x	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934
For the fiscal year ended DECEMBER 31, 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

(Exact name of registrant as specified in its charter)

California (State or other jurisdiction of incorporation or organization)	94-3021850 (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
Securities registered under section 12(b) of the Exchange Act: None
Securities registered under Section 12(g) of the Exchange Act:
Title of Each Class Common Stock, $0.0001 par value Series A Participating Preferred Stock Purchase Rights

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

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K 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 amendments to this Form 10-K. o

 

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

 

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant was approximately $67,866,000 as of June 30, 2004 (based upon the last trading price of the Common Stock of registrant on the Nasdaq National Market as of that date). Shares of common stock held as of June 30, 2004 by each director and executive officer of the registrant, as well as shares held by each holder of more than 10% of the common stock known to the registrant, have been excluded for purposes of the foregoing calculation. This calculation does not reflect a determination that any person is an affiliate of the registrant for any other purpose.

 

As of March 24, 2005, there were 7,422,073 shares of the registrant's Common Stock outstanding.

Items 10 (as to directors and Section 16 (a) Beneficial Ownership Reporting Compliance), 11, 12 (as to Beneficial Ownership), 13 and 14 of Part III of this Report on Form 10-K incorporates information by reference from registrant's definitive Proxy Statement to be filed with the Securities and Exchange Commission in connection with the solicitation of proxies for registrant's 2005 Annual Meeting of Shareholders to be held June 22, 2005.

 

 

Fiberstars®, BritePak®, OptiCore™, Lightly Expressed®, Jazz Light™, FX Light™, FX Spa Light™ and Fiberstars EFO® are our registered trademarks. We also refer to trademarks of other corporations and organizations in this document.

All references to “Fiberstars,” “we,” “us,” “our” or “the Company” means Fiberstars, Inc. and its subsidiaries, except where it is made clear that the term means only the parent company.

Incorporated in California in 1985, we design, develop and market fiber optic lighting systems for commercial and residential applications. We are one of the pioneers in the use of fiber optic technology in lighting. By continually improving the price and performance of our products and expanding our marketing efforts, we believe Fiberstars has become the world's leading supplier of fiber optic lighting systems.

Because our products often out-perform conventional lighting in areas of efficiency, safety, maintenance and beauty, they offer an attractive alternative to conventional lighting in a number of applications. By delivering special lighting effects which conventional lighting typically cannot match, fiber optic lighting systems are particularly attractive for a wide range of decorative applications such as the lighting of swimming pools and spas, signage, "neon" type decoration, landscaping and other applications within the commercial and residential markets. Our technology is increasingly being used in commercial and industrial downlight systems with savings of up to 80% of the energy consumed by conventional electric lighting. Technology which we developed and market is also used in a new, non-fiber optic electric light for swimming pools which offers many benefits compared to other electric pool lights.

We market and distribute our lighting systems and products worldwide, primarily through independent sales representatives, distributors and swimming pool builders.

Our fiber optic lighting systems combine three types of products—illuminators, fiber, and fixtures—in configurations designed to meet the needs of specific markets. The electrically powered illuminators generate and focus light into the ends of optical fiber. Fiber tubing products connect to the illuminators and are designed to emit light either at the end of the fiber optics as a spot source of light, or along the length of the fiber optics, similar in effect to neon lighting. The systems can also include fixtures and other accessories designed for specific applications.

 

 Illuminators

We manufacture a number of different illuminators for use in differing applications. Most of our commercial illuminators utilize metal halide high intensity discharge (H.I.D.) lamps to provide long life and maximum brightness. Some include patented optical systems which we designed to enhance performance. Our lower cost illuminators use quartz halogen lamps, some of which are custom manufactured to our specifications.

We also manufacture our EFO® commercial lighting product, which is based on a small H.I.D. lamp, highly efficient optics and more efficient, large core fiber. Designed to provide energy efficient lighting, we market this product for retail, building construction and government applications where energy efficiency is an important customer concern.

 Fiber Tubing

Our EFO® systems utilize a patented, proprietary large core fiber optic product called EFO® Large Core Fiber, which has outstanding clarity with low attenuation for fiber optic lighting applications. The combination of CPC™ optics (Compound Parabolic Collector) and EFO® Large Core Fiber yields system light output efficiency ranging from 30 to 60 lumens-per-watt (depending on system configuration), compared to approximately 12-15 lumens-per-watt for systems using traditional incandescent or halogen lamps. We manufacture EFO® Large Core Fiber at our facility in Solon, Ohio.

We also market small diameter stranded fiber products, such as our patented BritePak® fiber tubing that can maintain reasonably consistent brightness for side-lit fiber runs up to 100 feet in length. For end-lit applications, we offer a wide variety of fiber SKU’s (stock keeping units) enabling one illuminator to illuminate several spotlights which are typically placed within twenty feet of the illuminator. We purchase stranded fiber from Mitsubishi which we then cable and/or encase in a PVC tube at our Fremont, California facility.

Our fiber tubing products are manufactured in various lengths and diameters to meet the requirements of each particular market and application. We carry small amounts of finished goods inventory except during certain times of the year prior to heavy seasonal sales.

 Fixtures and Accessories

We design and manufacture certain of the fixtures and accessories within our product lines while others are supplied by third parties. Our Commercial Lighting Division produces a broad assortment of ceiling and landscape fixtures from which lighting designers may choose.

We market Lightly Expressed light bars, a line of high-end display case fixtures, as well as light bars designed for the EFO system. We believe that fiber optics are ideal for case lighting because all of the light is directed within a 60-degree angle, highlighting merchandise well without generating heat like incandescent, halogen, fluorescent or LED lighting can.

In 2004, we introduced new lighted water feature systems through our Pool and Spa division. These systems include lighted waterfalls, lighted laminar flows, lighted flowerpots and lighted globes for outdoor swimming pools and spas.

We manufacture our fiber optic lighting products to the specifications of architects, professional lighting designers, swimming pool builders and end-users. Our commercial lighting applications include installations in fast food restaurants such as Sonic and McDonalds; retail stores such as Footlocker, Starbucks, Tiffany & Co., Gertrude Hawke Chocolates, Macys, Toys R Us and Nordstrom; grocery stores such as Albertsons, Giant Food and Whole Foods; casinos such as the MGM Grand, Caesars Palace, the Venetian, Bellagio, Foxwoods, the Mirage and the Stratosphere Tower in Las Vegas; and entertainment facilities such as Cinemark multiplex theaters and theme parks operated by the Walt Disney Company and Universal Studios. Our commercial lighting system installations also include a number of specialty applications from theatrical productions, bridges, theater aisles and ceilings, to installations by the Monterey Bay Aquarium, HBO Studios, AMC theaters, Chevron, New York's Trump Tower and the New York Life building.

 

Our primary swimming pool and spa lighting products are designed to provide underwater lighting for newly constructed pools. In addition, we market products for spa lighting, pool perimeter lighting, patios, decks and landscape lighting. Our underwater lighting systems are installed in pools and spas built by major national pool builders and builder groups, as well as regional and local pool builders throughout the United States, Canada, Europe and Australia.

 Commercial Lighting Products

In the commercial lighting market, we direct our marketing efforts at creating specifications for our systems in plans developed by architects, professional lighting designers and building owners. We reach these professionals through our own national account sales personnel as well as approximately 66 independent lighting representative organizations throughout the United States. Approximately 20 of these representatives account for a large majority of our commercial lighting product sales. Our independent lighting representatives assist with the specification process, directing orders to electrical equipment distributors who, in turn, purchase our products. Domestic distributors of commercial lighting products typically do not engage in marketing efforts or stock inventory of our products. Our arrangements with independent lighting representatives do not restrict their handling of conventional lighting products, including those that may compete with our products, although such representatives typically do not handle competing fiber optic lighting products.

We sell our products in Europe through two subsidiaries, Crescent Lighting Ltd. in the United Kingdom and Lichtberatung Mann (LBM) in Germany. These two companies manage our sales operations in Europe, Russia and the Middle East which, as in the United States, include sales through sub-distributors and sales representatives.

Beyond Europe, Russia and the Middle East, we sell our commercial lighting products internationally in most industrialized countries through distributors, including ADLT Australia, Magic Lite in Canada and Mitsubishi and Koto in Japan.

