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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

Form 10-Q

(Mark one)

ý
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES AND EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2004

OR

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

For the transition period from                              to                                            

Commission file number    0-24230

_________________________________________________________

FIBERSTARS, INC.
(Exact name of registrant as specified in its charter)
_________________________________
 
California
 
94-3021850
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
44259 Nobel Drive, Fremont, CA
 
94538
(Address of principal executive offices)
 
(Zip Code)
 
 
 
(Registrant’s telephone number, including area code): (510) 490-0719

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 whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
 
Yes o No ý
 
The number of outstanding shares of the registrants’ Common Stock, $0.0001 par value, as of July 31, 2004 was 7,065,788.
 
 
     
 
TABLE OF CONTENTS

 
 
 

 Part I - FINANCIAL INFORMATION

  
     
Item 1 Financial Statements: 
  
     
 
a.    Condensed Consolidated Balance Sheets at June 30, 2004 (unaudited) and December 31, 2003

 2

     
 
b.     Condensed Consolidated Statements of Operations for the Three Months and Six Months Ended June 30, 2004 and 2003 (unaudited)

 3

     
 
c.    Condensed Consolidated Statements of Comprehensive Operations for the Three Months and Six Months Ended June 30, 2004 and 2003 (unaudited)

4

     
 
d.    Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2004 and 2003 (unaudited)

5

     
  e.    Notes to Condensed Consolidated Financial Statements (unaudited)

6

     
Item 2 Management’s Discussion and Analysis of Results of Operations and Financial Condition

11

     
Item 3 Quantitative and Qualitative Disclosures About Market Risk 

18

     
Item 4 Controls and Procedures 

18

     
 

 Part II - OTHER INFORMATION

  
     
Item 4 Submission of Matters to a Vote of Security Holders

19

     
Item 6 Exhibits and Reports on Form 8-K 

20

     
  Signatures

21

 
 
 
  1  
 
 
Item 1.     Financial Statements

FIBERSTARS, INC.
CONDENSED
CONSOLIDATED BALANCE SHEETS
(amounts in thousands)

 
 
June 30,
2004
 
December 31,
2003
 
   

(unaudited)

  
 
 
 
  
 
 
 
ASSETS
 
 
 
 
 
Current assets:
 
 
 
 
 
Cash and cash equivalents
 
$
2,957
 
$
4,254
 
Accounts receivable trade, net
 
6,618
 
5,610
 
Notes and other accounts receivable
 
120
 
143
 
Inventories, net
 
7,425
 
6,618
 
Prepaids and other current assets
 
787
 
246
 
   
  		 
  		  
Total current assets
 
17,907
 
16,871
 
 
 
 
 
 
 
Fixed assets, net
 
2,548
 
2,634
 
Goodwill, net
 
4,154
 
4,190
 
Intangibles, net
 
251
 
306
 
Other assets
 
108
 
118
 
   
 
 
Total assets
 
$
24,968
 
$
24,119
 
   
 
 
 
 
 
 
 
 
LIABILITIES
 
 
 
 
 
Current liabilities:
 
 
 
 
 
Accounts payable
 
$
2,359
 
$
2,205
 
Accrued liabilities
 
2,002
 
2,413
 
Short-term bank borrowings
 
213
 
30
 
   
 
 
Total current liabilities
 
4,574
 
4,648
 
Other long-term liabilities
 
28
 
46
 
Long-term bank borrowings
 
450
 
475
 
   
 
 
Total liabilities
 
5,052
 
5,169
 
   
 
 
 
 
 
 
 
 
Commitments and contingencies (Note 9)
 
 
 
 
 
 
 
 
 
 
 
SHAREHOLDERS’ EQUITY
 
 
 
 
 
Common stock
 
1
 
1
 
Additional paid-in capital
 
26,112
 
24,531
 
Note receivable from shareholder
 
—
 
(224
)
Unearned stock-based compensation
 
(550
)
—
 
Accumulated other comprehensive income
 
442
 
428
 
Accumulated deficit
 
(6,089
)
(5,786
)
   
 
 
Total shareholders’ equity
 
19,916
 
18,950
 
   
 
 
Total liabilities and shareholders’ equity
 
$
24,968
 
$
24,119
 
   
 

The accompanying notes are an integral part of these financial statements

  2  
 

FIBERSTARS, INC.
CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS
(amounts in thousands except per share amounts)
(unaudited)



 
 
Three months
ended June 30,
 
Six months
ended June 30,
 
 
 
2004
 
2003
 
2004
 
2003
 
Net sales
 
$
8,550
 
$
7,574
 
$
14,558
 
$
13,453
 
Cost of sales
 
4,983
 
4,699
 
8,890
 
8,532
 
Gross profit
 
3,567
 
2,875
 
5,668
 
4,921
 
Operating expenses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Research and development
 
217
 
202
 
487
 
398
 
Sales and marketing
 
2,210
 
1,865
 
4,187
 
3,613
 
General and administrative
 
645
 
676
 
1,268
 
1,344
 
Total operating expenses
 
3,072
 
2,743
 
5,942
 
5,355
 
Profit (loss) from operations
 
495
 
132
 
(274
)
(434
)
Other income (expense):
 
 
 
 
 
 
 
 
 
Equity in joint venture’s income
 
1
 
—
 
1
 
—
 
Interest income (expense), net
 
(29
)
(28
)
(23
)
(60
)
 
 
 
 
 
 
 
 
 
 
Profit (loss) before income taxes
 
467
 
104
 
(296
)
(494
)
Benefit from (provision for) income taxes
 
(6
)
(19
) 
(7
) 
(43
)
Net income (loss)
 
$
461
 
$
85
 
$
(303
)
$
(537
)
 
 
 
 
 
 
 
 
 
 
Net income (loss) per share – basic
 
$
0.06
 
$
0.02
 
$
(0.04
)
$
(0.10
)
 
 
 
 
 
 
 
 
 
 
Shares used in computing net income per share – basic
 
7,219
 
5,244
 
7,135
 
5,179
 
 
 
 
 
 
 
 
 
 
 
Net income (loss) per share – diluted
 
$
0.06
 
$
0.02
 
$
(0.04
)
$
(0.10
)
 
 
 
 
 
 
 
 
 
 
Shares used in computing net income (loss) per share – diluted
 
8,100
 
5,285
 
7,135
 
5,179
 
 
 
 
 
 
 
 
 
 
 
 

The accompanying notes are an integral part of these financial statements

  3  
 

FIBERSTARS, INC.
CONDENSED
CONSOLIDATED STATEMENTS OF COMPREHENSIVE OPERATIONS
(amounts in thousands)
(unaudited)
 

 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
   
 
 
 
 
 
2004
 
 
2003
 
 
2004
 
 
2003
 
   
 
 
 
