UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2005
[ ]
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: 000-49746
VISCOUNT SYSTEMS, INC.
(Name of small business issuer in its charter)
| NEVADA | 88-0498181 |
| (State or other jurisdiction of | (I.R.S. Employer Identification No.) |
| incorporation or organization) | |
| 4585 Tillicum Street, Burnaby, British Columbia, Canada | V5J 5K9 |
| (Address of principal executive offices) | (Zip Code) |
| Issuer’s telephone number: | (604) 327-9446 |
| Securities registered pursuant to Section 12(b) of the Act: | None |
| Securities registered pursuant to Section 12(g) of the Act: | Common Stock, $.001 per share |
| (Title of class) |
Check whether the issuer is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act. [ ]
Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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 [ X ] No [ ]
Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B contained in this form, and no disclosure will be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. [ X ]
Check whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] N0 [ X ]
State issuer’s revenues for its most recent fiscal year: $4,311,603 ($5,013,492 in Canadian dollars converted at an exchange rate of US$0.860/CDN$ 1.000) .
State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was sold, or the average bid and asked price of such common equity, as of a specified date within the past 60 days. (See definition of affiliate in Rule 12b-2 of the Exchange Act.): $8,520,055 as at January 20, 2006.
State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date: 16,079,950 shares of common stock as at March 21, 2006.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's Proxy Statement for the Annual Meeting of Stockholders are incorporated by reference into Part III of this Form 10-KSB, which Proxy Statement is to be filed within 120 days after the end of the Registrant's fiscal year ended December 31, 2005.
Transitional Small Business Disclosure Format (Check one): Yes [ ] No [ X ]
FORM 10-KSB
TABLE OF CONTENTS
1
FORM 10-KSB
VISCOUNT SYSTEMS, INC.
PART I.
Certain statements in this Form 10-KSB regarding future expectations and financial performance should be regarded as forward-looking statements and are subject to various risks and uncertainties including those described elsewhere in this Form 10-KSB, and in our filings with the Securities and Exchange Commission.
Currency of Financial Information and Exchange Rate Table
We maintain our books of account in Canadian dollars and references to dollar amounts herein are to the lawful currency of Canada unless otherwise indicated.
The following table sets forth, for the periods indicated, certain exchange rates based on the noon buying rate in New York City for cable transfers in Canadian dollars. Such rates are the number of Canadian dollars per one (1) U.S. dollar and are the inverse of rates quoted by the Federal Reserve Bank of New York for U.S. dollars per CDN$1.00. On January 20, 2006, the exchange rate was US$1.00 per CDN$1.1527. The high and low exchange rates for each month during the previous six months were as follows:
| High | Low | |
| February 2006 | 1.1614 | 1.1398 |
| January 2006 | 1.1794 | 1.1372 |
| December 2005 | 1.1754 | 1.1427 |
| November 2005 | 1.1977 | 1.1642 |
| October 2005 | 1.1923 | 1.1588 |
| September 2005 | 1.1936 | 1.1588 |
The following table sets out the exchange rate information as at each of the years ended December 31, 2005 and 2004.
| Year Ended December 31 | ||
| 2005 | 2004 | |
| Rate at end of Period | 1.1630 | 1.2020 |
| Average Rate during Period | 1.2116 | 1.3015 |
| Low | 1.1467 | 1.1746 |
| High | 1.2696 | 1.4003 |
Item 1. DESCRIPTION OF BUSINESS
GENERAL
We are a manufacturer, developer and service provider of access control security products. In 2005, commercial sales of our MESH product line continued to impact our total sales. MESH (Multimedia Embedded Security Hub) was a new technology developed by Viscount that converges voice (intercom, emergency communications), data (access control, elevator control, alarm) and some video to provide increased security at a reduced cost of hardware, cabling and installation and with simplified database management.
In addition to MESH, our current access control and security product lines include the following: Enterphone 2000, a building intercom; Entercheck, a card access system; RadioClik and InfraClik, radio frequency and infrared remote controls; Elektra, liquid crystal display intercom panels; EmerPhone, emergency telephone entry systems; and
2
various accessories. We also have a service division that provides service for the Enterphone 2000. We currently have 1,780 service agreements in place.
