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FORM 10-K

STOCKERYALE, INC.

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K 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.  x

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule12b-2, of the Act).  YES  o     NO  x

The registrant's revenues for the fiscal year ended December 31, 2002 were $12,992,000.

The aggregate market value of common stock held by non-affiliates of the registrant as of June 30, 2002 was $15,861,651.

The number of shares outstanding of the registrant's common stock as of February 28, 2003 was 12,696,633.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the definitive Proxy Statement to be delivered to shareholders in connection with the Annual Meeting of Shareholders to be held May 22, 2003 are incorporated by reference into Part III.

StockerYale, Inc.

    FORM 10-K

For the Fiscal Year Ended December 31, 2002

INDEX

This Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.You can identify forward-looking statements by the use of the words "believe," "expect," "anticipate," " intend," "estimate," "assume," and other similar expression which predict or indicate future events and trends and which do not relate to historical matters. The Company's actual results, performance or achievements could differ materially from our expectations expressed or implied by the forward-looking statements sometimes for reasons that are beyond the Company's control. Such reasons include, without limitation: the existence of other suppliers of optical components and illumination products, who may have greater resources than the Company; the risk that the Company's products may infringe patents held by other parties; the uncertainty that the Company's significant investments in R&D will result in products that achieve market acceptance; the Company's ability to attract and maintain key personnel; whether the Company is able to design products to meet the special needs of its customers; and that market conditions could make it more difficult or expensive for the Company to obtain the necessary capital to finance necessary research and development projects, operations as well as its ability to refinance existing debt. Additional factors that might cause such a difference are discussed in the section entitled "Certain Factors Affecting Future Operating Results" beginning on page 20 of this Form 10-K.

ITEM 1.    BUSINESS

GENERAL

StockerYale, Inc. (the Company) is an independent designer and manufacturer of structured light lasers, light emitting diodes, (LEDs), fiber optic, and fluorescent illumination technologies as well as specialty optical fiber, phase masks, and advanced optical sub-components for use in a wide range of markets and industries including the machine vision, telecommunications, aerospace, defense and security, utilities, industrial inspection, and medical markets.

 DEVELOPMENTS DURING FISCAL 2002

In 2002, StockerYale adjusted its business plans to a challenging economic environment by significantly reducing its cost structure, curtailing capital expenditures and ceased funding two research and development joint ventures. The key goals were to focus research and development on projects which could produce revenue in the short-term and adjust operating expenses to compensate for a declining revenue plan. As part of that adaptation the Company:

COMPANY HISTORY

StockerYale, Inc. was incorporated on March 27, 1951 under the laws of the Commonwealth of Massachusetts. In December 1995, the Company completed the registration of its Common Stock with the U.S. Securities and Exchange Commission and its stock now trades on the NASDAQ National Market under the trading symbol "STKR".

On May 13, 1998, the Company acquired StockerYale Canada, Inc., formerly known as Lasiris, Inc., a Canadian manufacturer of industrial lasers and other illumination and photonics products. The acquisition of StockerYale Canada provided the Company with the capability to manufacture laser-based illumination products and phase masks, which are used to manufacture fiber Bragg gratings for telecommunication applications.

The Company acquired StockerYale Canada through Lasiris Holdings, Inc., a newly formed New Brunswick corporation ("LHI") and a wholly owned subsidiary of the Company.  StockerYale Canada is operated as a wholly owned Canadian subsidiary of LHI. In connection with this transaction, the former stockholders of StockerYale Canada received shares of capital stock in LHI, which are exchangeable into shares of the Company's common stock on a one-for-one basis at any time at the option of the holder.

In addition to Lasiris Holdings, Inc., the Company has two active subsidiaries. On June 16, 2000, the Company acquired StockerYale (IRL) Ltd., formerly known as CorkOpt Ltd, which is a wholly owned Irish subsidiary and StockerYale Asia PTE Ltd., formerly known as Radiant Asiatec Pte, Ltd., a Singapore corporation that was formed in December 1997 and is an 80% owned subsidiary of the Company. The acquisition of StockerYale (IRL) Ltd. provided the Company with the capability to manufacture and sell light-emitting diodes, or LEDs, for industrial applications. StockerYale Asia PTE Ltd. is the entity through which the Company sells its illumination products in Southeast Asia.

As of February 28, 2003, the authorized capital stock of the Company was 100,000,000 shares of Common Stock of which 12,696,633 shares were issued and outstanding. Additionally, 2,308,981 shares of Common Stock were reserved for issuance upon the exercise of outstanding options or warrants to purchase Common Stock and upon the exchange of 85,290 shares of Lasiris Holdings, which are exchangeable into Company Common Stock on a one-for-one basis.

FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS

The Company operated within two segments, namely illumination and optical components. Illumination products include structured light lasers, specialized fiber optic, fluorescent, and light-emitting diode (LED) products for the machine vision, industrial inspection, and defense and security industries. The optical components segment includes communication and sub-component and specialty optical fiber for the telecommunications, aerospace, utility and medical markets.

PRODUCTS

ILLUMINATION PRODUCTS

StockerYale is a leading developer and manufacturer of specialized illumination products for the inspection, machine vision, medical, and military markets and continues to be the only company with design and manufacturing competencies in four illumination disciplines: fiber optic, fluorescent, structured light laser, and light emitting diode (LED) technologies. The Company also differentiates itself from many of its competitors by delivering custom designed lighting solutions that can operate as a stand-alone illumination source or as an integral component of a larger OEM system.

The Company's fiber optic illumination products provide shadow-free, glare-free, cool illumination by way of a halogen light source (i.e., fiber optic illuminator) and the components (i.e., fiber optic light guide) that carry the illumination output to the intended location.

StockerYale manufactures high output, 0.66 and 0.55 numerical aperture (N.A.) glass fiber, in addition to polymer clad fused silica (quartz) fiber that is used in its fiber optic components, providing customers with the lighting solution that best fits their application. StockerYale's illumination fiber is internally produced in its Salem drawing facility rather than outsourced. This ensures that a higher quality of light demanded by increasingly sophisticated imaging systems and advanced quality assurance processes is delivered.