 Pool and Spa Products

We sell underwater lighting products primarily for installation in new swimming pools and spas. Accordingly, our marketing efforts for swimming pool and spa products depend in large part upon swimming pool builders recommending our products to their customers and adapting their swimming pool designs to include our lighting systems. We utilize regional sales representative organizations that specialize in selling swimming pool products to pool builders and pool product distributors. Each representative organization typically has the exclusive right to sell our products within its territory, receiving commissions on territory sales.

Regional and national distributors in the swimming pool market stock our products to fill orders received from swimming pool builders. Some of these distributors engage in limited marketing activities supportive of our products.

We enter into incentive arrangements to encourage pool builders to purchase our products. We have agreements with certain large national pool builders under which they may purchase systems directly from us and offer our products with their swimming pools. We provide pool builders and independent sales representatives with marketing tools, including promotional videos, showroom displays and demonstration systems. We also use trade advertising and direct mail in addition to an ongoing program of sales presentations to pool builders and distributors.

South Central Pools, or SCP, the largest pool distributor in the United States and our largest pool customer, accounted for approximately 10% of our net sales in 2004, 11% in 2003 and 9% in 2002. We expect to maintain our business relationship with SCP; however, a cessation or substantial decrease in the volume of purchases by this customer could reduce availability of our products to end users and, in turn, have a material adverse effect on our net sales and results of operations. At December 31, 2004, SCP accounted for 10% of accounts receivable and at December 31, 2003, they accounted for 14% of accounts receivable.

 

 

 

We sell our spa products directly to spa manufacturers on an OEM basis throughout the United States and Canada, and through distributors in other locations. Sales of our swimming pool and spa products follow a seasonal pattern. This typically results in higher sales in the second and fourth quarters as pool distributors stock shelves for the spring and summer seasons. First quarter pool sales tend to be the lowest for a given year. Consistent with industry practice, we provide extended terms to distributors for shipments in the fourth quarter of a given year whereby they receive products in November and December for which they pay in equal installments from March through June of the following year.

We sell the majority of our swimming pool lighting systems within the United States, Canada and Australia. Our pool lighting sales in Europe were not material in 2004, 2003 or 2002.

 Geographic Areas and Product Lines

We have two worldwide product lines: Pool and Spa Lighting and Commercial Lighting. Information reflecting the geographic split of revenues and revenues by product line may be found in Note 11 to our Consolidated Financial Statements appearing at Item 15, below.

We typically ship standard products within a few days after receipt of an order and custom products within 30 to 60 days of order receipt. Generally, there is not a significant backlog of orders, except at year-end. Our backlog at the end of 2004 was $1,454,000 compared to $1,261,000 at the end of 2003. We anticipate that all of our backlog as of December 31, 2004 will be filled within the current year.

Our products compete with a variety of lighting products, including conventional electric lighting, metal halide, LED's, compact fluorescent and decorative neon lighting. We also encounter competition from other companies offering products containing fiber optic technology. Principal competitive factors include price, performance (including brightness, reliability and other factors), aesthetic appeal (including light color), market presence, ease of installation, power consumption and maintenance requirements.

We believe that our products compete favorably against conventional lighting in such areas as aesthetic appeal, ease of installation, maintenance and power consumption. The unique characteristics of fiber optic lighting (such as no heat or electricity at the light fixture, the ability to change colors and remote lamp replacement) favor the use of our products in certain situations over conventional lighting. However, the initial purchase price of our products is typically higher than that of conventional lighting, and our products can be less bright than conventional alternatives. We believe these disadvantages are being addressed in whole or in part by our EFO® systems. In the case of neon lighting, certain popular neon colors, such as bright red, cannot be achieved as effectively with our products.

We plan to engage in a continual effort to improve our existing products and adapt them to new applications, and to design and engineer new products. We expect that our ability to compete effectively with conventional lighting technologies, other fiber optic lighting products and new lighting technologies that may emerge will depend substantially upon achieving greater performance and reducing the cost of our EFO® systems. Improvements in both the cost and the performance of EFO were made in 2004.

Conventional lighting system competitors include large lamp manufacturers and lighting fixture companies whose financial resources substantially exceed ours. These conventional lighting companies may introduce new or improved products that may reduce or eliminate some of the competitive advantages of our products. In commercial lighting, we also compete primarily with local and regional neon lighting manufacturers and craftspeople that, in many cases, are more established in their local markets than we are.

 

 

Our products compete directly with other fiber optic lighting and pool lighting products. Competitive products are offered in the pool market by Pentair, Inc.'s American Products Division, a major manufacturer of pool equipment and supplies, as well as Super Vision International. In commercial lighting, fiber optic lighting products are offered by a number of smaller companies, some of which compete aggressively on price. Some of these competitors offer products with performance characteristics similar our products. Additionally, certain conventional lighting companies now manufacture or license fiber optic lighting systems that compete with our products. Schott, a German glass fiber company, markets fiber optic systems in the United States. Many companies compete with us in Asia, including Philips, Mitsubishi, Bridgestone and Toray. Mitsubishi also sells our BritePak™ fiber tubing in Japan.

While we cannot predict the impact of competition on our business, we believe that an increase in the rate of Fiberstars’ market expansion may be accompanied by increased competition. Increased competition could result in price reductions, reduced profit margins and loss of market share, developments which could adversely affect our operating results. There can be no assurance that we will be able to continue to compete successfully against current and future competitors.

Our illuminator manufacturing consists primarily of final assembly, testing and quality control. We use independent contractors to manufacture some components and sub-assemblies and have worked with a number of our vendors to design custom components to meet our specific needs. We manage inventories of domestically produced component parts on a just-in-time basis when practicable. Our quality assurance program provides for testing of all sub-assemblies at key stages in the assembly process as well as testing of finished products.

In 2004 we continued our program of manufacturing more of our products offshore, primarily in India and Mexico. As this process continues we expect that more high volume products will be sourced offshore where labor and component cost savings may be achieved. In October 2003, we entered into a Production Share Agreement with North American Production Sharing, Inc. and Industrias Unidas de B.C., S.A. de C.V., or North American. Under this agreement North American provides administrative and manufacturing services, including labor services and the use of manufacturing facilities in Mexico for the manufacture and assembly of certain of our fiber optic systems and related equipment and components.

We manufacture our large core fiber with technology obtained from an earlier acquisition of Unison Fiber Optic Systems, LLC, or Unison. Under a supply agreement, which was last renewed in January 2000, Mitsubishi is the sole supplier of our small diameter stranded fiber. In sales volume, small diameter stranded fiber is the single largest fiber product that we sell and represents significant sales volume. If we were to discontinue selling this product it would represent a significant loss of business.  We expect to maintain our relationship with Mitsubishi.

We also rely on sole source suppliers for certain lamps, reflectors, remote control devices and power supplies. Although we cannot predict the effect that the loss of one or more of such suppliers would have on our results of operations, such loss could result in delays in the shipment of products and additional expenses associated with redesigning products and could have a material adverse effect on our operating results.

We believe that growth in fiber optic lighting will be driven by improvements in technology to provide increased light output at lower costs. Accordingly, we commit much of our research and development resources to those challenges. Optical technology which we developed following the Unison acquisition resulted in illuminator products for both the Pool and Spa (Jazz®) and the Commercial Lighting Division (EFO). We believe that these products remain state-of-the-art within the fiber optic lighting industry. Despite our ongoing development efforts, we can provide no assurance that we will succeed in our efforts to achieve further improvements in brightness and cost, or that competitors will not develop lighting technologies that are brighter, less expensive or otherwise superior to ours.

In 2003, we successfully completed a three year $2,000,000 research and development project to develop a continuous extrusion process for large core plastic optical fiber funded under a grant from the National Institute of Standards and Technology, or NIST, of the United States Department of Commerce.

 

 

 

In February 2003, the Defense Advanced Research Projects Agency, or DARPA, through the Army Aviation and Missile Command, or AMCOM, awarded to us and our partners a research and development contract for the development of next generation light sources, optics, luminaire and integrated illuminated technologies for its High Efficiency Distributed Lighting, or HEDLight, project. This contract calls for total payment of up to $7,824,000, including payments for subcontractors, over three years based on the achievement of milestones in the development of fiber optic illuminators and fixtures for installation on ships and aircraft. For the year ending December 31, 2005, we anticipate qualifying for receipt of gross amounts, including amounts for subcontractors, of up to $2,497,000 ($1,952,000, net of subcontractor amounts), subject to attainment of scheduled milestones. We have received total gross funding of $5,327,000 under this contract through December 31, 2004. The contracts term runs through early 2006.