 
Net income (loss)
 
$
461
 
$
85
 
$
(303
)
$
(537
)
 
 
 
 
 
 
 
 
 
 
Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
 
 
Foreign currency translation adjustments
 
(13
)
230
 
22
 
224
 
Provision for income taxes
 
5
 
(85
) 
(8
)
(132
)
   
 
 
 
 
Comprehensive income (loss)
 
$
453
 
$
230
 
$
(289
)
$
(313
)
   
 
 
 
 
 

The accompanying notes are an integral part of these financial statements

 
  4  
 

FIBERSTARS, INC.
CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(amounts in thousands)
(unaudited)

 
 
Six Months Ended June 30,
 
   
 
 
 
2004
 
2003
 
   
 
Cash flows from operating activities:
 
 
 
 
 
Net loss
 
$
(303
)
$
(537
)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
 
 
 
 
 
Depreciation and amortization
 
498
 
445
 
Equity in joint venture
 
(1
)
19
 
Changes in assets and liabilities:
 
 
 
 
 
Accounts receivable
 
(989
)
(745
) 
Notes and other receivables
 
23
 
66
 
Inventories
 
(794
)
373
 
Prepaids and other current assets
 
(535
) 
(82
)
Other assets
 
10
 
4
 
Accounts payable
 
135
 
(299
)
Accrued liabilities
 
(348
)
(331
)
Total adjustments
 
(2,001
)
(550
)
Net cash used in operating activities
 
(2,304
)
(1,087
)
 
 
 
 
 
 
Cash flows from investing activities:
 
 
 
 
 
 
 
 
 
 
 
Acquisition of fixed assets
 
(352
)
(93
)
Net cash used in investing activities
 
(352
)
(93
)
 
 
 
 
 
 
Cash flows from financing activities:
 
 
 
 
 
Cash proceeds from exercise of stock options
 
1,032
 
¾
 
Cash proceeds from sale of common stock
 
¾
 
2,769
 
Proceeds from (Repayment of) short-term bank borrowings and bank overdraft
 
88
 
(1,142
)
Collection of loan made to shareholder
 
224
 
75
 
Other long term liabilities
 
28
 
44
 
   
 
 
Net cash provided by financing activities
 
1,372
 
1,746
 
 
 
 
 
 
 
Effect of exchange rate changes on cash
 
(13
)
169
 
 
 
 
 
 
 
Net increase (decrease) in cash and cash equivalents
 
(1,297
)
735
 
Cash and cash equivalents, beginning of period
 
4,254
 
231
 
Cash and cash equivalents, end of period
 
$
2,957
 
$
966
 
 
 
 
 
 
 

The accompanying notes are an integral part of these financial statements

 
  5  
 
FIBERSTARS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2004
(Unaudited)

1.     Summary of Significant Accounting Policies

Interim Financial Statements (unaudited)
Although unaudited, the interim financial statements in this report reflect all adjustments, consisting of all normal recurring adjustments, which are, in the opinion of management, necessary for a fair statement of financial position, results of operations and cash flows for the interim periods covered and of the financial condition of Fiberstars, Inc. (the “Company”) at the interim balance sheet dates. The results of operations for the interim periods presented are not necessarily indicative of the results expected for the entire year.

Year-end Balance Sheet
The year-end balance sheet information was derived from audited financial statements but does not include all disclosures required by generally accepted accounting principles. These financial statements should be read in conjunction with the Company’s audited financial statements and notes thereto for the year ended December 31, 2003, contained in the Company’s 2003 Annual Report on Form 10-K.

Foreign Currency Translation
The Company’s international subsidiaries use their local currency as their functional currency. For those subsidiaries, assets and liabilities are translated at exchange rates in effect at the balance sheet date and income and expense accounts at average exchange rates during the year. Resulting translation adjustments are recorded to a separate component of shareholders’ equity.

Earnings Per Share
Basic earnings per share (“EPS”) is computed by dividing income available to shareholders by the weighted average number of common shares outstanding for the period. Diluted EPS is computed by giving effect to all dilutive potential common shares that were outstanding during the period. Dilutive potential common shares consist of incremental shares upon exercise of stock options and warrants.

A reconciliation of the numerator and denominator of basic and diluted EPS is provided as follows (unaudited, in thousands, except per share amounts):

 
 
Three months ended June 30,
 
Six months ended June 30,
 
   
 
 
 
 
2004
 
2003
 
2004
 
2003
 
   
 
 
 
 
Numerator - Basic and Diluted EPS
 
 
 
 
 
 
 
 
 
Net income (loss)
 
$
461
 
$
85
 
$
(303
)
$
(537
)
Denominator - Basic EPS
 
 
 
 
 
 
 
 
 
Weighted average shares outstanding
 
7,219
 
5,244
 
7,135
 
5,179
 
   
 
 
 
 
Basic net income (loss) per share
 
$
0.06
 
$
0.02
 
$
(0.04
)
$
(0.10
)
   
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Denominator - Diluted EPS
 
 
 
 
 
 
 
 
 
Denominator - Basic EPS
 
7,219
 
5,285
 
7,135
 
5,179
 
Effect of dilutive securities:
 
 
 
 
 
 
 
 
 
Stock options and warrants
 
881
 
41
 
—
 
—
 
   
 
 
 
 
 
 
8,100
 
5,285
 
7,135
 
5,179
 
   
 
 
 
 
Diluted net income (loss) per share
 
$
0.06
 
$
0.02
 
$
(0.04
)
$
(0.10
)
   
 
 
 


The shares outstanding used for calculating basic and diluted EPS include 120,000 shares of common stock issuable for no cash consideration upon exercise of certain exchange provisions of warrants held by Advanced Lighting Technologies, Inc. (“ADLT”).

 
  6  
 
 
At June 30, 2004, options and warrants to purchase 1,105,322 shares of common stock were outstanding, but were not included in the calculation of diluted EPS because their inclusion would have been antidilutive. Options to purchase 1,872,000 shares of common stock were outstanding at June 30, 2003, but were not included in the calculation of diluted EPS for the six months ended June 30, 2003 because their inclusion would have been antidilutive.
 
Stock Based Compensation
The Company accounts for stock-based compensation plans under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. The following table illustrates the effect on net income (loss) and earnings per share if the Company had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation.