StockerYale has over twenty years experience designing and manufacturing high-quality fluorescent illumination products that are primarily used in microscopy and machine vision applications. The Company's fluorescent illuminators provide the critical lighting needs for a diversity of microscopes and cameras that are widely used for inspection in the semiconductor and disk drive manufacturing industries as well as machine vision applications. StockerYale has the most comprehensive line of fluorescent products available and believes that its Model 9 circular fluorescent microscope illuminator (CFMI) is one of the world's leading microscope illuminators. The Company also custom designs fluorescent illumination systems to meet a customer's exact lighting requirements.

For customers looking for a compact, long lasting illumination source, StockerYale offers LED lighting systems. The Company's patented, state-of-the-art, chip-on-board LED units draw less power and are not subject to the influences of oxidation that other lighting technologies endure, resulting in a life span of over 60,000 hours. Furthermore, because of the intrinsic characteristics of LEDs, which can be engineered into virtually any geometric configuration, StockerYale's LED's are ideal for specialized illumination applications within the semiconductor and electronics and also the medical industries that require the properties and benefits that only this lighting technology can deliver.

StockerYale's Lasiris^TM brand laser pattern projectors are used in the industrial inspection and 3-D machine vision industries and have most recently been introduced into the medical and military industries for specialized applications. The Company's patented optical lens produces a non-Gaussian (evenly illuminated) distinct laser line or a more complex laser light pattern that maintains a consistent intensity along the length and height of the projection. StockerYale's lasers are electrostatic discharge (ESD) protected, feature interchangeable head patterns, and most meet Class II eye safety ratings. By applying nearly 15 years of electro-optic R&D experience, the Company offers custom designed laser pattern projectors that meet even the most stringent requirements.

Lasers can be useful for contour mapping of parts, surface defect detection, depth measurements, guidelines, edges detection, and alignment. For example, in machine vision applications, structured light lasers may be used on systems recording the gap and flushness between car body components. In industrial inspection applications, these products may draw attention to parts that do not conform to specifications, such as defective parts.

OPTICAL COMPONENTS

StockerYale is an independent designer and manufacturer of specialty optical fiber and phase masks that are primarily used by fiber optic sensor, fiber optic gyroscope and telecommunication equipment manufacturers around the world.

Today, the Company is a leading supplier of phase masks, which are high precision phase diffraction gratings used as both a key enabling technology for the production of fiber Bragg gratings (FBGs) and for biomedical applications. FBGs offer a passive fiber-based means of filtering and stabilizing wavelengths to improve the performance of optical components used in various telecommunication and sensor applications. The Company also has the technical expertise and R&D facilities to optimize or custom design a phase mask that supports a special wavelength operation or tailor the mask dimensions to satisfy a customer's specific application.

The phase mask product line is sold by a direct sales force in North America and Europe and through distributor channels in Asia.

StockerYale designs and produces high-quality specialty optical fiber for both industry standard and custom applications.

StockerYale's specialty optical fiber fall into five broad categories: rare-earth doped fibers, polarization maintaining fibers, photosensitive fibers, bend insensitive fibers and custom designed fibers. These specialty optical fibers support a diverse range of applications, including erbium-doped fiber amplifiers, (EDFAs), fiber Bragg gratings, (FBGs), high-voltage current sensors, gyroscopes, and other applications related to optical fiber sensors and telecommunications.

StockerYale introduced many new specialty optical fibers in late 2002 including erbium doped fiber, polarization maintaining fiber, cladding mode suppression fiber and select cut-off single mode fiber. The specialty optical fiber is sold by a direct sales force in North America and Europe and through distributor channels in Asia. The Company is focusing a significant amount of its specialty optical fiber development resources outside of the telecommunications market due to a significant downturn in the industry. Many of the products are targeted at the defense sector and oil exploration industries and have longer qualification periods due to the nature of the applications. The Company expects additional opportunities in the telecommunications sectors as existing industry inventories are depleted and when the market returns to more favorable conditions.

SALES DATA

DOMESTIC AND FOREIGN REVENUE

Sales to unaffiliated customers in foreign countries represented 40%, 38% and 40% of net revenues in 2002, 2001and 2000, respectively.

MARKETING AND DISTRIBUTION

The Company's products are sold to over 10,000 customers, primarily in North America, Europe and the Pacific Rim. The Company sells directly to, and works with, a group of approximately 50 distributors and machine vision integrators to sell its specialized illumination products. Optical components are sold directly to OEM customers by the Company's sales organization.

COMPETITION AND COMPETITIVE POSITION

The Company competes with a number of firms in the design and manufacture of its specialized illumination, optical fiber and sub-component products. Some competitors have greater resources than the Company, and as a result, may have competitive advantages in the research and development and sales and distribution.

In the industrial fluorescent lighting market, the Company has two primary competitors. MicroLite markets a product similar in appearance to the Company's circular fluorescent microscope illuminator. Techni-Quip Corporation offers industrial fluorescent lighting as part of its product line but as a whole, its lighting product line is limited and represents a small percentage of that company's total business.

The Company has five primary competitors in the fiber optic illumination market. The most established segment of this market relates to illumination for microscopes. Within that market, Volpi Manufacturing USA, Inc. and Dolan-Jenner Industries, Inc. compete directly with the Company's products. Both of these companies have been producing fiber optic products for more than thirty years and offer a complete line of fiber optic illumination systems for microscopy applications. A third company, Cuda Products, Inc., also supplies fiber optic lighting for microscopy; however, its primary market is medical. The value-oriented segment of the microscopy market is dominated by Chiu Technical Corp, which offers an inexpensive, "no-frills", fiber optic lighting system. A newer segment in the fiber optic lighting market relates to automated imaging and inspection equipment for machine vision. Schott-Fostec, Inc. is the leading provider of fiber optic lighting for the machine vision industry.

The Company has developed the in-house capability to draw its own glass fiber in variable dimensions to suit customer needs. Although some of the above-named competitors also have this capability, the Company believes that its proprietary manufacturing techniques result in fiber that has increased reliability. Since mid-1996, the Company has invested in developing its in-house design and research capabilities, including the hiring of personnel trained in optical, chemical, mechanical and electrical engineering and related disciplines, and the purchase of computers and laboratory equipment necessary to support these personnel. Further, the Company has succeeded in designing and developing a complete line of fiber optic lighting products for both the machine vision and microscopy markets.