 

In April 2003, we announced, together with a partner, APL Engineered Materials, a subsidiary of Advanced Lighting Technologies Inc. or ADLT, the award of an additional $2,700,000 research and development contract from DARPA for the development of a new arc discharge light source. Of this amount, $300,000, to be received based on achievement of milestones, relates to our contribution to this project which is otherwise led by APL Engineered Materials. We anticipate that this new light source will exceed the performance of our existing Fiberstars EFO® light source in efficiency, brightness and color rendering.

 

In June 2004, we announced an additional $1 million in funding from DARPA, dependent on the achievement of certain milestones, to develop a Light Emitting Diode (LED) version of the HEDLight system. Also in June, we announced two Small Business Innovative Research (SBIR) awards from the Department of Energy. One is to work on an instant-on version of EFO, and the other is to develop a fast cure for the fiber production process, which would lower cost and improve throughput on the fiber production line. These awards were for $100,000 each for the first feasibility phase, with the potential of additional funding of up to $750,000 for each project for the completion phase. The Department of Energy will determine in 2005 whether we will receive the additional funding on these projects. We have commercial rights to all of the technology we develop as part of the various government research and development contracts.

Net of payments to subcontractors, we received from DARPA aggregate payments of $2,482,000 in 2004 compared to $1,463,000 in 2003.

We augment our internal research and development efforts by involving certain of our component suppliers, independent consultants and other third parties. We depend substantially on these parties to undertake research and development efforts necessary to achieve improvements that would not otherwise be possible given the multiple and diverse technologies that must be integrated into our products and our limited engineering, personnel and financial resources. These third parties have no material contractual commitments to participate in these efforts, and there can be no assurance that they will continue to do so.

We believe that the success of our business depends primarily on our technical innovations, marketing abilities and responsiveness to customer requirements, rather than on patents, trade secrets, trademarks, copyrights and other intellectual property rights. Nevertheless, we have a policy of seeking to protect our intellectual property through patents, license agreements, trademark registrations, confidential disclosure agreements and trade secrets. As of December 31, 2004, our intellectual property portfolio consisted of 41 issued United States and foreign patents, various pending United States patent applications and various pending Patent Cooperation Treaty, or PCT, patent applications filed with the World Intellectual Property Organization that serve as the basis of national patent filings in countries of interest. Our issued patents expire at various times between August 2008 and April 2023. Generally, the term of patent protection is 20 years from the earliest effective filing date of the patent application. There can be no assurance, however, that our issued patents are valid or that any patents applied for will be issued. There can be no assurance that our competitors or customers will not copy aspects of our fiber optic lighting systems or obtain information that we regard as proprietary. There also can be no assurance that others will not independently develop products similar to ours. The laws of some foreign countries in which we sell or may sell our products do not protect proprietary rights to products to the same extent as do the laws of the United States.

 

 

We are aware that a large number of patents and pending patent applications exist in the field of fiber optic technology. We are also aware that 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, we have in the past, and again recently received, communications from third parties asserting rights in our patents or that our technology infringes intellectual property 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. There can be no assurance that third parties will not assert claims that our products infringe third party patents or other intellectual property rights or that, in case of a dispute, licenses to such technology will be available, if at all, on reasonable terms. In addition, we may need to take legal action to enforce our intellectual property rights in the future. In the event of litigation to determine the validity of any third-party claims or claims by us against third-parties, such litigation, whether or not determined in our favor, could result in significant expense to us and divert the efforts of our technical and management personnel from productive tasks. Also, in the event of an adverse ruling in such litigation, we might be required to expend significant resources to develop non-infringing technology or to obtain licenses to the infringing technology, which licenses may not be available on acceptable terms. In the event of a successful claim against us and our failure to develop or license a substitute technology, our operating results could be adversely affected.

As of December 31, 2004, we had 114 full time employees, of whom 30 were involved in sales, marketing and customer service, 20 in research and product development, 50 in assembly and quality assurance, and 14 in finance and administration. From time to time we employ part-time personnel in various capacities, primarily assembly and clerical support. We have never experienced a work stoppage. No employees are subject to any collective bargaining agreement, and we believe our employee relations to be good.

We believe that our future success will depend to a large extent on the continued contributions of certain employees, many of whom would be difficult to replace, and 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.

Our Web site is http://www.fiberstars.com. We make available free of charge, on or through our Web site, our annual, quarterly and current reports, and any amendments to those reports, as soon as reasonably practicable after electronically filing such reports with the SEC. Information contained on our Web site is not part of this Report. 

Our principal executive offices and manufacturing and assembly facilities are located in a 60,000 square foot facility in Fremont, California, under a lease agreement expiring in 2006. We have other local sales offices in the United States in Solon, Ohio and New York and in Europe sales and operations offices in the United Kingdom in Thatcham, under lease. We also own a local office in Berching, Germany. We believe that our current facilities are adequate to support our current and anticipated near-term operations and that we can obtain additional space we may need in the future at commercially reasonable terms.

We are a third-party defendant in a lawsuit pending in the Court of Common Pleas, Cuyahoga County, Ohio, filed September 21, 2004. In that matter Sherwin-Williams Company, plaintiff, brought suit against defendant and third-party plaintiff, Wagner Electric Sign Company, or Wagner, for alleged breach of warranty and breach of contract in connection with an allegedly defective sign manufactured and sold by Wagner. The complaint alleges $141,739.06 in compensatory damages. Third-party plaintiff, Wagner, has cross-claimed against us requesting unspecified damages alleging that the signs’ failure, if any, arises from defective fiber optic lighting components, instructions and/or services purportedly supplied to it by us. We deny these allegations in our responsive pleadings and discovery proceeds on all claims. While we cannot predict the ultimate outcome of the litigation, we do not currently believe its outcome will have a material impact on our results of operations or financial condition.

 

There were no matters submitted to a vote of security holders during the quarter ended December 31, 2004.

 

Our executive officers who are not directors, and their ages as of December 31, 2004, are as follows:

Name		Age		Position
John Davenport		59		Chief Operating Officer and Chief Technology Officer
Roger Buelow		32		Vice President, Engineering
Robert A. Connors		56		Vice President, Finance and Chief Financial Officer
Ted des Enfants		33		Vice President and General Manager, Fiberstars EFO
Barry R. Greenwald		58		Senior Vice President and General Manager, Pool Division
J. Steven Keplinger		45		Senior Vice President, Operations

Mr. Davenport joined us in November 1999 as Vice President, Chief Technology Officer and was appointed Chief Operating Officer in July 2003. Prior to joining the Company, Mr. Davenport served as President of Unison Fiber Optic Lighting Systems, LLC, or Unison, from 1998 to 1999. Mr. Davenport began his career at GE Lighting in 1972 as a research physicist and thereafter served 25 years in various capacities including GE Lighting's research and development manager and as development manager for high performance LED projects. He is a recognized global expert in light sources, lighting systems and lighting applications, with special emphasis in low wattage discharge lamps, electronic ballast technology and distributed lighting systems using fiber optics.

Mr. Buelow was appointed Vice President, Engineering for the Company in February 2003. Prior to joining Fiberstars in 1999, he served as Director of Engineering for Unison from 1998 to 1999. Prior to that he served four years as an engineer at GE Lighting working on several fiber optic lighting projects. Mr. Buelow is a Certified Quality Engineer with five utility patents.

Mr. Connors joined the Company in July 1998 as Vice President, Finance, and Chief Financial Officer. From 1984 to 1998, Mr. Connors held a variety of positions for Micro Focus Group Plc, a software company with 1997 revenues of $165 million, including Chief Financial Officer and Chief Operating Officer. Prior to working for Micro Focus Group Plc, he held senior finance positions with Eagle Computer and W. R. Grace.

Mr. des Enfants joined the Company in January 2004 as Vice President and General Manager, Fiberstars EFO. From 1994 to 2003, Mr. des Enfants held a variety of positions with the GE Lighting, most recently as District Sales Manager in the eastern region. From 1998 to 2001, he was National Account Manager with GE Lighting and from 1994 to 1998 held various Sales and Sales Manager positions at GE Lighting.

Mr. Greenwald joined the Company in October 1989 as General Manager, Pool Division. He became Vice President in September 1993 and Senior Vice President in February 1997. Prior to joining the Company, Mr. Greenwald served as National Sales Manager at Aquamatic, a swimming pool accessory company, from August 1987 to October 1989. From May 1982 to August 1987, Mr. Greenwald served as National Sales Manager at Jandy Inc., a swimming pool equipment company.

