Series A no par value; no  shares issued and outstanding at December 31, 2007 and 500 shares issued  and outstanding at December 31, 2006   |       | —                |       | 500,000 |   |
|                                                                                                                                                                                        |       |                  |       |   |   |
| 10% convertible preferred stock, Series B no par value; no  shares issued and outstanding at December 31, 2007 and 2,082 shares  issued and outstanding at December 31, 2006 |       | —                |       | 2,082,000 |   |
|                                                                                                                                                                                        |       |                  |       |   |   |
| Common stock: $.01 par value; 60,000,000 authorized shares 10,104,719  issued at December 31, 2007 and 7,882,074 issued at December 31,  2006                                     |       | 101,046               |       | 78,820 |   |
| Capital in excess of par value                                                                                                                                                              |       | 15,320,771            |       | 11,926,815 |   |
| Accumulated deficit                                                                                                                                                                         |       | (7,694,068            | )          | (9,335,982 | ) |
|                                                                                                                                                                                        |       | 7,727,749             |       | 5,251,653 |   |
|                                                                                                                                                                                        |       |                  |       |   |   |
| Less — Common stock in treasury, at cost (4,600 shares)                                                                                                                                |       | (14,950               | )          | (14,950 | ) |
| **Total Shareholders’ Equity**                                                                                                                                                         |       | 7,712,799             |       | 5,236,703 |   |
| **Total Liabilities & Shareholders’  Equity**                                                                                                                                 |       | $                     | 16,077,947 |   | $ | 15,316,260 |   |

 

See notes toconsolidated financial statements

 

25

----

 

**PHOTONICPRODUCTS GROUP, INC AND SUBSIDIARIES**

 

**CONSOLIDATED STATEMENTS OF OPERATIONS**

 
| ** **                                                                   | ** ** | **Years Ended December 31,** | ** ** |
|------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                   | ** ** | **2007**                          | ** ** | **2006** | ** ** | **2005** | ** ** |
| **Revenues**                                                                 | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net sales                                                                    |       | $                                 | 15,099,878 |   | $ | 13,921,127 |   | $ | 13,785,057 |   |
|                                                                         |       |                              |       |   |   |   |   |
| **Cost and expenses**                                                        | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cost of goods sold                                                           |       | 9,141,049                         |       | 9,377,313 |   | 9,956,125 |   |
| Selling, general and administrative expense                                  |       | 3,561,570                         |       | 3,627,244 |   | 3,450,224 |   |
| Internal research and development expense                                    |       | —                            |       | — |   | 20,279 |   |
|                                                                         |       | 12,702,619                        |       | 13,004,557 |   | 13,426,628 |   |
|                                                                         |       |                              |       |   |   |   |   |
| **Operating income**                                                         |       | 2,397,259                         |       | 916,570 |   | 358,429 |   |
| ** **                                                                   | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Other income (expense)**                                                   | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** |
|                                                                         |       |                              |       |   |   |   |   |
| Interest expense, net                                                        |       | (261,327                          | )          | (402,154 | ) | (504,509 | ) |
| Settlement of insurance claim                                                |       |                              |       | 300,000 |   | — |   |
| (Loss) gain on sale of precious metals                                       |       | (5,851                            | )          | — |   | 135,931 |   |
| Other                                                                        |       |                              |       | (21,150 | ) | (1,249 | ) |
|                                                                         |       | (267,178                          | )          | (123,304 | ) | (369,827 | ) |
|                                                                         |       |                              |       |   |   |   |   |
| **Income (loss) before income tax provision and  preferred stock dividends** |       | 2,130,081                         |       | 793,266 |   | (11,398 | ) |
|                                                                         |       |                              |       |   |   |   |   |
| **Income tax provision**                                                     |       | 250,000                           |       | 21,000 |   | — |   |
|                                                                         |       |                              |       |   |   |   |   |
| **Net income (loss)**                                                        |       | 1,880,081                         |       | 772,266 |   | (11,398 | ) |
|                                                                         |       |                              |       |   |   |   |   |
| **Preferred stock dividends**                                                |       | (238,167                          | )          | (234,500 | ) | (134,000 | ) |
|                                                                         |       |                              |       |   |   |   |   |
| **Net income (loss) applicable to common  shareholders**                     |       | $                                 | 1,641,914  |   | $ | 537,766 |   | $ | (145,398 | ) |
|                                                                         |       |                              |       |   |   |   |   |
| **Net income (loss) per share —  basic**                                |       | $                                 | 0.19       |   | $ | 0.07 |   | $ | (0.02 | ) |
|                                                                         |       |                              |       |   |   |   |   |
| **Net income (loss) per share —  diluted**                              |       | $                                 | 0.13       |   | $ | 0.06 |   | $ | (0.02 | ) |
|                                                                         |       |                              |       |   |   |   |   |
| **Weighted average shares  outstanding — basic**                        |       | 8,609,822                         |       | 7,572,637 |   | 7,218,244 |   |
| ** **                                                                   | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Weighted average shares  outstanding — diluted**                      |       | 13,777,114                        |       | 11,915,090 |   | 7,218,244 |   |
| ** **                                                                   |       |                              |       |   |   |   |   |

 

See notes toconsolidated financial statements

 

26

----

 

**PHOTONICPRODUCTS GROUP, INC. AND SUBSIDIARIES**

 