Over the last eighteen months, the Company completed a program to expand its specialty optical fiber capability to include specialty optical fibers (SOF) for the defense and security, utility and telecommunication industries. The Company made substantial capital investments in plant and equipment in connection with its development of a complete line of specialty optical fibers (SOF). The Company's major competitors in this area include OFS, formally Lucent's Optical Fiber Solutions division, Corning, and 3M. With OFS (now owned by Furukawa), Corning and 3M consuming the majority of their SOF products internally, the Company believes it is positioned to be a leading independent supplier of SOF.

BACKLOG

The Company maintains an inventory of standard materials and components and generally manufactures standard illumination product configurations within one to five days after receipt of a customer order. The optical components and specialty optical products are generally manufactured to specifications of the customer order with a one to four week turnaround between order and shipment. Although such rapid response is, and historically has been, a selling advantage for the Company, some orders are placed for future delivery. At December 31, 2002, the Company had a backlog of orders for future delivery of approximately $2,258,000, compared to approximately $2,858,000 as of December 31, 2001. The principal reason for the backlog decline was a "last-time buy" for a portion of the printer and recorder business which represented approximately $700,000 of the $2,858,000 backlog as of December 31, 2001.

RAW MATERIALS

The raw materials and components used in the Company's products are purchased from a number of different suppliers and are generally available from several sources.

DEPENDENCE ON ONE OR A FEW MAJOR CUSTOMERS

The Company's customer base consists of more than 10,000 customers in various industries worldwide. Sales to the Company's largest single customer represented 16% of the Company's total net sales in fiscal 2002. The Company's top ten customers represented approximately 32% of total net sales in fiscal 2002, 32% in 2001 and 38% in 2000.

PATENTS AND TRADEMARKS

The Company holds patents in the United States and Ireland and has filed additional patent applications in the United States, Canada, Europe and Japan. StockerYale (IRL), Ltd holds a patent on a method for attaching semiconductor chips and has applied for two patents in the United States, Canada and Europe on new LED ring light and line light technologies. StockerYale Canada holds exclusive rights to three patents in the United States and one patent in Canada through licensing agreements. A wholly-owned subsidiary of the Company, Innovative Specialty Optical Fiber Components LLC, has applied for a patent in the United States on a fiber optic technology for depolarizing light. A 49% owned joint venture of the Company, Optune Technologies, Inc. has applied for two patents in the United States on a tunable optical filter for optical communications.

The Company has four patents relating to fundamental technological devices and methodologies used to achieve low-cost fluorescent light dimming; these patents expire on August 18, 2009, August 24, 2010, September 6, 2011 and September 13, 2011. StockerYale Canada's material patents consist of four patents for lenses, which expire on May 2, 2006, November 27, 2007, June 4, 2013 and December 15, 2015. The Company believes that patents are an effective way of protecting its competitive technological advantages, and considers its patents to be a strong deterrent against unauthorized manufacture, use and sale of its products and key product attributes. There can be no assurance, however, that a patent will be issued with respect to the Company's pending patent applications or whether the Company's patents or license rights will provide meaningful protection for the Company.

The Company also relies upon trade secret protection for its confidential and proprietary information. There can be no assurance that others will not independently develop substantially equivalent proprietary information and techniques, or otherwise gain access to and use or disclose the Company's trade secrets or that the Company can meaningfully protect its trade secrets.

The Company holds rights in certain trademarks to protect its brand name recognition in various markets. Because of the Company's long history and reputation for designing and manufacturing high quality products, trademark protection enhances the Company's position in the market.

Although the Company believes that its products and other proprietary rights do not infringe the proprietary rights of third parties, there can be no guarantee that infringement claims will not be asserted against the Company in the future or that any such claims will not require the Company to enter into royalty arrangements or result in costly litigation.

RESEARCH AND DEVELOPMENT

The Company intends to continue to invest significant amounts in research and development for new products and for enhancements to existing products. Research and development expenditures for the Company were $6,203,000 or 48% of net sales in 2002 and $5,465,000 or 35% of net sales in 2001. The increase was primarily a result of the strategic decision to focus on the development of the Company's optical communication sub-component product line.

On-going research and development expenses were greatly reduced in the second half of 2002 and as of February 28, 2003, the Company employed 55 full-time scientists and engineers compared to 85 as of February 28, 2002. Outside firms and consultants are selectively engaged to develop or assist with the development of new products when opportunities exist.

COMPLIANCE WITH ENVIRONMENTAL LAWS

The Company is subject to evolving Federal, state and local environmental laws and regulations. Compliance with such laws and regulations in the past has had no material effect on the capital expenditures, earnings or competitive position of the Company. The Company believes that it complies in all material respects with existing environmental laws and regulations applicable to it. However, the Company's Salem, New Hampshire headquarters are currently the subject of environmental testing and monitoring relating to soil and groundwater contamination that occurred under prior ownership. The costs incurred to date for such testing and for remediation planning have been paid by third parties. The Company believes that the costs of any required remediation will be covered by an environmental indemnity obtained from the seller, John Hancock Mutual Life Insurance Company. In addition, it is management's understanding that in April 1996, the Massachusetts Department of Environmental Protection circulated notices to parties identified as "potentially responsible parties" with respect to the Company's Salem, New Hampshire headquarters. The Company did not receive such notice. Compliance with environmental laws and regulations in the future may require additional capital expenditures, and the Company expects that in the foreseeable future such capital expenditures will be financed by cash flow from operations.

EMPLOYEES

As of February 28, 2003, the Company employed approximately 175 people, of whom six were part‑time employees. None of the Company's employees are represented by a labor union and the Company believes that it has good relations with its employees.

ITEM 2.     PROPERTIES

The Company conducts its business at two Company owned facilities and in two leased facilities. The Company's headquarters are located in a 95,000 square foot facility in Salem, New Hampshire, which also houses research and development, manufacturing, sales and distribution capacities for the Company's specialized lighting and specialty optical fiber products. In December 2000, the Company purchased a 65,000 square foot building and property located in Dollard-des-Ormeaux, Quebec for research and development, manufacturing and sales and distribution by its Canadian subsidiary, StockerYale Canada. StockerYale Asia Pte, Ltd. operates out of an approximately 2,733 square foot leased office space in Singapore. StockerYale (IRL), Ltd leases approximately 5,500 square feet in Cork, Ireland.