Mr. Keplinger joined the Company in August 1988 as Manager of Operations. He became Vice President in 1991 and Senior Vice President in February 1997. From June 1986 to August 1988, Mr. Keplinger was a sales representative at Leemah Electronics, an electronics manufacturing company. From February 1983 to June 1986, Mr. Keplinger was a sales manager with California Magnetics Corp, a custom transformer manufacturing company.

Our common stock trades on The Nasdaq National Market under the symbol FBST. The following table sets forth, for the periods indicated, the high and low sales prices for our common stock as reported on The Nasdaq National Market in its consolidated transaction reporting system.

		High			Low
First quarter 2003			4.40			2.66
Second quarter 2003			4.00			2.85
Third quarter 2003			4.20			3.13
Fourth quarter 2003			8.25			3.71
First quarter 2004			10.75			6.15
Second quarter 2004			10.95			7.01
Third quarter 2004			10.50			6.70
Fourth quarter 2004			10.49			6.40

There were approximately 149 holders of record of our common stock as of March 24, 2005, and we estimate that at that date there were approximately 800 additional beneficial owners.

We have not declared or paid any cash dividends and do not anticipate paying cash dividends in the foreseeable future.

Information regarding the Securities Authorized for Issuance Under our Equity Compensation Plans can be found under Item 12 of this Annual Report on Form 10-K.

The Selected Operations and Balance Sheet Data set forth below have been derived from our Consolidated Financial Statements. It should be read in conjunction with the information appearing under the heading "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in Item 7 of this Report and the Consolidated Financial Statements and related notes found in Item 15 of this Report.

 

YEARS ENDED DECEMBER 31,		2004			2003			2002			2001			2000
OPERATING SUMMARY
Net sales		$	29,731		$	27,238		$	30,960		$	29,053		$	36,921
Gross profit			11,511			10,341			11,474			11,447			15,019
As a percent of net sales			38.7	%		38.0	%		37.1	%		39.4	%		40.7	%
Research and development expenses			1,188			1,279			2,290			2,764			1,673
As a percent of net sales			4.0	%		4.7	%		7.4	%		9.5	%		4.5	%
Sales and marketing expenses			8,595			7,188			7,907			8,371			9,038
As a percent of net sales			28.9	%		26.4	%		25.5	%		28.8	%		24.5	%
General and administrative expenses			2,458			2,435			2,709			3,627			4,023
As a percent of net sales			8.3	%		8.9	%		8.8	%		12.5	%		10.9	%
Write-off in-process technology acquired			—			—			—			—			938
As a percent of net sales			—	%		—	%		—	%		—	%		2.5	%
Loss before tax			(762	)		(594	)		(1,441	)		(3,381	)		(711	)
As a percent of net sales			(2.6	)%		(2.2	)%		(4.7	)%		(11.6	)%		(1.9	)%
Net loss			(704	)		(608	)		(3,519	)		(2,128	)		(454	)
As a percent of net sales			(2.4	)%		(2.2	)%		(11.4	)%		(7.3	)%		(1.2	)%
Net loss per share
Basic		$	(0.10	)	$	(0.10	)	$	(0.70	)	$	(0.45	)	$	(0.10	)
Diluted		$	(0.10	)	$	(0.10	)	$	(0.70	)	$	(0.45	)	$	(0.10	)
Shares used in per share calculation:
Basic			7,269			5,993			5,028			4,756			4,572
Diluted			7,269			5,993			5,028			4,756			4,572
FINANCIAL POSITION SUMMARY
Total assets		$	27,018		$	24,343		$	20,101		$	21,434		$	24,619
Cash, cash equivalents and short-term investments			3,609			4,254			231			584			1,230
Working capital			14,541			12,449			7,417			8,498			10,602
Short-term borrowings			38			30			593			101			8
Long-term borrowings			484			521			449			419			482
Shareholders' equity			21,202			19,174			14,240			16,431			18,560
Common shares outstanding			7,351			6,317			4,667			4,328			4,288

In accordance with SFAS 142, we ceased amortizing goodwill as of December 31, 2001. Refer to Note 5 of the Notes to Consolidated Financial Statements.

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with "Selected Consolidated Financial Data" and the Consolidated Financial Statements and related Notes included elsewhere in this Report as well as the note regarding forward looking statements on page 1 of this report.

 

The preparation of financial statements requires that we make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingencies and the reported amounts of revenue and expenses in the financial statements. Material differences may result in the amount and timing of revenue and expenses if different judgments or different estimates were utilized. Critical accounting policies, judgments and estimates which we believe have the most significant impact on our financial statements are set forth below:

 

 Revenue Recognition

We recognize revenue when: (1) we have received a purchase order from the customer or completed of a sales agreement with the customer; (2) shipment of the product has occurred or services have been provided; and (3) the sales price is fixed or determinable and collectibility is reasonably assured. Revenue from product sales is generally recognized upon shipment, and allowances are provided for estimated returns, discounts, incentives and warranties. Such allowances are adjusted periodically to reflect actual and anticipated returns, discounts, incentives and warranty expenses. Revenue on sales that include services such as design, integration and installation is generally recognized using the percentage-of-completion method. Under the percentage-of-completion method, revenue recognized reflects the portion of the anticipated contract revenue that has been earned, equal to the ratio of labor costs expended to date to anticipated final labor costs, based on current estimates of labor costs to complete the project. Our products are generally subject to warranties, and we provide for the estimated future costs of repair, replacement or customer accommodation in costs of sales. Fees for research and development services are determined on a cost-plus basis and are recognized as revenue when ownership of the completed work-product passes to the customer.

We recognize shipments to pool lighting distributors as revenue upon shipment. Estimated sales returns are recorded upon recognition of revenues from distributors having rights of return, including exchange rights for unsold products. Historically, returns have been minimal. Shipments made to commercial lighting representatives and distributors are also recognized as revenue upon shipment because in these instances the representative or distributor is acting as a pass-through agent to a specific lighting project for which we have an existing contract or purchase order.

Revenue recognition in each period is dependent on our application of these accounting policies. Our application of percentage-of-completion accounting is subject to our estimates of labor costs to complete each project. In the event that actual results differ from these estimates or we adjust these estimates in future periods, our operating results for a particular period could be materially affected.

 Allowances for Doubtful Accounts, Returns and Discounts

We establish allowances for doubtful accounts, returns and discounts for specifically identified doubtful accounts, returns and discounts based on credit profiles of our customers, current economic trends, contractual terms and conditions and historical payment, return and discount experience. For each year ended December 31, the allowance for doubtful accounts, returns and discounts was $1,218,000 for 2004, $1,096,000 for 2003 and $1,034,000 for 2002. The amount charged to revenue for returns and discounts was $131,000 in 2004, $141,000 in 2003 and $956,000 in 2002. The amount charged to expenses for doubtful accounts was $47,000 in 2004, $2,000 in 2003 and $78,000 in 2002. In the event that actual returns, discounts and bad debts differ from these estimates or we adjust these estimates in future periods, our operating results and financial position could be materially affected.

 Valuation of Inventories

We state inventories at the lower of standard cost (which approximates actual cost determined using the first-in-first-out method) or market. We establish provisions for excess and obsolete inventories after evaluation of historical sales, current economic trends, forecasted sales, product lifecycles and current inventory levels. During 2004, $116,000 was charged to cost of sales for excess and obsolete inventories. Adjustments to our estimates, such as forecasted sales and expected product lifecycles, could harm our operating results and financial position.

 

 Accounting for Income Taxes

As part of the process of preparing our consolidated financial statements, we are required to estimate our income tax liability in each of the jurisdictions in which we do business. This process involves estimating our actual current tax expense together with assessing temporary differences resulting form differing treatment of items, such as deferred revenues, for tax and accounting purposes. These differences result in deferred tax assets and assets and liabilities, which are included in our consolidated balance sheet. We must then assess the likelihood that these deferred tax assets will be recovered from future taxable income and, to the extent we believe that recovery is not more likely than not or is unknown, we must establish a valuation allowance.

Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against our deferred tax assets. At December 31, 2004, we have recorded a full valuation allowance against our deferred tax assets, due to uncertainties related to our ability to utilize our deferred tax assets, primarily consisting of certain net operating losses carried forward. The valuation allowance is based on our estimates of taxable income by jurisdiction and the period over which our deferred tax assets will be recoverable.

