UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D. C. 20549




FORM
10-K




(Mark
      One)ý
            ANNUAL
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934For
      the fiscal year ended: December 31, 2009ORo
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934For
      the transition period from
                     
      toCommission
      file number: 0-11668




Photonic
Products Group, Inc.


(Exact
name of registrant as specified in its charter)




New
      Jersey
            
            22-2003247State
      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 area code 201-767-1910




Securities
registered pursuant to Section 12(b) of the Act: None




Name
      of each exchangeTitle
      of each class
            
            on
      which registered




Securities
registered pursuant to section 12(g) of the Act:


Common
stock, par value $.01 Per Share




Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the
Securities Act. Yes o.      No ý.




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




Note –
Checking the box above will not relieve any registrant required to file reports
pursuant to Section 13 or 15(d) of the Exchange Act from their obligations under
those Sections.




Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.




Yes
            ý
            No
            o




Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not
be contained, to the best of registrant’s knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form
10-K or any amendment to this Form 10-K.  o




Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated file, or a smaller reporting
company.  See definition of large accelerated filer, accelerated filer
and smaller reporting company 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 a shell company (as defined in Rule
12b-2 of the Exchange Act).




Yes
            o
            No
            ý




State the
aggregate market value of the voting and non-voting common equity held by
non-affiliates computed by reference to the price at which the common equity was
last sold, or the average bid and asked price of such common equity, as of the
last business day of the registrant’s most recently completed second fiscal
quarter. $10,057,576  (For
purposes of determining this amount, only directors, executive officers and
shareholders with voting power of 10% or more of our stock  have been
deemed affiliates.)




Note.If a
determination as to whether a particular person or entity is an affiliate cannot
be made without involving unreasonable effort and expense, the aggregate market
value of the common stock held by non-affiliates may be calculated on the basis
of assumptions reasonable under the circumstances, provided that the assumptions
are set forth in this Form.




Indicate
the number of shares outstanding of each of the registrant’s classes of common
stock, as of the latest practicable date.




Common
Shares outstanding as of March 29, 2010


11,552,150


Documents
Incorporated by Reference




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














Photonic
Products Group, Inc.





INDEX




Part
      IItem
      1.
              
              Business
              3Item
      1A.
              
              Risk
      Factors
              7Item
      1B.
              
              Unresolved
      Staff Comments
              9Item
      2.
              
              Properties
              9Item
      3.
              
              Legal
      Proceedings
              9Item
      4.
              
              Reserved
              9Part
      IIItem
      5.
              
              Market
      for Registrant’s Common Equity and Related Stockholder Matters and Issuer
      Purchases of Equity Securities
              10Item
      6.
              
              Selected
      Financial Data
              11Item
      7.
              
              Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operation
              11Item
      7A.
              
              Quantitative
      and Qualitative Disclosures about Market Risk
              18Item
      8.
              
              Financial
      Statements and Supplementary Data
              19Item
      9.
              
              Changes
      in and Disagreements with Accountants on Accounting and Financial
      Disclosure
              19Item
      9A
              
              Controls
      and Procedures
              19Item
      9B
              
              Other
      Information
              19Part
      IIIItem
      10.
              
              Directors,
      Executive Officers and Corporate Governance
              20Item
      11.
              
              Executive
      Compensation
              20Item
      12.
              
              Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters
              20Item
      13.
              
              Certain
      Relationships and Related Transactions, and Director
      Independence
              20Item
      14.
              
              Principal
      Accounting Fees and Services
              20Part
      IVItem
      15
              
              Exhibits
      and Financial Statement Schedules
              21Signatures
              23




2




PART
1




Caution Regarding Forward Looking
Statements




This
Annual Report contains forward-looking statements as that term is defined in the
federal securities laws.  The Company wishes to insure that any
forward-looking statements are accompanied by meaningful cautionary statements
in order to comply with the terms of the safe harbor provided by the Private
Securities Litigation Reform Act of 1995.  The events described in the
forward-looking statements contained in this Annual Report may not
occur.  Generally, these statements relate to business plans or
strategies, projected or anticipated benefits or other consequences of the
Company’s plans or strategies, projected or anticipated benefits of acquisitions
made by the Company, projections involving anticipated revenues, earnings, or
other aspects of the Company’s operating results.  The words “may”,
“will”, “expect”, “believe”, “anticipate”, “project”, “plan”, “intend”,
“estimate”, and “continue”, and their opposites and similar expressions are
intended to identify forward-looking statements.  The Company cautions
you that these statements are not guarantees of future performance or events and
are subject to a number of uncertainties, risks, and other influences, many of
which are beyond the Company’s control, that may influence the accuracy of the
statements and the projections upon which the statements are
based.  Factors which may affect the Company’s results include, but
are not limited to, the risks and uncertainties discussed in Items 1A, 7 and
7A.  Any one or more of these uncertainties, risks, and other
influences could materially affect the Company’s results of operations and
whether forward-looking statements made by the Company ultimately prove to be
accurate.  Readers are further cautioned that the Company’s financial
results can vary from quarter to quarter, and the financial results for any
period may not necessarily be indicative of future results.  The
foregoing is not intended to be an exhaustive list of all factors that could
cause actual results to differ materially from those expressed in
forward-looking statements made by the Company.  The Company’s actual
results, performance and achievements could differ materially from those
expressed or implied in these forward-looking statements.  The Company
undertakes no obligation to publicly update or revise any forward looking
statements, whether from new information, future events, or otherwise, except as
otherwise required by law.




Item 1. Business




Photonic
Products Group, Inc. (the “Company” or “PPGI”), incorporated in New Jersey in
1973, develops, manufactures and markets products and services for use in
diverse photonics industry sectors via its multiple business units.




Prior
to September, 2003, PPGI was named and did business solely as Inrad,
Inc.  Company management, the Board of Directors, and shareholders
approved the name change in 2003.




In
November 2003, the Company purchased the assets and certain liabilities of Laser
Optics, Inc. of Bethel, CT.  Laser Optics, Inc. was a custom optics
and optical coating services provider, in business since 1966.  PPGI
integrated the Bethel team and their operations into the Company’s Northvale, NJ
operations in mid-2004, combining them with Inrad’s custom optics and optical
coating product lines under the Laser Optics name.




In
October 2004, the Company acquired MRC Precision Metal Optics, Inc. (“MRC”) of
Sarasota Florida, a precision metal optics and diamond-turned aspheric optics
manufacturer, specializing in CNC and single point diamond machining, optical
polishing, nickel plating, aluminum, albemet and beryllium
machining.  MRC also provides opto-mechanical assembly
services.




PPGI’s
products fall into two main categories: optical components (which include
standard and custom optical components, optical assemblies, single crystals, and
crystal components), and laser system accessories (which include wavelength
conversion products and Pockel’s cells that use nonlinear crystals for laser
wavelength conversion).




The
Company is an optical component, subassembly, and sub-system supplier to
original equipment manufacturers (“OEM”), research institutes and researchers in
the photonics industry.




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




Custom
optic manufacturing is a major product area for PPGI.  The Company
specializes in high-end precision components.  It develops,
manufactures and delivers precision custom optics and thin film optical coating
services through its Laser Optics and MRC business units.  Glass,
metal, and crystal substrates are processed using modern manufacturing
equipment, complex processes and techniques to manufacture components, deposit
optical thin films, and assemble sub-components used in advanced Photonic
systems.  The majority of custom optical components and optical
coating services supplied are used in inspection, process control systems,
defense and aerospace electro-optical systems, laser system applications,
industrial scanners, and medical system applications.




The
Company also develops and manufactures synthetic optical crystals, optical
crystal components, and laser accessories through its INRAD business
unit.  It grows synthetic crystals with electro-optic (EO), non-linear
and optical properties for use in both its standard and custom
products.  The majority of crystals, crystal components and laser
accessories manufactured are used in laser systems, defense EO systems, and
R&D applications by engineers within corporations, universities and national
laboratories.




3




The
following table summarizes the Company’s product sales by product categories
during the past three years.  Laser accessories include all non-linear
and electro-optical crystal components.




Years
      Ended December 31,2009
            
            
            2008
            
            
            2007Category
            
            Sales
            
            
            %
            
            
            Sales
            
            
            %
            
            
            Sales
            
            
            %Optical
      Components
            
            $
            10,350,000
            
            
            
            94
            
            
            $
            14,750,000
            
            
            
            90
            
            
            $
            13,410,000
            
            
            
            89Laser
      Accessories
            
            
            701,000
            
            
            
            6
            
            
            
            1,551,000
            
            
            
            10
            
            
            
            1,690,000
            
            
            
            11TOTAL
            
            $
            11,051,000
            
            
            
            100
            
            
            $
            16,301,000
            
            
            
            100
            
            
            $
            15,100,000
            
            
            
            100




Products Manufactured by the
Company




Optical
Components




a)           Custom Optics and Optical
Coating Services




Manufacturing
of high-performance custom optics is at present a major product area for PPGI,
and is addressed in the marketplace through the three separate brands of INRAD,
Laser Optics and MRC.




Laser
Optics was formed in 2003 with the combination of INRAD’s custom optics and
optical coating services and those of Laser Optics, Inc. which the Company
acquired.  The Company had been active in the field since 1973, and
Laser Optics, Inc. since 1966.




The Laser
Optics business unit produces custom products manufactured to its customer’s
requirements.  It specializes in the manufacture of optical
components, optical coatings (ultra-violet wavelengths through infra-red
wavelengths) and subassemblies for military, aerospace, industrial and medical
marketplace.  Planar, prismatic and spherical components are
fabricated from glass and synthetic crystals, including fused silica, quartz,
infra-red materials (including germanium, zinc selenide and zinc sulfide),
magnesium fluoride and silicon.  Components consist of mirrors,
lenses, prisms, waveplates, polarizing optics, monochrometers, x-ray mirrors,
and cavity optics for lasers.




Most
optical components and sub-assemblies require thin film coatings on their
surfaces.  Depending on the design, optical coatings can refract,
reflect, or transmit specific wavelengths.  Laser Optics optical
coating specialties include high laser damage resistance, polarizing, high
reflective, anti-reflective, infra-red, and coating to complex custom
multi-wavelength requirements on a wide range of substrate
materials.  Laser Optics coating capability is mainly directed towards
optical components it manufactures, as well as customer furnished
components.  Coating deposition process technologies employed included
electron beam, thermal, and ion assist.




MRC
Optics, established in 1983, is a fully integrated precision metal optics and
optical assembly manufacturer.  The Company employs high precision CNC
and diamond machining, polishing, plating, aluminum, albemet, beryllium and
stainless steel opto-mechanical design, component manufacturing and assembly
services in the manufacture of custom optics.  MRC has developed
custom processes to support prototyping through medium to high rates
of  production for 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 and motor assemblies.  Plating specialties include
void-free gold and electroless nickel.




b)           UV Filter Optical
Components




The INRAD
crystals and crystal components product lines include crystalline filter
materials, including both patented and proprietary materials, that have unique
transmission and absorption characteristics that enable them to be used in
critical applications in defense systems such as missile warning
sensors.  Such materials include nickel sulphate, and proprietary
materials such as UVC-7 and LAC.




Laser
Accessories




The INRAD
business unit manufactures crystal-based products that are used in laser
systems. These products include wavelength conversion crystals, Pockel’s cells,
and wavelength conversion instruments.




a)           Crystal
Components




Certain
synthetic crystals, because of their internal structure, have unique optical,
non-linear, or electro-optical properties that are essential to application in
or with laser systems.  Electro-optic and nonlinear crystal devices
can alter the intensity, polarization or wavelength of a laser
beam.  Developing growth processes for high quality synthetic crystals
and manufacturing and design processes for crystal components lies at the heart
of the INRAD laser accessory product lines.  Other crystal components,
both standard and custom, are used in laser research and in commercial laser
systems to change the wavelength of laser light.  Synthetic crystals
currently in production include Lithium Niobate, Beta Barium Borate, Alpha
Barium Borate, KDP, deuterated KDP Zinc Germanium DiPhosphide, as well as other
species.




4




b)           Pockel’s
Cells




INRAD
manufactures a line of Pockel’s Cells and associated
electronics.  Pockel’s cells are used in applications that require
fast switching of the polarization direction of a beam of
light.  These uses include Q-switching of laser cavities to generate
pulsed laser light, coupling light into and out from regenerative amplifiers,
and light intensity modulation.  These devices are sold on an OEM
basis to laser manufacturers, researcher institutes and laser system design
engineers.




c)           Harmonic Generation
Systems




PPGI’s
Inrad business unit designs and manufactures harmonic generation laser
accessories.  Harmonic generation systems enable the users of lasers
to convert the fundamental frequency of the laser to another frequency required
for specific applications.  Harmonic generators are used in
spectroscopy, semiconductor processing, medical lasers, optical data storage and
scientific research.




Many
commercial lasers have automatic tuning features, allowing them to produce a
range of frequencies.  The INRAD Autotracker product, when used in
conjunction with these lasers, automatically generates tunable ultraviolet light
or infrared light for use in spectroscopic applications.




Markets




In 2009,
2008 and 2007 the Company’s product sales were made to customers in the
following market areas:


Market  (In
      thousands)
              
              2009
              
              
              2008
              
              
              2007Defense/Aerospace
              
              $
              7,454
              
              
              
              (68
              )%
              
              $
              10,329
              
              
              
              (63
              )%
              
              $
              9,456
              
              
              
              (63
              )%Process
      control & metrology
              
              
              2,339
              
              
              
              (21
              )%
              
              
              4,692
              
              
              
              (29
              )%
              
              
              3,760
              
              
              
              (25
              )%Laser
      systems (non-military)
              
              
              138
              
              
              
              (1
              )%
              
              
              463
              
              
              
              (3
              )%
              
              
              932
              
              
              
              (6
              )%Universities
      & national laboratories
              
              
              492
              
              
              
              (4
              )%
              
              
              203
              
              
              
              (1
              )%
              
              
              352
              
              
              
              (2
              )%Other
              
              
              628
              
              
              
              (6
              )%
              
              
              614
              
              
              
              (4
              )%
              
              
              600
              
              
              
              (4
              )%Total
              
              $
              11,051
              
              
              
              (100
              )%
              
              $
              16,301
              
              
              
              (100
              )%
              
              $
              15,100
              
              
              
              (100
              )%




Major
market sectors served by the Company include defense and aerospace, process
control & metrology, laser systems (non-military), universities and national
laboratories, and various other markets not separately
classified.  The “defense and aerospace” area consists of sales to OEM
defense electro-optical systems and subsystems manufacturers, manufacturers of
non-military satellite-based electro-optical systems and subsystems, and direct
sales to governments where the products have the same end-use.  The
“process control and metrology” area consists of customers who are OEM
manufacturers of capital equipment used in manufacturing process implementation
and control, optics-based metrology and quality assurance, and inventory and
product control equipment.  Examples of applications for such
equipment include semiconductor (i.e., chip) fabrication and testing and
inventory management and distribution control.  The “laser systems”
market area consists principally of customers who are 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 to market areas
that, while they may be the object of penetration plans by the Company, 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.




The
Company is a provider of optical components, both specialty crystal components
and high precision custom optical components for customers in the aerospace and
defense electro-optical systems sector.  End-use applications include
military laser systems, military electro-optical systems, satellite-based
systems, and missile warning sensors and systems that protect
aircraft.  The dollar volume of shipments of product within this
sector depends in large measure on the U.S. Defense Department budget and its
priorities, that of foreign governments, the timing of their release of
contracts to their prime equipment and systems contractors, and the timing of
competitive awards from this customer community to the Company.  The
Company’s sales of products to this customer sector increased as a percentage of
total sales in 2009, although revenue in this sector fell by almost 28% and 21%
from 2008 and 2007, respectively, as the decline in sales in these market areas
was less than the decline in sales all other market areas on a percentage
basis.  Defense/aerospace sector sales represented approximately 68%
of sales in 2009 and 63% of sales in both 2008 and 2007. The Company believes
that the defense and aerospace sector will continue to represent a significant
market for the Company’s products and offers an ongoing opportunity for growth
given the Company’s capabilities in specialty crystal, glass and metal precision
optics.




Sales in
the Process Control and Metrology market sector, the Company’s second largest
market, decreased in 2009 both as a percentage of total sales and in relative
sales dollars.  This reflected the impact of the economic recession,
particularly in the commercial market and within the customer base that the
Company serves.  Sales were $2,339,000 or 21% of total sales compared
to sales in 2008 of $4,692,000 or 29% of total sales, and sales in 2007 of
$3,760,000 or 25% of total sales. Despite the downturn in 2009, the Company
believes that the optical and x-ray inspection segment of the semiconductor
industry offers continued opportunities which match its capabilities in
precision optics, crystal products, and monochrometers.




5




The
Company serves the non-military laser industry as an OEM supplier of standard
and custom optical components and laser accessories.  In this sector,
2009 sales were $138,000 or 1%. In 2008, sales were 463,000 or 3% of total sales
compared with sales in 2007 of $932,000 or 6% of total
sales.    The sales decline over the last few years
primarily reflects the decline in orders from one major customer in this
market.