The Company's Salem facility is owned by the Company subject to a mortgage granted to TJJ Corporation, which secures obligations of the Company to such party. The Company's Canadian facility in Dollard-des-Ormeaux is owned by the Company subject to a mortgage granted to Toronto Dominion Bank, which secures obligations of the Company to such party. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS-Liquidity and Capital Resources."

The Company's facilities are generally operated on the basis of one shift per day, five days per week. Management considers the facilities to be in generally good condition, to be adequately maintained and insured, and sufficient to satisfy the Company's needs for the foreseeable future.

ITEM 3.     LEGAL PROCEEDINGS

At times the Company may be involved in disputes and/or litigation with respect to its products and operations in its normal course of business. The Company does not believe that the ultimate impact of the resolution of such matters would have a material adverse effect on the Company's financial condition or results of operations. The Company is not currently involved in any legal proceedings.

ITEM 4.    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

There were no matters submitted to a vote of stockholders during the fourth quarter of fiscal 2002.

ITEM 5.     MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS

In connection with entering into a Term Note secured by its Salem facility with TJJ Corporation, on December 27, 2002, the Company issued warrants to purchase 250,000 shares of its common stock at an exercise price of $1.35 per share, which expire December 27, 2007. The Company did not engage an underwriter or agent in connection with this transaction. The issuance of the warrants was exempt for registration pursuant to Section 4(2) of the Securities Act of 1933, as amended.

ITEM 6.     SELECTED FINANCIAL DATA

The following selected consolidated financial data are derived from the Company's audited consolidated financial statements. The data should be read in conjunction with the related notes and other information included herein.

RESULTS OF OPERATIONS FOR 2002 AND 2001

Management Discussion and Analysis contains statements that are forward-looking. These statements are based on expectations and assumptions that are subject to risks and uncertainties. Actual results could differ materially because of factors discussed in "Certain Factors Affecting Future Operating Results." As further discussed in the following Liquidity and Capital Resources section, the Company is experiencing liquidity problems and is in default of its loan agreements.

 NET SALES

Net sales were $13.0 million in 2002 compared to $15.6 million in 2001, a decrease of 17% or $2.6 million.

Net sales from the Company's specialized illumination products were $10.9 million in 2002 compared to $10.8 million in 2001, an increase of $0.1 million or 1%. Sales of fluorescent and fiber optic illumination products manufactured in the Company's Salem facility declined $0.6 million or 14% primarily due to a reduction in demand as a result of a general slow down in the semiconductor, disk drive inspection and electronic assembly markets. Sales of laser illumination products manufactured in the Company's Montreal facility increased $0.7 million or 14% as new products and new applications, especially in the defense industry gained acceptance. Sales from its Irish and Singapore subsidiaries in 2002 were level with 2001. The majority of the Company's sales of specialized illumination products are made for companies in industries who use specialized lighting for industrial inspection and machine vision applications; however, the Company recently made significant inroads in the military and medical markets.

Net sales from the Company's optical fiber and sub-component products were $1.1 million in 2002 compared to $3.6 million in 2001, a decrease of $2.5 million or 67%. A sharp decline in phase masks, which are principally sold to the telecommunications industry, accounted for 95% of the revenue decline in this product line. Revenue from our printer and recorder product line declined from $1.2 million in 2001 to $1.0 million in 2002. A portion of this product line was transferred to an outside distributor on consignment in the fourth quarter of 2002. The Company will be reimbursed beginning in 2003 for inventory transferred to this distributor plus a 5% royalty on future revenues.

COST OF SALES

Cost of sales was $11.2 million in 2002 compared to $11.3 million in 2001, a decrease of 1.3% or $0.1 million. The decrease in cost of sales resulted primarily from a sharp reduction in material cost related to the decline in phase mask revenue, which was offset by higher manufacturing overhead costs and increased obsolete inventory charges related to the printer and recorder product line.

GROSS PROFIT

Approximately $1.2 million of the $2.5 million gross profit decline was a result of the reduced phase mask revenue. The remaining $1.3 million erosion was the result of increased obsolete inventory costs related to the printer and recorder product line and increased depreciation and incremental overhead costs associated with the fiber and optical component product lines in both Salem and Montreal.

OPERATING EXPENSES

Operating expenses decreased $1.3 million from $18.4 million in 2001 to $17.1 million in 2002.

Selling expenses declined $1.0 million or 22% from $4.5 million in 2001 to $3.5 million in 2002. Salaries and fringe benefits remained level despite a 20% reduction in year-end headcount between fiscal 2001 and 2002 as increased staffing in the second half of 2001 was offset by reduced personnel in the second half of 2002. Commission expenses and bad debt expenses declined approximately $0.4 million due to lower revenues and tighter credit controls. Travel and trade show expenses declined approximately $0.2 million as the Company reduced staff and the number of events attended. The remaining $0.4 million in savings was realized through reduced administrative sales support cost, including: postage, telephone, office supplies, and recruiting costs.

Research and development expenses increased $0.7 million or 13% from $5.5 million in 2001 to $6.2 million in 2002. Salaries and fringe benefits increased $0.3 million or 12% as the cost reductions implemented in the second half of 2002 only partially offset the ramp up of staff in the second half of 2001 that continued through the second quarter of 2002. Depreciation expense increased $0.6 million as the equipment investments made in 2001 became operational in 2002.

General and administrative expenses declined $2.3 million or 30% from $7.8 million in 2001 to $5.5 million in 2002. Salaries and fringe benefit costs declined $0.7 million as a result of reduced headcount and salary reductions for both senior and middle management. Professional fees were reduced $0.5 million as the Company undertook a large portion of services previously outsourced. Travel expenses declined $0.3 million as a result of reduced staff and the use of alternative methods to conduct business with investors, customers, and vendors. Reduced support expenses, including training and recruiting, office supplies, and investor relations materials represented the majority of the remaining savings.

Management reviewed the requirements of SFAS No. 144, Accounting for the Impairment or Disposal of Long-lived Assets, which became effective for financial statements issued for the fiscal years beginning after December 15, 2001. Based upon this review and analysis, the Company recorded a $1.6 million asset impairment charge primarily related to a reduction in the carrying value of internal and joint venture research and development projects in Montreal.