**CONSOLIDATED STATEMENT OFSHAREHOLDERS’ EQUITY**

 
| ** **                                                          | ** ** | ** **        | ** ** | ** **          | ** **  | **Preferred  Stock** | ** ** | **Preferred  Stock** | ** ** | **Capital  in** | ** ** | ** **    | ** ** | ** **             | ** **     | **Total**      | ** **     |
|---------------------------------------------------------------------|------------|-------------------|------------|---------------------|-------------|----------------------|------------|----------------------|------------|-----------------|------------|---------------|------------|------------------------|----------------|----------------|----------------|
| ** **                                                          | ** ** | **Common  Stock** | ** ** | **(Series A)** | ** **  | **(Series B)**  | ** ** | **excess  of**       | ** ** | ** **      | ** ** | **Treasury**  | ** ** | **Shareholders’** | ** **     |
| ** **                                                          | ** ** | **Shares**        | ** ** | **Amount**          | ** **  | **Shares**           | ** ** | **Amount**           | ** ** | **Shares**      | ** ** | **Amount**    | ** ** | **par  value**         | ** **     | **Deficit**    | ** **     | **Stock** | ** ** | **Equity** | ** ** |
| **Balance, January 1, 2005**                                   | ** ** | **7,186,794**     | ** ** | **71,868**          | ** **  | **500**              | ** ** | **500,000**          | ** ** | **2,100**       | ** ** | **2,100,000** | ** ** | **11,036,561**         | ** **     | **(9,728,350** | **)**          | **(14,950** | **)** | **3,965,129** | ** ** |
|                                                                |       |              |       |                |        |                 |       |                 |       |            |       |          |       |                   |           |           |           |   |   |   |   |
| 401K contribution                                                   |       | 61,404            |       | 614                 |        | —               |       | —               |       | —          |       | —        |       | 68,166                 |           | —         |           | — |   | 68,780 |   |
|                                                                |       |              |       |                |        |                 |       |                 |       |            |       |          |       |                   |           |           |           |   |   |   |   |
| Dividend on Preferred Stock                                         |       | 39,200            |       | 380                 |        | —               |       | —               |       | —          |       | —        |       | 38,808                 |           | (134,000       | )              | — |   | (94,812 | ) |
|                                                                |       |              |       |                |        |                 |       |                 |       |            |       |          |       |                   |           |           |           |   |   |   |   |
| Accelerated stock options                                           |       | —            |       | —              |        | —               |       | —               |       | —          |       | —        |       | 21,398                 |           | —         |           | — |   | 21,398 |   |
|                                                                |       |              |       |                |        |                 |       |                 |       |            |       |          |       |                   |           |           |           |   |   |   |   |
| Costs of issuance  of common stock                                  |       | —            |       | —              |        | —               |       | —               |       | —          |       | —        |       | (19,690                | )              | —         |           | — |   | (19,690 | ) |
|                                                                |       |              |       |                |        |                 |       |                 |       |            |       |          |       |                   |           |           |           |   |   |   |   |
| Net loss for the year                                               |       | —            |       | —              |        | —               |       | —               |       | —          |       | —        |       | —                 |           | (11,398        | )              | — |   | (11,398 | ) |
|                                                                |       |              |       |                |        |                 |       |                 |       |            |       |          |       |                   |           |           |           |   |   |   |   |
| **Balance, December 31, 2005**                                 | ** ** | **7,287,398**     | ** ** | **72,862**          | ** **  | **500**              | ** ** | **500,000**          | ** ** | **2,100**       | ** ** | **2,100,000** | ** ** | **$**                  | **11,145,243** | ** **     | **(9,873,748** | **)** | **(14,950** | **)** | **3,929,407** | ** ** |
|                                                                |       |              |       |                |        |                 |       |                 |       |            |       |          |       |                   |           |           |           |   |   |   |   |
| 401K contribution                                                   |       | 144,836           |       | 1,448               |        | —               |       | —               |       | —          |       | —        |       | 149,053                |           | —         |           | — |   | 150,501 |   |
|                                                                |       |              |       |                |        |                 |       |                 |       |            |       |          |       |                   |           |           |           |   |   |   |   |
| Dividend on Preferred Stock                                         |       | 134,000           |       | 1,340               |        | —               |       | —               |       | —          |       | —        |       | 233,160                |           | (234,500       | )              | — |   | — |   |
|                                                                |       |              |       |                |        |                 |       |                 |       |            |       |          |       |                   |           |           |           |   |   |   |   |
| Issuance of  common stock payable                                   |       | 174,800           |       | 1,760               |        | —               |       | —               |       | —          |       | —        |       | 152,252                |           | —         |           | — |   | 154,012 |   |
|                                                                |       |              |       |                |        |                 |       |                 |       |            |       |          |       |                   |           |           |           |   |   |   |   |
| Exercise of stock options                                           |       | 145,000           |       | 1,450               |        | —               |       | —               |       | —          |       | —        |       | 111,380                |           | —         |           | — |   | 112,830 |   |
|                                                                |       |              |       |                |        |                 |       |                 |       |            |       |          |       |                   |           |           |           |   |   |   |   |
| Cancellation of common stock                                        |       | (3,960            | )          | (40                 | )           | —               |       | —               |       | —          |       | —        |       | 40                     |           | —         |           | — |   | — |   |
|                                                                |       |              |       |                |        |                 |       |                 |       |            |       |          |       |                   |           |           |           |   |   |   |   |
| Cancellation of preferred stock                                     |       | —            |       | —              |        | —               |       | —               |       | (18             | )          | (18,000       | )          | 18,000                 |           | —         |           | — |   | — |   |
|                                                                |       |              |       |                |        |                 |       |                 |       |            |       |          |       |                   |           |           |           |   |   |   |   |
| Share-based  compensation expense                                   | ** ** | ** **        | ** ** | ** **          | ** **  | ** **           | ** ** | ** **           | ** ** | ** **      | ** ** | ** **    |       | 117,687                | ** **     | ** **     | ** **     | ** ** |   | 117,687 |   |
|                                                                |       |              |       |                |        |                 |       |                 |       |            |       |          |       |                   |           |           |           |   |   |   |   |
| Net income for the year                                             |       | —            |       | —              |        | —               |       | —               |       | —          |       | —        |       | —                 |           | 772,266        |           | — |   | 772,266 |   |
|                                                                |       |              |       |                |        |                 |       |                 |       |            |       |          |       |                   |           |           |           |   |   |   |   |
| **Balance, December 31, 2006**                                 | ** ** | **7,882,074**     | ** ** | **78,820**          | ** **  | **500**              | ** ** | **500,000**          | ** ** | **2,082**       | ** ** | **2,082,000** | ** ** | **$**                  | **11,926,815** | ** **     | **(9,335,982** | **)** | **(14,950** | **)** | **5,236,703** | ** ** |
|                                                                |       |              |       |                |        |                 |       |                 |       |            |       |          |       |                   |           |           |           |   |   |   |   |
| 401K contribution                                                   |       | 124,133           |       | 1,241               |        | —               |       | —               |       | —          |       | —        |       | 165,453                |           | —         |           | — |   | 166,694 |   |
|                                                                |       |              |       |                |        |                 |       |                 |       |            |       |          |       |                   |           |           |           |   |   |   |   |
| Dividend on preferred stock                                         |       | 134,612           |       | 1,346               |        | —               |       | —               |       | —          |       | —        |       | 236,821                |           | (238,167       | )              | — |   | — |   |
|                                                                |       |              |       |                |        |                 |       |                 |       |            |       |          |       |                   |           |           |           |   |   |   |   |
| Common stock  issued on conversion of Series A Preferred Stock |       | 500,000           |       | 5,000               |        | (500                 | )          | (500,000             | )          | —          |       | —        |       | 495,000                |           | —         |           | — |   | — |   |
|                                                                |       |              |       |                |        |                 |       |                 |       |            |       |          |       |                   |           |           |           |   |   |   |   |
| Common stock  issued on exercise of options                         |       | 651,100           |       | 6,511               |        | —               |       | —               |       | —          |       | —        |       | 438,736                |           | —         |           | — |   | 445,247 |   |
|                                                                |       |              |       |                |        |                 |       |                 |       |            |       |          |       |                   |           |           |           |   |   |   |   |
| Share-based  compensation expense                                   |       | —            |       | —              |        | —               |       | —               |       | —          |       | —        |       | 34,074                 |           | —         |           | — |   | 34,074 |   |
|                                                                |       |              |       |                |        |                 |       |                 |       |            |       |          |       |                   |           |           |           |   |   |   |   |
| Common stock  issued on conversion of Series B Preferred Stock |       | 812,800           |       | 8,128               |        | —               |       | —               |       | (2,032          | )          | (2,032,000    | )          | 2,023,872              |           | —         |           | — |   | — |   |
|                                                                |       |              |       |                |        |                 |       |                 |       |            |       |          |       |                   |           |           |           |   |   |   |   |
| Redemption of  Series B Preferred Stock                        |       | —            |       | —              |        | —               |       | —               |       | (50             | )          | (50,000       | )          | —                 |           | —         |           | — |   | (50,000 | ) |
|                                                                |       |              |       |                |        |                 |       |                 |       |            |       |          |       |                   |           |           |           |   |   |   |   |
| Net income for the year                                             |       | —            |       | —              |        | —               |       | —               |       | —          |       | —        | ** ** | ** **             |           | 1,880,081      |           | — |   | 1,880,081 |   |
| ** **                                                          | ** ** | ** **        | ** ** | ** **          | ** **  | ** **           | ** ** | ** **           | ** ** | ** **      | ** ** | ** **    | ** ** | ** **             | ** **     | ** **     | ** **     | ** ** | ** ** | ** ** | ** ** |
| **Balance, December 31, 2007**                                 | ** ** | **10,104,719**    | ** ** | **$**               | **101,046** | ** **           | ** ** | ** **           | **$**      | ** **      | ** ** | ** **    | ** ** | **$**                  | ** **     | ** **     | **$**          | **15,320,771** | ** ** | **$** | **(7,694,068** | **)** | **$** | **(14,950** | **)** | **$** | **7,712,799** | ** ** |
|                                                                     |            |                   |            |                     |             |                      |            |                      |            |                 |            |               |            |                        |                |                |                |  |  |  |  |  |  |  |  |  |  |  |

 

See notes toconsolidated financial statements

 

27

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**PHOTONICPRODUCTS GROUP, INC AND SUBSIDIARIES**

 

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

 
| ** **                                                                                         | ** ** | **Years Ended December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                                         | ** ** | **2007**                          | ** ** | **2006** | ** ** | **2005** | ** ** |
| **Cash flows from operating  activities:**                                                         | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income (loss)                                                                                  |       | $                                 | 1,880,081  |   | $ | 772,266 |   | $ | (11,398 | ) |
|                                                                                               |       |                              |       |   |   |   |   |
| **Adjustments to reconcile net income (loss) to  net cash provided by operating activities:** | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Depreciation and amortization                                                                      |       | 1,119,887                         |       | 1,099,003 |   | 1,025,074 |   |
| Loss/(gain) on sale of precious metal                                                              |       | 5,851                             |       | — |   | (135,931 | ) |
| 401K common stock contribution                                                                     |       | 166,694                           |       | 150,501 |   | 68,780 |   |
| Stock option acceleration expense                                                                  |       | —                            |       | — |   | 21,298 |   |
| Stock option expense                                                                               |       | 34,074                            |       | 117,687 |   | — |   |
| Change in allowance for doubtful accounts                                                          |       | —                            |       | — |   | (73,000 | ) |
| Change in inventory reserve                                                                        |       | 163,391                           |       | 102,817 |   | (254,526 | ) |
| ** **                                                                                         | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Changes in operating assets and  liabilities:**                                                  | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Accounts receivable                                                                                |       | 214,627                           |       | (130,552 | ) | (744,939 | ) |
| Inventories                                                                                        |       | (758,438                          | )          | (14,971 | ) | 309,720 |   |
| Other current assets                                                                               |       | 12,522                            |       | (22,864 | ) | (66,184 | ) |
| Other assets                                                                                       |       | 32,854                            |       | 39,549 |   | 28,981 |   |
| Accounts payable and accrued liabilities                                                           |       | 246,568                           |       | 222,718 |   | 81,740 |   |
| Customer advances                                                                                  |       | (117,413                          | )          | 335,699 |   | 110,546 |   |
| Total adjustments                                                                                  |       | 1,120,617                         |       | 1,899,587 |   | 371,659 |   |
| **Net cash provided by operating activities**                                                      |       | 3,000,698                         |       | 2,671,853 |   | 360,261 |   |
|                                                                                               |       |                              |       |   |   |   |   |
| **Cash flows from investing  activities:**                                                         | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Capital expenditures                                                                               |       | (246,518                          | )          | (986,732 | ) | (453,615 | ) |
| Proceeds from sale of precious metals                                                              |       | 12,030                            |       | — |   | 314,764 |   |
| **Net cash used in investing activities**                                                          |       | (234,488                          | )          | (986,732 | ) | (138,851 | ) |
|                                                                                               |       |                              |       |   |   |   |   |
| **Cash flows from financing  activities:**                                                         | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net proceeds (uses) from issuance of common stock                                                  |       | 445,247                           |       | 112,830 |   | (19,492 | ) |
| Proceeds from secured notes payable                                                                |       |                              |       | 700,000 |   | — |   |
| Redemption of Series B Preferred shares                                                       |       | (50,000                           | )          | — |   | — |   |
| Principal payments of notes payable                                                                |       | (647,215                          | )          | (326,724 | ) | (166,515 | ) |
| Principal payments of convertible promissory notes                                                 |       | (1,000,000                        | )          |   |   |   |   |
| Principal payments of capital lease obligations                                                    |       | (196,349                          | )          | (249,738 | ) | (272,347 | ) |
|                                                                                               |       |                              |       |   |   |   |   |
| **Net cash provided by (used in) financing  activities**                                           |       | (1,448,317                        | )          | 236,368 |   | (458,354 | ) |
|                                                                                               |       |                              |       |   |   |   |   |
| **Net increase (decrease) in cash  and cash equivalents**                                          |       | 1,317,893                         |       | 1,921,489 |   | (236,944 | ) |
|                                                                                               |       |                              |       |   |   |   |   |
| **Cash and cash equivalents at beginning  of the year**                                            |       | 3,078,052                         |       | 1,156,563 |   | 1,393,507 |   |
|                                                                                               |       |                              |       |   |   |   |   |
| **Cash and cash equivalents at  end of the year**                                                  |       | $                                 | 4,395,945  |   | $ | 3,078,052 |   | $ | 1,156,563 |   |
| ** **                                                                                         | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** |