Sales to
customers within the University and National Laboratories market sector consist
primarily of the Company’s legacy systems, Pockel’s cells and related
repairs.  In 2009, the sales increased to $492,000 or 4% of total
sales primarily reflecting a large order from one national
laboratory.  This follows a sales decline in 2008 to $203,000 from
$352,000 in 2007.




Other
sector sales have been in the $500,000 to $700,000 range historically and growth
remained relatively flat at $628,000 in 2009, compared to sales of $614,000 and
$600,000 in 2008 and 2007, respectively.




The
Company’s export sales, which are primarily to customers in countries within
Europe, the Near East and Japan, amounted to approximately 7.2%, 5.2%, and 9.5%
of product sales in 2009, 2008 and 2007, respectively.




The
Company had sales to three major domestic customers which accounted for 17.7%
and 13.8%, and 9.8% of sales in 2009.  Each customer is an
electro-optical systems division of a major U.S. defense corporation who
manufactures systems for U.S. and allied foreign
governments.     In 2008, the same three customers
represented 8.7%, 21.6% and 5.9% of sales, respectively.  Sales to
these markets are mainly through independent distributors.




During
the past three years, sales to the Company’s top five customers represented
approximately 51.6%, 58.8% and 56.9% of sales, respectively, in the
aggregate.   These top customers have been manufactures either in
the Defense sector or the process control and metrology sector.  Given
the concentration of sales within a small number of customers, the loss of any
of these customers would have a significant negative impact on the Company and
its business units.




Long-Term
Contracts




Certain
of the Company’s agreements with customers provide for periodic deliveries at
fixed prices over a long period of time.  In such cases, as in most
other cases as well, the Company attempts to obtain firm price commitments, as
well as,  cash advances from these suppliers for the purchase of the
materials necessary to fulfill the order.




Marketing and Business
Development




The
Company’s two Northvale, NJ-based business units and its MRC Optics subsidiary
market their products domestically through their sales, marketing and customer
service teams, located in Northvale and Sarasota, respectively, led by the
Corporate Vice President–Sales and Marketing.  The Company has moved
towards a strategy of utilizing these combined sales and marketing resources for
cross-selling all products, across all business lines.




Independent
sales agents are used in countries in major non-U.S. markets, including Canada,
UK, EU, Israel, and Japan.




Trade
show participation, Internet-based marketing, media and non-media advertising
and promotion, and international sales representative and distributor
relationships are coordinated at the corporate level under the auspices of the
corporate Vice President – Marketing and Sales.




Backlog




The
Company’s order backlog at December 31, 2009 was $4,359,000, essentially all of
which is expected to be shipped in 2010.  The Company’s order backlog
as of December 31, 2008 and 2007 was $6,102,000 and $9,432,000,
respectively.




Competition




Within
each product category in which the Company’s business units are active, there is
competition.




Changes
in the Photonics industry have had an effect on suppliers of custom
optics.  As end users have introduced products requiring large volumes
of optical components, suppliers have responded either by staying small and
carving out niche product areas or by ramping up their own manufacturing
capacity and modernizing their manufacturing methods to meet higher volume
production rates.  Many custom optics manufacturers lack in-house thin
film coating capability.  As a result, there are fewer well-rounded
competitors in the custom optics arena, and many are equipped with modern
facilities and manufacturing methods.  The Company has and continues
to judiciously deploy capital towards modernizing its facilities, and has
staffed its manufacturing groups with individuals with comprehensive experience
in manufacturing management, manufacturing engineering, advanced finishing
processes and optical coating processes.  The Company competes on the
basis of providing consistently high quality products delivered on time,
developing and maintaining strong customer relationships, and continuously
improving its capabilities, labor productivity, cost structure, and product
cycle times.




Competition
for the Company’s laser accessories is limited, but competitors’ products are
generally lower priced.  The Company’s laser accessories are
considered to be high quality and generally offer a combination of features not
available elsewhere.  Because of the Company’s in-house crystal growth
capability, the Company’s staff is knowledgeable about matching appropriate
crystals to given applications for its laser accessories.




6




For the
crystal product area, price, quality, delivery, and customer service are market
drivers.  With advancing globalization, many of the Company’s
competitors supplying non-linear optical crystals are overseas and can offer
significantly reduced pricing for some crystal species.  Sales in this
arena are declining, but the Company has been able to retain a base by providing
the quality and customer service needed by certain OEM customers not readily
available from others, and by offering proprietary crystal components for which
the Company is either the sole source or one of the few available
sources.  On many occasions, the quality of the crystal component
drives the ultimate performance of the component or instrument into which it is
installed.  Thus, quality and technical support are considered to be
valuable attributes for a crystal supplier by some, but not all, OEM
customers.




Although
price is a principal factor in many product categories, competition is also
based on product design, product performance, customer confidence, quality,
delivery, and customer service.  The Company is a sole-source supplier
of products to several major customers who are leaders in their
industries.  Based on its performance to date, the Company believes
that it can continue to compete successfully in its niches, although no
assurances can be given in this regard.




Employees




As of the
close of business on March 29, 2010, the Company had 81 full-time
employees.




Patents and
Licenses




The
Company relies on its manufacturing and technological expertise, rather than on
patents, to maintain its competitive position in the industry.  The
Company takes precautionary and protective measures to safeguard its design and
technical and manufacturing data, and relies on nondisclosure agreements with
its employees to protect its proprietary information.




Regulation




Foreign
sales of certain of the Company’s products may require export licenses from the
United States Department of Commerce or Department of State.  Such
licenses are generally available to all but a limited number of countries and
are obtained when necessary.  Company sales in 2009, 2008 and 2007
requiring U.S. State Department export approval represented less than 1.0% of
total sales.  In all cases, the required export approvals were
granted.




There are
no other federal regulations or any unusual state regulations that directly
affect the sale of the Company’s products other than those environmental
compliance regulations that generally affect companies engaged in manufacturing
operations in New Jersey and Florida.




Item 1A. Risk
Factors




The
Company cautions investors that its performance (and, therefore, any forward
looking statement) is subject to risks and uncertainties.  Various
important factors, including but not limited to the following, may cause the
Company’s future results to differ materially from those projected in any
forward looking statement.




a)
            As general economic
      conditions deteriorate, the Company’s financial results may
      suffer




Significant
economic downturns or recessions in the United States or Europe, such as the
current economic environment in which the Company operates, could adversely
affect the Company’s business, by causing a temporary or longer term decline in
demand for the Company’s goods and services and thus its
revenues.  The economic uncertainty has resulted in our key customers
delaying orders due to decreased demand by the end users of their products and
their difficulty in assessing and projecting end-user needs.




b)
            The
      Company has exposure to Government
Markets




Sales to
customers in the defense industry have increased in the recent
past.  These customers in turn generally contract with a governmental
entity, typically the U.S. government.  Most governmental programs are
subject to funding approval and can be modified or terminated with no warning
upon the determination of a legislative or administrative body.  The
current economic crisis is having significant effects on government spending and
it is particularly difficult, at this time, to assess how this will impact our
defense industry customers and the timing and volume of business we do with
them. The loss or failure to obtain certain contracts or a loss of a major
government customer could have a material adverse effect on our business,
results of operations or financial condition.




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




For the
year ended December 31, 2009, five customer accounts represented in the
aggregate of approximately 52% of total revenues, and three customers accounted
for 41% of revenues.  These three customers each represented
approximately 18%, 14% and 10% of sales, respectively.  Since we are a
supplier of custom manufactured components to OEM customers, the relative size
and identity of our largest customer accounts changes somewhat from year to
year.  In the short term, the loss of any of these large customer
accounts or a decline in demand in the sectors they represent, could have a
material adverse effect on business, our results of operations, and our
financial condition.




7




d)
            The Company depends
      on, but may not succeed in, developing and acquiring new products and
      processes




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




e)
            The Company’s business
      success depends on its ability to recruit and retain key
      personnel




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




f)
            The Company may not be
      able to fully protect its intellectual
  property




The
Company currently holds one material patent applicable to an important product,
but does not in general rely on patents to protect its products or manufacturing
processes.  The Company generally relies on a combination of trade
secret and employee non-competition and nondisclosure agreements to protect its
intellectual property rights.  There can be no assurance that the
steps the Company takes will be adequate to prevent misappropriation of the
Company’s technology.  In addition, there can be no assurance that, in
the future, third parties will not assert infringement claims against the
Company.  Asserting the Company’s rights or defending against
third-party claims could involve substantial expense, thus materially and
adversely affecting the Company’s business, results of operations or financial
condition.




g)
            Many of the Company’s
      customer’s industries are
cyclical




The
Company’s business is significantly dependent on the demand its customers
experience for their products.  Many of their end users are in
industries that historically have experienced a cyclical demand for their
products.  The industries include but are not limited to, the defense
electro-optics industry and the manufacturers of process control capital
equipment for the semiconductor tools industry.  As a result, demand
for the Company’s products are subject to cyclical fluctuations, and this could
have a material adverse effect on our business, results of operations, or
financial condition.




h)
            The Company’s stock
      price may fluctuate widely




The
Company’s stock is thinly traded.  Many factors, including, but not
limited to, future announcements concerning the Company, its competitors or
customers, as well as quarterly variations in operating results, announcements
of technological innovations, seasonal or other variations in anticipated or
actual results of operations, changes in earnings estimates by analysts or
reports regarding the Company’s industries in the financial press or investment
advisory publications, could cause the market price of the Company’s stock to
fluctuate substantially.  In addition, the Company’s stock price may
fluctuate widely for reasons which may be unrelated to operating
results.  These fluctuations, as well as general economic, political
and market conditions such as recessions, military conflicts, or market or
market-sector declines, may materially and adversely affect the market price of
the Company’s Common Stock.  In addition, any information concerning
the Company, including projections of future operating results, appearing in
investment advisory publications or on-line bulletin boards or otherwise
emanating from a source other than the Company could in the future contribute to
volatility in the market price of the Company’s Common Stock.




i)
            The Company’s
      manufacturing processes require products from limited sources of
      supply




The
Company utilizes many relatively uncommon materials and compounds to manufacture
its products.  Examples include optical grade quartz, specialty
optical glasses, scarce natural and manmade crystals, beryllium and its alloys,
and high purity chemical compounds.  Failure of the Company’s
suppliers to deliver sufficient quantities of these necessary materials on a
timely basis, or to deliver contaminated or inferior quality materials, or to
markedly increase their prices could have an adverse effect on the Company’s
business, despite its efforts to secure long term commitments from the Company’s
suppliers.  Adverse results might include reducing the Company’s
ability to meet commitments to its customers, compromising the Company’s
relationship with its customers, adversely affecting the Company’s ability to
meet expanding demand for its products, or causing the Company’s financial
results to deteriorate.




j)
            The Company faces
      competition




The
Company encounters substantial competition from other companies positioned to
serve the same market sectors that the Company serves.  Some
competitors may have financial, technical, capacity, marketing or other
resources more extensive than ours, or may be able to respond more quickly than
the Company to new or emerging technologies and other competitive
pressures.  Some competitors have manufacturing operations in low-cost
labor regions such as the Far East and Eastern Europe and can offer products at
lower price than the Company.  The Company may not be successful in
winning orders against the Company’s present or future competitors, and
competition may have a material adverse effect on our business, results of
operations or financial condition.




8




Item 1B. Unresolved Staff
Comments




Not
applicable




Item 2. Properties




Administrative,
engineering and manufacturing operations are housed in a 42,000 square foot
building located in Northvale, New Jersey and in a 25,000 square foot building
located in Sarasota, FL.  The headquarters of the Company are in its
Northvale facility.  On November 1, 2008, the Company signed an
extension of its Northvale lease for two years to October 31,
2010.  The Company has an option for renewing the lease for two
additional two year periods, at fixed terms, through October 31,
2012.




Photonic
Products Group, Inc’s subsidiary, MRC Precision Metal Optics, is located in
Sarasota, FL pursuant to a net lease expiring on August 31, 2010.  MRC
Optics has the option of extending the lease for three additional two year
periods through August 31, 2016, at fixed terms.




The
facilities are adequate to meet current and future projected production
requirements.




The total
rent for these leases was approximately $582,000, $588,000 and $570,000 in 2009,
2008 and 2007, respectively.  The Company also paid real estate taxes
and insurance premiums that totaled approximately $172,000 in 2009, $179,000 in
2008 and $189,000 in 2007.




Item 3. Legal
Proceedings




There are
no legal proceedings involving the Company as of the date hereof.




Item 4. Reserved




None




9





PART
II




Item 5. Market for Registrant’s
Common Equity and Related Stockholder Matters




a)           Market
Information




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




The
following table sets forth the range of high and low closing prices for the
Company’s Common Stock in each fiscal quarter from the quarter ended March 31,
2008 through the quarter ended December 31, 2009, as reported by the National
Association of Securities Dealers NASDAQ System.  Such
over-the-counter quotations reflect inter-dealer prices, without retail mark-up,
mark-down or commission and may not necessarily represent actual
transactions.





PriceHigh
            
            
            LowQuarter
      ended December 31, 2009
            
            $
            1.50
            
            
            $
            1.00Quarter
      ended September 30, 2009
            
            
            1.50
            
            
            
            .96Quarter
      ended June 30, 2009
            
            
            1.90
            
            
            
            1.27Quarter
      ended March 31, 2009
            
            
            2.00
            
            
            
            1.50Quarter
      ended December 31, 2008
            
            
            2.80
            
            
            
            1.40Quarter
      ended September 30, 2008
            
            
            3.25
            
            
            
            1.45Quarter
      ended June 30, 2008
            
            
            4.20
            
            
            
            2.90Quarter
      ended March 31, 2008
            
            
            4.60
            
            
            
            3.51




As of
March 29, 2010 the Company’s closing stock price was $1.00 per
share.




b)           Shareholders




As of
March 15 2010, there were approximately 158 shareholders of record of our Common
Stock.  The number of shareholders of record of common stock was
approximated, based upon the Shareholders’ Listing provided by the Company’s
Transfer Agent.  As of the same date, the Company estimates that there
are an additional 590 beneficial shareholders.




c)           Dividends




There was
no common stock dividend paid in 2009 or 2008.  In 2007, the Company
paid an annual dividend of 134,000 shares of Common Stock on its outstanding
Series A and Series B convertible preferred stock, valued at the closing price
on the dividend date.  The value of the dividend was
$238,167.




The
Series A convertible preferred stock consisted of 500 shares outstanding at a
stated value of $1,000 per share and convertible into common shares at the rate
of $1.00 per share was converted into 500,000 common shares of the Company’s
stock in April 2007.  A total of 2,032 shares of the Series B
convertible preferred stock consisting of 2,082 shares at a stated value 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 preferred stock were redeemed by the Company for a cash
payment of $50,000 and an accrued stock dividend of 1,332 common
shares.




The
Company has not historically paid cash dividends.  Payment of cash
dividends is at the discretion of the Company’s Board of Directors and depends,
among other factors, upon the earnings, capital requirements, operations and
financial condition of the Company.  The Company does not anticipate
paying cash dividends in the immediate future.




d)           Recent Sales of Unregistered
Securities




There
were no sales of unregistered securities during 2009.




10




e)           Securities Authorized for
Issuance under Equity Compensation Plans







Number
      of securities to be issued upon exercise of outstanding options, warrants
      and rights
            
            
            Weighted-average
      price of outstanding options, warrants and rights
            
            
            Number
      of securities remaining for future issuance under equity compensation
      plans2000
      Equity Compensation Program approved by shareholders
            
            
            1,233,719
            
            
            $
            1.12
            
            
            
            3,615,177




Item 6. Selected Financial
Data




The
following data is qualified in its entirety by the financial statements
presented elsewhere in this Annual Report on Form 10-K.




As
      of December 31, orFor
      the Year Ended December 31,2009
              
              
              2008
              
              
              2007
              
              
              2006
              
              
              2005Revenues
              
              $
              11,051,127
              
              
              $
              16,301,209
              
              
              $
              15,099,878
              
              
              $
              13,921,127
              
              
              $
              13,785,057Net
      (loss) income
              
              
              (2,799,992
              )
              
              
              1,098,421
              
              
              
              1,880,081
              
              
              
              772,266
              
              
              
              (11,398
              )Net
      (loss) income applicable to common shareholders
              
              $
              (2,799,992
              )
              
              $
              1,098,421
              
              
              $
              1,641,914
              
              
              $
              537,766
              
              
              $
              (145,398
              )Earnings
      per shareBasic
      (loss) earnings  per share
              
              
              (0.25
              )
              
              
              0.10
              
              
              
              0.19
              
              
              
              0.07
              
              
              
              (0.02
              )Diluted
      (loss) earnings per share
              
              
              (0.25
              )
              
              
              0.08
              
              
              
              0.13
              
              
              
              0.06
              
              
              
              (0.02
              )Weighted
      average sharesBasic
              
              
              11,331,258
              
              
              
              10,902,061
              
              
              
              8,609,822
              
              
              
              7,572,637
              
              
              
              7,218,244Diluted
              
              
              11,331,258
              
              
              
              15,619,304
              
              
              
              13,777,114
              
              
              
              11,915,090
              
              
              
              7,218,244Common
      stock dividends on Preferred shares
              
              
              —
              
              
              
              —
              
              
              
              238,167
              
              
              
              234,500
              
              
              
              134,000Total
      assets
              
              
              12,610,740
              
              
              
              15,732,149
              
              
              
              16,077,947
              
              
              
              15,316,260
              
              
              
              13,481,021Long-term
      obligations
              
              
              2,844,946
              
              
              
              2,853,663
              
              
              
              2,990,730
              
              
              
              6,299,767
              
              
              
              5,963,411Shareholders’
      equity
              
              
              7,777,715
              
              
              
              10,124,175
              
              
              
              7,712,799
              
              
              
              5,236,703
              
              
              
              3,929,407




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




The
following discussion and analysis should be read in conjunction with the
Company’s consolidated financial statements and the notes thereto presented
elsewhere herein.  The discussion of results should not be construed
to imply any conclusion that such results will necessarily continue in the
future.