The Company terminated further capital expenditures on an internally developed capital project in the second quarter of 2002. At the time, the Company was considering selling the equipment to a third party, based upon the third party receiving funding to purchase the equipment. The Company was informed in the fourth quarter of 2002 that the third party was not successful in obtaining the funding and therefore the Company recorded an impairment charge in the fourth quarter of 2002.

The Company ceased funding a joint venture in the second quarter of 2002. At the time, the joint venture was soliciting additional funding from several venture capital firms. The joint venture was informed in the fourth quarter of 2002 that these venture capitalists were not interested in providing additional funding to the joint venture and therefore the Company recorded an impairment charge in the fourth quarter of 2002.

INTEREST AND OTHER INCOME

Interest and other income was $142,000 in 2002 compared to $441,000 in 2001. Interest and other income was comprised primarily of $103,000 of interest income for 2002.

INTEREST EXPENSE

Interest expense was $417,000 in 2002 compared to $757,000 in 2001 as lower interest rates offset a higher level of borrowings.

PROVISION (BENEFIT) FOR INCOME TAXES

The Company has not recorded an income tax benefit during 2002. The Company has recorded a valuation allowance against its net deferred tax assets after concluding that it is more likely than not that such deferred tax assets will not be recoverable.

RESULTS OF OPERATIONS FOR 2001 AND 2000

NET SALES

Net sales were $15.6 million in 2001 compared to $18.4 million in 2000, a decrease of 15% or $2.8 million. 

Net sales from the Company's specialized illumination products were $10.8 million in 2001 compared to $13.6 million in 2000, a decrease of 21% or $2.8 million. The decrease was primarily caused by a reduction in demand due to a general slow down in the semi-conductor, disk drive inspection and electronic assembly markets. The majority of the Company's sales of specialized illumination products are made to companies in industries who use specialized lighting for industrial inspection and machine vision applications.

Net sales from the Company's optical sub-component products were $3.6 million in 2001 compared to $3.0 million in 2000, an increase of 21% or $0.6 million. Net sales from the Company's other products, largely printers and recorders, decreased from $1.8 million in 2000 to $1.2 million in 2001.

COST OF SALES

Cost of sales were $11.3 million in 2001 compared to $11.5 million in 2000, a decrease of 1% or $157,000. The decrease in cost of sales resulted primarily from the decrease in net sales.

GROSS PROFIT

Gross profit was $4.3 million or 28% in 2001 compared to $6.9 million or 38% in 2000. Gross margin declined primarily due to unabsorbed fixed overhead costs related to the decrease in revenue in the illumination business as well as increased depreciation and incremental management costs related to the implementation of specialty optical fiber and optical components manufacturing capacity in anticipation of revenues in 2002. The Company also recorded a charge of approximately $0.4 million related to inventory obsolescence related to its printer and recorder product line.

OPERATING EXPENSES

Operating expenses increased $10.3 million from $8.1 million in 2000 to $18.4 million 2001. The increase is directly related to the Company's new business strategy to invest in the optical components market.

Research and development expenses rose $4.2 million from $1.3 million in 2000 to $5.5 million in 2001. Salaries and benefits increased $2.7 million as the scientific and engineering staff evolved from 24 at December 31, 2000 to 85 at December 31, 2001. The increase in professional staff completed the Company's substantial intellectual capital investment in the optical components and specialty optical fiber markets. Prototype material expenses and higher depreciation costs accounted for $1.1 million of the higher research and development expenses.

Selling expenses increased $2.3 million as a result of staff doubling from 12 to 24 representing a $1.0 million growth in salaries, benefits, commissions and traveling expenses. In addition, advertising, promotion and trade show costs increased from $0.4 million to $1.0 million. The majority of these higher expenses were in support of the Company's strategic initiative into the specialty optical fiber market.

General and administrative expenses more than doubled from $3.6 million in 2000 to $7.8 million in 2001. Salaries and associated costs, including benefit and travel expenses, rose $0.9 million as headcount grew from 27 to 35. Occupancy and professional fees rose $1.6 million while Information Technology costs increased $0.5 million. The full year impact of the June 2001 acquisition of CorkOpt Ltd. also represented a $0.5 million increase in general and administrative expenses. The Company believes these incremental costs were necessary to provide the infrastructure to support the new complexity of the Company.

The increase in operating expenses in 2001 versus 2000 was based upon a strategic decision of the Company to invest in the optical component and specialty optical fiber markets.

INTEREST AND OTHER INCOME

Interest and other income was $441,000 in 2001 compared to $394,000 in 2000. Interest and other income were comprised primarily of $425,000 of interest income for 2001.

INTEREST EXPENSE

Interest expense was $757,000 in 2001 compared to $475,000 in 2000. The increase in interest expense resulted primarily from an increase in borrowings to fund working capital.

PROVISION (BENEFIT) FOR INCOME TAXES

The tax benefit recorded in 2001 relates primarily to net operating losses ($465,000) and research and development tax credits ($236,000) being benefited in the Canadian tax jurisdiction. In accordance with the provisions of Statement of Financial Accounting Standards (SFAS) No. 109, Accounting for Income Taxes, the deferred tax assets were recognized up to the amount offsetting deferred tax liabilities in the applicable tax jurisdiction.

LIQUIDITY AND CAPITAL RESOURCES

As of December 31, 2002, the Company was out of compliance with the financial covenants of the Toronto Dominion Credit Agreement and as a result triggered the cross default provisions of all other borrowing agreements as described under Borrowing Agreements.

Three years ago the Company made a strategic decision to utilize its optics and manufacturing expertise in phase masks and fiber optic illumination to expand into specialty optical fiber and optical components. This was based on high growth expectations for the telecommunications infrastructure in order to facilitate the rapid growth in Internet traffic. Given management's expectations of the optical component industry's rapid growth and the communications industry's growing demand for advanced telecommunications equipment, the Company over the following three years invested significant equity capital in plant and equipment, research and development and commercialization expenses.

However, as the original equipment manufacturers (OEMs) in the telecommunication sector continued to curtail purchases in the first half of 2002, the Company realized that while the telecom equipment market still offered long-term growth potential, near-term revenue opportunities for optical components would be adversely affected. This change in market conditions required the Company to significantly modify its expectations for specialty fiber and component revenue in the foreseeable future.