(in thousands, except per share amounts):
                     

 
 
Three months ended June 30,
 
Six months ended June 30,
 
   
 
 
 
 
2004
 
2003
 
2004
 
2003
 
   
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income (loss)
 
$
461
 
$
85
 
$
(303
)
$
(537
)
 
 
 
 
 
 
 
 
 
 
Add: Stock-based employee compensation expense included in reported net income (loss), net of related tax effects
 
—
 
—
 
—
 
—
 
                   
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of tax related effects
 
(78
)
(88
)
(133
)
(167
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
   
 
 
 
 
Net income (loss)-Pro forma
 
 
383
 
 
(3
)
 
(436
)
 
(704
)
   
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Basic net income (loss) per share — As reported
 
$
0.06
 
$
0.02
 
$
(0.04
)
$
(0.10
)
   
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Basic net income (loss) per share — Pro forma
 
$
0.05
 
$
—
 
$
(0.06
)
$
(0.14
)
   
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Diluted net income (loss) per share — As reported
 
$
0.06
 
$
0.02
 
$
(0.04
)
$
(0.10
)
   
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Diluted net income (loss) per share — Pro forma
 
$
0.05
 
$
—
 
$
(0.06
)
$
(0.14
)
   
 
 
 
 
 
Product Warranties
The Company warrants finished goods against defects in material and workmanship under normal use and service for periods of one to three years for illuminators and fiber. A liability for the estimated future costs under product warranties is maintained for products outstanding under warranty:
 

 
 
Six months ended
June 30, 2004
 
 
 
(in thousands)
 
Balance at the beginning of the period
 
$
330
 
Accruals for warranties issued during the period
 
297
 
Accruals related to pre-existing warranties (including changes in estimates)
 
 
45
 
Settlements made during the period (in cash or in kind)
 
(297
)
Balance at the end of the period
 
$
375
 

 
  7  
 
 

2.     Inventories

Inventories are stated at the lower of standard cost (which approximates actual cost determined using the first-in, first-out cost method) or market and consist of the following (unaudited, in thousands):

 
 
June 30,
2004
 
December 31,
2003
 
   
 
 
 
 
 
 
 
 
Raw materials
 
$
6,144
 
$
5,955
 
Inventory reserve
 
(546
)
(714
)
   
 
 
 
 
 
 
 
 
Finished goods
 
1,827
 
1,377
 
   
 
 
 
 
$
7,425
 
$
6,618
 
   
 


3.     Bank Borrowings

The Company has a $5,000,000 Loan and Security Agreement (Accounts Receivable and Inventory) dated December 7, 2001, with Comerica Bank bearing interest equal to prime plus 0.25% per annum computed daily or a fixed rate term option of LIBOR plus 3%. Borrowings under this Loan and Security Agreement are collateralized by the Company’s assets and intellectual property. Specific borrowings are tied to accounts receivable and inventory balances, and the Company must comply with certain covenants with respect to effective net worth and financial ratios. The Company had no borrowings against this facility as of June 30, 2004 and December 31, 2003. The Company was in conformity with its bank covenants as of June 30, 2004. On April 2, 2004, the Company and Comerica Bank amended the Loan and Security Agreement to eliminate the profitability covenant.

The Company also has a $413,000 (in UK pounds sterling based on the exchange rate at June 30, 2004) bank overdraft agreement with Lloyds Bank Plc through its UK subsidiary. There were no borrowings against this facility as of June 30, 2004 and December 31, 2003.

The Company has a $671,000 (contracted in Euros, based on the exchange rate at June 30, 2004) bank borrowing facility secured by real property owned by its German subsidiary, with Sparkasse Neumarkt Bank. As of June 30, 2004, the Company had a total borrowing of $464,000 against this credit facility. As of December 31, 2003, the Company had $475,000 borrowed against this facility. Additionally, there is a revolving line of credit of $233,000 (contracted in Euros, based on the exchange rate at June 30, 2004) with Sparkasse Neumarkt Bank. As of June 30, 2004, there was a total borrowing of $179,000 against this facility, and there were no borrowings against this facility as of December 31, 2003.

4.     Comprehensive Operations

Comprehensive income (loss) is defined as net income (loss) plus sales, expenses, gains and losses that, under generally accepted accounting principles, are included in comprehensive income (loss) but excluded from net income (loss). A separate statement of comprehensive operations has been presented with this report.

5.     Segments and Geographic Information

The Company operates in a single industry segment that manufactures, markets and sells fiber optic lighting products. The Company has two primary product lines: the pool and spa lighting product line and the commercial lighting product line, each of which markets and sells fiber optic lighting products. The Company markets its products for worldwide distribution primarily through independent sales representatives, distributors and swimming pool builders in North America, Europe and the Far East.
 
 
  8  
 

A summary of sales by geographic area is as follows (unaudited, in thousands):

 
 
Six months ended June 30,
 
   
 
 
 
2004
 
2003
 
   
 
 
U.S. Domestic
 
$
10,509
 
$
9,919
 
Germany
 
 
1,765
 
 
1,551
 
U.K.
 
 
1,931
 
 
1,664
 
Other countries
 
353
 
319
 
   
 
 
 
 
$
14,558
 
$
13,453
 
   
 

Geographic sales are categorized based on the location of the customer to whom the sales are made.

A summary of sales by product line is as follows (unaudited, in thousands):

 
 
Six months ended June 30,
 
   
 
 
 
2004
 
2003
 
   
 
 
 
 
 
 
 
 
Pool and Spa Lighting
 
$
8,235
 
$
7,235
 
Commercial Lighting
 
6,323
 
6,218
 
   
 
 
 
 
$
14,558
 
$
13,453
 
   
 


A summary of geographic long lived assets (fixed assets, goodwill and intangibles) is as follows (in thousands):

 
 
June 30,
2004
 
December 31,
2003
 
   
 
 
 
 
(unaudited)
 
 
 
U.S. Domestic
 
$
5,007
 
$
5,306
 
Germany
 
1,833
 
1,458
 
Other Countries
 
113
 
164
 
   
 
 
 
 
$
6,953
 
$
6,928
 

6.     Recent pronouncements

In May 2003, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.”  This Statement establishes standards for how an issuer classifies and measures in its statement of financial position certain financial instruments with characteristics of both liabilities and equity.  It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances) because that financial instrument embodies an obligation of the issuer.  This Statement is effective for financial instruments entered into or modified after May 31, 2003 and otherwise is effective at the beginning of the first interim period beginning after June 15, 2004, except for mandatory redeemable financial instruments of nonpubli c entities. It is to be implemented by reporting the cumulative effect of a change in an accounting principle for financial instruments created before the issuance date of the statement and still existing at the beginning of the interim period of adoption.  The adoption of SFAS No. 150 did not have an impact on the Company’s financial position, results of operations or cash flows.

In January 2003, the FASB issued FASB Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51.” FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective immediately for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual period beginning after June 15, 2003. In addition, FIN 46 requires that a company make disc losures in its consolidated financial statements for the year ended December 31, 2002 when the company believes it is reasonably possible that it will consolidate or disclose information about variable interest entities after FIN 46 becomes effective. In December 2003, FASB issued a revised FIN 46. The FASB deferred the effective date for VIEs that are non-special purpose entities created before February 1, 2003, to the first interim or annual reporting period that ends after March 15, 2004. At this time, the Company does not believe that it is reasonably possible that it will consolidate or disclose information about VIEs. However, the Company will continue to assess the impact of FIN 46 on its consolidated financial statements.
 