Critical Accounting
Policies




The
Company’s significant accounting polices are described in Note 1 of the
Consolidated Financial Statements that were prepared in accordance with
accounting principles generally accepted in the United States of
America.  In preparing the Company’s financial statements, the Company
made estimates and judgments that affect the results of its operations and the
value of assets and liabilities the Company reports.  The Company’s
actual results may differ from these estimates.




The
Company believes that the following summarizes critical accounting polices that
require significant judgments and estimates in the preparation of the Company’s
consolidated financial statements.




Revenue
Recognition




The
Company records revenue in accordance with Securities and Exchange Commission
Staff Accounting Bulletin No. 104, “Revenue Recognition” (“SAB
104”).  Under SAB 104, revenues are recorded when all four of the
following criteria are met:  persuasive evidence of an arrangement
exists; delivery has occurred or services have been rendered; the sales price is
fixed or determinable; and collectability is reasonably
assured.    Losses on contracts are recorded when
identified.




11




Inventory




Inventories
are stated at the lower of cost (first-in, first-out method) or
market.  Cost of manufactured goods includes material, labor and
overhead.




The
Company records a reserve for slow moving inventory as a charge against earnings
for all products identified as surplus, slow moving or
discontinued.  Excess work-in-process costs are charged against
earnings whenever estimated costs-of-completion exceed unbilled
revenues.




Goodwill and Intangible
assets




Intangible
assets with finite lives are amortized on a straight-line basis over the assets’
estimated useful life up to 14 years.  The Company periodically
evaluates on an annual basis, or more frequently when conditions require,
whether events or circumstances have occurred indicating the carrying amount of
intangible assets may not be recoverable.  When factors indicate that
intangible assets should be evaluated for possible impairment, the Company uses
an estimate of the associated undiscounted future cash flows compared to the
related carrying amount of assets to determine if an impairment loss should be
recognized.




Goodwill
and intangible assets not subject to amortization are tested in December of each
year for impairment, or more frequently if events and circumstances indicate
that the assets might have become impaired.  An impairment loss is
recognized to the extent that the carrying amount exceeds the asset’s fair
value.




Share-based
compensation




Stock
based compensation expense is estimated at the grant date based on the fair
value of the award.  The Company estimates the fair value of stock
options granted using the Black-Scholes option pricing model.  The
fair value of restricted stock units granted is estimated based on the closing
market price of the Company’s common stock on the date of the
grant.  The fair value of these awards, adjusted for estimated
forfeitures, is amortized over the requisite service period of the award, which
is generally the vesting period.




Results of
Operations




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





Years
      Ended December 31,2009
            
            
            2008
            
            
            2007Category
            
            Sales
            
            
            %
            
            
            Sales
            
            
            %
            
            
            Sales
            
            
            %(In
      thousands)Optical
      Components
            
            $
            10,350
            
            
            
            94
            
            
            $
            14,750
            
            
            
            90
            
            
            $
            13,410
            
            
            
            89Laser
      Accessories
            
            
            701
            
            
            
            6
            
            
            
            1,551
            
            
            
            10
            
            
            
            1,690
            
            
            
            11TOTAL
            
            $
            11,051
            
            
            
            100
            
            
            $
            16,301
            
            
            
            100
            
            
            $
            15,100
            
            
            
            100






The
following table provides information on the Company’s sales to its major
business sectors during the past three years:


Market
              
              
              2009
              
              
              
              2008
              
              
              
              2007(In
      thousands)Defense/Aerospace
              
              $
              7,454
              
              
              
              (68
              )%
              
              $
              10,329
              
              
              
              (63
              )%
              
              $
              9,456
              
              
              
              (63
              )%Process
      control & metrology
              
              
              2,339
              
              
              
              (21
              )%
              
              
              4,692
              
              
              
              (29
              )%
              
              
              3,760
              
              
              
              (25
              )%Laser
      systems (non-military)
              
              
              138
              
              
              
              (1
              )%
              
              
              463
              
              
              
              (3
              )%
              
              
              932
              
              
              
              (6
              )%Universities
      & national laboratories
              
              
              492
              
              
              
              (4
              )%
              
              
              203
              
              
              
              (1
              )%
              
              
              352
              
              
              
              (2
              )%Other
              
              
              628
              
              
              
              (6
              )%
              
              
              614
              
              
              
              (4
              )%
              
              
              600
              
              
              
              (4
              )%Total
              
              $
              11,051
              
              
              
              (100
              )%
              
              $
              16,301
              
              
              
              (100
              )%
              
              $
              15,100
              
              
              
              (100
              )%






12




The
following table sets forth, for the past three years, the percentage
relationship of statement of operations categories to total
revenues.





Years ended December 31,2009
            
            
            2008
            
            
            2007Revenues:Product
      sales
            
            
            100.0
            %
            
            
            100.0
            %
            
            
            100.0
            %Costs
      and expenses:Cost
      of goods sold
            
            
            80.5
            %
            
            
            70.5
            %
            
            
            60.5
            %Gross
      profit margin
            
            
            19.5
            %
            
            
            29.5
            %
            
            
            39.5
            %Selling,
      general and administrative expenses
            
            
            29.7
            %
            
            
            23.7
            %
            
            
            23.6
            %Goodwill
      impairment charge
            
            
            14.1
            %
            
            
            —
            %
            
            
            —
            %(Loss)
      income from operations
            
            
            (24.3
            )
      %
            
            
            5.9
            %
            
            
            15.9
            %Net
      (loss) income
            
            
            (25.3
            )
      %
            
            
            6.7
            %
            
            
            12.5
            %




Revenues




Total
revenues were $11,051,000 in 2009, $16,301,000 in 2008 and $15,100,000 in 2007
reflecting the consolidated results from all three business
units.  Revenues decreased 32% in 2009 compared with increases of 8%
in 2008 and 8.5% in 2007.  Overall, sales were impacted by the severe
economic recession and delayed defense procurement which negatively affected
demand for the Company’s products.




Sales to
the Defense and Aerospace sector showed revenue declines, down by almost 28% and
21% from 2008 and 2007, respectively.  Sales were $7,454,000, lower by
$2,875,000 from 2008 and $2,002,000 from 2007.  Defense spending on
electro-optical systems over the fiscal period has slowed, impacting the demand
for the Company’s services in manufacturing custom products for its OEM
customers.




Sales in
the Process Control and Metrology market sector, the Company’s second largest
market, decreased in 2009 both as a percentage of total sales and in relative
sales dollars.  This reflected the impact of the economic downturn,
particularly in the commercial and semi-conductor markets and the customer base
that the Company serves.  Sales were $2,339,000 or 21% of total sales
compared to sales in 2008 of $4,692,000 or 29% of total sales, and sales in 2007
of $3,760,000 or 25% of total sales.




The
Company serves the non-military laser industry as an OEM supplier of standard
and custom optical components and laser accessories.  In this sector,
2009 sales declined to $138,000 or 1% of total sales. In 2008, sales were
$463,000 or 3% of total sales compared with sales in 2007 of $932,000 or 6% of
total sales.    The sales decline over the last few years
primarily reflects the decline in orders from one major customer in this
market.




Sales to
customers within the University and National Laboratories market sector
increased to $492,000 or 4% of total sales primarily reflecting a large order
from one specific customer.  This follows a sales decline in 2008 to
$203,000 from $352,000 in 2007.




Other
sector sales have been in the $500,000 to $700,000 range historically and
remained relatively flat at $628,000 in 2009, compared to other sector sales of
$614,000 and $600,000 in 2008 and 2007, respectively.




The
Company has refocused its sales and marketing efforts to expand current markets,
add to its customer base, increase sales and marketing efforts in the
international segment and in developing new products, so as to be positioned to
take advantage of new opportunities as economic conditions improve and industry
demand strengthens.




Bookings




The
Company booked new orders totaling $9.5 million in 2009, down from $13.0 million
in 2007 and $17.8 million in 2007 reflecting a decline across the business
sectors that the Company serves.  Despite the decrease, the Company
was able to add several new customers while maintaining most of its existing
customer base.




In 2008,
the bookings decrease from the prior year was partly attributable to lower
orders for legacy INRAD laser accessories and decreased demand for crystal
components from one large customer.  Additionally, bookings in our MRC
Optics business decreased from 2007 levels.  MRC had two large
bookings near the end of 2007 which were scheduled to carry through 2008 and
into 2009.  In the second half of 2008, MRC orders decreased as the
impact of the economic downturn and defense sector slowdown affected our
commercial customer’s and they experienced a slowdown in their business
activities and demand for its products.  This carried over into
2009.




Bookings
in 2007 were up due to increased demand for optical components, mainly in our
Laser Optics and MRC Optics brands.  In particular, orders from one
large INRAD customer in the Process Control and Metrology sector and one large
Laser Optics OEM customer in the Defense/Aerospace sector contributed
significantly to the increase in 2007 from 2006.  One large new
Defense/Aerospace OEM was added in 2007 while orders from another declined by
50%.  Additionally, a large new OEM customer in the Process Control
and Metrology sector was added in 2007.




13




The
decline in bookings in 2009 affected the Company’s backlog as of
December 31, 2009 which decreased to $4.4 million, down from $6.1 million
at December 31, 2008 and $9.4 million at December 31, 2007.




Cost of Goods Sold and Gross
Profit Margin




Cost of
goods sold as a percentage of sales was 80.5%, 70.5% and 60.5%, for the years
ended December 31, 2009, 2008 and 2007, respectively.  In dollar
terms, 2009 cost of goods sold was $8,897,000 which is down 22.5% from
$11,487,000 in 2008, compared with a 32% sales decline over the comparable
period.




The
increase in Cost of Goods Sold percentage in 2009 compared to 2008 is
primarily due to the significant decline in sales volume during the year, net of
cost reductions implemented by the Company during the year.  Compared
to last year, material cost as a percentage of sales remained unchanged from
2008 although in dollar terms material costs declined by $913,000, as expected
with the lower sales volume levels. Total manufacturing wages and salaries
declined by approximately $832,000 but rose by 5.6 percentage points, as a
percentage of sales.  Non-labor operating costs excluding depreciation
also fell in dollar terms in 2009 by approximately $606,000 or 26.7% from 2008,
but as a percentage of sales, increased by about 1.1 percentage points from the
prior year.




In 2008,
Cost of Goods Sold compared to 2007 was up 25.7% from $9,141,000 and was 70.5%
of sales compared to 60.5% in 2007.  Approximately 8% of the increase
related to higher sales volumes, but the major part of the increase was due to
other factors.  Material cost as a percentage of sales increased in
2008 due partly to a change in product/sales mix, including several new OEM
products which were weighted towards a higher cost material content than in
2007.  Contributing to this was the conclusion of an agreement with
one large OEM customer which included customer supplied materials in 2007 and
early 2008.  The Company was required to purchase material for ongoing
orders for this customer over the last nine months of 2008 and resulted in an
increase in material cost of sales for the year.  Also, production
problems during 2007 at our Florida operation resulted in higher than
expected material costs from rework requirements, relative to 2008.




Production
labor costs, in dollar terms, rose by approximately 32% from
2007.  Increases in employment levels of production personnel to
support higher sales volumes, contributed to the higher costs during
2008.  Also, as noted above, production issues which affected material
costs, as noted above, also resulted in inefficiencies and excessive rework that
negatively impacted labor and overhead costs throughout most of the
year.  This also resulted in direct inventory write-offs and increased
reserves against work in process during the year which totaled approximately
$48,000 and $161,000, respectively.




Gross
margin in 2009 was $2,154,000 or 19.5% which was down from 2008 gross margin of
$4,815,000 or 29.5%.  This compares with a gross margin of $5,959,000
or 39.5% in 2007.




Selling, General and
Administrative Expenses




Selling,
general and administrative expenses (“SG&A”) were $3,278,000 in 2009, down
$580,000 or 15% from 2008, and as a percentage of sales represented 29.7% of
sales in 2009 and 23.7% of sales in 2008. The decline in dollar expense resulted
mainly from reductions in SG&A salaries and wages and fringe benefits
reflecting personnel reductions implemented in the first quarter of 2009 and
continued cost management throughout the year.  Overall SG&A
salary and wages decreased by 14.5% over the prior year.  Non-payroll
SG&A expenses excluding depreciation also declined by 15.5% compared to
2008.




Selling,
general and administrative expenses in 2008 increased in dollar terms from those
in 2007 by $296,000, or 8.3%.  Higher wage, recruitment and relocation
costs related to new personnel during the year contributed to the increase. In
addition, sales travel and trade show expenses related to increased business
development activity increased during the year. Travel expenses also rose as a
result of more frequent travel by corporate staff between our operation centers
in New Jersey and Florida.  Stock-based compensation expenses rose due
to sign-on grants to new employees and the expense associated with fully vested
stock option awards to the Company’s former CEO.  These were offset by
reductions in commission expenses to independent sales agents and lower
consulting costs.  Increases in SG&A salaries and wages reflected
both annual SG&A pay increases as well as one-time living allowances paid to
replacement sales staff brought on at the end of 2007.




Operating (Loss)
Income




The
Company had an operating loss of $2,682,000 in 2009 after recording a non-cash
charge for the impairment of goodwill of $1,558,000, as discussed in Note 4 of
the Company’s Consolidated Financial Statements.  Excluding the charge
for goodwill impairment, the Company had an operating loss of $1,124,000
primarily reflecting the significant decrease in sales, as discussed
above.




The
Company had operating income of $957,000 in 2008 which was a decline from
$2,397,000 in the previous year as a result of the increases in the Company’s
cost of sales and lower margins related to production inefficiencies and
increased labor and overhead costs in our MRC business unit, as well as a less
profitable sales mix and higher selling, general and administrative
costs.




14




Operating
income in 2007 was $2,397,000, or 15.9% of sales, up $1,481,000 or 161% from the
prior year.




Other Income and
Expenses




Net
interest expense of $130,000 in 2009 declined 23.5% from $170,000 in
2008.  Interest expense was $167,000 in 2009 compared to $236,000 in
2008 which reflects the positive impact of the Company’s continued
reduction in debt and long term notes.  Interest income for 2009 was
$37,000 down from $66,000 in 2008 mainly as a result of reductions in bank
interest rates on invested cash balances.




Net
interest expense of $170,000 in 2008 was down 34.8% from $261,000 in
2007.  Interest expense was $236,000 compared to $424,000 in
2007.  The reduction in net interest expense reflects the positive
impact of the Company’s continued reduction in debt and long term notes and
capital lease balances due to both scheduled amortization and accelerated
principal re-payments, including the $1,700,000 subordinated convertible debt in
the first quarter of 2008.  Interest income for 2008 was $66,000, down
from $163,000 in 2007 as the result of lower cash balances available for
investment during the year and reductions in bank interest rates on invested
cash balances.




Income
Taxes




In 2009,
the Company did not record a current provision for either state tax or federal
alternative minimum tax due to the losses incurred for both income tax and
financial reporting purposes.




In 2008,
the Company recorded a current provision for state tax and federal alternative
minimum tax of $100,000 and $5,000, respectively, after the application of net
operating losses of $523,000 against federal tax.  In 2007, the
Company recorded income tax expense in the amount of $250,000 after utilizing
net operating losses of approximately $2,700,000 to offset federal taxes
payable.




The
Company recognizes deferred tax liabilities and assets for the expected future
tax consequences of events that have been recognized in the Company’s financial
statements or tax returns.  Deferred tax liabilities and assets are
determined based on the difference between the financial statements carrying
amounts and the tax basis of assets and liabilities using enacted tax rates in
effect in the years in which the differences are expected to
reverse.




At
December 31, 2009, the Company had a total net deferred tax asset balance of
$2,857,000, an increase of $716,000 from 2008 primarily from the increase to the
net operating loss carry forward position that resulted for the losses incurred
in 2009 and depreciation.   Although the Company believes that
the current year’s losses were caused by the recent economic conditions, the
Company has increased the valuation allowance to $2,449,000 to fully offset the
current year’s increase in the deferred tax asset.