In May of 2002, the Company began to significantly reduce its overall operating expenses, and most importantly, its investment in research and development expenses related to optical components. The Company ceased funding two joint ventures and reduced its headcount in research and development, as well as selling and general and administration expenses.

Since the Company has not been immune to the difficulties of raising capital in the current equity markets, it shifted its short-term goals to financing operations based upon a revised business plan. The Company leveraged its asset investments in both real estate and equipment to obtain debt financing rather than issuing additional equity capital to support its short-term cash requirements.

Over the past year, the Company has significantly reduced its cash requirements by adjusting its operating expenses to a reduced revenue forecast. Incremental capital expenditures have been eliminated. The Company closely monitors its on-going cash requirements and is prepared to implement additional cost reductions as necessary.

Based upon our current forecast for 2003, the Company is pursuing various options to raise additional funds to finance operations through the end of 2003. The Company can give no assurances to the timing or terms of such arrangements, assuming it is able to consummate one or more of these options. If the Company is unable to raise sufficient funds through these options by the end of the second quarter of 2003, it will need to implement further cost reduction strategies, and the Company may not have adequate capital to sustain its current operations. Financing options in process or under consideration include: a new Canadian bank revolving credit facility that would refinance the existing Toronto Dominion facility, a Canadian government development loan, sale of real estate and/or a private placement of equity/debt securities. The Company expects to close several of these financing options by the end of the second quarter of 2003.

Historically, the Company has financed operations through private equity placements, third-party credit facilities and cash from operations. During the year ended December 31, 2002, the Company completed a private placement transaction selling an aggregate of 1,242,600 shares of common stock resulting in net proceeds of approximately $9.7 million. In addition, the Company obtained additional funding of $6.6 million primarily through the proceeds from the TJJ Note of $4.0 million and utilization of $3.4 million from the Merrill Lynch credit facility. This was partially offset by the repayment of the $1.2 million mortgage note with Granite Bank. The Company has used the proceeds from the private placement and bank debt primarily to fund operating losses, capital expenditures and for general working capital purposes. As of December 31, 2002, unrestricted cash and cash equivalents were $3.1 million.

Cash used in operating activities was $12.8 million in 2002, as a result of a net loss of $15.5 million and a decrease in accounts payable of $1.7 million partially offset by depreciation and amortization of $2.7 million, a decrease in inventories of $0.7 million and an asset impairment charge of $0.9 million. Cash used in investing activities was $1.8 million principally due to an increase in property, plant and equipment of $1.5 million. Included in property, plant and equipment was approximately $0.5 million of fixed assets purchased from CIENA Corporation in the second quarter of 2002. Cash provided by financing activities was $16 million in 2002 principally as a result of the Company's sale of common stock through a private placement transaction with net proceeds of $9.7 million as well as an increase in net proceeds from bank debt of $6.4 million.

BORROWING AGREEMENTS

On December 27, 2002, the Company entered into a second amendment of the credit agreement, which decreased the borrowing availability to $6,000,000 by decreasing the line of credit to $2,500,000 and maintaining the revolver at $3,500,000. The line of credit is subject to review and renewal as of July 31, 2003. As of December 31, 2002, $2,886,995 was outstanding under the reducing revolver and $3,500,000 was outstanding under the line of credit. The outstanding principal balance of all advances under this credit facility bears interest at 2.5% over the one month LIBOR rate. As of December 31, 2002 the interest rate was approximately 3.9%. The Company's obligations under this credit facility are secured by substantially all the Company's Salem assets, excluding real property, plus a pledge of restricted cash in the amount of $2,000,000. In addition, the Company is required to maintain a $7.8 million tangible net worth. The Company was not in compliance with all provisions of the credit agreement due to cross default provisions related to the Toronto Dominion Bank credit facility. The reducing revolver is a seven-year loan with monthly principal and interest payments.

The Company's headquarters in Salem, New Hampshire was subject to a mortgage and note issued to Granite Bank on August 26, 1996 (the "Granite Note"). The Granite Note, in an initial principal amount of $1,500,000 was due August 29, 2011. The Granite Note bore interest at a rate of 5.75% per annum and was reviewed annually in August. The principal and interest were repayable in 180 equal monthly installments. In accordance with the terms of the Granite Note, the Company could prepay amounts outstanding there under, in whole or in part, at any time without premium or penalty. As of December 31, 2002, the Granite note was paid in full from the proceeds of the TJJ Corporation Term Note.

However, the long-term portion of debt outstanding to TJJ Corporation of $4,000,000 and Toronto Dominion Bank of $1,555,000 as of December 31, 2002 has been reclassified from long-term to short-term debt due to cross default provisions in the debt covenants with both institutions. Although Toronto Dominion Bank has extended repayment  until May 31, 2003, under SFAS No. 78, Classification of Obligations that are Callable by the Creditor, the Company is required to reclassify all long-term obligations as current.

Therefore, all long-term obligations due both TJJ Corporation and Toronto Dominion Bank are considered current liabilities as of December 31, 2002. The cross default covenants will be cured upon the closing of the National Bank of Canada credit facility, which will replace the entire Toronto Dominion Bank credit facility (see Note 22 for additional information). Subsequent to the replacement of the Toronto Dominion Bank credit facility with the new National Bank of Canada credit facility, the Company expects the TJJ Corporation Term Note of $4,000,000 as of December 31, 2002 ($5,000,000 as of March 31, 2003) and the National Bank of Canada mortgage of $885,000 to be classified in accordance with their scheduled repayment terms. The Company can give no assurance to the timing or its ability to secure financing with the National Bank of Canada.

The Board of Directors of the joint venture, which includes Dr. Nicolae Miron and representatives of StockerYale, (the Joint Venture Board), held four meetings during 2002 to discuss product development progress as well as the market for tunable optical filters in light of the economic conditions that had negatively impacted the telecommunications market.

The Joint Venture Board concluded that although the potential demand for the tunable optical filters was promising, that material product and/or license revenue from the technology in the short term was unlikely. Therefore, the Board on August 8, 2002 unanimously approved an amendment to the original joint venture agreement, whereby StockerYale would cease funding the joint venture and was no longer obligated to fund up to the $4,000,000 as originally contemplated in the joint venture. Both Dr. Miron and StockerYale will continue to own 51% and 49%, respectively of the joint venture.