 Net Sales

Net sales increased 9% to $29,731,000 in 2004 compared to $27,238,000 in 2003 and $30,960,000 in 2002. The 2004 increase largely reflects an increase in sales of pool products of 13% or $1,997,000 combined with a smaller increase in sales of commercial lighting products of 4% or $496,000. This increase in pool lighting sales was primarily due to $1,574,000 in increased sales from our in-ground fiber pool lighting products and $1,094,000 in increased sales from our Jazz electric light products, and was partially off-set by a decline in sales of $662,000 from our spa light products. The increase in commercial lighting sales was due to $410,000 in increased sales of EFO products combined with relatively flat sales from our core legacy commercial lighting products. We expect net sales to increase in 2005 due to an anticipated increase in demand for EFO systems in commercial lighting markets and expected continued growth in demand for our pool products. The market for our products is highly dependent upon general economic conditions.

Our net sales decreased 12% to $27,238,000 in 2003 as compared to $30,960,000 in 2002, primarily as a result of a decrease in the sales of pool products of 17% or $3,037,000 combined with a decline in sales of commercial lighting products of 5% or $685,000. This decline in pool lighting sales was primarily due to a $2,046,000 decrease in sales of spa products and in-ground pool lighting products as compared to 2002, attributable to a soft pool market in the first half of 2003 and increased competition. The decrease in commercial lighting sales was due to a decline in United States domestic lighting sales of 16% or $905,000 partially offset by an increase in international sales of $262,000. Of the decrease in our 2003 domestic lighting sales, $300,000 was due to a drop in resort and casino business. 

International sales accounted for approximately 33% of net sales in 2004 as compared to 30% of net sales in 2003 and 26% in 2002. The relative increase in international sales from 2003 to 2004 reflects a higher rate of growth in our European compared to domestic sales, and is largely attributable to increased sales from our U.K. operation combined with the effect of reporting those sales in terms of the weakening 2004 United States dollar. The relative increase in international sales from 2002 to 2003 was due to growth in European sales compared to a decline in domestic sales. The increase in 2003 international sales was a result of higher sales from our German operation.

 Gross Profit

Gross profit of $11,511,000 in 2004 increased by 11% compared to $10,341,000 in 2003. Gross profit as a percent of sales increased to 39% in 2004 compared to 38% in 2003. This increase was primarily due to improved gross profit margins from pool and spa lighting sales (3 percentage points) partially offset by lower gross profit margins from commercial lighting sales. Pool and spa lighting gross profit margins improved as a result of lower direct costs obtained by manufacturing some products off-shore. Commercial lighting gross profit margins declined due to increased competition for our core legacy products in Europe and in the United States. We expect gross profit margin to improve slightly in 2005 depending upon general economic conditions.

 

 

 

Gross profit of $10,341,000 in 2003 declined by 10% compared to gross profit of $11,474,000 achieved in 2002. However, gross profit as a percent of sales increased to 38% in 2003 compared to 37% in 2002. This increase was primarily due to a reduction in direct product costs in the second half of the year as a result of moving some of our manufacturing to off-shore locations.

 Operating Expenses

Research and development expenses were $1,188,000 in 2004, a 7% decrease from research and development expenses of $1,279,000 in 2003. Although we increased spending in research and development expense on personnel and project costs related to government contract work and on improvements for existing products, this spending was offset by the increase in expense credits for funds received in 2004 under certain Department of Energy, or DOE, contracts and under Defense Advanced Research Projects Agency, or DARPA, research and development contracts awarded in February and April of 2003. The gross research and development spending along with credits from government contracts is shown the table:

 

			Year ended December 31,
			(in thousands)
			2004			2003			2002
Gross expenses for research and development		$	3,670		$	3,325		$	3,164
Deduct: credits for NIST award			--			(583	)		(874	)
Deduct: credits from DARPA & DOE contracts			(2,482	)		(1,463	)		--
Net research and development expense		$	1,188		$	1,279		$	2,290

Funds received from DOE and DARPA for milestones achieved during the fiscal year are recorded as a credit to research and development expense. Net of payments to subcontractors, this amounted to $2,482,000 in 2004 compared to $1,463,000 in 2003. This increase in DOE and DARPA credits was  offset by an increase in research and development spending of $345,000, which was made up of increased personnel and project costs for government projects along with a decrease in other goverment research and development credits of $583,000. Research and development expenses were 4.0% of sales in 2004 compared to 4.7% of sales in 2003. We expect research and development expenses to increase in 2005 due to a decrease in anticipated DOE and DARPA credits.

Our 2003 research and development expenses of $1,279,000 reflect a 44% decrease from our 2002 research and development expenses of $2,290,000. As in 2004, this 2003 decrease was largely due to the increase in expense credits in 2003 under DARPA contracts awarded to us in February and April of 2003. Net of payments to subcontractors, DARPA expense credits amounted to $1,463,000 in 2003. Additionally in 2003 we realized research and development expense credits of $583,000 for funds received from the National Institute of Standards and Technology, or NIST, under a NIST project completed that year, a decrease of $291,000 from NIST credits realized in 2002. The additional decrease in research and development expense in 2003 came as a result of lower personnel and project costs in non-government funded projects due to reductions in personnel. Research and development expenses were 4.7% of sales in 2003 compared to 7.4% of sales in 2002.

Sales and marketing expenses were $8,595,000 in 2004, a 20% increase compared to the $7,188,000 in sales and marketing expenses for 2003. This increase was due in part to increased commission expenses of $516,000 in 2004 compared to $239,000 in 2003. This largely reflects a change from our selling pool and spa products through salaried inside sales people in 2003 to our using outside commissioned sales agents in 2004. The balance of the 2004 increase in sales and marketing expenses was primarily due to an increase in personnel, promotional literature and advertising costs and stock option expenses associated with marketing our EFO products. Sales and marketing expenses were 29% of sales in 2004 and 26% of sales in 2003. The Company expects sales and marketing expenses to increase in absolute dollars in 2005 compared to 2004.

 

Our sales and marketing expenses of $7,188,000 in 2003 reflect a 9% decrease as compared to the $7,907,000 for 2002. The 2003 decrease was due in part to lower commission expenses of $239,000 from the discontinuance of an agency sales agreement in the middle of 2002. These savings were combined with decreases in personnel and travel expenses in both pool and spa lighting and commercial lighting due to headcount reductions. Sales and marketing expenses were 26% of sales in each of 2003 and 2002.

General and administrative expenses were $2,459,000 in 2004, a $23,000 increase as compared to $2,435,000 in 2003. General and administrative expenses were 8% of sales in 2004 and 9% of sales in 2003 and 2002. We expect general and administrative expenses to increase significantly in 2005 due to anticipated higher accounting fees and expenses associated with the impact of Section 404 of the Sarbanes Oxley Act of 2002.

Our general and administrative expenses of $2,435,000 in 2003 reflect a 10% decrease as compared to $2,709,000 in 2002. This decrease was largely due to a decrease in personnel expense due to headcount reductions, reduced bad debt expense and reduced investor relations and computer costs in 2003. General and administrative expenses were 9% of sales in 2003 and 2002.

Our interest expense, which consists of expense for bank interest, was $18,000 in 2004 as compared to $119,000 in 2003 and $66,000 in 2002. The decrease in 2004 compared to 2003 was a result of reduced bank borrowings in the United States in 2004. Net interest expense in 2003 was $119,000 compared to $66,000 in 2002. The increase in interest expense in 2003 compared to 2002 was a result of more borrowings against our bank line of credit in 2003 as compared to 2002. The higher borrowings were used to fund operations.

We have a full valuation allowance against our deferred tax assets. There was no operating statement tax expense or benefit for our United States operations in 2004 as any expected benefit was offset by an increase in our valuation allowance. The $58,000 tax benefit shown for 2004 is a result of deferred tax for our German operations which experienced a loss in 2004 after being profitable in prior years. We took a non-cash charge of $2,405,000 in 2002 to record an initial valuation allowance against our deferred tax asset in accordance with FASB 109.

Due to the increase in expenses in 2004 partially offset by the increase in gross profit, the amount of loss before income taxes was $762,000, an increase from the loss before taxes of $594,000 in 2003. After including taxes from international operations the loss was $704,000, an increase of $96,000 over 2003. This compares to a 2002 loss of $3,519,000.

 

At December 31, 2004, our cash and cash equivalents were $3,609,000 as compared to $4,254,000 and $231,000 at December 31, 2003 and 2002, respectively. We had no bank borrowings against our $5,000,000 domestic line of credit at each of December 31, 2004 and 2003, respectively.