As of
December 31, 2009 and 2008, the Company recognized a portion of the net deferred
tax assets in the amount of $408,000 which the Company’s management is
reasonably assured will be fully utilized in future periods.  In
evaluating the Company’s ability to recover deferred tax assets in future
periods, management considers the available positive and negative factors,
including the Company’s recent operating results, the existence of cumulative
losses and near term forecasts of future taxable income that is consistent with
the plans and estimates that management is using to manage the underlying
business.  The Company’s valuation allowance as of December 31, 2009
will be maintained until management concludes that it is more likely than not
that the remaining deferred tax assets will be realized. When sufficient
positive evidence exists, the Company’s income tax expense will be reduced by
the decrease in its valuation allowance. An increase or reversal of the
Company’s valuation allowance could have a significant negative or positive
impact on the Company’s future earnings.




At
December 31, 2007, the Company had a net deferred tax asset of approximately
$2,041,000, the primary component of which was net operating loss carry
forwards.  Through December 31, 2007, the Company had established a
valuation allowance to fully offset this deferred tax asset in the event the tax
asset will not be realized in the future.   The Company
determined that based on a recent history of consistent earnings and future
income projections, a full valuation allowance was no longer
required.  Accordingly, during the year ended December 31, 2008, the
Company reduced the valuation allowance and recognized a deferred tax benefit
available from the Company’s net operating loss carry forward position of
$408,000 based on the effective federal tax rate of 34%.  This
resulted in the Company recording a net benefit from income taxes of $303,000
after offsetting the deferred tax benefit against the current tax
provision.  At December 31, 2008, the Company had net deferred tax
asset balance of $2,141,000 offset by a valuation allowance of
$1,733,000.




Net (Loss)
Income




The
Company had a net loss of $2,800,000 in 2009 attributable to a $1,558,000
non-cash charge for goodwill impairment, as well as lower sales volumes and
reduced profit margins which were somewhat offset by manufacturing and SG&A
cost reductions.   Net income in 2008 was $1,098,000, down
$782,000 from net income of $1,880,000.




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




Net
(loss) income applicable to common shareholders is arrived at after deducting
the value of the stock dividends issued by the Company to the holders of its
Series A and Series B convertible preferred stock. The dividend value is
calculated by reference to the market price of the common shares on the dividend
distribution date.  The number of common shares issued in settlement
of the dividend is determined based on the coupon rate of the preferred shares,
the total shares outstanding, and the conversion price of each series of
preferred shares.




15




In 2009
and 2008, the Company did not pay common stock dividends as all Preferred Series
A and B stock had been redeemed in the prior year.  In April of 2007
and 2006, the Company distributed common stock dividends valued at $238,200 and
$234,500, respectively to the holders of its Series A and B convertible
preferred stock.




In 2007,
all of the shares of the Series A convertible preferred stock and approximately
98% of the shares of the Series B convertible preferred stock were converted by
the preferred shareholders into 812,800 shares of the Company’s common
stock.  The stock of the remaining holder of 50 shares of Series B
convertible preferred stock was redeemed by the Company on the payment of
$50,000, the liquidation value, plus an accrued stock dividend of
$5,000.




As a
result, net loss applicable to common shareholders in 2009 was $2,800,000 or
$(0.25) per share basic and diluted, compared to net income applicable to common
shareholders in 2008 which was $1,098,000, or $0.10 per share basic and $0.08
per share diluted.  Net income applicable to common shareholders for
the same period in 2007 was $1,642,000, and earnings per share were $0.19 per
share basic and $0.13 per share diluted.




Liquidity and Capital
Resources




A major
source of cash in recent years has been from operating cash
flows.  Other sources of cash include proceeds received from the
exercise of stock options, short-term borrowing, and issuance of common
stock.  The Company’s major uses of cash in the past three years have
been for capital expenditures and for repayment and servicing of outstanding
debt.




Supplemental
information pertaining to our source and use of cash is presented
below:





Selected
      Sources (uses) of cash
            
            Years ended December 31,2009
            
            
            2008
            
            
            2007(In
      thousands)Net
      cash provided by operations
            
            $
            815
            
            
            $
            548
            
            
            $
            3,001Net
      Proceeds from issuance of common stock,exercise
      of stock options and warrants
            
            
            162
            
            
            
            1,064
            
            
            
            395Capital
      Expenditures
            
            
            (211
            )
            
            
            (785
            )
            
            
            (247
            )Principal
      payments on lease obligations
            
            
            —
            
            
            
            (47
            )
            
            
            (196
            )Principal
      payments on debt obligations
            
            
            (137
            )
            
            
            (1,715
            )
            
            
            (1,647
            )




In 2009,
the Company primarily used excess cash to repay outstanding debt and finance
capital expenditures. In 2008 and 2007, excess cash was used to retire the
Company’s convertible preferred shares, in addition to accelerating the
repayment of debt and financing of capital
expenditures.




During
2009, 84,500 stock options were exercised for proceeds of $96,600 at a weighted
exercise price of $1.14 per share and converted into an equivalent number of
shares of the Company’s common stock.  This compares with proceeds
from the exercise of stock options of $285,000 in 2008, with 182,000 stock
options exercised at a weighted average exercise price of approximately $1.42
per share.  By comparison, in 2007, proceeds from the exercise of
stock options were $445,000 with 651,100 stock options exercised at a weighted
average exercise price of $0.68 each and converted into an equivalent number of
shares of common stock




During
2009, a total of 50,000 warrants issued pursuant to a 2004 private placement
were exercised by warrant holders with a total exercise price of
$67,500.  Also in July 2009, 893,790 warrants with an exercise price
of $1.35 expired unexercised. These warrants were originally issued as part of a
private placement of common stock in 2004 in which the Company issued 1,581,000
Units consisting of 1,581,000 shares and warrants, exercisable through August
2009, to acquire an additional 1,185,750 shares at $1.35 per
share.  In addition, 276,675 warrants were issued to the agent for the
private placement.  During 2008, 518,635 warrants from the private
placement were exercised by warrant holders.  A total of 375,520
warrants with a total exercise price of $507,000 were surrendered to the Company
in exchange for the issuance of 375,250 shares of the Company’s common
stock.  An additional 142,385 placement agent warrants were exercised
using a cashless feature available for these warrants, in exchange for 89,702
shares of the Company’s common stock.




16




In May
2009, the Company repaid a Promissory Note prior to maturity, in the amount of
$125,000 and accrued interest of $4,212, which represented the balance of a Note
issued by the Company as part of the purchase price of MRC in 2004, to the sole
shareholder of the acquired company.




In March
2009, the maturity date of a $1,000,000 Subordinated Convertible Promissory Note
to Clarex Limited (“Clarex”), a major shareholder and debt holder, was extended
to April 1, 2011.  The note bears interest at 6% and was originally
due in January 2006, extended to December 31, 2008 and subsequently
again to April 1, 2009.  Interest accrues yearly 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 Units consisting of 1,000,000 shares of common stock and
warrants.  The warrants had an original expiration date of August 2009
and allowed the holder to acquire 750,000 shares of common stock at a price of
$1.35 per share.  The expiration date of the warrants under the
conversion terms have been extended to April 1, 2014.




In
March of 2009, the maturity date of a $1,500,000 Subordinated Convertible
Promissory Note bearing interest at 6% was extended to April 1,
2011.  The note was originally due in January 2006 and was
subsequently extended to April 1, 2009.  Interest accrues yearly and
along with principal may be converted into Common Stock, and/or securities
convertible into Common Stock.  The note is convertible into 1,500,000
Units consisting of 1,500,000 shares of Common Stock and Warrants to acquire
1,125,000 shares of Common stock at a price of $1.35 per share up to August
2009. The original expiration date of warrants of August 2009 was extended to
April 1, 2014. The holder of the note is a major shareholder of the
Company.




On
January 29, 2008, the Company repaid in full a $1,700,000 Secured
Promissory Note held by Clarex, including accrued interest of
$477,444.  The note was originally issued in June 2003 for a period of
18 months at an interest rate of 6% per annum and was secured by all assets
of the Company.  As additional consideration for the note, the Company
issued 200,000 warrants to Clarex.  In 2004, the note was extended for
an additional 36 months and the Company issued 200,000 additional warrants
to Clarex.  The initial and subsequent warrants were exercisable at
$0.425 per share and $1.08 per share, respectively, and had an expiration date
of March 31, 2008 and May 18, 2008.  The note was extended
again, to December 31, 2008, without issuance of warrants or any other
further consideration.




In March,
2008, Clarex elected to exercise the 200,000 warrants expiring on March 31, 2008
and the Company issued 200,000 shares of its common stock for proceeds of
$85,000.




In May,
2008, Clarex exercised the remaining 200,000 warrants set to expire on May 18,
2008 for $216,000 and the Company issued 200,000 shares of its common
stock.




In
December 2007, the Company repaid the outstanding balance of $554,600 principal
and accrued interest of $1,740 of the original $700,000 loan from Clarex,
retiring this debt.  The loan was originally issued in February 2006
to provide the Company with financing to fund the acquisition of certain capital
assets required for expanded capabilities to meet customer demand. The terms
called for repayment in equal monthly installments, including interest and
principal, commencing March 2006, until maturity in March 2013 at an annual
interest rate of 6.75% and allowed for early repayment.




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




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




On
October 25, 2007, two principal holders, two outside Directors, and the
Company’s CEO, notified the Company they were exercising their 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 specified conversion price of
$2.50 per share.  In the aggregate, these holder’s shares of the
Series B represented 1,560 shares or 75% 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 remaining balance of 522 issued and
outstanding Series B shares on November 29, 2007.  The 10 holders of
these shares had the option of converting their shares into common stock prior
to the redemption date.  Nine holders elected to convert, and the
remaining holder elected to redeem the preferred shares for cash and a final
stock dividend accrued to the redemption date.  In all, the Series B
was converted into 812,800 shares of common stock through conversion, and
through redemption into a cash payment of $50,000 and an accrued final stock
dividend of 1,332 shares of common stock.




17




In 2009,
non-cash investments in the amount of $800,000 were redeemed compared to a
purchase of $800,000 in 2008.




Capital
expenditures for the year ended December 31, 2009 were $211,000 and
included planned expenditures primarily for manufacturing and optical testing
equipment that increased production capacity at our Northvale, New Jersey
location.  During the year, a review program for planned capital
expenditures was instituted, in order to identify and defer expenditures, where
practical, to minimize the impact on the Company’s cash
flows.  Offsetting the impact of capital expenditures on cash flows
was the receipt of $5,000 from the sale of fully depreciated surplus
manufacturing equipment during the fourth quarter of 2009.  In 2009,
the Company purchased precious metal manufacturing tools for $53,000 offset by
the receipt of $16,000 for similar precious metal tools that were sold as part
of the purchase.




This
compares to capital expenditures in 2008 and 2007 of approximately $784,000 and
$247,000, respectively.  In 2008, capital expenditures were primarily
for increased production capacity and capability in both our Sarasota, Florida
and Northvale, New Jersey locations.  Offsetting the impact of capital
expenditures on cash flows was the receipt of $10,000 from the sale of surplus
manufacturing equipment during the second quarter of 2008.




As a
result of the above, cash and cash equivalents increased by $1,397,000 for
2009. In  2008, cash and cash equivalents decreased by $1,724,000
reflecting lower cash provided from operations and after cash used in investing
activities for capital expenditures and increased cash used in financing
activities related to the Company’s repayment of convertible
debt.  The Company had certificates of deposit with terms greater than
three months and showed these separately from cash and cash equivalents on the
balance sheet.  For 2007, cash and cash equivalents increased by
$1,318,000 to $4,396,000, after net cash outlays for debt repayments and
redemptions of $1,697,000.




A summary
of the Company’s contractual cash obligations at December 31, 2009 is as
follows:


Contractual Obligations
            
            Total
            
            
            Less than
              1 Year
            
            
            1-3 Years
            
            
            4-5
              Years
            
            
            Greater
              Than 5
              Years(In
      thousands)Convertible
      notes payable
            
            $
            2,500
            
            
            $
            —
            
            
            $
            2,500
            
            
            $
            —
            
            
            $
            —Notes
      payable-other, including interest
            
            
            550
            
            
            
            23
            
            
            
            69
            
            
            
            46
            
            
            
            412Operating
      leases (1)
            
            
            451
            
            
            
            451
            
            
            
            —
            
            
            
            —
            
            
            
            —Total
      contractual cash obligations
            
            $
            3,501
            
            
            $
            474
            
            
            $
            2,569
            
            
            $
            46
            
            
            $
            412





(1)  Excludes
all future lease renewal options available to Company and which have not yet
been exercised.




Overview of Financial
Condition




As shown
in the accompanying financial statements, the Company reported a net loss of
$2,800,000, which included a non-cash charge for goodwill of $1,558,000 and
recorded net income of $1,098,000 in 2008 and $1,880,000 in
2007.  During 2009, 2008 and 2007, the Company’s working capital
requirements were provided by positive cash flow from its
operations.




Net cash
provided by operations was $815,000 in 2009, $548,000 in 2008 and $3,001,000 in
2007.  The increase in cash provided by operations was primarily the
results of the net improvement in working capital requirements, which includes a
decrease in accounts receivable and inventory (excluding reserves) offset by an
increase in accounts payable and accrued liabilities and customer advances, and
offset by a decrease from the net loss, after adjusting for the non-cash charge
for goodwill. The Company’s management expects that future cash flow from
operations and its existing cash reserves will provide adequate liquidity for
the Company’s operations and working capital requirements in 2010.




Off-Balance Sheet
Arrangements




The Company did not have any
off-balance sheet arrangements at December 31, 2009 and 2008.




Item 7A. Quantitative and Qualitative
Disclosures about Market Risk




The
Company believes that it has limited exposure to changes in interest rates from
investments in certain money market accounts.  The Company does not
utilize derivative instruments or other market risk sensitive instruments to
manage exposure to interest rate changes.




18




Item 8. Financial
Statements and Supplementary Data




The
financial statements and supplementary financial information required to be
filed under this Item are presented commencing on page 24 of the Annual Report
on Form 10-K, and are incorporated herein by reference.




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




None




Item
9A. Controls
and Procedures




a)  Evaluation of Disclosure
Controls and Procedures




The
Company’s management, including the Chief Executive Officer and the Chief
Financial Officer, has evaluated the effectiveness of the design and operation
of the Company’s disclosure controls and procedures (as defined in Exchange Act
Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this
Annual Report on Form 10-K.  Based upon that evaluation, the Company’s
Chief Executive Officer and Chief Financial Officer have concluded that the
disclosure controls and procedures as of December 31, 2009 are effective to
ensure that information required to be disclosed in the reports the Company
files or submits under the Exchange Act is recorded, processed, summarized and
reported within the time periods specified in the SEC’s rules and forms and that
such information is accumulated and communicated to the Company's management,
including the Chief Executive Officer and the Chief Financial Officer, to allow
timely decisions regarding disclosure.




b)  Management’s Annual Report
on Internal Control over Financial Reporting




Our
management is responsible for establishing and maintaining an adequate system of
internal control over financial reporting.  Our internal control 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.




Due to
its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements.  Projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.  All internal control
systems, no matter how well designed, have inherent
limitations.  Therefore, even those systems determined to be effective
can provide only reasonable assurance with respect to financial statement
preparation and presentation.  Because of the inherent limitations of
internal control, there is a risk that material misstatements may not be
prevented or detected on a timely basis by internal control over financial
reporting.  However, these inherent limitations are known features of
the financial reporting process.  Therefore, it is possible to design
into the process safeguards to reduce, though not eliminate, this
risk.




Our
management assessed the effectiveness of our system of internal control over
financial reporting as of December 31, 2009.  In making this
assessment, management used the framework in Internal Control — Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (“COSO”).  Based on our assessment and the criteria set
forth by COSO, management has concluded that the Company maintained effective
internal control over financial reporting as of December 31,
2009.




Our
annual report on Form 10-K does not include an attestation report of the
Company’s registered public accounting firm regarding internal control over
financial reporting.  Management’s report was not subject to
attestation by the Company’s registered public accounting firm pursuant to
temporary rules of the Securities and Exchange Commission that permit the
Company to provide only management’s report in this annual report.




c)  Changes in Internal Control
over Financial Reporting




There
have been no significant changes in the Company’s internal control over
financial reporting identified in connection with the evaluation that occurred
during the Company’s last fiscal quarter that have materially affected, or that
are reasonably likely to materially affect, the Company’s internal controls over
financial reporting.




Item 9B Other
Information




None




19




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 2010 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 2010 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 2010 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 2010 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 2010 Annual Meeting of
Stockholders.




20




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 24.




(a)
(2)                      Financial Statement
Schedule.