Our website address is www.viscount.com. All periodic and current reports are available, free of charge, on our website as soon as reasonably practicable after such material is electronically filed with, or furnished to, the U.S. Securities and Exchange Commission. Electronic or paper copies of our filings are also available, free of charge, upon request.
BUSINESS OVERVIEW
We design, manufacture and service access control and security products, including intercom and door access control systems and emergency communications systems. These systems use telecommunications wiring to control access to buildings and other facilities for security purposes. While much of our current revenues are derived from sales of the Enterphone technology and related security products, sales from our MESH product line continues to impact and provide a significant source of revenues. Service sales from our existing 1,780 service agreements also continue to provide a significant source of revenues.
Enterphone continues to be our leading sales product. Enterphone is a building access control system that uses a building’s internal phone wiring thereby avoiding use of telephone utility services. Our products include access control panels that use the Enterphone technology. Our control panels are typically installed at entrances to apartment buildings, government facilities, and other buildings and facilities where security concerns require access control systems. The control panels are sold in various formats and with varying features and capabilities. Our Enterphone technology control panels are sold through an established distribution network, and can be found installed in approximately 35,000 buildings throughout North America. We also package and sell access control and security products that are complementary to our Enterphone product, including card access systems, radio frequency remote controls, intercom monitors and closed circuit cameras.
MESH technology is based on a proprietary software platform that can be used for a variety of security and access control applications as well as communication functions. The technology represents a departure from traditional access control and security systems. Traditional systems use controllers that have a capacity to control from 1 to 8 access points per controller. A building access system using the MESH technology can control several hundred points of access from a single remote hardware and software platform. The technology also allows several previously independent building control systems to be hosted on a single hardware and software platform. Our proprietary MESH software is designed to be modular, permitting additional applications to be added as modules, each operating other building and area control systems and high technology requirements.
COMPANY HISTORY
Our current business is operated primarily through our wholly owned subsidiary Viscount Communication and Control Systems Inc. The business of our subsidiary began operations in 1969 as a manufacturer of video switching equipment. In 1970, the business was acquired by B.C. Telecom Inc. (BC Tel), which was acquired by Telus Corporation in 1999. BC Tel was the telephone utility for British Columbia, Canada controlled by GTE Corporation (now Verizon Communications Inc.). Under BC Tel, the business operated as an electronics research laboratory and manufacturing facility. Among the products manufactured were central office telephone test equipment, telephone demarcation blocks, and a satellite based kiosk system used to provide information at airports and other public facilities. Responsibility for the manufacture of the Enterphone system was transferred into the business in 1984 from BC Tel. BC Tel contracted to sell the business in 1997 to Blue Mountain Technologies Inc., a company that purchases and installs our products. Blue Mountain Technologies Inc. simultaneously assigned its contractual rights to acquire all of the business assets, except for certain leasehold interests, to our subsidiary, Viscount Communication. BC Tel consented to the assignment and accordingly the business was acquired by our subsidiary, Viscount Communication and Control Systems Inc.
We were incorporated on May 24, 2001 under the laws of the State of Nevada under the name OMW4 Corp. Our subsidiary, Viscount Communication was incorporated in 1997 under the laws of British Columbia, Canada, for the purposes of carrying on our present access control business. We acquired all of the issued and outstanding shares in
3
the capital of Viscount Communication on July 27, 2001, in exchange for 10,000,000 shares of our common stock, thereby making it our wholly owned subsidiary. As a result of the acquisition, the former shareholders of Viscount Communication obtained a controlling interest in OMW4 Corp. In connection with the acquisition, we changed our name to Viscount Systems Inc. effective August 27, 2001.
In 2002, we acquired the assets of Sigma Data Systems of British Columbia, Canada. Sigma Data Systems had been designing and manufacturing electronic assemblies for telecommunications and hydroelectric applications since 1993. Sigma Data Systems’ largest customer was BC Hydro, the government owned hydro-electric utility for the Province of British Columbia. We assumed their contract with BC Hydro, which involved custom manufacturing of communications equipment. This contract expired in May of 2005 In 2003 we acquired certain inventory and service agreements from Telus Corporation. The service agreements relate to the maintenance of approximately 1,780 Enterphone installations throughout Western Canada. The inventory was comprised of various products and components for installation and repair of these Enterphone installations.