 

See notes to consolidated financial statements 

 

28

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**PHOTONICPRODUCTS GROUP, INC. AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

**THREEYEARS ENDED DECEMBER 31, 2007**

 

**1.         Nature of Business and Summary ofSignificant Accounting Policies and Estimates**

 

a.             Natureof Operations

 

Photonic Products Group, Inc. and Subsidiaries(the “Company”, formerly known as Inrad, Inc.) is a manufacturer ofcrystals, crystal devices, electro-optic and optical components, andsophisticated laser subsystems and instruments. The Company’s principal customers include commercial instrumentationcompanies and OEM laser manufacturers, research laboratories, governmentagencies, and defense contractors.  TheCompany’s products are sold domestically using its own sales staff, and inmajor overseas markets, principally Europe and the Far East, using independentsales agents.

 

b.             Principlesof consolidation

 

The accompanying consolidated financial statementsinclude the accounts of the Company and its wholly-owned Subsidiaries.  Upon consolidation, all inter-companyaccounts and transactions are eliminated.

 

c.             Accountsreceivable

 

Accounts receivable are stated at the historicalcarrying amount, net of write-offs and allowances.  The Company establishes an allowance fordoubtful accounts based on estimates as to the collectibility of accountsreceivable.  Management specificallyanalyzes past-due accounts receivable balances and, additionally, considers baddebt history, customer credit-worthiness, current economic trends and changesin customer payment terms when evaluating the adequacy of the allowance fordoubtful accounts.  Uncollectibleaccounts receivable are written-off when it is determined that the balance willnot be collected.

 

d.             Inventories

 

Inventories are stated at the lower of cost (first-in,first-out method) or market.  Costincludes material, labor and overhead. The Company records a reserve for slowmoving inventory as a charge against earnings for all products identified assurplus, slow moving or discontinued. Excess work-in-process costs are charged against earnings wheneverestimated costs-of-completion exceed unbilled revenues.

 

e.             Plantand Equipment

 

Plant and Equipment are depreciated using thestraight-line method over the estimated useful lives of the related assetswhich range between 5 and 7 years. Amortization of leasehold improvements is computed using thestraight-line method over the lesser of 10 years or the remaining term of thelease including optional renewal periods. Maintenance and repairs of property and equipment are charged to operationsand major improvements are capitalized. Upon retirement, sale or other disposition of property and equipment,the cost and accumulated depreciation are eliminated from the accounts and again or loss is recorded.

 

f.              Incometaxes

 

The Company accounts for income taxes under Statementof Financial Accounting Standards (“SFAS”) No, 109, “Accounting for IncomeTaxes.”  Deferred tax assets andliabilities are determined based on differences between financial reporting andtax bases of assets and liabilities, and are measured using the enacted taxrates and laws that will be in effect when the differences are expected toreverse.

 

g.             Impairmentof long-lived assets

 

In accordance with SFAS No. 144, long-livedassets, such as property, plant and equipment, and purchased intangiblessubject to amortization, are reviewed for impairment whenever events or changesin circumstances indicate that the carrying amount of an asset may not berecoverable.  Recoverability of assets tobe held and used is measured by a comparison of the carrying amount of an assetto estimate undiscounted future cash flows expected to be generated by theasset.  If the carrying amount of anasset exceeds its estimated future cash flows, an impairment charge isrecognized by the amount by which the carrying amount of the asset exceeds thefair value of the assets.  Assets to bedisposed of would be separately presented in the balance sheet and reported atthe lower of the carrying amount or fair value less costs to sell and are nolonger depreciated.  The assets andliabilities of a disposed group classified as held for sale would be presentedseparately in the appropriate asset and liability sections of the balancesheet.

 

29

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h.             Goodwilland Intangible assets

 

Acquiredgoodwill and intangible assets consists of goodwill approximating $1,870,000and other acquired intangible assets with finite lives, consisting principallyof non-contractual customer relationships, completed technology and trademarksthat approximated $1,100,000.  Intangibleassets with finite lives are amortized on a straight-line basis over the assets’estimated useful life up to 14 years. The Company evaluates whether events or circumstances have occurredindicating the carrying amount of intangible assets may not berecoverable.  When factors indicate thatintangible assets should be evaluated for possible impairment, the Company usesan estimate of the associated undiscounted future cash flows compared to therelated carrying amount of assets to determine if an impairment loss should berecognized.  Goodwill and intangibleassets not subject to amortization are tested in December of each year forimpairment, or more frequently if events and circumstances indicate that theassets might be impaired.  An impairmentloss is recognized to the extent that the carrying amount exceeds the asset’sfair value.

 

The gross carrying amount of intangible assets as of December 31,2007, and as of December 31, 2006 was $1,100,000, respectively.  Accumulated amortization related tointangible assets approximates $270,000 as of December 31, 2007 and$191,000 as of December 31, 2006. Amortization expense was approximately $79,000 for the years ended December 31,2007 and December 31, 2006, respectively. Aggregate amortization for the five succeeding years from January 1,2008 through December 31, 2012 approximates $395,000, accumulating at therate of $79,000 per year.  The weightedaverage life of the Company’s intangible assets is approximately 10.5 years.

 

The changes in the carrying amounts of goodwill, byacquisition, for the year ended December 31, 2007, are as follows:

 
| ** **   | ** ** | **Balance  Jan. 1, 2007** | ** ** | **Goodwill Additions** | ** ** | **Purchase Price  Adjustment** | ** ** | **Balance  Dec. 31, 2007** | ** ** |
|--------------|------------|--------------------------------|------------|------------------------|------------|--------------------------------|------------|---------------------------------|------------|
| Laser Optics |       | $                              | 311,572    |                   | $          | —                         |       | $                               | —     |   | $ | 311,572 |   |
|         |       |                           |       |                   |       |                           |       |                            |       |
| MRC          |       | $                              | 1,558,074  |                   | $          | —                         |       | $                               | —     |   | $ | 1,558,074 |   |
|         |       |                           |       |                   |       |                           |       |                            |       |
| Total        |       | $                              | 1,869,646  |                   | $          | —                         |       | $                               | —     |   | $ | 1,869,646 |   |

 

The following schedule details the Company’sintangible asset balance by major asset class.

 

| ** **           | ** ** | **At December 31, 2007** | ** ** |
|----------------------|------------|-------------------------------|------------|
| ** **           | ** ** | **Gross Carrying   Amount**   | ** ** | **Accumulated   Amortization** | ** ** | **Net Carrying   Amount** | ** ** |
|                 |       |                          |       |   |   |   |   |
| Customer-related     |       | $                             | 549,937    |   | $ | (134,865 | ) | $ | 415,072 |   |
| Completed technology |       | 362,958                       |       | (89,011 | ) | 273,947 |   |
| Trademarks           |       | 186,979                       |       | (45,854 | ) | 141,125 |   |
|                 |       |                          |       |   |   |   |   |
| Total                |       | $                             | 1,099,874  |   | $ | (269,730 | ) | $ | 830,144 |   |

 

| ** **           | ** ** | **At December 31, 2006** | ** ** |
|----------------------|------------|-------------------------------|------------|
| ** **           | ** ** | **Gross Carrying   Amount**   | ** ** | **Accumulated   Amortization** | ** ** | **Net Carrying   Amount** | ** ** |
|                 |       |                          |       |   |   |   |   |
| Customer-related     |       | $                             | 549,937    |   | $ | (95,583 | ) | $ | 454,354 |   |
| Completed technology |       | 362,958                       |       | (63,085 | ) | 299,873 |   |
| Trademarks           |       | 186,979                       |       | (32,498 | ) | 154,481 |   |
|                 |       |                          |       |   |   |   |   |
| Total                |       | $                             | 1,099,874  |   | $ | (191,166 | ) | $ | 908,708 |   |

 

i.              Stock-basedcompensation

 

Effective January 1, 2006, the Company accountsfor stock-based compensation in accordance with the recognition and measurementprovisions of Statement of Financial Accounting Standards (“SFAS”) No. 123(revised 2004), Share-Based Payment (“SFAS 123(R)”), which replaces SFAS No. 123,Accounting for Stock-Based Compensation, and supersedes Accounting PrinciplesBoard Opinion (“APB”) No. 25, Accounting for Stock Issued to Employees,and related interpretations.  Prior to January 1,2006, the Company accounted for similar transactions in accordance with APB No. 25which employed the intrinsic value method of measuring compensation cost.  Accordingly, compensation expense was notrecognized for certain fixed stock options that the Company had previouslygranted, if the exercise price of the option equaled or exceeded the fair valueof the underlying stock at the grant date.