Reference
is made to the Index to Financial Statements and Financial Statement
Schedule on Page 24.  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 Exhibit2.1
            
            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 (incorporated by reference to Exhibit 4.10 to the
      Company’s Annual Report on Form 10-K filed with the Securities and
      Exchange Commission on March 28, 2008)4.11
            
            Extension
      of Promissory Note dated February 15, 2008 originally issued to Welland,
      Ltd. on December 31, 2002 (incorporated by reference to Exhibit 4.11 to
      the Company’s Annual Report on Form 10-K filed with the Securities
      and Exchange Commission on March 28, 2008)4.12
            
            Subordinated
      Convertible Promissory Note dated April 1, 2009 held by Clarex, Ltd.
      (which supersedes documents 4.6 and 4.10) (incorporated by reference to
      Exhibit 4.12 to the Company’s Annual Report on Form 10-K filed with
      the Securities and Exchange Commission on March 31,
  2009)4.13
            
            Subordinated
      Convertible Promissory Note dated April 1, 2009 held by Welland,
      Ltd.  (which supersedes documents 4.7 and 4.11) (incorporated by
      reference to Exhibit 4.13 to the Company’s Annual Report on Form 10-K
      filed with the Securities and Exchange Commission on March 31,
      2009)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 Exhibit 14.1 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 Exhibit 21.1 to the
      Company’s Annual Report on Form 10-K filed with the Securities and
      Exchange Commission on March 31,
2006)




21




23.1
            
            Consent
      of Holtz Rubenstein Reminick LLP Independent Registered Public Accounting
      Firm31.1
            
            Certification
      of Chief Executive Officer pursuant to Section 302 of the
      Sarbanes-Oxley Act of 200231.2
            
            Certification
      of Chief Financial Officer pursuant to Section 302 of the
      Sarbanes-Oxley Act of 200232.1
            
            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
      200232.2
            
            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




22







SIGNATURES




Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.





PHOTONIC
      PRODUCTS GROUP, INC.By:
            /s/
      Joseph J. RutherfordJoseph
      J. RutherfordChief
      Executive OfficerDated:
      March 31, 2010







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




Signature
            
            Title
            
            Date/s/
      Jan M. Winston
            
            Chairman
      of the Board
            
            March
      31, 2010Jan
      M. Winston
            
            of
      Directors/s/
      Luke P. LaValle, Jr.
            
            Director
            
            March
      31, 2010Luke
      P. LaValle, Jr./s/
      Thomas H. Lenagh
            
            Director
            
            March
      31, 2010Thomas
      H. Lenagh/s/
      Dennis G. Romano
            
            Director
            
            March
      31, 2010Dennis
      G. Romano/s/
      N.E. Rick Strandlund
            
            Director
            
            March
      31, 2010N.E.
      Rick Strandlund/s/
      Joseph J. Rutherford
            
            President,
      Chief Executive Officer
            
            March
      31, 2010Joseph
      J. Rutherford
            
            and
      Director/s/
      William J. Foote
            
            Chief
      Financial Officer, Secretary and
            
            March
      31, 2010William
      J. Foote
            
            Treasurer




23




PHOTONIC PRODUCTS GROUP,
INC. AND SUBSIDIARIES





INDEX TO THE CONSOLIDATED
FINANCIAL STATEMENTS





THREE YEARS ENDED DECEMBER
31, 2009





CONTENTS




PageReport
      of Independent Registered Public Accounting Firm
            
            
            25Consolidated
      balance sheets as of December 31, 2009 and 2008
            
            
            26Consolidated
      statements of operations for each of the three years in the period ended
      December 31, 2009
            
            
            27Consolidated
      statements of shareholders’ equity for each of the three years in the
      period ended December 31, 2009
            
            
            28Consolidated
      statements of cash flows for each of the three years in the period ended
      December 31, 2009
            
            
            29Notes
      to consolidated financial statements
            
            
            30-43Schedule
      II – Valuation and Qualifying Accounts
            
            
            44




24




Report
of Independent Registered Public Accounting Firm
 
 
 Board of
Directors and Shareholders
 Photonic
Products Group, Inc. and Subsidiaries
 Northvale,
New Jersey




We have
audited the accompanying consolidated balance sheets of Photonic Products Group,
Inc. and Subsidiaries as of December 31, 2009 and 2008, and the related
consolidated statements of operations, shareholders' equity and cash flows for
each of the three years in the period ended December 31, 2009. We have also
audited the schedule listed in Item 15(a)(2) of this Form 10-K for the years
ended December 31, 2009, 2008 and 2007. These consolidated financial statements
and financial statement schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements and financial statement schedule based on our
audits.





We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audits to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. The Company
is not required to have, nor were we engaged to perform, an audit of its
internal control over financial reporting. Our audits included consideration of
internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Company's internal control
over financial reporting.  Accordingly, we express no such opinion. An
audit includes examining on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements.  An audit also
includes assessing the accounting principles used and significant estimates made
by management, as well as, evaluating the overall consolidated financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.





In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Photonic Products Group,
Inc. and Subsidiaries as of December 31, 2009 and 2008, and the results of their
operations and their cash flows for each of the three years in the
period ended December 31, 2009, in conformity with accounting principles
generally accepted in the United States of America. Also in our opinion, the
related financial statement schedule, when considered in relation to the basic
financial statements taken as a whole, presents fairly in all material respects
the information set forth therein.











/s/Holtz
Rubenstein Reminick LLP





New York,
New York


March 31,
2010





25




PHOTONIC
PRODUCTS GROUP, INC AND SUBSIDIARIES





CONSOLIDATED BALANCE
SHEETS





December
      31,2009
            
            
            2008AssetsCurrent
      assets:Cash
      and cash equivalents
            
            $
            4,069,310
            
            
            $
            2,672,087Certificates
      of deposit
            
            
            —
            
            
            
            800,000Accounts
      receivable (after allowance for doubtful accounts of $15,000 in 2009 and
      2008)
            
            
            1,927,672
            
            
            
            2,810,602Inventories,
      net
            
            
            2,265,973
            
            
            
            2,732,336Other
      current assets
            
            
            164,081
            
            
            
            188,084Total
      Current Assets
            
            
            8,427,036
            
            
            
            9,203,109Plant
      and equipment:Plant
      and equipment at cost
            
            
            14,604,728
            
            
            
            14,445,027Less:
      Accumulated depreciation and amortization
            
            
            (12,016,247
            )
            
            
            (11,139,771
            )Total
      plant and equipment
            
            
            2,588,481
            
            
            
            3,305,256Precious
      Metals
            
            
            157,443
            
            
            
            112,851Deferred
      Income Taxes
            
            
            408,000
            
            
            
            408,000Goodwill
            
            
            311,572
            
            
            
            1,869,646Intangible
      Assets, net of accumulated amortization
            
            
            673,016
            
            
            
            751,580Other
      Assets
            
            
            45,192
            
            
            
            81,707Total
      Assets
            
            $
            12,610,740
            
            
            $
            15,732,149Liabilities and
      Shareholders’ EquityCurrent
      Liabilities:Current
      portion of notes payable -other
            
            $
            9,000
            
            
            $
            136,892Accounts
      payable and accrued liabilities
            
            
            1,632,650
            
            
            
            2,160,665Customer
      advances
            
            
            346,429
            
            
            
            456,754Total
      Current Liabilities
            
            
            1,988,079
            
            
            
            2,754,311Related
      Party Convertible Notes Payable
            
            
            2,500,000
            
            
            
            2,500,000Notes
      Payable – Other, net of current portion
            
            
            344,946
            
            
            
            353,663Total
      Liabilities
            
            
            4,833,025
            
            
            
            5,607,974CommitmentsShareholders’
      equity:Common
      stock: $.01 par value; 60,000,000 authorized shares 11,443,347 issued
      at December 31, 2009 and 11,230,678 issued at December 31,
      2008
            
            
            114,433
            
            
            
            112,306Capital
      in excess of par value
            
            
            17,073,871
            
            
            
            16,622,466Accumulated
      deficit
            
            
            (9,395,639
            )
            
            
            (6,595,647
            )7,792,665
            
            
            
            10,139,125Less
      - Common stock in treasury, at cost (4,600 shares)
            
            
            (14,950
            )
            
            
            (14,950
            )Total
      Shareholders’ Equity
            
            
            7,777,715
            
            
            
            10,124,175Total
      Liabilities and Shareholders’ Equity
            
            $
            12,610,740
            
            
            $
            15,732,149








See notes
to consolidated financial statements




26





PHOTONIC
PRODUCTS GROUP, INC AND SUBSIDIARIES





CONSOLIDATED STATEMENTS OF
OPERATIONS





Years
      Ended December 31,2009
            
            
            2008
            
            
            2007RevenuesNet
      sales
            
            $
            11,051,127
            
            
            $
            16,301,209
            
            
            $
            15,099,878Cost
      and expensesCost
      of goods sold
            
            
            8,896,539
            
            
            
            11,486,620
            
            
            
            9,141,049Selling,
      general and administrative expense
            
            
            3,278,161
            
            
            
            3,857,805
            
            
            
            3,561,570Goodwill
      Impairment Charge
            
            
            1,558,074
            
            
            
            —
            
            
            
            —13,732,774
            
            
            
            15,344,425
            
            
            
            12,702,619Operating
      (loss) income
            
            
            (2,681,647
            )
            
            
            956,784
            
            
            
            2,397,259Other
      income (expense)Interest
      expense, net
            
            
            (130,387
            )
            
            
            (170,476
            )
            
            
            (261,327
            )Gain
      on sale of plant and equipment
            
            
            4,671
            
            
            
            9,113
            
            
            
            —Gain
      (loss) on sale of precious metals
            
            
            7,371
            
            
            
            —
            
            
            
            (5,851
            )(118,345
            )
            
            
            (161,363
            )
            
            
            (267,178
            )(Loss)
      income before income taxes and preferred stock dividends
            
            
            (2,799,992
            )
            
            
            795,421
            
            
            
            2,130,081Income
      tax benefit (provision)
            
            
            —
            
            
            
            303,000
            
            
            
            (250,000
            )Net
      (loss) income
            
            
            (2,799,992
            )
            
            
            1,098,421
            
            
            
            1,880,081Preferred
      stock dividends
            
            
            —
            
            
            
            —
            
            
            
            (238,167
            )Net
      (loss) income applicable to common shareholders
            
            $
            (2,799,992
            )
            
            $
            1,098,421
            
            
            $
            1,641,914Net
      (loss) income per share - basic
            
            $
            (0.25
            )
            
            $
            0.10
            
            
            $
            0.19Net
      (loss) income per share - diluted
            
            $
            (0.25
            )
            
            $
            0.08
            
            
            $
            0.13Weighted
      average shares outstanding - basic
            
            
            11,331,258
            
            
            
            10,902,061
            
            
            
            8,609,822Weighted
      average shares outstanding – diluted
            
            
            11,331,258
            
            
            
            15,619,304
            
            
            
            13,777,114





See notes
to consolidated financial statements




27





PHOTONIC PRODUCTS GROUP,
INC. AND SUBSIDIARIES





CONSOLIDATED STATEMENTS OF
SHAREHOLDERS’ EQUITY




Preferred
      Stock
                
                
                Preferred
      Stock
                
                
                Capital
      in
                
                
                
                
                
                
                
                
                TotalCommon
      Stock
                
                
                (Series
      A)
                
                
                (Series
      B)
                
                
                excess
      of
                
                
                
                
                
                Treasury
                
                
                Shareholders’Shares
                
                
                Amount
                
                
                Shares
                
                
                Amount
                
                
                Shares
                
                
                Amount
                
                
                par
      value
                
                
                Deficit
                
                
                Stock
                
                
                EquityBalance,
      January 1, 2007
                
                
                7,882,074
                
                
                $
                78,820
                
                
                
                500
                
                
                $
                500,000
                
                
                
                2,082
                
                
                $
                2,082,000
                
                
                $
                11,926,815
                
                
                $
                (9,335,982
                )
                
                $
                (14,950
                )
                
                $
                5,236,703401K
      contribution
                
                
                124,133
                
                
                
                1,241
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                165,453
                
                
                
                —
                
                
                
                —
                
                
                
                166,694Dividend
      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
                
                
                
                —
                
                
                
                —
                
                
                
                445,247Stock-based
      compensation expense
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                34,074
                
                
                
                —
                
                
                
                —
                
                
                
                34,074Common
      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
                
                
                
                —
                
                
                
                1,880,081Balance,
      December 31, 2007
                
                
                10,104,719
                
                
                
                101,046
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                15,320,771
                
                
                
                (7,694,068
                )
                
                
                (14,950
                )
                
                
                7,712,799401K
      contribution
                
                
                75,907
                
                
                
                759
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                159,422
                
                
                
                —
                
                
                
                —
                
                
                
                160,181Common
      stock issued on exercise of options
                
                
                185,100
                
                
                
                1,851
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                254,919
                
                
                
                —
                
                
                
                —
                
                
                
                256,770Common
      stock issued on conversion of warrants
                
                
                864,952
                
                
                
                8,650
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                798,937
                
                
                
                —
                
                
                
                —
                
                
                
                807,587Stock-based
      compensation expense
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                88,417
                
                
                
                —
                
                
                
                —
                
                
                
                88,417Net
      income for the year
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                1,098,421
                
                
                
                —
                
                
                
                1,098,421Balance,
      December 31, 2008
                
                
                11,230,678
                
                
                
                112,306
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                16,622,466
                
                
                
                (6,595,647
                )
                
                
                (14,950
                )
                
                
                10,124,175401K
      contribution
                
                
                66,469
                
                
                
                664
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                178,404
                
                
                
                —
                
                
                
                —
                
                
                
                179,068Common
      stock issued on exercise of options
                
                
                84,500
                
                
                
                845
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                95,730
                
                
                
                —
                
                
                
                —
                
                
                
                96,575Common
      stock issued on conversion of warrants
                
                
                50,000
                
                
                
                500
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                67,000
                
                
                
                —
                
                
                
                —
                
                
                
                67,500Common
      stock issued on vesting of stock grants
                
                
                11,700
                
                
                
                118
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                (2,679
                )
                
                
                —
                
                
                
                —
                
                
                
                (2,561
                )Stock-based
      compensation expense
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                112,950
                
                
                
                —
                
                
                
                —
                
                
                
                112,950Net
      loss for the year
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                (2,799,992
                )
                
                
                —
                
                
                
                (2,799,992
                )Balance,
      December 31, 2009
                
                
                11,443,347
                
                
                $
                114,433
                
                
                
                —
                
                
                $
                —
                
                
                
                —
                
                
                $
                —
                
                
                $
                17,073,871
                
                
                $
                (9,395,639
                )
                
                $
                (14,950
                )
                
                $
                7,777,715




See notes
to consolidated financial statements




28




PHOTONIC
PRODUCTS GROUP, INC AND SUBSIDIARIES





CONSOLIDATED STATEMENTS OF CASH
FLOWS




Years
      Ended December 31,2009
              
              
              2008
              
              
              2007Cash
      flows from operating activities:Net
      (loss) income
              
              $
              (2,799,992
              )
              
              $
              1,098,421
              
              
              $
              1,880,081Adjustments
      to reconcile net (loss) income to net cash provided by operating
      activities:Depreciation
      and amortization
              
              
              1,008,310
              
              
              
              1,059,741
              
              
              
              1,119,887Goodwill
      impairment charge
              
              
              1,558,074
              
              
              
              —
              
              
              
              —401K
      common stock contribution
              
              
              179,068
              
              
              
              160,180
              
              
              
              166,694Deferred
      income taxes
              
              
              —
              
              
              
              (408,000
              )
              
              
              —Gain
      on sale of plant and equipment
              
              
              (4,671
              )
              
              
              (9,113
              )
              
              
              —(Gain)
      loss on sale of precious metal
              
              
              (7,371
              )
              
              
              —
              
              
              
              5,851Stock-based
      compensation expense
              
              
              112,950
              
              
              
              88,417
              
              
              
              34,074Change
      in inventory reserve
              
              
              94,628
              
              
              
              302,511
              
              
              
              163,391Changes
      in operating assets and liabilities:Accounts
      receivable
              
              
              882,930
              
              
              
              (628,743
              )
              
              
              214,627Inventories
              
              
              371,735
              
              
              
              (103,767
              )
              
              
              (758,438
              )Other
      current assets
              
              
              24,003
              
              
              
              (24,019
              )
              
              
              12,522Other
      assets
              
              
              34,107
              
              
              
              7,865
              
              
              
              32,854Accounts
      payable and accrued liabilities
              
              
              (528,015
              )
              
              
              (581,301
              )
              
              
              246,568Customer
      advances
              
              
              (110,325
              )
              
              
              (413,796
              )
              
              
              (117,413
              )Total
      adjustments
              
              
              3,615,423
              
              
              
              (550,025
              )
              
              
              1,120,617Net
      cash provided by operating activities
              
              
              815,431
              
              
              
              548,396
              
              
              
              3,000,698Cash
      flows from investing activities:Proceeds
      (purchase) of certificates of deposit
              
              
              800,000
              
              
              
              (800,000
              )
              
              
              —Purchase
      of plant and equipment
              
              
              (210,563
              )
              
              
              (784,534
              )
              