Enterphone is a specialized telephone switch used to provide intercom and access control functions in buildings. It was originally developed by BC Tel in 1965. Mirroring the increased security awareness in buildings over the past few years, we have been providing a more comprehensive package of complementary products. Products packaged, using third party technologies for this purpose, include card access systems, radio frequency remote controls, intercom display panels and closed circuit cameras.
The MESH product line, which has been under development since 1998, is an integrated platform for building access control and management. MESH continues to be the focus of our corporate development.
INDUSTRY OVERVIEW
We compete in the building intercom and access control systems industry. The intercom and access control industry is sometimes referred to as a segment of the low voltage systems industry. Our intercom and access control systems are designed to automate the control of access to buildings or other restricted access areas. Intercom systems and access control systems are complementary; however they can also be used independently depending on user requirements. For example, most modern residential apartment or condominium buildings have an intercom system for visitors wishing to communicate with residents. Residents, on the other hand, are issued access cards that can be used in conjunction with card readers installed beside doors or elevators in order to gain access.
Access control systems provide two functions for a building. Building tenants use access cards and readers that control access through doors, gates or elevators, while visitors use telephone intercoms to be granted admission by a building occupant or manager. The systems also provide sophisticated alarm functions such as identifying doors left open or forced entry. The sophistication of systems ranges from controlling a single door where records are kept manually, to large enterprise systems covering hundreds of buildings from a dedicated security facility.
The building control industry has traditionally been highly segmented based on function. This has meant that makers of heating/ventilation and air-conditioning systems and security card access systems essentially manufacture input/output systems, while intercom makers manufacture voice systems, and security camera makers manufacture closed circuit video systems. Stated otherwise, audio, video, environment and access control systems are traditionally all separate building control systems that are independently controlled. There has been strong convergence of technologies in the computer and telephone related industries based on digital standards; however the building control industry has not as yet undergone a similar convergence of technologies. Traditionally, where systems need to be compatible, the industry has relied on integration instead of convergence. Integration is the use of a host computer to tie separate and distinct systems, typically from different manufacturers, together on a common software platform. Convergence, in the case of building control systems, is the provision of a new service that is designed to operate multiple systems using homogenous control parameters. Convergence is generally considered preferable to integration, as fewer distinct systems means lower operational and maintenance costs.
Along with certain other industry participants, we have turned to current high-technology solutions in order to reduce costs of ownership of security systems, while improving functionality. We have developed new system platforms that will permit convergence of the control of various building functions, such as access control, intercom,
4
closed circuit television, and heating/ventilation and air-conditioning. These systems can be operated on a single commercially available host server and can operate using standard communications techniques. As a result of using a single full service system to replace the three or more separate dedicated systems, each requiring its own host server, the overall cost of ownership of a security and control system has been reduced.
Access Control Systems Technology
The access control industry has traditionally used a technology known as Wiegand. Approximately 90% of the world’s installed access systems are based on Wiegand technology. Today, these systems are commonly found in residential, commercial and industrial buildings in the form of access control cards and card readers. Wiegand was initially developed in 1970 by Senso Engineering as an access card technology. The card technology uses a special patented process whereby wires are imbedded in a plastic access card to encode its data. When passed through a magnetic field generated by a card reader, the card generated a signal which is received and interpreted by the card reader. If the signal is recognized, the reader will transmit the information to a host controller to activate a switch, which for example purposes, may release a lock or open an elevator to permit building access to the cardholder. A host controller is essentially computer hardware that is programmed to receive information from the card reader in order to permit access to a building. Wiegand technology has established itself as the industry standard as it is viewed as being reliable and difficult to counterfeit the access cards.
Other products that use the Wiegand principals for access control are magnetic strip cards and radio frequency cards. These products function similarly by providing a card reader with a signal that the reader interprets and transmits to a host controller in order to grant or deny access.
Wiegand access control technology requires card readers that are connected to a host controller. Each host controller can operate between 1 to 8 doors. Accordingly, a building with a large number of controlled access points could require a large number of host controllers, resulting in greater hardware costs. Host controllers can in turn be connected to a central server that monitors the host controllers and collects information on access point usage.