 

Net cash provided by operating activities primarily consists of net income (loss) adjusted by non-cash items, including depreciation, amortization, stock-based compensation, and the effect of changes in working capital. Cash decreased during 2004 by a net loss of $704,000 compared to net losses of $608,000 and $3,519,000 for 2003 and 2002, respectively. After adjustments for the non-cash items, stock-based compensation and depreciation and amortization, but excluding the effect of changes in working capital, net cash provided by operating activities was $431,000 in 2004 as compared to $380,000 for 2003.

 

There were notable changes in working capital in 2004. Cash decreased by $1,448,000 to fund an increase in accounts receivable. Of this amount, $886,000 was attributable to higher DARPA payments outstanding. The balance of the increase in accounts receivable was due to increased sales in 2004 compared to 2003. We further decreased cash in 2004 by $1,673,000 utilized to fund an increase in inventories. The additional inventory is primarily additional finished goods held in order to have goods on hand to ship to customers for the coming pool season while inventories are shipping from off-shore locations.

 

Including adjustments for all non-cash items, including cash used for working capital, net cash used in operating activities was $2,481,000 in 2004 compared to $929,000 provided by operating activities in 2003 and $1,872,000 used in operating activities in 2002.

 

 

There was a net utilization of cash of $724,000 in investing activities in 2004 primarily due to the acquisition of fixed assets. This compares to $717,000 spent on fixed asset acquisitions in 2003.

 

 

There was a net contribution to cash from financing activities of $2,523,000 in 2004 compared to net contributions of $3,447,000 and $2,213,000 in 2003 and 2002, respectively. This net contribution was primarily due to our receipt of $2,379,000 from the sale of our common stock upon the exercise of outstanding stock options and warrants.

 

As a result of the cash provided by operating and financing activities and the cash used in investing activities, there was a net decrease in cash in 2004 of $645,000 that resulted in an ending cash balance of $3,609,000. This compares to a net increase in cash of $4,023,000 in 2003 resulting in an ending cash balance of $4,254,000 for 2003.

 

We have a $5,000,000 Loan and Security Agreement (Accounts Receivable and Inventory) dated December 7, 2002, 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 December 31, 2004 or as of December 31, 2003. As of December 31, 2004, we were not in compliance with the profit covenant but we received a waiver of this covenant from the bank. This Loan and Security Agreement expires in June 2005.

 

Through our U.K. subsidiary, we maintain a bank overdraft facility of $479,000 (in UK pounds sterling, based on the exchange rate at December 31, 2004) under an agreement with Lloyds Bank Plc. There were no borrowings against this facility as of December 31, 2004 and 2003, respectively. The facility is subject to annual renewal on January 1 and bears an interest rate of 7%.

 

Through our German subsidiary, we maintain a credit facility under an agreement with Sparkasse Neumarkt Bank. This credit facility is in place to finance our building of new offices in Berching, Germany to be owned and occupied by our German subsidiary. As of December 31, 2004, we had borrowings of $477,000 (in Euros, based on the exchange rate at December 31, 2004) against this credit facility, all of which comes due in 2008. In addition, our German subsidiary has a revolving line of credit for $203,000 (in Euros, based on the exchange rate at December 31, 2004) with Sparkasse Neumarkt Bank. As of December 31, 2004, there were no borrowings against this facility. The revolving facility is subject to annual renewal on January 1 and bears an interest rate of 8.75%.

 

In a March 2002 private placement, we sold 328,633 shares of common stock for net proceeds of $972,000 (net of fees and expenses). In addition, we issued to each purchaser a warrant to purchase a number of shares of our common stock equal to 20% of the number of shares purchased by such purchaser in the offering. The $3.00 per share offering price was based on an 8.8% discount on the 10-day average price as of March 14, 2003. The purchase price of the common stock for insiders who participated in the offering was $3.35, which was the higher of (1) the price on the closing date or (2) the 10-day average price as of March 14, 2002, plus a $.03 premium because of the issuances of the warrants. The warrants have an initial exercise price of $4.30 per share, with a life of 5 years.

 

 

 

On June 17, 2003, we entered into a securities purchase agreement to sell up to 1,350,233 shares of common stock and warrants to purchase 405,069 shares of common stock for an aggregate purchase price of $4,388,250 in a two-stage private placement. The first stage of the private placement, involving the sale of 923,078 shares of common stock and warrants to purchase 276,922 shares of common stock, closed on June 17, 2003 with our receiving net proceeds of $2,769,000 (net of fees and expenses). The second stage of the private placement, involving the sale of 427,155 shares of common stock and warrants to purchase 128,147 shares of common stock, closed on August 18, 2003 with our receiving net proceeds of $1,043,000 (net of fees and expenses). As required by NASDAQ Marketplace Rules, the issuance and sale of the shares and warrants in the second stage were subject to shareholder approval because the price was less than the greater of book or market value per share and amounted to 20% or more of the our common stock. The shareholders approved the issuance and sale of the shares and warrants in the second stage at a special meeting of shareholders held on August 12, 2003. For both stages, the purchase price of the common stock was $3.25 per share, which was a 12.5% discount on the 10-day average price as of June 1, 2003. The warrants have an initial exercise price of $4.50 per share and a life of 5 years. The warrants were valued at $641,000 and $297,000 for the first and second stages, respectively, based on a Black-Scholes calculation as of the June 17, 2003 and August 18, 2003 closing dates and under EITF 00-19 were included at those values in long term liabilities at the time of each closing. The balance of the net proceeds was accounted for as additional paid in capital. Under EITF 00-19, we marked-to-market the value of the warrants at the end of each accounting period until the registration statement for the shares and warrants was declared effective by the SEC on September 24, 2003. Once the registration statement for the shares and warrants was declared effective, the warrant value on the effective date was reclassified to equity as additional paid in capital. As a result of the change in value of the warrants issued in the first stage from the closing date to the end of the second quarter on June 30, 2003, we realized a benefit of $8,000 that was included in other income in the second quarter of 2003. As a result of the change in value of the first stage warrants from June 30, 2003 and the second stage warrants from the second closing date to September 30, 2003, we realized a benefit of $15,000 that was included in other income in the third quarter of 2003. We are subject to certain indemnity provisions included in the stock purchase agreement entered into as part of the financing. In 2003, we also issued warrants to purchase 81,104 shares of common stock to the firm Merriman Curhan Ford & Co. as compensation as placement agent for the private placement. These warrants have the same terms as the warrants issued in the private placement.

 

We believe that existing cash balances, proceeds available through our bank lines of credit along with funds that may be generated from operations, will be sufficient to finance our currently anticipated working capital requirements and capital expenditure requirements for the next twelve months. However, unforeseen adverse competitive, economic or other factors may damage 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 stockholders, and debt financing, if available, may involve restrictive covenants. Strategic arrangements, if necessary to raise additional funds, may require that we relinquish its rights to certain of its 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 its ability to achieve its intended business objectives.

 

 

The following summarizes our contractual obligations as of December 31, 2004, consisting of future payments for borrowings by our German subsidiary and minimum lease payments under operating leases and the effect these obligations are expected to have on our liquidity and cash flow in future periods.

		Borrowings By German Subsidiary and other			Non- Cancelable Operating Leases
2005		$	7		$	1,094
2006			—			815
2007			—			39
Thereafter			477			—
		$	484		$	1,948

We had no off-balance sheet arrangements as of December 31, 2003 or 2004.

In May 2003, the Financial Accounting Standards Board, or FASB, issued SFAS 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” It establishes classification and measurement standards for three types of freestanding financial instruments that have characteristics of both liabilities and equity.  Instruments within the scope of SFAS No. 150 must be classified as liabilities within our Consolidated Financial Statements and be reported at settlement date value.  The provisions of SFAS No. 150 are effective for (1) instruments entered into or modified after May 31, 2003, and (2) pre-existing instruments as of July 1, 2003. In November 2003, through the issuance of FSP 150-3, the FASB indefinitely deferred the effective date of certain provisions of SFAS No. 150, including mandatorily redeemable instruments as they relate to minority interests in consolidated finite-lived entities.  The adoption of SFAS No. 150, as modified by FSP 150-3, did not have a material effect on our Consolidated Financial Statements.