              
              (246,518
              )Purchase
      of precious metals
              
              
              (53,538
              )
              
              
              —
              
              
              
              —Proceeds
      from sale of plant and equipment
              
              
              4,671
              
              
              
              10,000
              
              
              
              —Proceeds
      from sale of precious metals
              
              
              16,317
              
              
              
              —
              
              
              
              12,030Net
      cash provided by (used in) investing activities
              
              
              556,887
              
              
              
              (1,574,534
              )
              
              
              (234,488
              )Cash
      flows from financing activities:Net
      proceeds from issuance of common stock
              
              
              161,514
              
              
              
              1,064,357
              
              
              
              445,247Redemption
      of Series B Preferred shares
              
              
              —
              
              
              
              —
              
              
              
              (50,000
              )Principal
      payments of notes payable-other
              
              
              (136,609
              )
              
              
              (14,989
              )
              
              
              (647,215
              )Principal
      payments of convertible promissory notes
              
              
              —
              
              
              
              (1,700,000
              )
              
              
              (1,000,000
              )Principal
      payments of capital lease obligations
              
              
              —
              
              
              
              (47,088
              )
              
              
              (196,349
              )Net
      cash provided by (used in) financing activities
              
              
              24,905
              
              
              
              (697,720
              )
              
              
              (1,448,317
              )Net
      increase (decrease) in cash and cash equivalents
              
              
              1,397,223
              
              
              
              (1,723,859
              )
              
              
              1,317,893Cash
      and cash equivalents at beginning of the year
              
              
              2,672,087
              
              
              
              4,395,945
              
              
              
              3,078,052Cash
      and cash equivalents at end of the year
              
              $
              4,069,310
              
              
              $
              2,672,087
              
              
              $
              4,395,945Supplemental
      Disclosure of Cash Flow Information:Interest
      paid
              
              $
              19,000
              
              
              $
              508,000
              
              
              $
              298,000Income
      taxes (refund) paid
              
              $
              (8,000
              )
              
              $
              408,000
              
              
              $
              69,000





See notes
to consolidated financial statements




29





PHOTONIC PRODUCTS GROUP,
INC. AND SUBSIDIARIES





NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS





THREE YEARS ENDED DECEMBER
31, 2009




1.           Nature of
Business and Summary of Significant Accounting Policies and
Estimates




a.
            Nature of
      Operations




Photonic
Products Group, Inc. and Subsidiaries (the “Company”) is a manufacturer of
crystals, crystal devices, electro-optic and optical components, and
sophisticated laser subsystems and instruments.  The Company’s
principal customers include commercial instrumentation companies and OEM laser
manufacturers, research laboratories, government agencies, and defense
contractors.  The Company’s products are sold domestically using its
own sales staff, and in major overseas markets, principally Europe and the Far
East, using independent sales agents.




b.
            Principles of
      consolidation




The
accompanying consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries.  Upon consolidation, all
inter-company accounts and transactions are eliminated.




c.
            Use of
      estimates




The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
certain estimates and assumptions.  These estimates and assumptions
affect the reported amounts in the financial statements and accompanying
notes.  Actual results could differ from these estimates.




d.
            Cash and cash
      equivalents




The
Company considers cash-on-hand and highly liquid investments with original
maturity dates of three months or less at the date of purchase to be cash and
cash equivalents. Investments with original maturity dates exceeding three
months are separately disclosed on the Consolidated Balance Sheets and as cash
flows from investing activities on the Consolidated Statements of Cash
Flows.




e.
            Accounts
      receivable




Accounts
receivable are carried at net realizable value, net of write-offs and
allowances.  The Company establishes an allowance for doubtful
accounts based on estimates as to the collectibility of accounts
receivable.  Management specifically analyzes past-due accounts
receivable balances and, additionally, considers bad debt history, customer
credit-worthiness, current economic trends and changes in customer payment terms
when evaluating the adequacy of the allowance for doubtful
accounts.  Uncollectible accounts receivable are written-off when it
is determined that the balance will not be collected.




f.
            Inventories




Inventories
are stated at the lower of cost (first-in, first-out method) or
market.  Cost of manufactured goods includes material, labor and
overhead.




The
Company records a reserve for slow moving inventory as a charge against earnings
for all products identified as surplus, slow moving or
discontinued.  Excess work-in-process costs are charged against
earnings whenever estimated costs-of-completion exceed unbilled
revenues.




g.
            Plant and
      Equipment




Plant and
equipment are depreciated using the straight-line method over the estimated
useful lives of the related assets which range between 5 and 7
years.  Amortization of leasehold improvements is computed using the
straight-line method over the lesser of 10 years or the remaining term of the
lease including optional renewal periods, as appropriate, when failure to renew
the lease imposes an economic penalty on the Company in such an amount that
renewal appears to be probable, as that term is defined in paragraph 840-10-20
of the FASB Accounting Standards Codification.  In determining the
amount of the economic penalty, management considers such factors as (i) the
costs associated with the physical relocation of the offices, manufacturing
facility and equipment, (ii) the economic risks associated with business
interruption and potential customer loss during relocation and transition to new
premises (iii) the significant costs of leasehold improvements required at any
new location to custom fit our specific manufacturing requirements, and (iv) the
economic loss associated with abandonment of existing leasehold improvements or
other assets whose value would be impaired by vacating the
facility.




30




Maintenance
and repairs of property and equipment are charged to operations and 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 a gain or loss is recorded.




h.
            Income
      taxes




The
Company accounts for income taxes under FASB ASC 740, Income Taxes(“ASC 740”).
Deferred taxes are provided on the asset and liability method whereby deferred
tax assets are recognized for deductible temporary differences and operating
loss and tax credit carry forwards and deferred tax liabilities are recognized
for taxable temporary differences. Temporary differences are the differences
between the amounts of assets and liabilities recorded for income tax and
financial reporting purposes. Deferred tax assets are reduced by a valuation
allowance when, in the opinion of management, it is more likely than not that
some portion or all of the deferred tax assets will not be realized. Deferred
tax assets and liabilities are adjusted for the effects of changes in tax laws
and rates on the date of enactment.


The
Company recognizes the financial statement benefit of an uncertain tax position
only after determining that the relevant tax authority would more likely than
not sustain the position. For tax positions meeting the more likely than not
threshold, the amount recognized in the financial statements is the largest
benefit that has a greater than 50 percent likelihood of being realized
upon ultimate settlement with the relevant tax authority. The Company adopted
the provisions of the current accounting guidance on January 1, 2007, as a
result of which, the Company did not recognize a material adjustment to the
liability for unrecognized income tax benefits.





The
Company classifies interest and penalties related to income taxes as income tax
expense in its Consolidated Financial Statements.




i.
            Impairment of
      long-lived assets




Long-lived
assets, such as property, plant and equipment, and purchased intangibles with
finite lives, which are subject to amortization, are reviewed for impairment
whenever events or changes in circumstances indicate that the carrying amount of
an asset may not be recoverable.  Recoverability of assets to be held
and used is measured by a comparison of the carrying amount of an asset to
estimate undiscounted future cash flows expected to be generated by the
asset.  If the carrying amount of an asset exceeds its estimated
future cash flows, an impairment charge is recognized by the amount by which the
carrying amount of the asset exceeds the fair value of the
assets.  Long-lived assets held for sale would be separately presented
in the balance sheet and reported at the lower of the carrying amount or fair
value less costs to sell and would no longer be
depreciated.




j.
            Goodwill and
      intangible assets with indefinite
lives




Goodwill
represents the excess of purchase price and related costs over the fair value
assigned to the net tangible and identifiable assets of business
acquisitions.  Goodwill and intangible assets with indefinite lives
are not amortized.  The Company tests for impairment of goodwill and
intangible assets with indefinite lives on an annual basis in December of each
year, or more frequently whenever events occur or circumstances exist that
indicates that impairment may exist.




k.
            Stock-based
      compensation




Stock
based compensation expense is estimated at the grant date based on the fair
value of the award.  The Company estimates the fair value of stock
options granted using the Black-Scholes option pricing model.  The
fair value of restricted stock units granted is estimated based on the closing
market price of the Company’s common stock on the date of the
grant.  The fair value of these awards, adjusted for estimated
forfeitures, is amortized over the requisite service period of the award, which
is generally the vesting period.




l.
            Revenue
      recognition




The
Company records revenue when all four of the following criteria are
met:




·
            persuasive
      evidence of an arrangement exists;




·
            delivery
      has occurred or services have been
rendered;




·
            the
      sales price is fixed or determinable;
and




·
            collectability
      is reasonably assured.




Losses on
contracts in progress are recorded when identified.




m.
            Internal research and
      development costs




Internal
research and development costs are charged to expense as incurred.




31




n.
            Precious
      metals




Precious
metals consist of various fixtures used in the high temperature crystal growth
manufacturing process.  They are valued at the lower of cost or net
realizable value, on a first-in, first-out basis.




o.
            Advertising
      costs




Advertising
costs included in selling, general and administrative expenses were $32,000,
$26,000 and $29,000 for the years ended December 31, 2009, 2008 and 2007,
respectively.  Advertising costs are charged to expense when the
related services are incurred or related events take place.




p.           Statement of cash flows and
non-cash transactions




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




In 2007,
non-cash financing transactions resulting from the exchange of Series A
convertible preferred stock in exchange for common shares amounted to $500,000
and the exchange of Series B convertible preferred stock for common stock
amounted to $2,032,000.




q.           Concentrations and credit
risk




The
Company may invest its excess cash in certificates of deposits with major
financial institutions.  Generally, the investments range over a
variety of maturity dates usually, within three to nine months, and therefore,
are subject to little risk. The Company has not experienced losses related to
these investments.




The
concentration of credit risk in the Company’s accounts receivable is mitigated
by the Company’s credit evaluation process, familiarity with its small base of
recurring customers and reasonably short collection terms and the geographical
dispersion of revenue.  The Company generally does not require
collateral but, in some cases, the Company negotiates cash advances prior to the
undertaking of the work.  These cash advances are recorded as current
liabilities on the balance sheet until corresponding revenues are
realized.




The
Company utilizes many relatively uncommon materials and compounds to manufacture
its products and relies on outside vendors for certain manufacturing
services.  Therefore, any failure by its suppliers to deliver
materials of an adequate quality and quantity could have an adverse effect on
the Company’s ability to meet the commitments of its customers.




For the
year ended December 31, 2009, the Company’s top five customer accounts in the
aggregate represented approximately 52% of total revenues, and three customers
accounted for 41% of revenues.  These three customers each represented
approximately 18%, 14% and 10% of sales, respectively.  Since the
Company is a supplier of custom manufactured components to OEM customers, the
relative size and identity of the largest customer accounts changes somewhat
from year to year.  In the short term, the loss of any one of these
large customer accounts could have a material adverse effect on business,
results of operations, and financial condition.




r.           Fair value
measurements




Effective
January 1, 2008, the Company adopted new accounting guidance for all
financial assets and liabilities and for non-financial assets and liabilities
that are recognized or disclosed in the financial statements at fair value on a
recurring basis. Additionally, effective January 1, 2009, the Company
adopted new accounting guidance for non-financial assets and liabilities that
are recognized or disclosed in the financial statements at fair value on a
non-recurring basis. Although such adoption did not have a material impact on
the Company’s Consolidated Financial Statements for 2009 or 2008, the
pronouncement may impact the Company’s accounting for future business
combinations, impairment charges and restructuring charges.




This new
accounting guidance established a framework for measuring fair value and
expanded related disclosures. The framework requires fair value to be determined
based on the exchange price that would be received for an asset, or paid to
transfer a liability (an exit price), in the principal or most advantageous
market for the asset or liability in an orderly transaction between market
participants.




The
valuation techniques required are based upon observable and unobservable inputs.
Observable inputs reflect market data obtained from independent sources, while
unobservable inputs reflect the Company’s market assumptions. The accounting
guidance requires the following fair value hierarchy:




·Level
      1 - Quoted prices (unadjusted) for identical assets and liabilities in
      active markets that the Company has the ability to access at the
      measurement date.





32





·Level
      2 - Quoted prices for similar assets and liabilities in active markets;
      quoted prices for identical or similar assets and liabilities in markets
      that are not active; and inputs other than quoted prices that are
      observable for the asset or liability, including interest rates, yield
      curves and credit risks, or inputs that are derived principally from or
      corroborated by observable market data through
  correlation.







·Level
      3 - Values determined by models, significant inputs to which are
      unobservable and are primarily based on internally derived assumptions
      regarding the timing and amount of expected cash
  flows.




Long-lived
assets, including goodwill and other intangible assets, may be measured at fair
value if such assets are held for sale or if there is a determination that the
asset is impaired. Managements’ determination of fair value, although highly
subjective, is based on the best information available, including internal
projections of future earnings and cash flows discounted at an appropriate
interest rate, quoted market prices when available, market prices for similar
assets, broker quotes and independent appraisals, as appropriate.




s.
            New Accounting
      Guidance




In
May 2009, the FASB issued new guidance on management’s assessment of subsequent
events, which establishes the accounting and disclosure of events that occur
after the balance sheet date but before financial statements are issued or are
available to be issued. It required the disclosure of the date through which an
entity evaluated subsequent events and the basis for that date. In February
2010, the FASB issued an update to this guidance which requires that SEC filers
evaluate subsequent events through the date financial statements are available
to be issued, but removed the requirement to disclose that date.  The
updated guidance was effective upon issuance, and did not have a material impact
on the Company’s consolidated financial statements




In
October 2009, the Financial Accounting Standards Board (“FASB”) issued
accounting guidance that changes the accounting model for revenue arrangements
that include both tangible products and software elements that function together
to deliver the product’s essential functionality.  The accounting
guidance more closely reflects the underlying economics of these
transactions.  The Company is evaluating the impact of adopting this
guidance which is effective beginning on January 1, 2011.




In
October 2009, the FASB issued accounting guidance that sets forth the
requirements that must be met for a company to recognize revenue from the sale
of a delivered item that is part of a multiple-element arrangement when other
items have not yet been delivered. The new guidance will be effective for the
Company prospectively for revenue arrangements entered into or materially
modified on or after January 1, 2011.  Early adoption of this standard
is permitted.  The Company is still assessing the potential impact of
adopting this new guidance.




In August
2009, the FASB issued accounting guidance which provides clarification that, in
the absence of a quoted price for a liability, companies may apply methods that
use the quoted price of an investment traded as an asset or other valuation
techniques consistent with the fair-value measurement principle.  The
Company does not expect this accounting guidance, which is effective for us
beginning October 1, 2009, to have a material impact on its consolidated
financial position, results of operations or cash flows.




In June
2009, the FASB issued authoritative guidance to establish the FASB Accounting
Standards Codification (the “Codification”) as the source of authoritative
accounting principles and the framework for selecting the principles used in the
preparation of financial statements of non-governmental entities that are
presented in conformity with generally accepted accounting principles in the
United States.  The Codification, which changes the referencing of
financial standards, supersedes current authoritative guidance and is effective
for interim or annual financial periods ending after September 15, 2009.
The Codification is not intended to change or alter existing GAAP and it is not
expected to result in a change in accounting practice for the Company. The
Company has updated its references to reflect the Codification.




In April
2009, the FASB issued additional accounting guidance for other-than-temporary
impairments to improve the consistency in the timing of impairment recognition,
as well as provide greater clarity to investors about credit and non-credit
components of impaired debt securities that are not expected to be
sold.  The adoption of this accounting guidance did not have a
material impact on our consolidated financial position, results of operations or
cash flows.




In April
2009, the FASB issued accounting guidance which primarily addresses the
measurement of fair value of financial assets and liabilities when there is no
active market or where the price inputs being used could be indicative of
distressed sales.  The adoption of this accounting guidance did not
have a material impact on the Company’s consolidated financial position, results
of operations or cash flows.




2.         Inventories,
net




Inventories
are comprised of the following and are shown net of inventory reserves of
$1,410,000 for 2009 and $1,315,000 for 2008:




33







December
      31,2009
            
            
            2008(In
      thousands)Raw
      materials
            
            $
            1,066
            
            
            $
            1,169Work
      in process, including manufactured parts and components
            
            
            654
            
            
            
            1,117Finished
      goods
            
            
            546
            
            
            
            446$
            2,266
            
            
            $
            2,732




3.         Property
and Equipment




Property
and equipment are comprised of the following:





December
      31,2009
            
            
            2008(In
      thousands)Office
      and computer equipment
            
            $
            1,330
            
            
            $
            1,274Machinery
      and equipment
            
            
            11,230
            
            
            
            11,127Leasehold
      improvements
            
            
            2,044
            
            
            
            2,04414,604
            
            
            
            14,445Less
      accumulated depreciation and amortization
            
            
            (12,016
            )
            
            
            (11,140
            )$
            2,588
            
            
            $
            3,305




Depreciation
expense (including amortization expense on software) recorded by the Company
totaled $1,006,000, $1,060,000 and $1,120,000 for 2009, 2008 and 2007,
respectively.