The underlying technology that operates these traditional access control systems is approximately 30 years old. The readers are considered “dumb” readers as they simply receive information from the access card and transmit it to a host controller. The host controller processes the information in order to determine whether to grant or deny access. If access is granted, the host controller then transmits a signal to activate a switch to open the access point where the reader is located. This is a simple input/output type relay system which requires a separate host controller for approximately every eight access points.
As a result of the limitations and hardware requirements of the traditional access control systems, some security industry manufacturers are developing and marketing “intelligent” access control and communications systems. Intelligent systems allow several previously independent building control systems, such as intercom, access control, video, and climate control, to be controlled by a single server. These systems are based on software designed to control hundreds of readers from a single computer server, combined with “smart chips” installed in readers at each control point. Smart chips are programmable computer chips that permit access card readers to grant or deny access without the need to relay a signal to and from a central host controller. Smart chips can be programmed to perform tasks for a diverse range of building control systems, such as fire alarm systems, heating/ventilation and air conditioning, and building access and elevator controls. As the smart chip is programmed to make its own decisions on a given application, this reduces the load on the central host computer. The host computer accordingly performs primarily a monitoring and information collection function.
We are participating in this advance in the access control industry with our proprietary MESH intelligent access control and communication technology system. We believe that intelligent systems, including smart chip readers and cards will replace reliance on systems based on Wiegand technology.
PRODUCTS
We are a manufacturer, developer, reseller and service provider of intercom and access control systems based on telephone, new and traditional access card and reader technologies. Our intercom and access control systems are installed throughout North America for various applications including: condominium/apartment building access and intercom; residential intercom; gated home/community access and intercom; seniors/government housing access,
5
tracking and intercom; elevator access and tracking; garage or perimeter gate control, and emergency communications.
For the year ended December 31, 2005, approximately 17% of total sales of our products and services were generated in the United States, and 83% in Canada. This represents a change from 2004, where sales to the United States and Canada were 28% and 72%, respectively. The change is in part due to increased sales of products and services in Canada as a result of our acquisition of service agreements and inventory from Telus Corporation. Information on our existing products can be viewed on our website at www.viscount.com.
Our Enterphone Access Control Products
Historically our principal product was the Enterphone intercom and access control system. Enterphone is our patented building entry control system that uses a building’s internal phone wiring to allow access control for tenants and intercom and access control between visitors and tenants. The use of a building’s internal phone wiring by our Enterphone system provides an option to using telephone company wiring, thereby bypassing monthly telephone charges. It also does not require tenants to pay for an individual phone line to operate their intercom and door access system and is not affected by interruptions in telephone company service. This makes our Enterphone system distinct from other “dial-up” telephone entry systems that use telephone company lines. Sales of our products based on the Enterphone system account for approximately 42% of our total sales in fiscal 2005. This is down from approximately 48% in fiscal 2004, due in part to the development of other sources of sales, including Enterphone maintenance contracts, new product lines, and our OEM product lines.
Our Enterphone system is sold as a central control panel which is installed in a building’s telephone control room. The control panel connects an intercom panel located at an entrance to the building with the telephone of building tenants. A visitor wishing to gain access to the building dials a 1 to 4 digit number at the entrance panel. The call is directed from the entrance panel, through the common control equipment and up to the tenant’s telephone. The tenant hears a unique ring and can unlock the entrance door by pressing a number on the telephone’s numeric keypad. The tenant does not need to rent a telephone line from the telephone company. Each control panel can process connections to as many as 840 suites.
We also manufacture electronic entry access panels that can operate using either our Enterphone system, or dial-up telephone company lines. Our panels are manufactured in various sizes and with various features in order to accommodate varying purposes and building types. For example, we manufacture panels that provide intercom and access control from 1 suite to up to 1000 suites; or panels that provide on-screen name search capabilities; or panels that are streamlined in shape or small in size. All panels that we manufacture incorporate the Enterphone technology, however most panels can also be installed to use telephone company lines.
Our Enterphone panels can also be combined with other technologies such as access tracking and control, closed circuit monitors, infrared and radio frequency remotes, and Wiegand cards and card readers. We purchase these technologies from other manufacturers and resell them under our brand names. Most of the products that we resell can be integrated into our Enterphone access control system.