In the fourth quarter of 2002, the Company determined based upon a lack of funding from the Company and the joint venture's inability to raise additional capital from other sources that the joint venture was impaired. The Company recorded a $474,000 CDN ($308,000 US) asset impairment to write off the Company's remaining investment in the joint venture.

Dr. Wong resigned from iSOFC on May 22, 2002. In a letter sent to Dr. Wong on August 19, 2002, iSOFC exercised its right under the Limited Liability Company Agreement to repurchase Dr. Wong's entire equity interest in the joint venture for fair market value. Although he had the right to dispute the repurchase price within ten business days, Dr. Wong did not respond to the exercise notice and the repurchase was effective as of August 29, 2002. The purchase price for all outstanding shares owned by Dr. Wong was $10,000.

As a result, StockerYale currently owns 100% of iSOFC, which has revised its business plan to operate as a wholly-owned subsidiary of StockerYale funded on a significantly reduced "as needed" basis, and StockerYale is no longer obligated to fund up to the $7,000,000 as originally contemplated in the joint venture.

From time to time, the Company contemplates raising additional capital by the issuance of equity securities, the proceeds of which may be used, among other things, to fund working capital needs and capital expenditures. As of March 8, 2002, the Company raised an additional $9.7 million through a private placement of 1,242,600 shares. In addition, the Company obtained additional funding of $6.6 million through proceeds from the TJJ Corporation Term Note of $4.0 million and utilization of $3.4 million from the Merrill Lynch credit facility. This was partially offset by the pay off of the $1.2 million mortgage note with Granite Bank.

CONTRACTUAL OBLIGATIONS

(1)       Includes approximately $4.6 million of credit lines, which expire during 2003. 

RECENT ACCOUNTING PRONOUNCEMENTS

In June, 2002, FASB issued SFAS No. 146, Accounting for Cost Associated with Exit or Disposal Activities. SFAS No. 146 nullifies previous guidance on accounting for costs associated with exit or disposal activities and requires a liability for these costs to be recognized and measured at its fair value in the period in which the liability is incurred. SFAS No. 146 is effective for exit or disposal activities initiated after December 31, 2002.

In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure. This Statement amends FASB Statement No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirements of Statement No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. This standard is effective for financial statements for fiscal years ending after December 15, 2002. The disclosure requirements of SFAS No. 148 have been implemented in Note 3 and the interim disclosure reporting requirements will be adopted by the Company in the first interim period.

CRITICAL ACCOUNTING POLICIES

StockerYale's discussion and analysis of its financial condition and results of operations are based upon the Company's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires StockerYale to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, StockerYale evaluates its estimates, including, accounts receivable, inventories, property, plant and equipment and goodwill and intangible assets. StockerYale develops its estimates based on historical experience as well as assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.

StockerYale believes the following critical policies affect its more significant judgments and estimates used in the preparation of its consolidated financial statements.

ACCOUNTS RECEIVABLE

The Company reviews the financial condition of all new customers prior to granting credit. After completing the credit review, the Company establishes a credit line for each customer. Periodically, the Company reviews the credit line for all major customers and adjusts the credit limit based upon an updated financial condition of the customer, historical sales and payment information and expected future sales. The Company has a large number of customers; therefore, material credit risk is limited to only a small number of customers. Sales to the Company's largest customer accounted for 16% of consolidated revenue in 2002. No other customer accounted for more than 10% of revenue in 2002. The Company periodically reviews the collectibility of its accounts receivable. Provisions are established for accounts that are potentially uncollectible. Determining adequate reserves for accounts receivable requires management's judgment. Conditions impacting the collectibility of the Company's receivables could cause actual write-offs to be materially different than the reserved balances as of December 31, 2002.

REVENUE RECOGNITION

The Company recognizes revenue from product sales at the time of shipment and when persuasive evidence of an arrangement exists, performance of the Company's obligation is complete, the price to the buyer is fixed or determinable, and collectibility is reasonably assured. In certain limited situations, customers have the right to return products. Such rights of return have not precluded revenue recognition because the Company has a long history with such returns and accordingly provides a reserve.

INVENTORY OBSOLESCENCE

The Company values inventories at the lower of cost or market using the first in, first-out ("FIFO") method. The Company specifically evaluates historical and forecasted demand of the illumination product line to determine if the carrying value of both finished goods and raw materials is recoverable through future sales. The Company also estimates the impact of increased revenues for new products versus the potential obsolescence of older products on a case-by-case basis. As a result of this analysis, the Company reduces the carrying amount of inventory. The Company has not established an inventory reserve for the optical components product line since these products are primarily manufactured based upon a customer order. Actual results could be different from management's estimates and assumptions.

INTANGIBLE ASSETS

The Company's intangible assets consist of goodwill, which is not being amortized commencing in 2002 and beyond and amortizing intangibles, which consist of patents, trademarks and purchased patented technologies, which are being amortized over their useful lives. All intangible assets are subject to impairment tests on a periodic basis.

Note 8 describes the impact of accounting for the adoption of SFAS No. 142, Goodwill and Intangible Assets, and the annual impairment methodology that the Company will employ on January 1st of each year in calculating the recoverability of goodwill. This same impairment test will be performed at other times during the course of the year should an event occur which suggests that the recoverability of goodwill should be challenged. Amortizing intangibles are currently evaluated for impairment using the methodology set forth in SFAS No. 144, Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed of. Recoverability of these assets is assessed only when events have occurred that may give rise to an impairment. When a potential impairment has been identified, forecasted undiscounted cash flows of the operations to which the asset relates are compared to the current carrying value of the long-lived assets present in that operation. If such cash flows are less than such carrying amounts, long-lived assets, including such intangibles, are written down to their respective fair values.

LONG-LIVED ASSETS

The Company reviews the recoverability of its long-lived assets, primarily property, plant and equipment, when events or changes in circumstances occur that indicate that the carrying value of the assets may not be recoverable. This review is based on the Company's ability to recover the carrying value of the assets from expected undiscounted future cash flows. If an impairment is indicated, the Company measures the loss based on the fair value of the asset using various valuation techniques. If an impairment loss exists, the amount of the loss will be recorded in the consolidated statements of operations. It is possible that future events or circumstances could cause these estimates to change.