4.         Goodwill




The
following table summarizes goodwill balances at December 31, 2009 and 2008 and
changes in the carrying amount of goodwill during the year ended December 31,
2009:




Amount
              (in
      thousands)Balance
      at December 31, 2008
            
            
            $
            1,870Impairment
      charge
            
            
            
            (1,558
            )Balance
      at December 31, 2009
            `
            
            $
            312




During
2009, the Company experienced declines in sales and profitability, and economic
and industry conditions remained uncertain.  As a result, the Company
tested for impairment of goodwill for its two reporting units which the Company
has identified as its two geographical operating units in Florida and New
Jersey. In making this assessment, management considered a number of factors
which include, among others, historical and current operating results and cash
flows, current projections of future financial results and cash flows, business
plans, current and projected economic conditions and industry
trends.  There are inherent uncertainties associated with these
factors and significant judgment is involved in evaluating each.




The
testing for goodwill impairment is a two-step process.  The first step
compares the fair value of each reporting unit to its carrying
value.  If the fair value of the reporting unit exceeds its carrying
amount, goodwill is not considered to be impaired as of the measurement date.
Otherwise, if the carrying value exceeds the fair value, a second step must be
followed to determine the level of impairment.  In establishing the
fair value of the reporting unit, the Company uses both a market based approach
and an income based approach as part of its valuation
methodology.  Since quoted market prices in an active market are not
separately available for the Company’s reporting units, the market based method
estimates the fair value of the reporting unit utilizing an industry multiple of
projected earnings before interest taxes, depreciation and amortization
(“EBITDA”).  Due to the small capitalization value of the Company, the
low trading volume of its stock and the niche market served by its products, the
application of available industry comparables in establishing fair value
requires a high degree of management judgment, and the actual fair value that
could be realized could differ from those used to evaluate the impairment of
goodwill. The income approach determines fair value based on the estimated
discounted cash flows that each reporting unit is expected to generate in the
future. For each method, the sensitivity of key assumptions are tested by using
a range of estimates and the results of each method are corroborated as part of
management’s determination of fair value.




The
second step of the testing process involves calculating the fair value of the
individual assets and liabilities of the reporting unit and measuring the
implied fair value of the goodwill against its carrying value to determine
whether an adjustment to the carrying value of goodwill is required. This
process also has inherent risks and uncertainties and requires significant
management judgment.




Upon
completion of the first step, the Company concluded that the carrying value of
its Florida reporting unit exceeded its fair value and a step two analysis was
required.  The step-two analysis resulted in the Company recording an
impairment charge against the full carrying value of goodwill of its Florida
reporting unit, in the amount of $1,558,000. The Company has determined that the
carrying value of its goodwill in connection with its acquisitions of its New
Jersey reporting unit in the amount of $312,000 is not impaired as of December
31, 2009.




34




The
Company also evaluated its property and equipment and intangible assets for
impairment.  Based on the results of the tests performed, management
concluded that that an impairment of its long-lived assets is not required at
December 31, 2009.




5.         Intangible
Assets




Intangible
assets include acquired intangible assets with finite lives, consisting
principally of non-contractual customer relationships, completed technology and
trademarks.  Intangible assets 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
occurred indicating the carrying amount of intangible assets may not be
recoverable.  When factors indicate that intangible assets should be
evaluated for possible impairment, the Company uses an estimate of the
associated undiscounted future cash flows compared to the related carrying
amount of assets to determine if an impairment loss should be
recognized.  An impairment loss is recognized to the extent that the
carrying amount exceeds the asset’s fair value.




The gross
carrying amount of intangible assets as of December 31, 2009 and 2008 was
$1,100,000, respectively.  Accumulated amortization related to
intangible assets was $427,000 as of December 31, 2009 and $348,000 as of
December 31, 2008.  Amortization expense was approximately $79,000 for
the years ended December 31, 2009 and December 31, 2008,
respectively.  Aggregate amortization for the five succeeding years
from January 1, 2010 through December 31, 2014 is expected to be approximately
$395,000, accumulating at the rate of $79,000 per year.  The weighted
average remaining life of the Company’s intangible assets is approximately 8.5
years.




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





At
      December 31, 2009Gross
      Carrying
              Amount
            
            
            Accumulated
              Amortization
            
            
            Net
      Carrying
              Amount(In
      thousands)Customer-related
            
            $
            550
            
            
            $
            (213
            )
            
            $
            337Completed
      technology
            
            
            363
            
            
            
            (141
            )
            
            
            222Trademarks
            
            
            187
            
            
            
            (73
            )
            
            
            114Total
            
            $
            1,100
            
            
            $
            (427
            )
            
            $
            673





At
      December 31, 2008Gross
      Carrying
              Amount
            
            
            Accumulated
              Amortization
            
            
            Net
      Carrying
              Amount(In
      thousands)Customer-related
            
            $
            550
            
            
            $
            (174
            )
            
            $
            376Completed
      technology
            
            
            363
            
            
            
            (115
            )
            
            
            248Trademarks
            
            
            187
            
            
            
            (59
            )
            
            
            128Total
            
            $
            1,100
            
            
            $
            (348
            )
            
            $
            752




6.         Related Party
Transactions




In March
2009, the maturity date of a $1,500,000 Subordinated Convertible Promissory Note
to Clarex Limited (“Clarex”) was extended to April 1, 2011.  The note
bears interest at 6% and was originally due in January 2006, extended to
December 31, 2008 and subsequently extended again to April 1,
2009.  Interest accrues yearly and along with principal may be
converted into securities of the Company as follows:  The Note is
convertible in the aggregate into 1,500,000 Units with each unit consisting of
one share of common stock and one warrant.  The warrants had an
original expiration date of August 2009 and each warrant allowed the holder to
acquire 0.75 shares of common stock at a price of $1.35 per
share.  The expiration date of the warrants under the conversion terms
has been extended to April 1, 2014.  Clarex is a major shareholder and
debt holder.




In
March 2009, the maturity date of a $1,000,000 Subordinated Convertible
Promissory Note bearing interest at 6% was extended to April 1,
2011.  The note was originally due in January 2006 and was
subsequently extended to April 1, 2009.  Interest accrues yearly and
along with principal may be converted into securities of the Company as
follows:  The Note is convertible in the aggregate into 1,000,000
Units with each unit consisting of one share of common stock and one
warrant.  The warrants had an original expiration date of August 2009
and each warrant allowed the holder to acquire 0.75 shares of common stock at a
price of $1.35 per share.  The expiration date of the warrants under
the conversion terms has been extended to April 1, 2014.  The holder
of the note is an affiliate of Clarex.




35




Both
these extensions of Subordinated Convertible Promissory Notes had no impact on
the Company’s financial statements.




In May,
2008, Clarex exercised 200,000 warrants set to expire on May 18, 2008 for
$216,000 and the Company issued 200,000 shares of its common stock.




In March,
2008, Clarex elected to exercise the 200,000 warrants expiring on March 31, 2008
and the Company issued 200,000 shares of its commons stock for proceeds of
$85,000.




In
January 2008, the Company repaid in full a $1,700,000 Secured Promissory Note
held by Clarex, including accrued interest of $477,444.




7.         Notes
Payable - Other




The
remaining $125,000 balance of a $175,000 Note originally issued as part of the
purchase of MRC on October 16, 2004, to the sole shareholder, along with accrued
interest of $4,212 was paid in May 2009, prior to the maturity
date.  Three additional notes, totaling $295,725, were assumed from
note holders of MRC subsequent to its acquisition.  The notes had
interest rates ranging from 6.0% to 10.5% and were payable from 2 to 4
years.  In 2005, two of the notes totaling $199,525 were exchanged for
two notes totaling $125,000, 80,000 shares of common stock of the Company and
60,000 warrants exercisable for 60,000 shares of common stock at $1.35 per
share.  The warrants expire in 2010.  Two of the three
additional notes were paid in full in 2006 and the remaining note was paid in
May 2009. In addition, a note payable to the U.S. Small Business Administration
was also assumed by the Company.  The remaining  note has a
balance of $353,946 as of December 31, 2009, bears interest at the rate of 4.0%
and is due in 2032.




Notes
payable - Other consist of the following:





December
      31,2009
            
            
            2008Notes
      payable - Other, payable in monthly installments of approximately $1,925,
      and bearing an interest rate of 4.0% and expiring in April
      2032.
            
            $
            354,000
            
            
            $
            491,000Less
      current portion
            
            
            (9,000
            )
            
            
            (137,000
            )Long-term
      debt, excluding current portion
            
            $
            345,000
            
            
            $
            354,000




Notes
payable other, mature as follows:





Year
      ending December 31:2010
            
            $
            9,0002011
            
            
            9,4002012
            
            
            9,8002013
            
            
            10,2002014
            
            
            10,600Thereafter
            
            
            305,000$
            354,000







36




8.         Accounts
Payable and Accrued Expenses




Accounts
payable and accrued expenses are comprised of the following:





December
      31,2009
            
            
            2008(in
      thousands)Trade
      accounts payable and accrued purchases
            
            $
            328
            
            
            $
            575Accrued
      vacation
            
            
            205
            
            
            
            389Accrued
      payroll
            
            
            63
            
            
            
            150Accrued
      interest
            
            
            975
            
            
            
            827Accrued
      payroll tax payable
            
            
            8
            
            
            
            9Accrued
      bonus
            
            
            —
            
            
            
            81State
      and Federal income tax (prepaid) payable
            
            
            (107
            )
            
            
            (92
            )Accrued
      401K common stock contribution
            
            
            155
            
            
            
            172Accrued
      expenses – other
            
            
            6
            
            
            
            50$
            1,633
            
            
            $
            2,161




9.         Income
Taxes




The
Company’s income tax benefit (provision) consists of the following:





Years
      EndedDecember
      31,2009
            
            
            2008
            
            
            2007Current:Federal
      provision
            
            $
            —
            
            
            $
            (5,000
            )
            
            $
            (50,000
            )State
      provision
            
            
            —
            
            
            
            (
      100,000
            )
            
            
            (200,000
            )—
            
            
            
            (105,000
            )
            
            
            (250,000
            )Deferred:Federal
      tax benefit
            
            
            —
            
            
            
            408,000
            
            
            
            —State
            
            
            —
            
            
            
            —
            
            
            
            ——
            
            
            
            408,000
            
            
            
            —Total
            
            $
            —
            
            
            $
            303,000
            
            
            $
            (250,000
            )




A
reconciliation of the income tax provision computed at the statutory Federal
income tax rate to our effective income tax rate follows (in
percent):





Year
      s EndedDecember
      31,2009
            
            
            2008
            
            
            2007Federal
      statutory rate
            
            
            (34.0
            )
      %
            
            
            34.0
            %
            
            
            34.0
            %State
      statutory rate
            
            
            (
      8.0
            )
            
            
            12.6
            
            
            
            9.4Net
      operating loss carryforward - Federal
            
            
            —
            
            
            
            (34.0
            )
            
            
            (34.0
            )Federal
      AMT
            
            
            —
            
            
            
            0.6
            
            
            
            2.3Expected
      tax benefit of net operating loss carryforward
            
            
            —
            
            
            
            (51.3
            )
            
            
            —Goodwill
      impairment charge
            
            
            22.0
            
            
            
            —
            
            
            
            —Change
      in Valuation Allowance
            
            
            25.6
            
            
            
            —
            
            
            
            —Prior
      year adjustments
            
            
            (
      5.6
            )
            
            
            —
            
            
            
            —Effective
      income tax rate
            
            
            —
            %
            
            
            (38.1
            )
      %
            
            
            11.7
            %




37




At
December 31, 2009, the Company has estimated Federal and State net operating
loss carry forwards of approximately $5,824,000 and $1,406,000,
respectively.  These tax loss carry forwards expire at various dates
through 2029.




Internal
Revenue Code Section 382 places a limitation on the utilization of Federal net
operating loss and other credit carry forwards when an ownership change, as
defined by the tax law, occurs.  Generally, this occurs when a greater
than 50 percentage point change in ownership occurs.  Accordingly, the
actual utilization of the net operating loss and carryforwards for tax purposes
may be limited annually to a percentage (approximately 6%) of the fair market
value of the Company at the time of any such ownership change.  The
Company has not prepared an analysis of ownership changes but does not believe
that such limitations would apply to the Company.




Deferred
tax assets (liabilities) are comprised of the following:




December
      31,2009
            
            
            2008Inventory
      reserves
            
            $
            593,000
            
            
            $
            410,000Accrued
      vacation
            
            
            86,000
            
            
            
            133,000Account
      receivable reserves
            
            
            6,000
            
            
            
            —Depreciation
            
            
            86,000
            
            
            
            (280,000
            )Loss
      carry forwards
            
            
            2,086,000
            
            
            
            1,878,000Gross
      deferred tax assets
            
            
            2,857,000
            
            
            
            2,141,000Valuation
      allowance
            
            
            (2,449,000
            )
            
            
            (1,733,000
            )Net
      deferred tax asset
            
            $
            408,000
            
            
            $
            408,000




In
evaluating the Company’s ability to recover deferred tax assets in future
periods, management considers the available positive and negative factors,
including the Company’s recent operating results, the existence of cumulative
losses and near term forecasts of future taxable income that is consistent with
the plans and estimates management is using to manage the underlying
business.  As of December 31, 2009 and 2008, the Company has
recognized a deferred tax asset of $408,000 which we estimate will be
recoverable in future periods, net of a valuation allowance of
$2,449,000.




10.           Equity
Compensation Program and Stock-based Compensation




a.           2000 Equity Compensation
Program




The
Company’s 2000 Equity Compensation Program provides for grants of options, stock
appreciation rights and performance shares to employees, officers, directors,
and others who render services to the Company.  The program consists
of four plans including:  (i) the Incentive Equity Compensation
Program which provide for grants of “incentive stock options”, (ii) the
Supplemental Program which provide for grants of stock options to non-employees,
(iii) the SAR Program which allows the granting of stock appreciation rights
and, (iv) the Performance Share Program under which eligible participants may
receive stock awards, including restricted stock and restricted stock
units.  The plans are administered by the Compensation Committee of
the Board of Directors.  Under these plans, an aggregate of up to
6,000,000 shares of common stock may be granted.  The 2000 Equity
Compensation plan expires in August 2010. The Company’s Board of Directors has
approved a new plan covering 4,000,000 million shares, which is subject to
shareholder approval at the Company’s next annual meeting.




b.           Stock Option
Expense




The
Company's results for the years ended December 31, 2009, 2008 and 2007 include
stock-based compensation expense for stock option grants totaling $65,000,
$47,000 and $34,000, respectively.  Such amounts have been included in
the Consolidated Statements of Operations within cost of goods sold ($7,000 for
2009, $8,000 for 2008 and $8,000 for 2007), and selling, general and
administrative expenses ($58,000 for 2009, $39,000 for 2008 and $26,000 for
2007).




As of
December 31, 2009, 2008 and 2007, there were $311,300, $17,000 and $52,300 of
unrecognized compensation costs, net of estimated forfeitures, related to
non-vested stock options, which are expected to be recognized over a weighted
average period of approximately 3 years, 1.1 years and 2.1 years,
respectively.




The
weighted average estimated fair value of stock options granted in the two years
ended December 31, 2009 and 2007 was $1.22 and $1.47,
respectively.  The fair value of options at the date of grant was
estimated using the Black-Scholes option pricing model.  The expected
volatility is based upon historical 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 the contractual term of the option.




38




The
following range of weighted-average assumptions were used for to determine the
fair value of stock option grants during the years ended December 31, 2009 and
2007:





Years
      EndedDecember
      31,2009
            
            
            2008
            
            
            2007Dividend
      yield
            
            
            0.00
            %
            
            
            —
            %
            
            
            0.00
            %Volatility
            
            
            180
      - 232
            %
            
            
            —
            %
            
            
            144.9
            %Risk-free
      interest rate
            
            
            2.5
      - 3.45
            %
            
            
            —
            %
            
            
            4.7
            %Expected
      life
            
            10
      years
            
            
            
            —
            
            
            10
      years




The
Company did not issue any stock options during 2008.




c.           Stock Option
Activity




The
Company granted 305,084 stock options during the year ended December 31, 2009 at
exercise prices ranging from $1.00 to $1.75, which was equal to the closing
market price on the respective date of each grant.  The Company
granted 29,039 options during the year ended December 31, 2007 at an exercise
price of $1.50, which was equal to the closing market price on the date of each
grant.  No stock options were granted in 2008.