 
  9  
 
 

7.     Acquired Intangibles

In February 2000, the Company purchased certain assets of Unison Fiber Optic Systems, Inc. (“Unison”) and accounted for the acquisition as a purchase. Acquired intangible assets are being amortized using the straight-line method over the estimated useful life of the assets ranging from 3 to 7 years.

8.     Income Taxes

A full valuation allowance is recorded against the Company’s U.S. deferred tax assets as management cannot conclude, based on available objective evidence, when the gross value of its deferred tax assets will be realized. The Company accrues foreign tax expenses or benefits as these are incurred.

9.    Commitments and Contingencies

Refer to Note 8 of the Company’s Notes to Consolidated Financial Statements included in its Annual Report on Form 10-K for the fiscal year ended December 31, 2003, as filed with the SEC.

 
 
  10  
 

Item 2.     Management’s Discussion and Analysis of Results of Operations and Financial Condition

The following discussion and analysis of the Company’s financial condition and results of operations should be read in conjunction with the Condensed Consolidated Financial Statements and related notes included elsewhere in this report and the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003.

When used in this discussion, the words “expects,” “anticipates,” “estimates,” “plan,” and similar expressions are intended to identify forward-looking statements. These statements, which include statements as to our future operating results, net sales growth, gross profit margin improvement, sources of revenues, expected operating expenses and capital expenditure levels, expected cash flows, the adequacy of capital resources, future growth in fiber optic lighting, plans for and expected benefits of outsourcing manufacturing, our future products, statements regarding claims involving our intellectual property, are subject to risks and uncertainties that could cause actual results to differ materially from those projected. These risks and uncertainties include, but are not limited to, those risks discussed below, as well as our ability to retai n and obtain customer and distributor relationships, our ability to maintain relationships with strategic partners and ADLT, our ability to manage expenses and inventory levels, our ability to reduce manufacturing overhead and general and administrative expenses as a percentage of sales, our ability to collect on doubtful accounts receivable, our ability to increase cash balances in future quarters, the cost of accessing or acquiring technologies or intellectual property, the cost of enforcing or defending intellectual property, risks relating to developing and marketing new products, the ability of our lighting products to meet customer expectations, manufacturing difficulties, possible delays in the release of products, risks associated with the evolution and growth of the fiber optic lighting market, trends in price performance and adoption rates of fiber optic lighting products in Europe and the United States, our dependence on a limited number of suppliers for components and distributors for sales, our ability to obtain high-quality components at reasonable prices, the impact of limited energy resources on our manufacturing operations and business, the impact of technological advances and competitive products, and seasonal and other fluctuations in the construction industry; and the matters discussed in “Factors That May Affect Results.” These forward-looking statements speak only as of the date hereof. We expressly disclaims any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.

RESULTS OF OPERATIONS

Net sales increased 13% to $8,550,000 for the quarter ended June 30, 2004, as compared to the same quarter a year ago. The increase was primarily the result of a 19% increase in pool lighting sales due to higher in-ground fiber product sales and Jazz light sales, partially offset by lower spa product sales. Commercial lighting sales were up by 5% over the same quarter a year ago, with increases in both U.S. and European commercial lighting sales. Net sales were $14,558,000 for the first six months of 2004, an increase of 8% over the first six months of 2003. The increase for the first six months of 2004 was due to a 14% increase in sales of pool lighting products from the same period a year ago. For the first six months of 2004, commercial lighting sales increased slightly by 2% compared to the first six months of 2003. Due to anticipated improvements in the pool and spa lighting marke ts and increased sales of EFOTM systems in commercial lighting markets, we believe our net sales will increase in 2004 compared to 2003.

Gross profit was $3,567,000 in the second quarter of fiscal 2004, a 24% increase compared to the same period in the prior year. The gross profit margin was 42% for the second quarter of fiscal 2004, compared to the 38% gross profit margin achieved in the same period in 2003. The gross profit margin improved due to lower direct product costs for pool lighting products and for commercial lighting products in Europe. Gross profit for the first six months of 2004 was $5,668,000, up 15% from gross profit for the same period last year. Gross profit margins was 39% for the first six months of 2004 compared to 37% for the first six months of 2003. The majority of the increase in the gross profit margin was a result of improvements in direct costs for pool lighting products as a result of the move to offshore production. If net sales increase, we believe overall gross profit will increase in 20 04, as we expect our cost of sales to decrease as we increase our offshore manufacturing in Mexico and India.
 
 
  11  
 
 
Research and development expenses were $217,000 in the second quarter of fiscal 2004, an increase of $15,000 compared with the second quarter of fiscal 2003. The increase was due to higher spending on research and development expense on personnel and on project costs related to government contract work and improvements for existing products, partially offset by higher credits received for achieving milestones under a development contract with the Defense Advanced Research Projects Agency (“DARPA”) which was signed in February 2003. The gross research and development spending along with credits from government contracts is shown in the table:
 
(in thousands):

 
 
Three months ended June 30,
 
Six months ended June 30,
 
 
 
2004
 
2003
 
2004
 
2003
 
Gross expenses for research and development
 
$
923
 
$
890
 
$
1,802
 
$
1,535
 
Deduct: credits for NIST award
 
 
—
 
 
(181
)
 
—
 
 
(287
)
Deduct: credits from DARPA contracts
 
 
(706
)
 
(507
)
 
(1,315
)
 
(850
)
Net research and development expense
 
$
217
 
$
202
 
$
487
 
$
398
 


In the second quarter of 2004, we accrued $719,000 in credits for funds to be received from DARPA under this contract. This compares to $478,000 in credits received in the second quarter of 2003. For the first six months of 2004, net research and development expenses were $487,000 compared to $398,000 for the same period in 2003. The increase in expense was primarily due to higher gross expenses for research and development on personnel and project costs in the first half of 2004, partially offset by higher DARPA credits to research and development expense of $1,306,000 for funds to be received for milestones achieved during the first six months of 2004. This compares to $820,000 in DARPA credits received during the same period in 2003. The increase in gross research and development expenses was due to additional costs for personnel and project costs associated with meeting the DARPA m ilestones. We expect research and development expenses to increase in 2004 as we plan to increase our development of commercial lighting products along with additional DARPA work.