Our MESH Access Control System
Overview
MESH is a software based building management system designed to replace traditional systems that are more hardware intensive. We continue to develop this technology that was started in 1998. MESH was pre-commercially released in late 2003.
MESH is a software platform that communicates with a network of “intelligent” input/output devices, such as card readers or building environment sensors. As such, the “intelligence” of the system can be said to be distributed among the input/output devices. This is contrasted with the traditional access control industry, which uses “dumb” readers that require information to be processed at a central host computer. An “intelligent” reader or input/output device uses a pre-programmed “smart chip” which allows it to process information on its own, and does not require the host computer to make action decisions, such as to grant or deny access to a door or to activate air-conditioning.
6
The use of “intelligent” devices accordingly reduces the load on the host computer which allows the host computer to allocate its resources to a greater number and diversity of tasks. The networked distribution of “intelligent” devices also means reduced cost resulting from reduced hardware requirements, easier training of control system operators, and the use of commercially available host computer hardware and communication techniques. Initially, we will apply the MESH technology for access control system purposes.
The conceptual basis for MESH is simple. Virtually every low voltage building technology, except building access, has evolved using “intelligent” addressable network devices. This includes fire alarms and heating/ventilation and air-conditioning. An addressable network is one in which devices can constantly communicate with a host server controller or can be polled for information. For example, if a smoke detector on a non-addressable fire alarm system fails, a fire in that location may go undetected since there is no way to identify the failure without actually testing the device. In contrast, the “smart chip” in an addressable smoke detector may be able to notify the fire panel of a problem immediately and call for service. Access control systems, however, continue to be based on a 30-year-old standard called Wiegand. The limitations of this standard continue to plague the industry due to the slow data transmission speed (9600 baud) between the reader and the host controller, the high cost and quantity of specialized and dedicated hardware, and the inability of the host computer to process voice or video signals. For example, buildings requiring elevator access control have traditionally required a significant amount of expensive dedicated hardware. The MESH network with “intelligent” readers can accomplish these functions without dedicated hardware, resulting in cost reductions, both in terms of the actual hardware required and the labor, cable and conduit costs associated with installation.
The MESH system bypasses the need for specialized and dedicated hardware. Instead, MESH provides a software-based platform that operates on an industrial computer server connected to “intelligent” readers transmitting data at high speed rates of up to 156,000 baud, while simultaneously running voice and video applications. The benefits and functionality derived from this approach can be significant.
MESH Structure
The MESH network consists of a main control computer server communicating with a series of “intelligent” readers, panels, and input/output devices. The key to the technology is the “smart chip” we use, known as the MPNode computer chip, a programmable chip. We purchase the MPNode chips and program them to perform certain functions upon detecting certain data. For access control applications, the chip is installed into a card reader. When data from an access card is received by the card reader, the chip processes the data and makes a decision to grant or deny access. Information on the transaction is passed along to the host computer for data storage and analysis purposes. Traditional Wiegand style card readers require an intermediate controller for every two or three reading devices. An intermediate controller is connected between the host computer and the group of readers controlled by it. In contrast, the MESH systems allows “intelligent” readers to be installed in series, or daisy-chain fashion, without the need for intermediate controllers. Small interface modules are used instead to maintain data flow. This reduces hardware costs as only one host computer is required.
MESH panels, located at entrance doors for visitor access, can operate independently or as slaves off the MESH server. The basic MESH panel that we have commercially released is a full color screen industrial computer. Panels may be located at entrance doors for visitor access or can be on-site managed by security guards as they manage the MESH network. The slave/master architecture of MESH panels reduces cost, simplifies programming, and improves data base management.
In designing MESH, much consideration has been made of the many dissimilar applications requiring a MESH network. In cases where building control is accomplished with on-site security and concierge staff, limited MESH hardware or possibly only software may be needed to perform the required functions. For example, MESH software may be sold as a simple visitor tracking system for commercial or gated residential sites.
In general, MESH has been designed to allow simple installations to be performed by small independent alarm contractors. However, provision has also been made for direct involvement by our staff in large campus wide and enterprise wide installations.