In December 2004, the FASB issued SFAS No. 123 (revised 2004) (SFAS 123R), “Share-Based Payments.” SFAS 123R requires all entities to recognize compensation expense in an amount equal to the fair value of share-based payments, such as stock options granted to employees. We are required to apply SFAS 123R on a modified prospective method. Under this method, we are required to record compensation expense (as previous awards continue to vest) for the unvested portion of previously granted awards that remain outstanding at the date of adoption. In addition, we may elect to adopt SFAS 123R by restating previously issued financial statements, basing the amounts on the expense previously calculated and reported in their pro forma disclosures that had been required by SFAS 123. SFAS 123R is effective for the first reporting period beginning after June 15, 2005. We have not completed its evaluation of the effect that SFAS 123R will have, but we believe that when adopted it will increase stock-based compensation expense and reduce earnings, with no or little impact on our overall financial position.

In February 2004, the FASB issued FIN 46-R which incorporated several changes to FIN 46 which relates to the consolidating and combining of financial statements of majority owned variable interest entities. We have adopted the provisions of FIN 46. The adoption of FIN 46-R did not have a material impact on our Consolidated Financial Statements.

 

 

 

In December 2004, the FASB issued SFAS No.151, “Inventory Costs,” which amends part of ARB 43, “Inventory Pricing,” concerning the treatment of certain types of inventory costs. The provisions of ARB No. 43 provided that certain inventory-related costs, such as double freight, re-handling, might be “so abnormal” that they should be charged against current earnings rather than be included in the cost of inventory and, that is capitalized to future periods. As amended by SFAS No. 151, the “so-abnormal” criterion has been eliminated. Thus, all such (abnormal) costs are required to be treated as current-period charges under all circumstances. In addition, fixed production overhead should be allocated based on the normal capacity of the production facilities, with unallocated overhead charged to expense when incurred. SFAS 151 is required to be adopted for fiscal years beginning after June 15, 2005. We are assessing the impact of adopting SFAS No.151, but do not believe its adoption will have a material impact on our overall financial position.

 

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. If we are not able to meet certain milestones in our DARPA contracts, research and development funding may be lost or delayed resulting in higher expenses. 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, we will not be able to make any significant adjustment in our operating expenses, and our operating results will be adversely affected.

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 the 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.

On-going terrorist threats and actual terrorist attacks have increased the uncertainty in both the United States and European economy, which are primary markets for our products, and may negatively impact general economic conditions in those markets. Economic conditions may also be negatively affected by social unrest, health epidemics or natural disasters. Because the markets for our products tend to be highly dependent upon general economic conditions a decline in general economic conditions could likely harm our operating results.

We expect to introduce additional new products in each year in the Pool and Spa Lighting and/or 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.

 

 

Competition is increasing in a number of our markets. A number of companies offer directly competitive products, including compact metal halide products for downlighting and color halogen lighting for swimming pools. We are also experiencing competition from light emitting diode, or 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 affect our operating results if we cannot compete effectively.

We currently hold 41 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, and again recently, received communications from third parties asserting rights in our patents or that our technology infringes intellectual property rights 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.

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 net sales and operating results.

 

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 outside sales agent could interfere with our ability to maintain customer relationships and result in declines in our net sales and operating results.

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.

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 and power supplies. 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.

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 is not renewed in a timely manner, we may experience some disruption of our large core fiber production while new facilities are found and prepared to support fiber manufacturing.

 

 

In order to control 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 United States or may be subject to natural disasters or diseases, 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 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, harm our reputation and relationship with our customers and negatively impact our results of operations.

 

 

EFO is a new type of lighting that may not achieve acceptance by lighting designers or other customers of lighting products. EFO products include components that are difficult to manufacture and/or procure in large quantities in the short term. These components include lamps and optical and electronic components. While we plan to increase our manufacturing capabilities to meet an increase in demand, if the increase is greater than expected or larger quantities are needed in a shorter time frame than anticipated, we may not be able to meet customers’ requirements and our ability to market the product may be adversely affected.

 

 

 

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 off-shore 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.

 

 

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.

 

 

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.

 

 

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. Conversely, if we overbuild inventories we run a risk of having inventory write-offs due to obsolescence.

 

 

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.

 

 

 

 

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 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 and 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.

 

 

Changes in the laws and regulations affecting public companies, including the provisions of the Sarbanes-Oxley Act of 2002 and new rules and regulations of the Securities and Exchange Commission and the Nasdaq National Market are creating new duties and requirements for us and our executives, directors, attorneys and independent accountants. In order to comply with these new rules, we expect to continue to incur additional costs for personnel and use additional outside legal, accounting and advisory services, which we expect will increase our operating expenses. Management time associated with these compliance efforts necessarily reduces time available for other operating activities, which could adversely affect operating results. While we expect these costs to increase our operating expenses significantly, we cannot predict or estimate the amount of future additional costs we may incur or the timing of such costs.

 

 

Section 404 of the Sarbanes-Oxley Act of 2004 requires our management to report on, and our independent auditors to attest to, the effectiveness of our internal control structure and procedures for financial reporting. We have an ongoing program to perform the system and process evaluation and testing necessary to comply with these requirements. This legislation is relatively new and neither companies nor accounting firms have significant experience in complying with its requirements. As a result, we expect to incur increased expense and to devote additional management resources to Section 404 compliance. In the event that our chief executive officer, chief financial officer or independent registered public accounting firm determine that our internal controls over financial reporting are not effective as defined under Section 404, investor perceptions of our company may be adversely affected and could cause a decline in the market price of our stock.

 

 

We prepare our financial statements to conform with generally accepted accounting principles, or GAAP, in the United States. These accounting principles are subject to interpretation by the American Institute of Certified Public Accountants, the Securities and Exchange Commission and various bodies formed to interpret and create appropriate accounting policies. A change in those policies can have a significant effect on our reported results and may affect our reporting of transactions completed before a change is announced. Changes to those rules or the questioning of current practices may adversely affect our reported financial results or the way we conduct our business. For example, accounting policies affecting many aspects of our business, including rules relating to employee stock option grants, have recently been revised or are under review. The Financial Accounting Standards Board and other agencies have finalized changes to U.S. generally accepted accounting principles that will require us, starting in our third quarter of 2005, to record a charge to earnings for employee stock option grants and other equity incentives. We may have significant and ongoing accounting charges resulting from option grant and other equity incentive expensing that could reduce our overall net income. In addition, since we historically have used equity-related compensation as a component of our total employee compensation program, the accounting change could make the use of equity-related compensation less attractive to us and therefore make it more difficult to attract and retain employees.

 

 

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:

 

 

 

 

 

 

 

 

 

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.

At December 31, 2004, we had $389,000 in cash held in foreign currencies based on the exchange rates at December 31, 2004. It is our practice to maintain cash balances in local currencies subject to periodic conversions prior to transfer to repay inter-company debts.

Through our German subsidiary, we maintain a credit facility under an agreement with Sparkasse Neumarkt Bank. At December 31, 2004, we had total borrowings of $477,000 against this facility which comes due in 2008 and is secured by real property owned by our German subsidiary. At December 31, 2003, we had $475,000 (in Euros) borrowed against this facility. In addition, our German subsidiary has a revolving line of credit for $203,000 (in Euros, based on the exchange rate at December 31, 2004) with Sparkasse Neumarkt Bank. There were no borrowings against this facility at December 31, 2004 and 2003, respectively. If funds from the credit facility are used to repay inter-company debts there is an exchange rate conversion risk.

Our consolidated financial statements and related notes required by this item are listed and set forth in this report at Item 15 beginning at page F-1. The accompanying notes are an integral part of our consolidated financial statements.

The following table sets forth our selected unaudited financial information for the eight quarters in the period ended December 31, 2004. This information has been prepared on the same basis as the audited financial statements and, in the opinion of management, contains all adjustments necessary for a fair presentation thereof.

 

2004 QUARTERS ENDED		DEC. 31			SEP. 30			JUN. 30			MAR. 31
Net sales		$	7,840		$	7,333		$	8,550		$	6,008
Gross profit			3,098			2,745			3,567			2,101
As a percent of net sales			39.5	%		37.4	%		41.7	%		35.0	%
Net income (loss)			(341	)		(60	)		461			(764	)
As a percent of net sales			(4.3	)%		(0.8	)%		5.4	%		(12.7	)%
Net income (loss) per share:
Basic		$	(0.05	)	$	(0.01	)	$	0.06		$	(0.11	)
Diluted		$	(0.05	)	$	(0.01	)	$	0.06		$	(0.11	)
2003 QUARTERS ENDED			DEC. 31			SEP. 30			JUN. 30			MAR. 31
Net sales		$	7,418		$	6,367		$	7,574		$	5,879
Gross profit			3,060			2,360			2,875			2,046
As a percent of net sales			41.3	%		37.1	%		38.0	%		34.8	%
Net income (loss)			110			(181	)		85			(622	)
As a percent of net sales			1.5	%		(2.8	)%		1.1	%		(10.6	)%
Net income (loss) per share:
Basic		$	0.02		$	(0.03	)	$	0.02		$	(0.12	)
Diluted		$	0.02		$	(0.03	)	$	0.02		$	(0.12	)

In accordance with SFAS 142 we ceased amortizing goodwill as of December 31, 2001. Refer to Note 5 of the Notes to Consolidated Financial Statements.