Sales and marketing expenses increased by 19% to $2,210,000 in the second quarter of fiscal 2004 as compared to $1,865,000 for the same period in fiscal 2003. This increase was largely due to an increase in commission expenses of $194,000, due in part to higher sales volume and a change in our method of marketing pool products from the second quarter of 2003 to the second quarter of 2004. In the second quarter of 2004, we relied on outside sales agents at higher commission rates to sell pool products. In the second quarter of 2003, we used inside sales managers to sell pool products, which resulted in a lower commission expense rate. In addition, there were increased expenses in U.S. domestic lighting and in European sales and marketing of $140,000 due to exchange rate effects (for Europe) and higher trade show and literature costs. For the first six months of 2004 sales and marketing expenses were $4,187,000 compared to $3,613,000 for the same period in 2003, a 16% increase. The increase was also due to the higher commission expenses, along with higher expenses in U.S. and European sales and marketing due to higher expenditures for personnel, trade shows, literature and exchange rate effects (in Europe). We expect sales and marketing expenses to increase for 2004 as we anticipate increasing our sales and marketing efforts for our new products.

General and administrative costs were $645,000 in the second quarter of fiscal 2004, a decrease of 5% compared to costs in the second quarter of fiscal 2003. For the first six months of 2004, general and administrative costs were $1,268,000 compared to $1,344,000 for the same period in 2003, a 6% decrease. These decreases were largely a result of lower accounting fees resulting from the change in public accounting firms taken in the third quarter of 2003. We expect general and administrative costs to be relatively flat in 2004 compared to 2003.

We recorded net income of $461,000 in the second quarter of fiscal 2004 as compared to net income of $85,000 in the second quarter of fiscal 2003. For the first six months of 2004, we had a net loss of $303,000 compared to a net loss of $537,000 for the same period in 2003. The lower net loss in 2004 was due primarily to the increase in net sales and the improvement in gross profit margin in the second quarter of 2004 compared to the second quarter of 2003.


LIQUIDITY AND CAPITAL RESOURCES

Cash and cash equivalents

 
  12  
 
 
At June 30, 2004, our cash and cash equivalents were $2,957,000 as compared to $4,254,000 at December 31, 2003, a net cash decrease of $1,297,000 during the first six months of 2004. This compares to a net cash increase of $735,000 for the same period in 2003, and an ending cash balance of $966,000 as of June 30, 2003.

We had no bank borrowings against our U.S. line of credit at June 30, 2004 and at December 31, 2003.

Cash decreased from operations during the first six months of 2004 principally due to a net loss of $303,000, an increase in accounts receivable of $989,000, an increase in prepaid expenses of $535,000, an increase in inventories of $794,000 and a decrease in accrued liabilities of $348,000. Our accounts receivable increased due to higher DARPA receivables and higher pool and spa accounts receivable resulting from higher sales in the second quarter of 2004 compared to the second quarter of 2003. These uses of cash from operations were partially offset by depreciation and amortization of $498,000 and an increase in accounts payable of $135,000. After these and other adjustments our total net cash used in operating activities in the second quarter of 2004 was $2,304,000 compared to $1,087,000 used in operating activities in the second quarter of 2003.

Cash Used in Investing Activities

Investing activities used cash of $352,000 during the first six months of 2004, compared to a use of cash of $93,000 for the same period of 2003. During both periods, cash was used for the acquisition of fixed assets.

Cash Provided by Financing Activities

Financing activities contributed $1,372,000 to cash during the first six months of 2004. This net contribution was due primarily to the proceeds from the exercise of employee stock options. For the same period in 2003, financing activities, from the sale of common stock of $2,769,000 was partially offset by repayment of bank borrowings, contributed $1,746,000 to cash. During both periods, we received cash contributions from the repayment of shareholder loans of $224,000 in 2004 and $75,000 in 2003.

We have a $5,000,000 Loan and Security Agreement (Accounts Receivable and Inventory) dated December 7, 2001, with Comerica Bank bearing interest equal to prime plus 0.25% per annum computed daily or a fixed rate term option of LIBOR plus 3%. Borrowings under this Loan and Security Agreement are collateralized by our assets and intellectual property. Specific borrowings are tied to accounts receivable and inventory balances, and we must comply with certain covenants with respect to effective net worth and financial ratios. We had no borrowings against this facility as of June 30, 2004 and December 31, 2003. On April 2, 2004, Fiberstars and Comerica Bank amended the Loan and Security Agreement to eliminate the profitability covenant.

We also have a $413,000 (in UK pounds sterling based on the exchange rate at June 30, 2004) bank overdraft agreement with Lloyds Bank Plc through its UK subsidiary. There were no borrowings against this facility as of June 30, 2004 and December 31, 2003.

We have a total bank borrowing facility of $671,000 (in Euros, based on the exchange rate at June 30, 2004) secured by real property owned by our German subsidiary, with Sparkasse Neumarkt Bank. As of June 30, 2004, we had total borrowings of $464,000 against this credit facility. As of December 31, 2003, we had $475,000 borrowed against this facility. Additionally, we have a revolving line of credit of $233,000 (in Euros, based on the exchange rate at June 30, 2004) with Sparkasse Neumarkt Bank. As of June 30, 2004, there was a total borrowing of $179,000 against this facility, and there were no borrowings against this facility as of December 31, 2003.

We believe that our existing cash balances and funds available to us through our bank lines of credit together with funds that we anticipate generating from our operations, will be sufficient to finance our currently anticipated working capital requirements and capital expenditure requirements for the next twelve months.  However, a sudden increase in product demand requiring a significant increase in manufacturing capability, or unforeseen adverse competitive, economic or other factors may impact our cash position, and thereby affect operations.  From time to time we may be required to raise additional funds through public or private financing, strategic relationships or other arrangements.  There can be no assurance that such funding, if needed, will be available on terms acceptable to us, or at all.  Furthermore, any additional equity financing may be dilutive to shareholders, and debt financing, if available, may involve restrictive covenants. Strategic arrangements, if necessary to raise additional funds, may require that we relinquish rights to certain of our technologies or products.  Failure to generate sufficient revenues or to raise capital when needed could have an adverse impact on our business, operating results and financial condition, as well as our ability to achieve intended business objectives.

 
  13  
 
 
Recent Accounting Pronouncements

In May 2003, the Financial Accounting Standards Board, or FASB, issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.”  This Statement establishes standards for how an issuer classifies and measures in its statement of financial position certain financial instruments with characteristics of both liabilities and equity.  It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances) because that financial instrument embodies an obligation of the issuer.  This Statement is effective for financial instruments entered into or modified after May 31, 2003 and otherwise is effective at the beginning of the first interim period beginning after June 15, 2004, except for mandatory redeemable financial instruments of nonpublic entitie s. It is t o be implemented by reporting the cumulative effect of a change in an accounting principle for financial instruments created before the issuance date of the statement and still existing at the beginning of the interim period of adoption.  The adoption of SFAS No. 150 did not have an impact on the our financial position, results of operations or cash flows.