7
MESH has many additional benefits, both in terms of building security and particularly relative to the legacy Wiegand protocol. It is our belief that addressable networks pose a serious threat to the continued use of the Wiegand format.
MESH is a modular product, meaning that the software can accommodate add-on features or upgraded features. We have developed various modules for our MESH technology, and we intend to develop further modules which will be released in a series of phases. Some of these product enhancement modules are described below:
Our other products
Our next generation of Enterphone systems, called EP3000, was due to release in late 2005, but due to continued research and development, this new product is scheduled for release during the first quarter of 2006. We expect this product to generate commercial sales during the second quarter of 2006. EP3000 will replace EP2000. EP3000, also a no phone line system like EP2000, is the next generation of Enterphone. EP3000 will be more cost effective because it will require less assembly and material input costs. EP3000 is designed to improve compatibility with MESH and other newer telephony technologies.
The Enterphone 2000 design dates back to 1990 and the architecture has created complications for both manufacturing and installation. The new universal controller will eliminate the need for Viscount to manufacture and carry inventory for 10 different circuit boards. Overall, EP3000 will reduce cost, produce higher margins, and improve our ability to market MESH.
Our other products include RadioClick and InfraClick. These are remote control access control products for doors and parking gates. They are sold separately or as complementary to our Enterphone, Entercheck and MESH systems. We also manufacture and sell EmerPhone, an intercom system that is sold in elevator phone, emergency phone and entry phone applications.
8
OTHER SERVICES
In addition to sales of our Enterphone, MESH and OEM products, we also service approximately 1,778 existing Enterphone installations within Western Canada.
PRODUCTION
Viscount has facilities for circuit board manufacture and mechanical assembly. We use a range of processes to produce our products. Some products including Enterphone, Infraclik, and Axess are completely manufactured in-house. MESH and Emerphone use outsourced circuit boards with final assembly and software installed at Viscount. Some access control, card readers, Elektra panels, Infraclik and various product accessories are purchased from other manufacturers and resold under our brand-names. We maintain full facilities to assemble through-hole circuit boards and limited facilities for assembling surface mount circuits. We have a policy of supporting old products as long as parts are available for servicing and replacement. We are designing our Enterphone 3000 to be backwards compatible with the 2000 series to improve the longevity and serviceability of both products.
The MESH software platform is loaded on standard industrial computer chassis. We are not developing hardware internally for MESH, since the required hardware controllers are commercially available at quality and price levels that make internal development uneconomical. In addition, by using off-the-shelf components, we improve our time to market, eliminate hardware debugging and increase our ability to be technologically flexible in the future. We are primarily executing final mechanical assembly of the MESH systems.
RESEARCH AND DEVELOPMENT
Our research and development continues to be focused on enhancing MESH and completing the development of EP3000. A number of these enhancements were identified in the “MESH Structure” and “Our other products” section of this document. Specific custom MESH applications are being considered, evaluated and implemented. An example of this process would be considering built-in badging printers and a virtual concierge.
MARKET AND MARKETING
The Market
The intercom and access control market is serviced by a number of large and small competitors. Our traditional products compete in a mature marketplace, that largely uses the 30 year old Wiegand technology. We believe that there currently exists an opportunity in the building and access control market for innovative products that use current technologies to reduce user costs. We have positioned our MESH technology to take advantage of this opportunity.
The access control market can generally be described as the market for any equipment used to control passage through a door, gate or other portal. A portion of this market is comprised of mechanical and electronic door locks that typically control access through single doors. Many of the single door systems have been engineered for low security levels for customers who do not desire a full access control host. The access control market that we compete in involves computerized access control systems that typically control access through multiple access points, such as our Enterphone system. MESH was designed to present a new technology to this computerized market niche. In particular, in large high-rises with a full MESH system, individual tenants may use the MESH server to control access to one or two doors.