INCOME TAXES

The Company accounts for income taxes under the liability method. Under this method the Company recognizes deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the financial statements or tax returns. Deferred tax assets and liabilities are determined based on the difference between the financial reporting and tax basis of the assets and liabilities using currently enacted tax rates. Valuation allowances are established when necessary to reduce deferred tax assets to the amount that is more likely than not to be realized.

CERTAIN FACTORS AFFECTING FUTURE OPERATING RESULTS

Statements, other than historical facts, made herein may constitute forward-looking statements. Such forward-looking statements are subject to risks and uncertainties, which may cause actual results to differ materially from those, anticipated in such statements. The factors that could cause actual results to differ materially from anticipated results include, without limitation, the Company's ability to, (i) compete with entities that have greater financial, technical and marketing resources than the Company, (ii) develop and market new products in its various business lines, (iii) gain sufficient market acceptance for its fiber products (iv) obtain financing on favorable terms or refinance indebtedness prior to maturity or (v) raise capital through equity or debt to fund anticipated expenditures and (vi) risks inherent with international operations. In addition, general economic conditions worldwide may affect the Company's results.

ITEM 7A:    QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

FOREIGN CURRENCY EXCHANGE RISK

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

INTEREST RATE RISK

The Company is exposed to market risk from changes in interest rates, which may adversely affect its financial position, results of operations and cash flows. In seeking to minimize the risks from interest rate fluctuations, the Company manages exposures through its regular operating and financing activities. The Company is exposed to interest rate risk primarily through its borrowings under its $2.5 million credit line and $3.5 million Reducing Revolver with Merrill Lynch with an interest rate at 2.5% over the one month LIBOR and its $2.0 million CDN line of credit with Toronto Dominion bank with an interest rate at 3% over Toronto Dominion's prime rate. As of December 30, 2002 the fair market value of the Company's outstanding debt approximates its carrying value due to the short-term maturities and variable interest rates. A 1% change in interest rates could increase or decrease interest expense by approximately $90,000 on an annual basis.

The information required by Item 8 is presented on pages 23 through 49 of this Form 10-K.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

INDEPENDENT AUDITORS' REPORT

To the Board of Directors and Stockholders of StockerYale, Inc.:

We have audited the accompanying consolidated balance sheet of StockerYale, Inc. and subsidiaries as of December 31, 2002, and the related consolidated statements of operations, stockholders' equity, and cash flows for the year then ended. Our audit also included the 2002 financial statement schedule listed in the Index at Item 15(a) 2. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on the 2002 financial statements and financial statement schedule based on our audit. The financial statements and financial statement schedule as of December 31, 2001, and for each of the years in the two-year period then ended, before the inclusion of the goodwill disclosures discussed in Note 8 to the financial statements, were audited by other auditors who have ceased operations. Those auditors expressed an unqualified opinion on those financial statements and stated that such 2001 and 2000 financial statement schedules, when considered in relation to the 2001 and 2000 basic financial statements taken as a whole, presented fairly, in all material respects, the information set forth therein, in their report dated February 25, 2002 (except with respect to the matter discussed in Note 18, as to which the date was March 8, 2002).

We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the 2002 consolidated financial statements present fairly, in all material respects, the financial position of StockerYale, Inc. and subsidiaries as of December 31, 2002, and the results of their operations and their cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the 2002 financial statement schedule, when considered in relation to the 2002 basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

As discussed above, the financial statements of StockerYale Inc. and subsidiaries as of December 31, 2001, and for the years ended December 31, 2001 and 2000, were audited by other auditors who have ceased operations. As described in Note 8, these financial statements have been revised to include the transitional disclosures required by Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets (SFAS 142), which was adopted by the Company as of January 1, 2002. Our audit procedures with respect to the disclosures in Note 8 with respect to 2001 and 2000 included (1) comparing the previously reported net loss to the previously issued financial statements and the adjustments to reported net loss representing amortization expense (including any related tax effects) recognized in those periods related to goodwill, intangible assets that are no longer being amortized, deferred credits related to an excess over cost, equity method goodwill, and changes in amortization periods for intangible assets that will continue to be amortized as a result of initially applying SFAS 142 (including any related tax effects) to the Company's underlying analysis obtained from management, and (2) testing the mathematical accuracy of the reconciliation of adjusted net loss to reported net loss and the related loss-per-share amounts. In our opinion, the disclosures for 2001 and 2000 in Note 8 are appropriate. However, we were not engaged to audit, review, or apply any procedures to the 2001 and 2000 financial statements of the Company other than with respect to such disclosures and, accordingly, we do not express an opinion or any other form of assurance on the 2001 and 2000 financial statements taken as a whole.

As discussed in Note 8, in the year ended December 31, 2002 the Company changed its method of accounting for goodwill and intangible assets to conform to the provisions of SFAS 142.

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Notes 1 and 13 to the financial statements, at December 31, 2002, the Company was not in compliance with the covenants of their loan agreements, which has resulted in certain banks demanding repayment and/or a reduction in their loan commitments. The Company is attempting to renegotiate the terms and covenants of the loan agreements and also is seeking other sources of long-term financing. The Company's difficulties in meeting its loan agreements covenants and financing needs, its recurring losses from operations, and its negative working capital position discussed in Note 1 raise substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are described in Note 2. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

Note:

The following audit report of Arthur Andersen LLP (Andersen) is a copy of the report previously issued by Arthur Andersen on February 25, 2002 (and on March 8, 2002 with respect to other matters) in connection with StockerYale, Inc.'s filing on Form 10-K for the year ended December 31, 2001. This audit report has not been reissued by Arthur Andersen LLP in connection with this filing on Form 10-K.

To the Directors and Stockholders of StockerYale, Inc.:

We have audited the accompanying consolidated balance sheets of StockerYale, Inc. (a Massachusetts corporation) and subsidiaries as of December 31, 2001 and 2000, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2002. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall 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 StockerYale, Inc. and subsidiaries as of December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001 in conformity with accounting principles generally accepted in the United States.

ITEM 8.     FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

CONSOLIDATED BALANCE SHEETS

See the notes to consolidated financial statements.

CONSOLIDATED STATEMENT OF OPERATIONS