 

30

----

 

The Company applied the modified prospective approachto transition, under which the provisions of FAS 123 (R) are applied tonew awards and to awards modified, repurchased, or cancelled after the requiredeffective date.  Additionally,compensation cost for the portion of awards for which the requisite service hasnot been rendered that are outstanding as of the required effective date arerecognized as the requisite service is rendered on or after the requiredeffective date.  The compensation costfor that portion of awards is based on the grant-date fair value of thoseawards as calculated for either recognition or pro-forma disclosures under FAS123.

 

Under the fair value recognition provision of SFAS123(R), stock based compensation cost is estimated at the grant date based onthe fair value of the award.  The Companyestimates the fair value of stock options granted using the Black-Scholesoption pricing model.  The fair value ofrestricted stock units granted is based on the closing market price of theCompany’s common stock on the date of the grant.  The fair value of these awards, adjusted forestimated forfeitures is amortized over the requisite service period of theaward, which is generally the vesting period.

 

j.              Revenuerecognition

 

The Company records revenue, other than on contractualtype work, when a product is shipped. Revenue on contractual type work is accounted for using thepercentage-of-completion method, whereby revenue and profits are recognizedthroughout the performance of the contracts. Percentage-of-completion is determined by relating the actual cost ofwork performed to date to the estimated total cost for each contract.  Losses on contracts are recorded whenidentified.

 

k.             Internalresearch and development costs

 

Internal research and development costs are charged toexpense as incurred.

 

l.              Preciousmetals

 

Precious metals not consumed in the manufacturingprocess are valued at the lower of cost or net realizable value, on a first-in,first-out basis.

 

m.            Useof estimates

 

The preparation of financial statements in conformitywith generally accepted accounting principles requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe financial statements and the reported amounts of revenues and expensesduring the reporting period.  Actualamounts could differ from those estimates.

 

n.             Advertisingcosts

 

Advertising costs included in selling, general andadministrative expenses were $29,000, $27,000 and $34,000 for the years ended December 31,2007, 2006 and 2005, respectively. Advertising costs are charged to expense when the related services areincurred or related events take place.

 

o.             Statementsof cash flows and non-cash transactions

 

For purposes of the consolidated statements of cashflows, the Company considers all highly liquid debt instruments purchased witha maturity of three months, or less, to be cash equivalents.

 

Interest paid during the years ended December 31,2007, 2006 and 2005 was $99,000, 116,000 and $183,000, respectively.

 

Income taxes paid were $69,000 in 2007, $7,000 in2006, and $7,000 in 2005.

 

In 2007, non-cash financing transactions resultingfrom the exchange of Series A convertible preferred stock in exchange forcommon shares amounted to $500,000 and the exchange of Series Bconvertible preferred stock for common stock amounted to $2,032,000.  In 2005 non-cash transactions included theexchange of debt for common stock in the amount of $59,200.

 

There were no adjustments to goodwill in 2007 or2006.  In 2005, non-cash transactionsresulting from an adjustment to increase the value of acquired goodwillamounted to $141,675.

 

p.             Concentrationof risk

 

The Company invests its excess cash in deposits andmoney market accounts with major financial institutions and in commercial paperof companies with strong credit ratings. Generally, the investments mature within three to six months, andtherefore, are subject to little risk. The Company has not experienced losses related to these investments.

 

The concentration of credit risk in the Company’saccounts receivable is mitigated by the Company’s credit evaluation process,reasonably short collection terms and the geographical dispersion ofrevenue.  The Company generally does notrequire collateral but, in some cases, the Company negotiates cash advancesprior to the undertaking of the work. These cash advances are recorded as current liabilities on the balancesheet until corresponding revenues are realized.

 

31

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The Company utilizes many relatively uncommonmaterials and compounds to manufacture its products.  Therefore, any failure by its suppliers todeliver materials of an adequate quality and quantity could have an adverseeffect on the Company’s ability to meet the commitments of its customers.

 

q.             Netincome (loss) per common share

 

The basic net income (loss) per share is computedusing the weighted average number of common shares outstanding for theapplicable period.  The diluted income(loss) per share is computed using the weighted average number of common sharesplus potential common equivalent shares outstanding, including the additionaldilution related to the conversion of stock options, warrants, convertiblepreferred shares, and potential common shares issuable upon conversion ofoutstanding convertible notes, except if the effect on the per share amounts isanti-dilutive.  For the year ended December 31,2006, there were 1,332,800 shares on the conversion of convertible preferredshares that have not been included in dilutive shares as the effect would beanti-dilutive.  For the year ended December 31,2005, the effect of outstanding stock options, warrants, convertible preferredshares and convertible notes is anti-dilutive since the Company had net losses,and has been excluded from the calculation of diluted net loss per share.

 

The following is the reconciliation of the basic anddiluted earnings per share computations required by Statement of FinancialStandards (“SFAS”) No. 128 (“Earnings per Share’)

 

| ** **                                                          | ** ** | **Years ended December 31,** | ** ** |
|---------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                          | ** ** | **2007**                                    | ** ** | **2006** | ** ** | **2005** | ** ** |
| **Numerators**                                                      |       |                                        |       |   |   |   |   |
|                                                                |       |                                        |       |   |   |   |   |
| Net income (loss)  applicable to common shareholders — basic   |       | $                                           | 1,641,914  |   | $ | 537,766 |   | $ | (145,398 | ) |
| Interest on Convertible  Debt                                       |       | 188,096                                     |       | 210,000 |   | — |   |
| Net income (loss)  applicable to common shareholders — diluted |       | $                                           | 1,830,010  |   | $ | 747,766 |   | $ | (145,398 | ) |
| ** **                                                          | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Denominators**                                                    |       |                                        |       |   |   |   |   |
|                                                                |       |                                        |       |   |   |   |   |
| Weighed average shares  outstanding — Basic                    |       | 8,609,822                                   |       | 7,572,637 |   | 7,218,244 |   |
| Convertible Debt                                                    |       | 3,102,740                                   |       | 3,500,000 |   | — |   |
| Warrants                                                            |       | 1,585,206                                   |       | 287,353 |   | — |   |
| Stock options                                                       |       | 479,346                                     |       | 555,100 |   | — |   |
| Weighted average shares  outstanding — diluted                 |       | 13,777,114                                  |       | 11,915,090 |   | 7,218,244 |   |
|                                                                |       |                                        |       |   |   |   |   |
| Net income (loss) per  common share — basic                    |       | $                                           | 0.19       |   | $ | 0.07 |   | $ | (0.02 | ) |
| Net income (loss) per  commons share — diluted                 |       | $                                           | 0.13       |   | $ | 0.06 |   | $ | (0.02 | ) |

##  

r.              Shippingand handling costs

 

The Company has included freight out as a component ofselling, general and administrative expenses that amounted to $36,000 in 2007,$27,000 in 2006 and $32,000 in 2005**.**  When applicable the Company bills itscustomers for freight costs.

 

s.             Recentlyissued accounting pronouncements

 

In September 2006, the FASB issued SFAS No. 157,“Fair Value Measures” (“SFAS 157”).  SFAS157 defines fair value, establishes a framework for measuring fair value andenhances disclosures about fair value measures required under other accountingpronouncements, but does not change existing guidance as to whether or not aninstrument is carried at fair value. SFAS 157 is effective for fiscal years beginning after November 15,2007, the year beginning January 1, 2008 for the Company.  The Company does not expect the adoption ofSFAS No.157 to have a significant impact on its financial statements.

 

In February 2007, the FASB issued SFAS No. 159“The Fair Value Option for Financial Assets and Financial Liabilities,” (“SFAS159”).  SFAS 159 provides companies withan option to report selected financial assets and financial liabilities at fairvalue.  Unrealized gains and losses onitems for which the fair value option has been elected are reported in earningsat each subsequent reporting date.  SFAS159 is effective for fiscal years beginning after November 15, 2007, theyear beginning January 1, 2008 for the Company.  The Company does not expect the adoption ofSFAS No. 159 to have a significant impact on its financial statements.

 

In December 2007,the FASB issued FASB Statement No. 141 (Revised 2007), “Business Combinations”(“SFAS 141(R)”).  SFAS 141(R) willsignificantly change the accounting for business combinations. Under SFAS141(R), an acquiring entity will be required to recognize all the assetsacquired and liabilities assumed in a transaction at the acquisition-date fairvalue with limited exceptions.  SFAS 141Rwill change the accounting treatment for certain specific items, including:

 

32

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·              Non-controlling interests (formerly known as “minorityinterests”) will be recorded at fair value at the acquisition date;

·              Acquired contingent liabilities will be recorded atfair value at the acquisition date and subsequently measured at either thehigher of such amount or the amount determined under existing guidance fornon-acquired contingencies;

·              In-process research and development will be recordedat fair value as an indefinite-lived intangible asset at the acquisition date;

·              Restructuring costs associated with a businesscombination will generally be expensed subsequent to the acquisition date; and

·              Changes in deferred tax asset valuation allowances andincome tax uncertainties after the acquisition date generally will affectincome tax expense.

 

SFAS 141(R) alsoincludes a substantial number of new disclosure requirements. The statementapplies to the Company prospectively for business combinations for which theacquisition date is on or after January 1, 2009.  Earlier adoption is prohibited.  The Company is currently assessing the impactof adopting SFAS 141(R) on its financial statements.