In January 2003, the FASB issued FASB Interpretation No. 46, or FIN 46, “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51.” FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective immediately for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual period beginning after June 15, 2003. In addition, FIN 46 requires that a company make disclosures in its consolidated financial statements for the year ended December 31, 2002 when the company believes it is reasonably possible that it will consolidate or disclose information about variable interest entities after FIN 46 becomes effective. In December 2003, FASB issued a revised FIN 46. The FASB deferred the effective date for VIEs that are non-special purpose entities created before February 1, 2003, to the first interim or annual reporting period that ends after march 15, 2004. At this time, we do not believe that it is reasonably possible that we will consolidate or disclose information about VIEs. However, we will continue to assess the impact of FIN 46 on our consolidated financial statements.

Factors that May Affect Results

Our operating results are subject to fluctuations caused by many factors that could result in decreased revenues and a drop in the price of our common stock.

Our quarterly operating results can vary significantly depending upon a number of factors. It is difficult to predict the lighting market’s acceptance of and demand for our products on a quarterly basis, and the level and timing of orders received can fluctuate substantially. Our sales volumes fluctuate, as does the relative volume of sales of our various products with significantly different product margins. Historically we have shipped a substantial portion of our quarterly sales in the last month of each of the second and fourth quarters of the year. Our product development and marketing expenditures may vary significantly from quarter to quarter and are made well in advance of potential resulting revenue. Significant portions of our expenses are relatively fixed in advance based upon our forecasts of future sales. If sales fall below our expectations in any given quarter, w e will not be able to make any significant adjustment in our operating expenses, and our operating results will be adversely affected.

Our sales are dependent upon new construction levels and are subject to seasonal and general economic trends.

Sales of our pool and spa lighting products, which currently are available only with newly constructed pools and spas, depend substantially upon the level of new construction of pools. Sales of commercial lighting products also depend significantly upon the level of new building construction and renovation. Construction levels are affected by housing market trends, interest rates and the weather. Because of the seasonality of construction, our sales of swimming pool and commercial lighting products, and thus our overall revenues and income, have tended to be significantly lower in the first and third quarter of each year. Various economic and other trends may alter these seasonal trends from year to year, and we cannot predict the extent to which these seasonal trends will continue.

 
  14  
 
 
On-going terrorist threats, or actual terrorist attacks, may disrupt the general economy, reducing demand for ours products.

On-going terrorist threats and actual terrorist attacks have increased the uncertainty in both the U.S. and European economy, which are primary markets for our products. Terrorist acts and similar events, could weaken the demand for our products as they did following the September 11, 2001 tragedy.

If we are not able to timely and successfully develop, manufacture, market and sell our new products, our operating results will decline.

We expect to introduce additional new products each year in the Pool and Spa Lighting and Commercial Lighting markets. Delivery of these products may cause us to incur additional unexpected research and development expenses. We could have difficulties manufacturing these new products as a result of our inexperience with them or the costs could be higher than expected. Any delays in the introduction of these new products could result in lost sales, loss of customer confidence and loss of market share. Also, it is difficult to predict whether the market will accept these new products. If any of these new products fails to meet expectations, our operating results will be adversely affected.

We operate in markets that are intensely and increasingly competitive.

Competition is increasing in a number of our markets. A number of companies offer directly competitive products, including fiber optic lighting products for downlighting, display case and water lighting, and neon and other lighted signs. We are also experiencing competition from light emitting diode, LED, products in water lighting and in neon and other lighted signs. Our competitors include some very large and well-established companies such as Philips, Schott, 3M, Bridgestone, Pentair, Mitsubishi and Osram/Siemens. All of these companies have substantially greater financial, technical and marketing resources than we do. We may not be able to adequately respond to fluctuations in competitive pricing. We anticipate that any future growth in fiber optic lighting will be accompanied by continuing increases in competition, which could adversely a ffect our operating results if we cannot compete effectively.

We rely on intellectual property and other proprietary information that may not be protected and that may be expensive to protect.

We currently hold 40 patents. There can be no assurance, however, that our issued patents are valid or that any patents applied for will be issued. We have a policy of seeking to protect our intellectual property through, among other things, the prosecution of patents with respect to certain of our technologies. There are many issued patents and pending patent applications in the field of fiber optic technology, and certain of our competitors hold and have applied for patents related to fiber optic lighting. Although, to date, we have not been involved in litigation challenging our intellectual property rights or asserting intellectual property rights of others, we have in the past received communications from third parties and recently received a communication from one of our competitors asserting rights in our patents or that our technology infringes intellectual property rig hts held by such third parties. Based on information currently available to us, we do not believe that any such claims involving our technology or patents are meritorious. However, we may be required to engage in litigation to protect our patent rights or to defend against the claims of others. In the event of litigation to determine the validity of any third party claims or claims by us against such third party, such litigation, whether or not determined in our favor, could result in significant expense and divert the efforts of our technical and management personnel, regardless of the outcome of such litigation.

We rely on distributors for a significant portion of our sales and terms and conditions of sales are subject to change with very little notice.

Most of our products are sold through distributors, and we do not have long-term contracts with our distributors. Some of these distributors are quite large, particularly in the pool products market. If these distributors significantly change their terms with us or change their historical pattern of ordering products from us, there could be a significant impact on our revenues and profits.

The loss of a key sales representative could have a negative impact on our net sales and operating results.

 
  15  
 
 
We rely on key sales representatives and outside sales agents for a significant portion of our sales. These sales representatives and outside sales agents have unique relationships with our customers and would be difficult to replace. The loss of a key sales representative or an outside sales agent could interfere with our ability to maintain customer relationships and result in declines in our net sales and operating results.

We depend on key employees in a competitive market for skilled personnel, and the loss of the services of any of our key employees could materially affect our business.

Our future success will depend to a large extent on the continued contributions of certain employees, many of whom would be difficult to replace. Our future success will also depend on our ability to attract and retain qualified technical, sales, marketing and management personnel, for whom competition is intense. The loss of or failure to attract and retain any such persons could delay product development cycles, disrupt our operations or otherwise harm our business or results of operations.

We depend on a limited number of suppliers from whom we do not have a guarantee of adequate supplies, increasing the risk that loss of or problems with a single supplier could result in impaired margins, reduced production volumes, strained customer relations and loss of business.

Mitsubishi is the sole supplier of our stranded fiber, which is used extensively in our fiber pool and spa lighting products. We also rely on a sole source for certain lamps, reflectors, remote control devices, power supplies and thin film coatings. The loss of one or more of our suppliers could result in delays in the shipment of products, additional expense associated with redesigning products, impaired margins, reduced production volumes, strained customer relations and loss of business or could otherwise harm our results of operations.

We depend on ADLT for a number of components for our products and for certain of our manufacturing facilities.