As disclosed in our current report on Form 8-K filed October 2, 2003, by decision of our audit committee we changed independent accountants effective September 29, 2003.

 

 

(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 (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 objectives of the disclosure controls and procedures are met. Our disclosure controls and procedures have been designed to meet, and management believes that they meet, reasonable assurance standards, subject to the deficiencies and weaknesses identified and discussed below. 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 its stated goals under all potential future conditions.

 

 

 

Based on their evaluation as of the end of the period covered by this Annual Report on Form 10-K, our Chief Executive Officer and Chief Financial Officer have concluded that, subject to the limitations noted above, and because of the material weakness in our internal controls discussed in this Item 9A(b) below, our disclosure controls and procedures were not fully 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 Annual Report on Form 10-K was being prepared.

 

(b)  Changes in internal controls. There was no change in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) identified in connection with the evaluation described in Item 9A(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. However, after completion of our fourth fiscal quarter and in connection with the audit of our consolidated financial statements for the year ended December 31, 2004, Grant Thornton LLP, our independent registered public accounting firm, identified and reported to management and the Audit Committee of our Board of Directors two items it considered in its judgment to be significant deficiencies in internal controls which aggregate to a material weakness under standards established by the Public Company Accounting Oversight Board, or PCAOB.

A control deficiency exists when the design or operation of a control does not allow management or employees, in the normal course of performing their assigned functions, to prevent or detect misstatements on a timely basis.  A significant deficiency is a control deficiency, or combination of control deficiencies, that adversely affects a company’s ability to initiate, authorize, record, process, or report external financial data reliably in accordance with accounting principles generally accepted in the United States such that there is more than a remote likelihood that a misstatement of the entity’s annual or interim financial statements that is more than inconsequential will not be prevented or detected.  A material weakness is a significant deficiency, or combination of significant deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. 

Grant Thornton has informed us that they believe that the following two significant deficiencies constitute a material weakness in our internal controls under available standards established by the standards of the PCAOB:

1)	We have inadequate segregation of duties in our financial reporting process and in our information technology governance controls This means there is limited opportunity for the exercise of review and monitoring controls over key reporting and disclosure preparation procedures.

2)	We also recorded a number of adjustments to our financial statements during the course of the audit, at least one of which was individually material.

These findings and adjustments constitute significant deficiencies that aggregate to form a material weakness in our internal controls.

We have taken and are taking steps to add personnel to augment our financial reporting processes and to cross-train our existing personnel in order to increase the segregation of duties. We expect that by adding personnel we will be better able to record adjustments to our financials on a more timely basis. We also intend to take measures to acquire additional internal and outside technical accounting expertise.

We intend to continue to evaluate these significant deficiencies and to take appropriate action to correct the internal control deficiencies identified. We further intend to develop and enhance our internal control policies, procedures, systems and staff to better allow us to mitigate the risk that material accounting errors might go undetected and be included in our consolidated financial statements. We are continuing to review our internal controls as part of our preparation for the complete phase-in of compliance standards under Section 404 of the Sarbanes-Oxley Act of 2002. Any further deficiencies identified by this review will be reported to the Audit Committee.

 

Not applicable.

 

 

The information required by this Item regarding directors and nominees is incorporated herein by reference to the information under the caption "PROPOSAL NO. 1: ELECTION OF DIRECTORS" in our definitive Proxy Statement to be filed with the SEC in connection with the solicitation of proxies for our 2005 Annual Meeting of Shareholders to be held on June 22, 2005 (the "Proxy Statement"). Information on our executive officers may be found in Part I of this report under the option "Executive Officers of the Registrant".

Item 405 of Regulation S-K calls for disclosure of any known late filings or failure by an insider to file a report required by Section 16 of the Securities Exchange Act of 1934, as amended. This disclosure is contained in the section entitled "SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE" in the Proxy Statement and is incorporated herein by reference.

We have a separately designated standing Audit Committee established in accordance with Section 3(a)(58)(A) of the Securities Exchange Act of 1934, as amended. The members of the Audit Committee are Michael Kasper (Chairperson), John B. Stuppin and Philip Wolfson. All of such members meet the independence standards established by The NASDAQ Stock Market for serving on an audit committee. SEC regulations require that we disclose whether a director qualifying as an “audit committee financial expert” serves on our Audit Committee. Our Board of Directors has determined that Mr. Stuppin qualifies as an “audit committee financial expert” within the meaning of such regulations.

 

Our Board of Directors adopted a Code of Ethics and Business Conduct for all of our directors, officers and employees on February 25, 2004. To request a copy of the Code of Ethics and Business Conduct, please send a written request to our Secretary at Fiberstars Inc., 44259 Nobel Drive, Fremont, California 94538. It is also available from our corporate website at http://www.fiberstars.com.

 

The information regarding executive compensation required by Item 11 is incorporated herein by reference from the information in the Proxy Statement under the captions "EXECUTIVE COMPENSATION AND OTHER MATTERS," "PROPOSAL NO. 1: ELECTION OF DIRECTORS—Director Compensation" and "PROPOSAL NO. 1: ELECTION OF DIRECTORS—Compensation Committee Interlocks and Insider Participation."

The information regarding security ownership of certain beneficial owners and management required by Item 12 is incorporated herein by reference from the information in the Proxy Statement under the caption "SECURITY OWNERSHIP OF PRINCIPAL SHAREHOLDERS AND MANAGEMENT."

 

 

The information regarding certain relationships and related transactions required by Item 13 is incorporated herein by reference to the information in the Proxy Statement under the caption "CERTAIN TRANSACTIONS."

 

The information regarding principal accountant fees and services and the pre-approval policies and procedures required by Item 14 is incorporated by reference from the information contained in the Proxy Statement under the caption “RATIFICATION OF APPOINTMENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTANTS - Principal Accountant Fees and Services” and “RATIFICATION OF APPOINTMENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTANTS - Pre-Approval Policies and Procedures.”

(a)

(1) Financial Statements

 

To the Board of Directors and Shareholders of Fiberstars, Inc.

Fremont, California

We have audited the accompanying consolidated balance sheets of Fiberstars, Inc. as of December 31, 2004 and 2003, and the related consolidated statements of operations, comprehensive income (loss), shareholders' equity, and cash flows for the years then ended.  These financial statements are the responsibility of the Company's management.  Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with auditing standards of the Public Company Accounting Oversight Board (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.  The Company is not required to have, nor were we engaged to perform an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, 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 consolidated financial position of Fiberstars, Inc. as of December 31, 2004 and 2003, and the consolidated results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.

/s/Grant Thornton LLP

San Francisco, California

March 11, 2005

The accompanying notes are an integral part of these financial statements.

		2004			2003			2002
Net sales		$	29,731		$	27,238		$	30,960
Cost of sales			18,220			16,897			19,486
Gross profit			11,511			10,341			11,474
Operating expenses:
Research and development			1,188			1,279			2,290
Sales and marketing			8,595			7,188			7,907
General and administrative			2,459			2,435			2,709
Total operating expenses			12,242			10,902			12,906
Loss from operations			(731	)		(561	)		(1,432	)
Other income (expense):
Equity in joint venture's income			6			6			16
Other income (expense)			(20	)		80			41
Interest expense			(17	)		(119	)		(66	)
Net loss before income taxes			(762	)		(594	)		(1,441	)
Benefit from (provision for) income taxes			58			(14	)		(2,078	)
Net loss		$	(704	)	$	(608	)	$	(3,519	)
Net loss per share—basic and diluted		$	(0.10	)	$	(0.10	)	$	(0.70	)
Shares used in per share calculation—basic and diluted			7,269			5,993			5,028

The accompanying notes are an integral part of these financial statements.

		2004			2003			2002
Net loss		$	(704	)	$	(608	)	$	(3,519	)
Other comprehensive income:
Foreign currency translation adjustments			370			870			444
Income tax benefit (provision)			(137	)		(323	)		(164	)
Comprehensive loss		$	(471	)	$	(61	)	$	(3,239	)

The accompanying notes are an integral part of these financial statements.