 

The FASB issued FASBStatement No. 160, “Non-controlling Interests in Consolidated FinancialStatements - An Amendment of ARB No. 51” in December 2007 (“SFAS 160”).  SFAS 160 establishes new accounting andreporting standards for the non-controlling interest in a subsidiary and forthe deconsolidation of a subsidiary. Specifically, this statement requires therecognition of a non-controlling interest (minority interest) as equity in theconsolidated financial statements. The amount of net income attributable to thenon-controlling interest will be included in consolidated net income on theface of the income statement. Statement 160 clarifies that changes in a parent’sownership interest in a subsidiary that do not result in deconsolidation areequity transactions if the parent retains its controlling financial interest.In addition, this statement requires that a parent recognize a gain or loss innet income when a subsidiary is deconsolidated. Such gain or loss will be measuredusing the fair value of the non-controlling equity investment on thedeconsolidation date. Statement 160 also includes expanded disclosurerequirements regarding the interests of the parent and its non-controllinginterest. Statement 160 is effective for the Company for fiscal years, andinterim periods within those fiscal years, beginning with the year ended December 31,2009. Earlier adoption is prohibited. The Company does not expect the adoption of SFAS No. 160 to have asignificant impact on its financial statements.

 

**2.         Inventories**

 

Inventories are comprised of the following:

 

| ** **                                                    | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                    | ** ** | **2007**              | ** ** | **2006** | ** ** |
|                                                          |       |                  |       |   |   |
| Raw materials                                                 |       | $                     | 786,000    |   | $ | 635,000 |   |
| Work in process, including  manufactured parts and components |       | 1,650,000             |       | 1,213,000 |   |
| Finished goods                                                |       | 495,000               |       | 488,000 |   |
|                                                          |       | $                     | 2,931,000  |   | $ | 2,336,000 |   |

 

**3.         Property and Equipment**

 

Property and equipmentare comprised of the following:

 

| ** **                                      | ** ** | **December 31,** | ** ** |
|-------------------------------------------------|------------|-----------------------|------------|
| ** **                                      | ** ** | **2007**              | ** ** | **2006** | ** ** |
| Office and computer  equipment                  |       | $                     | 1,164,000  |   | $ | 1,126,000 |   |
| Machinery and equipment                         |       | 10,550,000            |       | 10,381,000 |   |
| Leasehold improvements                          |       | 1,976,000             |       | 1,952,000 |   |
|                                            |       | 13,690,000            |       | 13,459,000 |   |
| Less accumulated  depreciation and amortization |       | 10,190,000            |       | 9,164,000 |   |
|                                            |       | $                     | 3,500,000  |   | $ | 4,295,000 |   |

 

**4.         Related Party Transactions**

 

During 2007, the Company accelerated repayment of theoutstanding balance of a secured promissory note dated February 13, 2006for $700,000 due to Clarex Limited (“Clarex”). The payment consisted of $554,607 in principal plus accrued interest of$1,744.  The note was pursuant to a financingarrangement with Clarex to fund the Company’s acquisition of capital assetsneeded to capture new business opportunities. The funds were originally received in February 2006 and the Companyissued the secured note which called for monthly installments over a term ofseven years with interest at 6.75%.

 

During 2007, the Company repaid prior to maturity, a6% Subordinated Convertible Promissory Note in the amount of $1,000,000 due toClarex.  The note was originally dated April 1,2004 and due on March 31, 2008 and was convertible into 1,000,000 

 

33

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Units consisting of 1,000,000 shares of common stockand warrants to acquire 750,000 shares of common stock at a price of $1.35 pershare.  An initial payment of $500,000was made on June 28, 2007 and a final payment of $500,000 plus accruedinterest of $196,520 was made on September 17, 2007.

 

A second Subordinated Convertible Promissory Notedated October 31, 2003 in the amount of $1,500,000 issued to Clarex anddue on December 31, 2008 was extended to April 1, 2009 withoutadditional consideration. The note bears interest at 6% per annum and isconvertible into 1,500,000 Units consisting of 1,500,000 common shares andwarrants to acquire 1,125,000 shares of common stock at a price of $1.35 pershare. The original proceeds from the note were used in the Company’sacquisition program.

 

 In April 2007,Clarex exercised its right to convert its holdings of 500 shares of Series A10% Convertible Preferred Stock (the “Series A”) with a liquidation valueof $500,000 into common shares of the Company. The preferred shares were convertible at a conversion price of $1.00 pershare and the Company issued 500,000 common shares in exchange.

 

In October 2007, Clarex exercised its right toconvert its holdings of 1,000 shares of the Company’s Series B 10%Convertible Stock (the “Series B”) with a liquidation value of $1,000,000into common stock of the Company at the specified conversion price of $2.50 pershare, along with all but one of the other Series B holders.  The Company issued 400,000 common shares toClarex, on the conversion.

 

In March 2004, Clarex received 200,000 warrantsfrom the Company in consideration for its loan against a $1,700,000 SecuredPromissory Note issued to Clarex in 2003. An additional 200,000 warrants were issued by the Company to Clarex forextending the maturity date of the note to December 2008.  The warrants are exercisable at $0.425 pershare and $1.08 per share, respectively, and expire in March 2008 and May 2008.The Company repaid the outstanding balance of the note of $1,700,000 in March 2008along with accrued interest in the amount of $477,444.  On March 27, 2008, Clarex Limitednotified the Company that they had elected to exercise the 200,000 warrantsexpiring on March 31, 2008.  TheCompany expects the 200,000 common shares resulting from this exercise will beissued on or about March 31, 2008.

 

During 2002, Welland Ltd., a related party to Clarex,received a 6% Subordinated Convertible Promissory Note due January 31,2006, that was subsequently extended to December 31, 2008, resulting inproceeds to the Company of $1,000,000. The Note has been extended to April 1,2009, without additional consideration. The note is convertible into 1,000,000 units consisting of 1,000,000common shares and warrants to acquire 750,000 shares of common stock at $1.35per share.

 

**5.         Notes Payable — Other**

 

In December 2005, the Company entered into afinancing arrangement in the amount of $700,000, with Clarex, Limited to fundthe acquisition of capital assets needed to capture new businessopportunities.  The funds were receivedin February 2006 and the Company issued a secured Promissory Note for$700,000.  The note is payable ininstallments over a term of seven years and bears interest at 6.75%.  In November, 2007 the Company repaid thebalance of the secured Promissory Note prior to maturity, in the amount of$554,607.

 

As part of the purchase price of MRC on October 19,2004, a $175,000 Note was issued to the sole shareholder of the company.  The note bears interest at the rate of 6% perannum and is payable annually on the anniversary of the closing date.  Under the terms of the note, $50,000 of thenote amount was repaid on October 19, 2006.  The remaining portion of the note along withany accrued unpaid interest shall be paid in full on October 19,2009.  Three notes, totaling $295,725,were assumed from note holders of MRC. The notes bear interest rates from 6.0% to 10.5% and are payable from 2to 4 years.  In 2005, two of the notestotaling $199,525 were exchanged for two notes totaling $125,000, 80,000 sharesof common stock of the Company and 60,000 warrants convertible into 60,000shares of common stock at $1.35 per share. A note payable to the U.S. Small Business Administration was alsoassumed by the Company.  The note in theamount of $390,497 bears interest at the rate of 4.0% and is due in 2032.

 

At the time of the purchase of Laser Optics, Inc.,the Company converted certain liabilities to notes payable.  Notes totaling $100,728 were issued to formerofficers of Laser Optics, Inc. for back pay and un-reimbursed businessexpenses.  A note in the amount of$86,777 was also issued to the former landlord for back rent.  These notes had repayment terms extendingover three years and were fully repaid in 2006.

 

Notes payable — Other consist of the following:

 

| ** **                                                                                                                                                                                                                                                                     | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------|------------|
| ** **                                                                                                                                                                                                                                                                     | ** ** | **2007**         | ** ** | **2006** | ** ** |
| Notes payable — Other, payable in aggregate monthly installments of  approximately $2,500, except for a note with a once yearly payment of  interest of $60,500, and bearing interest at rates ranging from 4.0% to 6.0%  and expiring at various dates up to April 2032. |       | $                | 505,545    |   | $ | 1,152,759 |   |
| Less current portion                                                                                                                                                                                                                                                           |       | 14,815           |       | 100,079 |   |
| Long-term debt, excluding  current portion                                                                                                                                                                                                                                     |       | $                | 490,730    |   | $ | 1,052,680 |   |

 

34

----

 

Notes payable other, mature as follows:

 

| 2008       |   | $       | 14,815  |   |
|------------|--------|---------|---------|--------|
| 2009       |   | 137,153 |    |
| 2010       |   | 9,623   |    |
| 2011       |   | 9,998   |    |
| 2012       |   | 10,387  |    |
| Thereafter |   | 323,569 |    |
|       |   | $       | 505,545 |   |

 

**6.         Accounts Payable and AccruedExpenses**

 

Accounts payable and accrued expenses are comprised ofthe following:

 

| ** **                                    | ** ** | **December 31,** | ** ** |
|-----------------------------------------------|------------|-----------------------|------------|
| ** **                                    | ** ** | **2007**              | ** ** | **2006** | ** ** |
| Trade accounts payable and  accrued purchases |       | $                     | 635,529    |   | $ | 575,261 |   |
| Accrued vacation                              |       | 326,998               |       | 332,031 |   |
| Accrued payroll                               |       | 85,179                |       | 200,497 |   |
| Accrued interest                              |       | 1,135,377             |       | 1,043,500 |   |
| Accrued unemployment tax  payable             |       | 6,532                 |       | 14,700 |   |
| Accrued bonus                                 |       | 177,000               |       | 76,500 |   |
| Accrued commission payable                    |       | 3,229                 |       | — |   |
| State and Federal income  tax payable         |       | 177,212               |       | — |   |
| Accrued 401K common stock  contribution       |       | 61,221                |       | 164,623 |   |
| Accrued expenses — other                 |       | 133,689               |       | 82,280 |   |
|                                          |       | $                     | 2,741,966  |   | $ | 2,495,398 |   |

 

**7.         Capital Lease Obligations**

 

Capital lease obligations consist of the following:

 

| ** **                                                                                                                                                                    | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                    | ** ** | **2007**              | ** ** | **2006** | ** ** |
| Capital leases, payable in aggregate monthly installments ranging  from $2,000, to $6,000 and interest at rates ranging from 10.4% to 14.1%  expiring through April 2008 |       | $                     | 47,087     |   | $ | 243,437 |   |
| Less current portion                                                                                                                                                          |       | 47,087                |       | 196,350 |   |
|                                                                                                                                                                          |       |                  |       |   |   |
| Long-term debt, excluding  current portion                                                                                                                                    |       | $                     | —     |   | $ | 47,087 |   |

 

Maturitiesof capital leases are as follows:

 

| **Year Ending**                                       | ** ** | ** ** | ** ** |
|-------------------------------------------------------|------------|------------|------------|
| **December 31, 2008**                            | ** ** | ** ** | ** ** |
|                                                  |       |       |       |
| Total future minimum lease  payments, all due in 2008 |       | 49,141     |       |
| Less amounts representing  interest                   |       | 2,054      |       |
|                                                  |       |       |       |
| Present value of minimum  payments                    |       | $          | 47,087     |   |
|                                                       |            |            |            |  |

 

35

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Capital lease obligations are collateralized by theacquired property and equipment with cost and related accumulated depreciationapproximating $305,000 and $138,000 at December 31, 2007.

 

**8.         Income Taxes**

 

The Company provision for income taxes consists of thefollowing:

 

| ** ** | ** ** | **Years Ended**       | ** ** |
|------------|------------|-----------------------|------------|
| ** ** | ** ** | **December 31,** | ** ** |
| ** ** | ** ** | **2007**              | ** ** | **2006** | ** ** | **2005** | ** ** |
|       |       |                  |       |   |   |   |   |
| Current:   |       |                  |       |   |   |   |   |
| Federal    |       | $                     | 50,000     |   | $ | — |   | $ | — |   |
| State      |       | 200,000               |       | 21,000 |   | — |   |
| Deferred:  |       |                  |       |   |   |   |   |
| Federal    |       | —                |       | — |   | — |   |
| State      |       | —                |       | — |   | — |   |
|       |       |                  |       |   |   |   |   |
| Total      |       | $                     | 250,000    |   | $ | 21,000 |   | $ | — |   |

 

A reconciliation of the income tax provision computedat the statutory Federal income tax rate to our effective income tax ratefollows (in percent):

 

| ** **                                      | ** ** | **Year Ended**        | ** ** |
|-------------------------------------------------|------------|-----------------------|------------|
| ** **                                      | ** ** | **December 31,** | ** ** |
| ** **                                      | ** ** | **2007**              | ** ** | **2006** | ** ** | **2005** | ** ** |
| Federal statutory rate                          |       | 34.0                  | %          | 34.0 | % | (34.0 | )% |
| Net operating loss  carryforward — Federal |       | (34.0                 | )          | (34.0 | ) |   |   |
| Loss in excess of  available benefit            |       | —                |       | — |   | 34.0 |   |
| Federal AMT                                     |       | 2.3                   |       | — |   | — |   |
| State tax provision                             |       | 9.4                   |       | 9.0 |   | — |   |
| Net Operating Loss  carryforward — State   |       | —                |       | (5.5 | ) | — |   |
| Allowable state  manufacturing credit           |       | —                |       | (0.9 | ) | — |   |
| Effective income tax rate                       |       | 11.7                  | %          | 2.6 | % | — | % |

 

At December 31, 2007, the Company has Federal andState net operating loss carry forwards for tax purposes of approximately$5,416,000 and $0, respectively.  The taxloss carry forwards expire at various dates through 2025.

 

Internal Revenue Code Section 382 places alimitation on the utilization of Federal net operating loss and other creditcarry forwards when an ownership change, as defined by the tax law,occurs.  Generally, this occurs when agreater than 50 percentage point change in ownership occurs.  Accordingly, the actual utilization of thenet operating loss and carryforwards for tax purposes may be limited annuallyto a percentage (approximately 6%) of the fair market value of the Company atthe time of any such ownership change.

 

Deferred tax assets (liabilities) comprise thefollowing:

 

| ** **                    | ** ** | **December 31,** | ** ** |
|-------------------------------|------------|-----------------------|------------|
| ** **                    | ** ** | **2007**              | ** ** | **2006** | ** ** |
|                          |       |                  |       |   |   |
| Inventory reserves            |       | $                     | 344,000    |   | $ | 323,000 |   |
| Accrued Vacation              |       | 111,000               |       | 126,000 |   |
| Section 263A  adjustment |       | 1,000                 |       | 12,000 |   |
| Depreciation                  |       | (256,000              | )          | (116,000 | ) |
| Loss carry forwards           |       | 1,841,000             |       | 2,720,000 |   |
| Gross deferred tax assets     |       | 2,041,000             |       | 3,065,000 |   |
| Valuation allowance           |       | (2,041,000            | )          | (3,065,000 | ) |
| Net deferred tax asset        |       | $                     | —     |   | $ | — |   |

 

36

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SFAS No. 109 “Accountingfor Income Taxes” provides for the recognition of deferred tax assets ifrealization of such assets is more likely than not to occur.  Based upon the Company’s assessment offactors such as its historical operating performance including net losseswithin the past five years, reported cumulative net losses since inception andthe uncertainty in forecasting the Company’s future results, we have provided afull valuation allowance against our net deferred tax assets.

 

**9.         Equity CompensationProgram and Stock-based Compensation**

 

a.             2000 Equity Compensation Program

 

The Company’s 2000 Equity Compensation Programprovides for grants of options, stock appreciation rights and performanceshares to employees, officers, directors, and others who render services to theCompany.  The program consists of fourplans including:  (i) the IncentiveEquity Compensation Program which provide for grants of “incentive stockoptions”, (ii) the Supplemental Program which provide for grants of stockoptions to non-employees, (iii) the SAR Program which allows the grantingof stock appreciation rights and, (iv) the Performance Share Program underwhich eligible participants may receive stock awards, including restrictedstock and restricted stock units.  Theplans are administered by the Compensation Committee of the Board ofDirectors.  Under these plans, anaggregate of up to 6,000,000 shares of common stock may be granted. The 2000Equity Compensation plan expires in August 2010.

 

b.             Stock Option Expense

 

The Company’s results for the years ended December 31,2007 and 2006 include stock-based compensation expense for stock option grants,as required by SFAS 123(R), totaling $34,000 and $118,000, respectively.  Such amounts have been included in theConsolidated Statements of Operations within cost of goods sold ($8,000 for2007 and $31,000 for 2006), and selling, general and administrative expenses($26,000 for 2007 and $87,000 for 2006). No income tax benefit has been recognized in the income statement due tothe Company’s history of operating losses. Stock compensation expense recorded under APB No. 25 in theConsolidated Statements of Operations for the year ended December 31, 2005was $-0-.  In the fourth quarter of 2005,the Company’s Board of Director approved the acceleration of the vesting ofcertain stock option grants which resulted in the Company recognizingstock-based compensation expense of $21,000 for the year.

 

As of December 31, 2007 and 2006, there was$52,300 and $56,600 of unrecognized compensation costs, net of estimatedforfeitures, related to non-vested stock options, which are expected to berecognized over a weighted average period of approximately 2.1 years and 2.3years, respectively.

 

The weighted average estimated fair value of stockoptions granted in the three years ended December 31, 2007, 2006 and 2005was $1.47, $1.46 and $1.02, respectively. The fair value of options at the date of grant was estimated using theBlack-Scholes option pricing model.  TheCompany follows guidance under SFAS 123(R) and SEC Staff AccountingBulletin No. 107 (SAB 107) when reviewing and updating assumptions.  The expected volatility is based uponhistorical volatility of our stock and other contributing factors.  The risk-free rate is based on the U.S.Treasury yield curve in effect at the time of the grant.  The expected term is based upon thecontractual term of the option.

 

The following range of weighted-average assumptionswere used for to determine the fair value of stock option grants during theyears ended December 31, 2007, 2006 and 2005:

 

| ** **              | ** ** | **Years Ended**       | ** ** |
|-------------------------|------------|-----------------------|------------|
| ** **              | ** ** | **December 31,** | ** ** |
| ** **              | ** ** | **2007**              | ** ** | **2006** | ** ** | **2005** | ** ** |
| Dividend yield          |       | 0.00                  | %          | 0.00 | % | 0.00 | % |
| Volatility              |       | 144.9                 | %          | 121.1 | % | 210.5 | % |
| Risk-free interest rate |       | 4.7                   | %          | 5.2 | % | 5.2 | % |
| Expected life           |       | 10  years             |       | 10  years |   | 10  years |   |

 

37

----

 

The table below illustrates the effect on net incomeand earnings per share as if the fair value recognition provisions of FAS No. 123had been applied to all outstanding and unvested awards in the year ended December 31,2005.