A summary
of the Company’s outstanding stock options as of and for the years ended
December 31, 2009, 2008 and 2007 is presented below:






Options
            
            Weighted
              Average
              Exercise
              Price
            
            Weighted
              Average
              Remaining
              Contractual
              Term
              (In
      Years)
            
            Aggregate
      Intrinsic
      Value(a)Outstanding
      as of January 1, 2007
            1,879,700
            
            $
            1.25Granted
            29,039
            
            
            1.98Exercised
            (651,100
            )
            
            0.68Forfeited /Expired
            (29,000
            )
            
            1.98Outstanding
      as of December 31, 2007
            1,228,639
            
            
            1.52Granted
            —
            
            
            —Exercised
            (182,000
            )
            
            1.42Forfeited/Expired
            (16,500
            )
            
            3.25Outstanding
      as of December 31, 2008
            1,030,139
            
            
            1.50Granted
            305,084
            
            
            1.22Exercised
            (84,500
            )
            
            1.14Forfeited /Expired
            (35,000
            )
            
            1.10Outstanding
      as of December 31, 2009(b)
            1,215,723
            
            $
            1.46
            
            3.5
            
            $
            63,295Exercisable
      as of December 31, 2009
            914,995
            
            $
            1.55
            
            1.9
            
            $
            63,295




(a)
Intrinsic value for purposes of this table represents the amount by which the
fair value of the underlying stock, based on the respective market prices as of
December 31, 2009 exceeds the exercise prices of the respective
options.





(b)  Based
on the Company’s historical forfeiture rate, the number of options expected to
vest is the same as the total outstanding at December 31, 2009.




39




The
following table represents non-vested stock options granted, vested, and
forfeited for the year ended December 31, 2009.





Non-vested
      Options
            
            Options
            
            
            Weighted-Average
      Grant-Date Fair ValueNon-vested  -
      January 1, 2009
            
            
            33,220
            
            
            $
            1.48Granted
            
            
            305,084
            
            
            $
            1.22Vested
            
            
            (37,576
            )
            
            $
            1.31Forfeited
            
            
            —
            
            
            
            —Non-vested
      – December 31, 2009
            
            
            300,728
            
            
            $
            1.21




The total
fair value of options vested during the years ended December 31, 2009, 2008 and
2007, was $49,000, $35,000 and $71,000, respectively.




The
following table summarizes information about stock options outstanding at
December 31, 2009:







Options
      Outstanding
            
            Options
      ExercisableWeightedAverage
            
            Weighted
            
            
            
            WeightedRemaining
            
            Average
            
            
            
            AverageRange
      of
            
            Number
            
            Contractual
            
            Exercise
            
            Number
            
            ExerciseExercise
      Price (1)
            
            Outstanding
            
            Life
      in Years
            
            Price
            
            Outstanding
            
            Price$0.50
      - $2.00
            
            
            1,143,123
            
            9.8
            
            $
            1.33
            
            842,394
            
            $
            1.37$3.25
      - $5.00
            
            
            72,600
            
            0.8
            
            $
            3.59
            
            72,600
            
            $
            3.59




(1)   There were no
outstanding options with an exercise price between $2.00 and
$3.25.




d.           Restricted Stock Unit
Awards




There
were no grants in 2009.  During 2008, the Company granted 23,500
restricted stock units under the 2000 Performance Share Program with a fair
market value of $85,300 based on the closing market price of the Company’s stock
on the grant date.  In December 2007, the Company granted 12,000
restricted stock units to one individual 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 grant date.  These grants vest over a three
year period contingent on continued employment over the vesting
period.  There were no previous grants of restricted stock units under
this plan.  The Company recognized related stock compensation expense
of $48,000 ($5,000 in Cost of Goods Sold and $43,000 in Selling, General and
Administrative expenses) in 2009, $41,000 ($5,000 in Cost of Goods Sold and
$36,000 in Selling, General and Administrative expenses) in 2008 and $0 in
2007.





A summary
of the Company’s non-vested restricted stock unit awards shares is as
follows:





#
      of Units
            
            Weighted
      Average
              Grant
      Date
              Fair
      ValueOutstanding
      as of January 1, 2008
            12,000
            
            $
            4.00Granted
            23,500
            
            $
            3.63Vested
            (4,000)
            
            $
            4.00Forfeited/Expired
            —
            
            $
            —Outstanding
      as of December 31, 2008
            31,500
            
            $
            3.72Granted
            —
            
            $
            —Vested
            (13,504)
            
            $
            3.79Forfeited/Expired
            —
            
            $
            —Outstanding
      as of December 31,
      2009
            17,996
            
            $
            3.68




The total
fair value of restricted stock units which vested during 2009 was $20,774 as of
the vesting date.




40




11.           Net (Loss)
Income per Share




The
Company computes and presents net (loss) income per common share in accordance
with FASB ASC Topic 260, “Earnings per Share”.  Basic (loss) income
per common share is computed by dividing net (loss) income by the weighted
average number of common shares outstanding. Diluted (loss) income per common
share is computed by dividing net (loss) income by the weighted average number
of common shares and common stock equivalents outstanding, calculated on the
treasury stock method for options, stock grants and warrants using the average
market prices during the period, including potential common shares issuable upon
conversion of outstanding convertible notes, except if the effect on the per
share amounts is anti-dilutive.For the year
ended December 31, 2009, all common equivalent shares outstanding have been
excluded from the diluted computation because their effect is
anti-dilutive.




This
included a weighted average of 2,500,000 anti-dilutive common shares issuable
upon conversion of outstanding convertible notes.  The weighted
average number of outstanding anti-dilutive warrants excluded from the
computation of diluted net income per common share year ended December 31,
2009 was 193,500 and the weighted average number of outstanding anti-dilutive
common stock options was 259,987.  In addition, a total weighted
average of 14,789 shares of non-vested restricted stock with a grant date fair
value in excess of the average market price of the common shares during the year
was excluded from the computation because their effect is
anti-dilutive.




A
reconciliation of the shares used in the calculation of basic and diluted
earnings per common share is as follows:





Years ended December 31,2009
            
            
            2008
            
            
            2007NumeratorsNet
      (loss) income applicable to common shareholders - basic
            
            $
            (2,799,992
            )
            
            $
            1,098,421
            
            
            $
            1,641,914Interest
      on Convertible Debt
            
            
            —
            
            
            
            150,000
            
            
            
            188,096Net
      (loss) income applicable to common shareholders - diluted
            
            $
            (2,799,992
            )
            
            $
            1,248,421
            
            
            $
            1,830,010DenominatorsWeighed
      average shares outstanding-Basic
            
            
            11,331,258
            
            
            
            10,902,061
            
            
            
            8,609,822Convertible
      Debt
            
            
            —
            
            
            
            2,500,000
            
            
            
            3,102,740Warrants
            
            
            —
            
            
            
            1,615,417
            
            
            
            1,585,206Stock
      options
            
            
            —
            
            
            
            594,972
            
            
            
            479,346Restricted
      stock units
            
            
            —
            
            
            
            6,854
            
            
            
            —Weighted
      average shares outstanding - diluted
            
            
            11,331,258
            
            
            
            15,619,304
            
            
            
            13,777,114Net
      income per common share – basic
            
            $
            (0.25
            )
            
            $
            0.10
            
            
            $
            0.19Net
      income per common share — diluted
            
            $
            (0.25
            )
            
            $
            0.08
            
            
            $
            0.13




12.           Work Force
Reduction




In the
first quarter of 2009, the Company reduced its combined work-force by
approximately 23%, in order to eliminate costs and align it’s workforce with its
current business requirements while ensuring the Company would continue to meet
its customers’ needs.  The reductions affected both the Company’s
Northvale, NJ and the Sarasota, FL operations. Annualized savings from the
reductions are expected to be approximately $1.1 million.  Severance
payments expensed in the first quarter of the year but paid in the first and
second quarters of the year totaled approximately $140,000.




13.           Commitments




a.
            Lease
      commitments




The
Company occupies approximately 42,000 square feet of space located at 181
Legrand Avenue, Northvale, New Jersey pursuant to a net lease.  Under
the terms of the lease, the Company is obligated for all real estate taxes,
maintenance and operating costs of the facility.  On November 1, 2008,
the lease was renewed for a two year term to October 31, 2010, at substantially
the same terms.  The Company has options to renew the Northvale lease
for two additional two year terms running through October 31, 2012, with fixed
terms.




The
Company’s MRC Optics subsidiary occupies approximately 25,000 square feet of
space located at 6405 Parkland Drive, Sarasota, FL pursuant to a net lease
originally expiring on August 31, 2006.  Under the terms of the lease,
the Company is obligated for all real estate taxes, maintenance and operating
costs of the facility.  During 2006, MRC Optics negotiated terms for
the renewal of the lease until August 31, 2008.  In 2008, the Company
elected to extend the lease until August 31, 2010 and has the option of three
additional two year renewal periods through August 31, 2016.




41




The total
rent for these leases was approximately $582,000, $588,000 and $570,000 in 2009,
2008 and 2007, respectively.




Future
minimum annual rentals which cover the remaining lease terms, excluding
uncommitted option renewal periods are $451,000 for 2010.





b.
            Retirement
      plans






The
Company maintains a 401(k) savings plan (the “Plan”) for all eligible employees
(as defined in the plan).  The 401(k) plan allows employees to
contribute up to 20% of their compensation on a salary reduction, pre-tax basis
up to the statutory limitation.  The 401(k) plan also provides that
the Company, at the discretion of the Board of Directors, may match employee
contributions based on a pre-determined formula.




In 2009,
the Company matched employee contributions of $154,524 in the form of 103,403
shares of the Company’s common stock, which were issued to the Plan in March
2010.  In 2008, the Company matched employee contributions in the
amount of $179,068 contributed in the form of 66,469 shares of the Company’s
common stock, distributed in February 2009.  The Company contributed
$160,181 in the form of 75,907 shares of the Company’s common stock in March
2008 for the 2007 fiscal year. The Company records the distribution of the
common shares in the Consolidated Statement of Shareholders’ Equity as of the
date of distribution to the 401(k) plan administrator.




14.           Product Sales, Foreign Sales
and Sales to Major Customers




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





Year
      Ended December 31,
            
            2009
            
            
            2008
            
            
            2007Category
            
            Sales
            
            
            %
            
            
            Sales
            
            
            %
            
            
            Sales
            
            
            %Optical
      Components
            
            $
            10,350,000
            
            
            
            94
            
            
            $
            14,750,000
            
            
            
            90
            
            
            $
            13,410,000
            
            
            
            89Laser
      Accessories
            
            
            701,000
            
            
            
            6
            
            
            
            1,551,000
            
            
            
            10
            
            
            
            1,690,000
            
            
            
            11TOTAL
            
            $
            11,051,000
            
            
            
            100
            
            
            $
            16,301,000
            
            
            
            100
            
            
            $
            15,100,000
            
            
            
            100




The
Company’s export sales, which are primarily to customers in countries within
Europe, the Near East and Japan, amounted to approximately 7.2%, 5.2%, and 9.5%
of product sales in 2009, 2008 and 2007, respectively.




The
Company had sales to three major domestic customers which accounted for 17.7%
and 13.8%, and 9.8% of sales.  Each customer is an electro-optical
systems division of a major U.S. defense corporation who manufactures systems
for U.S. and allied foreign governments.     In 2008,
the same three customers represented 8.7%, 21.6% and 5.9% of sales,
respectively.




During
the past three years, sales the Company’s top five customers represented
approximately 51.6%, 58.8% and 56.9% of sales, respectively.  Given
the concentration of sales within a small number of customers, the loss of any
of these customers would have a significant negative impact on the Company and
its business units.




15.           Shareholders’
Equity




a.
            Common shares reserved
      at December 31, 2009, are as
follows:





2000
      Equity compensation plan
            
            
            6,000,000Subordinated
      convertible notes
            
            
            2,500,000Warrants
      issuable on conversion of Subordinated convertible notes
            
            
            1,875,000Warrants
      outstanding
            
            
            60,000Accrued
      interest convertible to common shares at $1.00 per share
            
            
            975,000




b.
            Preferred
      stock




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




The
Company had no shares of preferred stock issued and outstanding as of December
31, 2009 or 2008.




42




In 2007,
the Series A preferred stock consisting of 500 shares at a stated value of
$1,000 per share and convertible into common shares at the rate of $1.00 per
share was converted into 500,000 common shares of the Company’s stock in April
2007.




A total
of 2,032 shares of the Series B preferred stock consisting of 2,082 shares at a
stated value 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.  One holder of the remaining 50 shares of Series B preferred
stock elected to redeem its shares for a cash payment of $50,000 and an accrued
stock dividend of 1,332 common shares of the Company.




There
were no common stock dividends, either declared or paid, for the year ended
December 31, 2009 or 2008.  For the years ended December 31, 2007, the
Company paid a common stock dividend on preferred stock of 134,612
shares equal to $238,167 based on the closing market price of the common
shares on the issue date.




c.           Warrants




As of
December 31, 2009, the Company has 60,000 outstanding warrants with an exercise
price of $1.35 and a fair value of $1.31 which expire in May
2010.  During the year ended December 31, 2009, a total of 50,000
warrants were exercised with a fair value of $1.29 and an exercise price of
$1.35 each or $67,500, in total.  A total of 893,790 warrants with an
exercise price of $1.35 and fair value of $1.29 expired during the
year.




16.           Fair Value
of Financial Instruments




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




Current
Assets and Current Liabilities:  The carrying amount of cash,
certificates of deposits, current receivables and payables and certain other
short-term financial instruments approximate their fair value as of December 31,
2009 due to their short-term maturities.




Long-Term
Debt:  The fair value of the Company’s long-term debt, including the
current portion, for notes payable and subordinated convertible debentures, was
estimated using a discounted cash flow analysis, based on the Company’s assumed
incremental borrowing rates for similar types of borrowing
arrangements.  The carrying amount of variable and fixed rate debt at
December 31, 2009 in the amount of $2,854,000 approximates fair
value.




17.           Quarterly
Data(Unaudited)




Summary
quarterly results were as follows:





Year
      2009
            
            First
            
            
            Second
            
            
            Third
            
            
            FourthNet
      sales
            
            $
            2,815,097
            
            
            $
            2,620,437
            
            
            $
            2,664,963
            
            
            $
            2,950,630Gross
      profit
            
            
            381,687
            
            
            
            419,098
            
            
            
            606,530
            
            
            
            747,273Net
      loss
            
            
            (314,409
            )
            
            
            (336,998
            )
            
            
            (2,122,330
            )
            
            
            (26,255
            )Net
      loss per share - Basic
            
            
            (0.03
            )
            
            
            (0.03
            )
            
            
            (0.19
            )
            
            
            (0.00
            )Net
      loss per share - Diluted
            
            
            (0.03
            )
            
            
            (0.03
            )
            
            
            (0.19
            )
            
            
            (0.00
            )








Year 2008
            
            First
            
            
            Second
            
            
            Third
            
            
            FourthNet
      sales
            
            $
            4,164,248
            
            
            $
            4,007,412
            
            
            $
            3,802,935
            
            
            $
            4,326,614Gross
      profit
            
            
            1,501,593
            
            
            
            1,219,202
            
            
            
            1,065,424
            
            
            
            1,028,370Net
      income
            
            
            491,200
            
            
            
            294,017
            
            
            
            169,120
            
            
            
            144,084Net
      income per share - Basic
            
            
            0.05
            
            
            
            0.03
            
            
            
            0.02
            
            
            
            0.01Net
      income per share - Diluted
            
            
            0.03
            
            
            
            0.02
            
            
            
            0.01
            
            
            
            0.01





Year 2007
            
            First
            
            
            Second
            
            
            Third
            
            
            FourthNet
      sales
            
            $
            3,540,874
            
            
            $
            3,678,796
            
            
            $
            3,837,660
            
            
            $
            4,042,548Gross
      profit
            
            
            1,381,500
            
            
            
            1,393,238
            
            
            
            815,825
            
            
            
            1,368,266Net
      income
            
            
            434,860
            
            
            
            396,488
            
            
            
            797,413
            
            
            
            251,320Net
      income per share - Basic
            
            
            0.06
            
            
            
            0.02
            
            
            
            0.09
            
            
            
            0.03Net
      income per share – Diluted
            
            
            0.04
            
            
            
            0.02
            
            
            
            0.06
            
            
            
            0.02





43





Schedule
II –Valuation and Qualifying Accounts




PHOTONIC
PRODUCTS GROUP, INC.


SCHEDULE
II VALUATION AND QUALIFYING ACCOUNTS




Balance
      at
                Beginning
                of
      Period
              
              
              Charged
                (Credited)
                to
      Expenses
              
              
              Additions
      (Deductions)
                to
      Other
                Accounts
              
              
              Deductions
              
              
              Balance
                at
      End of
                PeriodAllowance for Doubtful
    AccountsYear
      ended December 31, 2009
              
              $
              15,000
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              $
              15,000Year
      ended December 31, 2008
              
              $
              15,000
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              $
              15,000Year
      Ended December 31, 2007
              
              $
              15,000
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              $
              15,000




Valuation Allowance for Deferred Tax
      AssetsYear
      ended December 31, 2009
              
              $
              1,733,000
              
              
              
              —
              
              
              
              716,000
              
              
              
              —
              
              
              $
              2,449,000Year
      ended December 31, 2008
              
              $
              2,041,000
              
              
              
              (408,000
              )
              
              
              100,000
              
              
              
              —
              
              
              $
              1,733,000Year
      Ended December 31, 2007
              
              $
              3,065,000
              
              
              
              —
              
              
              
              (1,024,000
              )
              
              
              —
              
              
              $
              2,041,000





44