ADLT supplies us with certain lamps, power supplies, reflectors and coatings. We have identified alternative suppliers for these components, but there could be an interruption of supply and increased costs if a transition to a new supplier were required. We could lose current or prospective customers as a result of supply interruptions. Increased costs would negatively impact our gross profit margin and results of operations. We also lease our facility in Solon, Ohio from ADLT. In the event the ADLT lease was not renewed in a timely manner we might experience some disruption of our fiber production while new facilities were found and prepared to support fiber manufacturing.

We are becoming increasingly dependent on foreign sources of supply for many of our components and in some cases complete assemblies, which due to distance or political events may result in a lack of timely deliveries.

In order to save costs, we are continually seeking off-shore supply of components and assemblies. This results in longer lead times for deliveries which can mean less responsiveness to sudden changes in market demand for the products involved. Some of the countries where components are sourced may be less stable politically than the U.S., and this could lead to an interruption of the delivery of key components. Delays in the delivery of key components could result in delays in product shipments, additional expenses associated with locating alternative component sources or redesigning products, impaired margins, reduced production volumes, strained customer relations and loss of customers, any of which could harm our results of operations.

We are subject to manufacturing risks, including fluctuations in the costs of purchased components and raw materials due to market demand, shortages and other factors.

We depend on various components and raw materials for use in the manufacturing of our products. We may not be able to successfully manage price fluctuations due to market demand or shortages. In addition to risks associated with sole and foreign suppliers, significant increases in the costs of or sustained interruptions in our receipt of adequate amounts of necessary components and raw materials could harm our margins, result in manufacturing halts and negatively impact our results of operations.

 
  16  
 
 
We use plants in Mexico and India to manufacture and assemble many of our products. The supply of these finished goods may be impacted by local political or social conditions as well as the financial strength of the companies with which we do business.

As we attempt to reduce manufacturing expenses, we are becoming increasingly dependent upon offshore companies for the manufacturing and final assembly of many of our products. To do so, we must advance certain raw materials, inventory and production costs to these offshore manufacturers. The supply of finished goods from these companies, and the raw materials, inventory and funds which we advance to them, may be at risk depending upon the varying degrees of stability of the local political, economic and social environments in which they operate, and the financial strength of the manufacturing companies themselves.

Because we depend on a limited number of significant customers for our net sales, the loss of a significant customer, reduction in order size, or the effects of volume discounts granted to significant customers from time to time could harm our operating results.

Our business is currently dependent on a limited number of significant customers, and we anticipate that we will continue to rely on a limited number of customers. The loss of any significant customer would harm our net sales and operating results. Customer purchase deferrals, cancellations, reduced order volumes or non-renewals from any particular customer could cause our quarterly operating results to fluctuate or decline and harm our business. In addition, volume discounts granted to significant customers from time to time could lead to reduced profit margins, and negatively impact our operating results.

Our components and products could have design, defects or compatibility issues, which could be costly to correct and could result in the rejection of our products and damage to our reputation, as well as lost sales, diverted development resources and increased warranty reserves and manufacturing costs.

We cannot be assured that we will not experience defects or compatibility issues in components or products in the future. Errors or defects in our products may arise in the future, and, if significant or perceived to be significant, could result in rejection of our products, product returns or recalls, damage to our reputation, lost revenues, diverted development resources and increased customer service and support costs and warranty claims. Errors or defects in our products could also result in product liability claims. We estimate warranty and other returns and accrue reserves for such costs at the time of sale. Any estimates, reserves or accruals may be insufficient to cover sharp increases in product returns, and such returns may harm our operating results. In addition, customers may require design changes in our products in order to suit their needs. Losses, delays or damage to our reputation due to design or defect issues would likely harm our business, financial condition and results of operations.

If we are unable to predict market demand for our products and focus our inventories and development efforts to meet market demand, we could lose sales opportunities and experience a decline in sales.

In order to arrange for the manufacture of sufficient quantities of products and avoid excess inventory we need to accurately predict market demand for each of our products. Significant unanticipated fluctuations in demand could cause problems in our operations. We may not be able to accurately predict market demand in order to properly allocate our manufacturing and distribution resources among our products. As a result we may experience declines in sales and lose, or fail to gain, market share.

We depend on collaboration with third parties, who are not subject to material contractual commitments, to augment our research and development efforts.

Our research and development efforts include collaboration with third parties. Many of these third parties are not bound by any material contractual commitment leaving them free to end their collaborative efforts at will. Loss of these collaborative efforts would adversely affect our research and development efforts and could have a negative effect on our competitive position in the market. In addition, arrangements for joint development efforts may require us to make royalty payments on sales of resultant products or enter into licensing agreements for the technology developed, which could increase our costs and negatively impact our results of operations.

We have experienced negative cash flow from operations and may continue to do so in the future. We may need to raise additional capital in the near future, but our ability to do so may be limited.

 
  17  
 
 
While we have historically been able to fund cash needs from operations, from bank lines of credit or from capital markets, due to competitive, economic or other factors there can be no assurance that we will continue to be able to do so. If our capital resources are insufficient to satisfy our liquidity requirements and overall business objectives we may seek to sell additional equity securities or obtain debt financing. Adverse business conditions due to a continued weak economic environment or a weak market for our products have led to and may lead to continued negative cash flow from operations, which may require us to raise additional financing, including equity financing. Any equity financing may be dilutive to shareholders, and debt financing, if available, will increase expenses and may involve restrictive covenants. We may be required to raise additional capital, at times an d in amounts, which are uncertain, especially under the current capital market conditions. Under these circumstances, if we are unable to acquire additional capital or are required to raise it on terms that are less satisfactory than desired, it may have a material adverse effect on our financial condition, which could require us to curtail our operations significantly, sell significant assets, seek arrangements with strategic partners or other parties that may require us to relinquish significant rights to products, technologies or markets, or explore other strategic alternatives including a merger or sale of our company.

Our stock price has been and will likely continue to be volatile and you may be unable to resell your shares at or above the price you paid.

Our stock price has been and is likely to be highly volatile, particularly due to our relatively limited trading volume. Our stock price could fluctuate significantly due to a number of factors, including:
•   variations in our anticipated or actual operating results;
•   sales of substantial amounts of our stock;
•   dilution as a result of additional equity financing by us;
•   announcements about us or about our competitors, including technological innovation or new products or services;
•   conditions in the fiber optic lighting industry;
•   governmental regulation and legislation; and
•   changes in securities analysts’ estimates of our performance, or our failure to meet analysts’ expectations.

Many of these factors are beyond our control.

In addition, the stock markets in general, and The Nasdaq National Market and the market for fiber optic lighting and technology companies in particular, have experienced extreme price and volume fluctuations recently. These fluctuations often have been unrelated or disproportionate to the operating performance of these companies. These broad market and industry factors may adversely affect the market price of our common stock, regardless of our actual operating performance.