 

| ** **        | ** ** | ** **                                                                                                            | ** ** | **Year Ended**        | ** ** |
|-------------------|------------|-----------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **        | ** ** | ** **                                                                                                            | ** ** | **December 31,** | ** ** |
| ** **        | ** ** | ** **                                                                                                            | ** ** | **2005**              | ** ** |
| Net income(loss): |       |                                                                                                                  |       |
|              |       | As reported                                                                                                           |       | $                     | (11,398    | ) |
|              |       | Add: Stock-based employee Compensation included in reported net loss,  net of related tax effects                     |       | 21,398                |       |
|              |       | Less: Stock based employee compensation expense determined under fair  value based method, net of related tax effects |       | (140,630              | )          |
|              |       | Pro forma                                                                                                             |       | $                     | (130,630   | ) |
|              |       |                                                                                                                  |       |                  |       |
|              |       | Net earnings /(loss) per  share:                                                                                      |       |                  |       |
|              |       | Basic:                                                                                                                |       |                  |       |
|              |       | As reported                                                                                                           |       | $                     | (.02       | ) |
|              |       | Pro forma                                                                                                             |       | $                     | (.02       | ) |
|              |       | Diluted:                                                                                                              |       |                  |       |
|              |       | As reported                                                                                                           |       | $                     | (.02       | ) |
|              |       | Pro forma                                                                                                             |       | $                     | (.02       | ) |

 

c.             Stock Option Activity

 

The Company granted 29,039 stock options during theyear ended December 31, 2006 at an exercise price of $1.50, which wasequal to the closing market price on the date of the grant.  The Company granted 77,000 options during theyear ended December 31, 2006 at exercise prices ranging between $1.50 and$1.75, which was equal to the closing market price on the date of eachgrant.  For the year ended December 31,2005, the Company granted 125,500 options at an exercise price equal to theclosing market price on the date of each grant, ranging between $0.99 and$1.03.

 

The following table represents our stock optionsgranted, exercised, and forfeited during 2007.

 
| **Stock Options**                      | ** ** | **Number of  Options** | ** ** | **Weighted Average  Exercise Price  per Option** | ** ** | **Weighted Average  Remaining  Contractual Term** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|----------------------------------------|------------|------------------------|------------|--------------------------------------------------|------------|---------------------------------------------------|------------|---------------------------------|------------|
| Outstanding at  January 1, 2007   |       | 1,879,700              |       | $                                                | 1.25       |                                              |       |                            |       |   |
| Granted                                |       | 29,039                 |       | $                                                | 1.50       |                                              |       |                            |       |   |
| Exercised                              |       | (651,100               | )          | $                                                | 0.68       |                                              |       |                            | $          | 2,159,000 |   |
| Forfeited/expired                      |       | (29,000                | )          | $                                                | 1.98       |                                              |       |                            |       |   |
| Outstanding  atDecember 31, 2007  |       | 1,228,639              |       | $                                                | 1.52       |                                              | 4.0        |                            | $          | 3,049,000 |   |
|                                   |       |                   |       |                                             |       |                                              |       |                            |       |
| Exercisable at  December 31, 2007 |       | 1,171,855              |       | $                                                | 1.52       |                                              | 3.8        |                            | $          | 2,906,000 |   |

 

38

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The following table represents non-vested stockoptions granted, vested, and forfeited for the year ended December 31,2007.

 

| **Non-vested Options**                    | ** ** | **Options** | ** ** | **Weighted-Average  Grant-Date Fair Value** | ** ** |
|-------------------------------------------|------------|-------------|------------|---------------------------------------------|------------|
| Non-vested —  January 1, 2007   |       | 146,424     |       | $0.85                                       |       |
| Granted                                   |       | 29,039      |       | $1.47                                       |       |
| Vested                                    |       | (109,679    | )          | $0.65                                       |       |
| Forfeited                                 |       | (9,000      | )          | $1.43                                       |       |
| Non-vested —  December 31, 2007 |       | 56,784      |       | $1.48                                       |       |

 

The total fair value of options vested during theyears ended December 31, 2007, 2006 and 2005, was $71,000, $101,000 and$141,000, respectively.

 

The following table summarizes information about stockoptions outstanding at December 31, 2007:

 
| ** **             | ** **    | **Options Outstanding** | ** ** | **Options Exercisable** | ** ** |
|------------------------|---------------|-------------------------|------------|-------------------------|------------|
| ** **             | ** **    | ** **              | ** ** | **Weighted**            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **             | ** **    | ** **              | ** ** | **Average**             | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **             | ** **    | ** **              | ** ** | **Remaining**           | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| **Range of**           | ** **    | **Number**              | ** ** | **Contractual**         | ** ** | **Exercise** | ** ** | **Number** | ** ** | **Exercise** | ** ** |
| **Exercise Price (1)** | ** **    | **Outstanding**         | ** ** | **Life in Years**       | ** ** | **Price** | ** ** | **Outstanding** | ** ** | **Price** | ** ** |
| $                      | 0.50  - $2.00 |                    | 1,119,539  |                    | 7.34       |   | $ | 1.32 |   | 1,062,755 |   | $ | 1.31 |   |
| $                      | 3.25  - $5.00 |                    | 109,100    |                    | 3.1        |   | $ | 3.48 |   | 109,100 |   | $ | 2.98 |   |

----

(1)   Therewere no outstanding options with an exercise price between $2.01 and $3.24.

 

d.             Restricted Stock Unit Awards

 

                InDecember 2007, the Company granted 12,000 restricted stock units to oneindividual under the 2000 Performance Share Program with a fair market value of$48,000 based on the closing market price of the Company’s stock on the grantdate.  The grant will vest over a threeyear period contingent on continued employment over the vesting period.   There were no previous grants of restrictedstock units under this plan and the Company did not recognize any related stockcompensation expense in 2007, 2006 or 2005.

 

**10.          Commitments**

 

a.             Lease commitment

 

The Company occupies approximately 42,000 square feetof space located at 181 Legrand Avenue, Northvale, New Jersey pursuant to a netlease.  In September 2006, the leasewas renewed for a two year term to October 31, 2008, at substantially thesame terms.  The Company has alsonegotiated an option to renew the Northvale lease for two additional two yearterms running through October 21, 2012 but the renewal option has not yetbeen exercised.

 

The Company’s MRC Optics subsidiary occupiesapproximately 25,000 square feet of space located at 6405 Parkland Drive,Sarasota, FL pursuant to a net lease originally expiring on August 31,2006.  During 2006, MRC Optics negotiatedterms for the renewal of the lease until August 31, 2008.   The Company has the option of extending thelease for four additional two year periods through August 31, 2016, butthe company has not yet exercised the option to renew.

 

The Company’s total rental expense was approximately$570,000, $549,000 and $525,000 in 2007, 2006 and 2005, respectively, and realestate taxes were $70,000, $98,000, and $95,000 in 2007, 2006 and 2005,respectively.

 

Future minimum annual rentals which cover theremaining lease term for 2008 is $416,000.

 

b.             Retirement plans

 

The Company maintains a 401(k) savings plan forall eligible employees (as defined in the plan).  The 401(k) plan allows employees tocontribute up to 20% of their compensation on a salary reduction, pre-tax basisup to the statutory limitation.  The 401(k) planalso provides that the Company, at the discretion of the Board of Directors,may match employee contributions based on a pre-determined formula.

 

39

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In 2007, the Company matched employee contributions inthe amount of $155,691 contributed in the form of 74,247 shares of the Company’scommon stock, to be distributed in March 2008.   In 2006, the Company matched employeecontributions in the amount of $166,694 contributed in the form of 124,133shares of the Company’s common stock, distributed in March 2007.  The Company contributed $150,501 in the formof 144,836 shares of the Company’s common stock in 2005, distributed in March 2006.

 

c.             Employment agreements

 

The Company is party to an employment agreementthrough December 16, 2008 with the Chief Executive Officer that providesfor a minimum annual salary and benefits. The aggregate remaining minimum commitment under this agreement is$208,000.  Should the agreement beterminated without cause during the term of the contract, the officer would beentitled to one year’s salary payable within 30 days plus accrued bonus, ifearned, and all vested stock options would be exercisable for three years.

 

**11.          Product Sales, Foreign Sales and Sales to MajorCustomers**

 

The following table summarizes the Company’s productsales by product categories during the past three years:

 
| **Year Ended December 31,** | ** ** | **2007**  | ** ** | **2006** | ** ** | **2005**  | ** ** |
|----------------------------------|------------|-----------|------------|----------|------------|-----------|------------|
| **Category**                     | ** ** | **Sales** | ** ** | **%**    | ** ** | **Sales** | ** ** | **%** | ** ** | **Sales** | ** ** | **%** | ** ** |
| Optical Components               |       | $         | 13,410,000 |     | 89         |      | $          | 12,274,000 |   | 88 |   | $ | 11,798,000 |   | 85 |   |
| Laser Accessories                |       | 1,690,000 |       | 11       |       | 1,647,000 |       | 12 |   | 1,987,,000 |   | 15 |   |
| TOTAL                            |       | $         | 15,100,000 |     | 100        |      | $          | 13,921,000 |   | 100 |   | $ | 13,785,000 |   | 100 |   |

 

Export sales, primarily to customers in countrieswithin Europe, the Near East and Japan, amounted to 9.5%, 8.7% and 9.5% ofproduct sales in 2007, 2006 and 2005, respectively.  No single foreign customer accounted for morethan 10% of product sales in 2007, 2006, or 2005.