In the past, companies that have experienced volatility in the market prices of their stock have been the object of securities class action litigation. If we were the object of securities class action litigation, it could result in substantial costs and a diversion of management’s attention and resources.

Item 3.   Quantitative and Qualitative Disclosures About Market Risk

As of June 30, 2004, we had $381,000 in cash held in foreign currencies based on the exchange rates at June 30, 2004. The balances for cash held overseas in foreign currencies are subject to exchange rate risk. We have a policy of maintaining cash balances in local currencies unless an amount of cash is occasionally transferred in order to repay intercompany debts.

As of June 30, 2004, we had total borrowings of $464,000 (in Euros, based on the exchange rate at June 30, 2004) against a note payable secured by real property owned by our German subsidiary, with Sparkasse Neumarkt Bank. As of December 31, 2003, the Company had $475,000 borrowed against this facility. We have a total bank borrowing facility of $671,000. Additionally, there is a revolving line of credit of $233,000 (contracted in Euros, based on the exchange rate at June 30, 2004) with Sparkasse Neumarkt Bank. As of June 30, 2004, there was a total borrowing of $179,000 against this facility, and there were no borrowings against this facility as of December 31, 2003.

Item 4.   Controls and Procedures

 
  18  
 
 
(a)   Evaluation of disclosure controls and procedures.
 
We maintain “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, or the Exchange Act, that are designed to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the object ives of the disclosure controls and procedures are met. Additionally, in designing disclosure controls and procedures, our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving our stated goals under all potential future conditions.
 
Based on their evaluation as of the end of the period covered by this Quarterly Report on Form 10-Q, our Chief Executive Officer and Chief Financial Officer have concluded that, subject to the limitations noted above, our disclosure controls and procedures were effective to ensure that material information relating to us, including our consolidated subsidiaries, is made known to them by others within those entities, particularly during the period in which this Quarterly Report on Form 10-Q was being prepared.

(b)   Changes in internal control over financial reporting.
 
There was no significant changes in our internal control or over our financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) identified in connection with the evaluation described in item 4(a) above that occurred during our last fiscal quarter that has materially affected, or is reasonably likely to materially affect our internal control over financial reporting.
 
PART II - OTHER INFORMATION
 
Item 4.    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
(a)  The Annual Meeting of Stockholders was held on May 19, 2004.
 
(b)  The matters voted upon at the meeting and results of the voting with respect to those matters were as follows:
 
(1)     Election of Directors.

 
  
Votes For
Withheld
   
 
 
    David N. Ruckert
    
5,107,977
    
215,170
  
    Philip Wolfson
    
5,093,977
    
229,170
  
    John B. Stuppin
    
5,103,977
    
219,170
  
    Jeffrey H. Brite
    
5,111,977
    
211,170
  
    Wayne R. Hellman
    
5,111,977
    
211,170
  
    David Traversi
    
5,111,977
    
211,170
  
    Sabu Krishnan
    
5,107,955
    
215,192
  

(2)   To approve our 2004 Stock Incentive Plan.

Votes For
2,259,246
 
Against
702,796
 
 
Abstain
313,078
Broker non vote
2,048,027

(3)   To ratify the appointment of Grant Thornton LLP as our independent auditors for the year ending December 31, 2004,

Votes For
5,085,066
 
Against
232,416
 
Abstain
5,665


 
  19  
 


Item 6.   Exhibits and Reports on Form 8-K

(a)   Exhibits.
 

Exhibit Number

 

Description of Documents

10.1
 
Third Amendment to Loan and Security Agreement (Accounts and Inventory) and Amended and Restated Inventory Rider (Revolving Advances) dated April 2, 2004 by and between Comerica Bank and the Registrant.
31.1
 
Rule 13a-14(a) Certification of Chief Executive Officer.
31.2
 
Rule 13a-14(a) Certification of Chief Financial Officer.
32.1**
 
Statement of Chief Executive Officer under Section 906 of the Sarbanes-Oxley Act of 2003 (18 U.S.C. §1350).
32.2**
 
Statement of Chief Financial Officer under Section 906 of the Sarbanes-Oxley Act of 2003 (18 U.S.C. §1350).
 
 
 
________________________________
**   In accordance with item 601(b)(32)(ii) of Regulation S-K and SEC Release Nos. 33-8238 and 34-47986, Final Rule: Management’s Reports on Internal Control Over Financial Reporting and Certification of Disclosure in Exchange Act Periodic Reports, the certifications furnished in Exhibits 32.1 and 32.2 hereto are deemed to accompany this Form 10-Q and will not be deemed "filed" for purposes of Section 18 of the Exchange Act. Such certifications will not be deemed to be incorporated by reference into any filing under the Securities Act or the Exchange Act, except to the extent that the registrant specifically incorporates it by reference.

(b)    Reports on Form 8-K:

On April 21, 2004, the Company filed a Current Report on Form 8-K furnishing under item 12 the Company’s press release relating to its financial results for the quarter ended March 31, 2004.
 
 
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SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
     
  FIBERSTARS, INC.    
 
 		  
 		  
 
Date:  August 14, 2004 By:   /s/ David N. Ruckert
 

David N. Ruckert
Chief Executive Officer

   
 
     
 
 
 		  
 		  
 
  By:   /s/ Robert A. Connors
 
Robert A. Connors
Chief Financial Officer
(Principal Financial and Accounting Officer)
   



 
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Exhibit Index

Exhibit
Number
 
Description of Documents
10.1
 
Third Amendment to Loan and Security Agreement (Accounts and Inventory) and Amended and Restated Inventory Rider (Revolving Advances) dated April 2, 2004 by and between Comerica Bank and the Registrant.
31.1
 
Rule 13a-14(a) Certification of Chief Executive Officer.
31.2
 
Rule 13a-14(a) Certification of Chief Financial Officer.
32.1**
 
Statement of Chief Executive Officer under Section 906 of the Sarbanes-Oxley Act of 2003 (18 U.S.C. §1350).
32.2**
 
Statement of Chief Financial Officer under Section 906 of the Sarbanes-Oxley Act of 2003 (18 U.S.C. §1350).

________________________
**   In accordance with item 601(b)(32)(ii) of Regulation S-K and SEC Release Nos. 33-8238 and 34-47986, Final Rule: Management’s Reports on Internal Control Over Financial Reporting and Certification of Disclosure in Exchange Act Periodic Reports, the certifications furnished in Exhibits 32.1 and 32.2 hereto are deemed to accompany this Form 10-Q and will not be deemed "filed" for purposes of Section 18 of the Exchange Act. Such certifications will not be deemed to be incorporated by reference into any filing under the Securities Act or the Exchange Act, except to the extent that the registrant specifically incorporates it by reference.

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