 

In 2007, two domestic customers accounted for 13.5%and 19.0% of sales. Both of these customers are electro-optical systemsdivisions of major U.S defense industry corporations who manufacture systemsfor U.S. and allied foreign governments. In 2006, three domestic customersaccounted for 15%, 16%, and 11%, of sales. Two of these three customers are the same customers as in 2007. Thethird customer is also a defense electro-optical systems manufacturer.   In 2005, two U.S. customers accounted for13% and 14%, respectively, of sales. These two customers were the same customers as in 2007.  In the short-term, the loss of any of thesecustomers would have a significant negative impact on the company and itsbusiness units.

 

**12.          Shareholders’ Equity**

 

a.             Common shares reserved at December 31,2007, are as follows:

 

| 1991 Stock option plan                                             |   | 105,000   |   |
|--------------------------------------------------------------------|--------|-----------|--------|
| 2000 Stock option plan                                             |   | 6,000,000 |   |
| Convertible preferred  stock                                       |   | —    |   |
| Subordinated convertible  notes                                    |   | 2,500,000 |   |
| Warrants issuable on  conversion of Subordinated convertible notes |   | 1,875,000 |   |
| Warrants outstanding                                               |   | 1,922,425 |   |

 

b.             Preferred stock

 

The Company has authorized 1,000,000 shares ofpreferred stock, no par value, which the Board of Directors has the authorityto issue from time to time in a series. The Board of Directors also has the authority to fix, before theissuance of each series, the number of shares in each series and thedesignation, preferences, rights and limitations of each series.

 

 The Series Apreferred stock consisting of 500 shares at a stated value of $1,000 per shareand convertible into common shares at the rate of $1.00 per share was convertedinto 500,000 common shares of the Company’s stock in April 2007.

 

A total of 2,032 shares of the Series B preferredstock consisting of 2,082 shares at a stated value of $1,000 per share andconvertible into common shares at the rate of $2.50 per share were converted inOctober and November of 2007. One holder of the remaining 50 shares of Series B preferred stockelected to redeem their shares for a cash payment of $50,000 and an accruedstock dividend of 1,332 common shares of the Company.

 

For the years ended December 31, 2007, 2006 and2005, the Company paid a common stock dividend on preferred stock of 134,612,134,000 and 134,000 common shares for each year equal to $238,167,  $234,500 and $134,000 at the closing marketprice of the common shares on the issue date, respectively.

 

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c.             Warrants

 

Warrants outstanding expire from March 2008 to May 2010as per the below schedule:

 
| **Shares**  | ** ** | **Exercisable through** | ** ** | **Exercise Price** | ** ** | **Fair Value** | ** ** |
|-------------|------------|-------------------------|------------|--------------------|------------|----------------|------------|
| 1,462,425   |       | July 2009          |       | $                  | 1.35       |           | $          | 1.29 |   |
| 200,000     |       | May 2008           |       | $                  | 1.08       |           | $          | .42 |   |
| 200,000 (1) |       | March 2008         |       | $                  | .425       |           | $          | .42 |   |
| 60,000      |       | May 2010           |       | $                  | 1.35       |           | $          | 1.31 |   |

 

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(1)  The warrantswere exercised on March 27, 2008

 

**13.          FairValue of Financial Instruments**

 

The methods and assumptions used to estimate the fairvalue of the following classes of financial instruments were:

 

Current Assets and CurrentLiabilities:  The carrying amountof cash, current receivables and payables and certain other short-termfinancial instruments approximate their fair value.

 

Long-Term Debt:  The fair value of the Company’s long-termdebt, including the current portion, for notes payable and subordinatedconvertible debentures, was estimated using a discounted cash flow analysis,based on the Company’s assumed incremental borrowing rates for similar types ofborrowing arrangements.  The carryingamount of variable and fixed rate debt at December 31, 2007 approximatesfair value.

 

**14.          Quarterly Data** (Unaudited)

 

Summary quarterly resultswere as follows:

 
| **Year 2007**                               | ** ** | **First** | ** ** | **Second** | ** ** | **Third** | ** ** | **Fourth** | ** ** |
|---------------------------------------------|------------|-----------|------------|------------|------------|-----------|------------|------------|------------|
|                                        |       |      |       |       |       |      |       |       |       |
| Net sales                                   |       | $         | 3,540,874  |       | $          | 3,678,796 |       | $          | 3,837,660  |   | $ | 4,042,548 |   |
| Gross profit                                |       | 1,381,500 |       | 1,393,238  |       | 1,815,825 |       | 1,368,266  |       |
| Net Income                                  |       | 434,860   |       | 396,488    |       | 797,413   |       | 251,320    |       |
| Net Income (loss) per  share — Basic   |       | 0.06      |       | 0.02       |       | 0.09      |       | .03        |       |
| Net Income (loss) per  share — Diluted |       | 0.04      |       | 0.02       |       | 0.06      |       | .02        |       |
|                                             |            |           |            |            |            |           |            |            |            |  |  |  |  |

 
| **Year 2006**                          | ** ** | **First** | ** ** | **Second** | ** ** | **Third** | ** ** | **Fourth** | ** ** |
|---------------------------------------------|------------|-----------|------------|------------|------------|-----------|------------|------------|------------|
|                                        |       |      |       |       |       |      |       |       |       |
| Net sales                                   |       | $         | 3,662,776  |       | $          | 3,531,420 |       | $          | 3,049,333  |   | $ | 3,677,598 |   |
| Gross profit                                |       | 1,187,617 |       | 1,121,216  |       | 882,936   |       | 1,352,045  |       |
| Net Income (loss)                           |       | 201,653   |       | 6,839      |       | 173,000   |       | 390,774    |       |
| Net Income (loss) per  share — Basic   |       | 0.03      |       | (0.03      | )          | 0.02      |       | 0.05       |       |
| Net Income (loss) per  share — Diluted |       | 0.02      |       | (0.03      | )          | 0.02      |       | 0.04       |       |
|                                             |            |           |            |            |            |           |            |            |            |  |  |  |  |

 
| **Year 2005**                          | ** ** | **First** | ** ** | **Second** | ** ** | **Third** | ** ** | **Fourth** | ** ** |
|---------------------------------------------|------------|-----------|------------|------------|------------|-----------|------------|------------|------------|
|                                        |       |      |       |       |       |      |       |       |       |
| Net sales                                   |       | $         | 3,233,846  |       | $          | 3,107,079 |       | $          | 3,581,339  |   | $ | 3,862,793 |   |
| Gross profit                                |       | 597,601   |       | 745,376    |       | 1,105,767 |       | 1,380,188  |       |
| Net Income (loss)                           |       | (374,884  | )          | (286,248   | )          | 307,524   |       | 342,210    |       |
| Net Income (loss) per  share — Basic   |       | (0.05     | )          | (0.06      | )          | 0.04      |       | 0.05       |       |
| Net Income (loss) per  share — Diluted |       | (0.05     | )          | (0.06      | )          | 0.03      |       | 0.03       |       |
|                                             |            |           |            |            |            |           |            |            |            |  |  |  |  |

 

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**Report ofIndependent Registered Public Accounting Firm On Supplemental Information**

 
| Board of  Directors and Shareholders |
|--------------------------------------|
| Photonic  Products Group, Inc.       |
| and Subsidiaries                     |
| Northvale,  New Jersey               |

 

 

The audits referred to in ourreport dated March 21, 2008 relating to the consolidated financial statementsof Photonic Products Group, Inc. and subsidiaries, which is contained in Item 8in the Form 10K, include the audits of the financial statement schedule listedin the accompanying Schedule II for the years ended December 31, 2007, 2006 and2005.  This financial statement scheduleis the responsibility of the Company’s management.  Our responsibility is to express an opinionon this financial statement schedule based upon our audits.

 

In our opinion, such financialstatement schedule when considered in relation to the basic consolidatedfinancial statements take as a whole, presents fairly, in all materialrespects, the information set forth therein.

 

 
| /s/HOLTZ  RUBENSTEIN REMINICK LLP |
|-----------------------------------|
| Melville, NY                      |
| March 21, 2008                    |

 

 

 

 

 

 

 

 

 

 

 

 

 

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Schedule II — Valuation andQualifying Accounts

 

 

PHOTONIC PRODUCTS GROUP, INC.

SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS

(in thousands)

 

| ** **                      | ** ** | **Balance at  Beginning  of Period** | ** ** | **Charged  (Credited)  to Cost and  Expenses** | ** ** | **Acquired  Balance** | ** ** | **Deductions** | ** ** | **Balance  at End of  Period** | ** ** |
|---------------------------------|------------|--------------------------------------|------------|------------------------------------------------|------------|-----------------------|------------|----------------|------------|--------------------------------|------------|
| Allowance for Doubtful Accounts |       |                                 |       |                                           |       |                  |       |           |       |                           |       |
| Year ended December 31, 2007    |       | $                                    | 15,000     |                                           | —     |                  | —     |           | —     |                           | $          | 15,000 |   |
| Year ended December 31, 2006    |       | $                                    | 15,000     |                                           |       |                  |       |           | $          |                           |       | $ | 15,000 |   |
| Year Ended December 31, 2005    |       | $                                    | 40,000     |                                           | —     |                  | —     |           | 25,000     |                           | $          | 15,000 |   |
|                                 |            |                                      |            |                                                |            |                       |            |                |            |                                |            |  |  |  |

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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