Our traditional market for our Enterphone product was apartment and condominium buildings. While the market for telephone entry type systems amounts to about US$100 million, in the past 10 years there has been a strong trend towards increased building security resulting in much more sophisticated integrated installations. For example, in 1990, a typical condominium building would be equipped with an intercom to admit visitors. Today, a typical new building installation includes telephone entry, card access, closed circuit cameras, individual burglar alarms and panic stations. This puts pressure on manufacturers to provide a comprehensive package and represents an opportunity for significant revenue growth per system. MESH is our first in-house product that addresses these
9
multiple requirements. The modular nature of MESH also provides us with an excellent opportunity to design additional products on the MESH platform to provide enhanced options for a comprehensive building security package.
In addition to apartment entrances, MESH is also designed to provide access control for the rapidly growing gated community market. Monitor style directory panels are also used in thousands of commercial high-rises. The MESH panel provides features previously unavailable for this market. The overall effect of these system advances has enhanced our core business, while allowing us to find applications where the new features expand the traditional market for such systems.
We are targeting upgrades and retrofits to existing apartments and other complexes that use traditional telephone wire intercom access control systems. The low hardware costs and increased functionality of the MESH system continue to be marketed to building management companies, along with its turnkey installation as a replacement to existing access control systems for most modern buildings.
While complete MESH networks will typically be installed, the modular nature of MESH allows additional segmentation based on product application and end-user need. The nature and scope of a MESH installation depends on the level of security required, the product alternatives, the number of buildings, and the level of system management required. The nature and scope of an installation can be described in terms of a user spectrum ranging from price sensitive users to users requiring enhanced services. At one end of this spectrum is price. For these applications MESH has been competing with traditional Wiegand systems. We believe the cost reduction aspects of MESH has provided us with a competitive advantage over traditional Wiegand systems. For example, a typical condominium developer does not manage a building after construction. Therefore, the developer is looking for a very affordable, reliable access control system. Unless a more sophisticated product will help sell suites, the developer tends to keep the system simple. At the middle of the spectrum are customers who will adopt MESH mainly due to system benefits. For a commercial high-rise this may be the flexibility derived from a new user profile approach MESH uses for programming. On the enhanced service end of the spectrum we find customers who need to develop a much closer relationship due to the level of sophistication of their needs. At this level, we anticipate additional revenue opportunities for custom programming, data mining and hosting, and direct installations for national accounts.
While the core function is controlling access/egress, through the planned development of various MESH technology modules, we have been actively targeting all of these segments. For example, a MESH add-on module can be developed to provide an asset tracking system to prevent computer theft. The inherent alarm functions of MESH allow it to be used as an integrated theft/burglar alarm system for large facilities. The MESH telephony video capture function will allow government agencies to track alcohol and drug problem tenants of controlled housing complexes or other regulatory monitoring functions. Finally, MESH, along with our EmerPhone, can function to combat vandalism and to secure parking lots.
We rank controlling access/egress and securing parking facilities as the primary concerns of our traditional core multi-residential business.
Distribution Plan
We currently have approximately 500 dealers for our existing products throughout North America. When our existing business was acquired from BC Tel, we relied primarily on exclusive and semi-exclusive dealers in certain major metropolitan areas. Our distribution network is not static and we are constantly seeking additional sales channels. In October and November of 2003, we signed a distributor deal with Tri Ed, the security distribution subsidiary of Tyco. The agreement placed our security products in 27 Canadian and U.S. Tyco branches, including Denver, Dallas, Phoenix, Seattle and six locations in California.
As previously noted MESH can serve several different markets and the type of dealer serving each may vary. Simple installations may be performed by small independent dealers, but as the overall scope of the project increases, the technical ability of the dealer becomes increasingly important. At the extreme, our employees may be directly involved with the customer in designing, installing and servicing the product. In other cases, our personnel
10
may be involved on a co-op basis with large national security, building automation and heating/ventilation and air-conditioning contractors.
These distribution deals, along with our existing dealer base, gave us immediate access to the largest networks of dealers in the US, Canada and Mexico.
During the past two years, we have been targeting our existing markets for the sale of our MESH technology, as well as targeting the international marketplace. Internationally, we have sold MESH in China, India, France, and New Zealand. MESH is designed to accommodate foreign languages with minimal modifications to the software. This is in contrast to other products of its type which require a heavy software investment to provide alternative language software. With MESH, the core software can be applied in all languages with only the on screen text displays needing to be translated. Translation can be accomplished using commercially available translation software.
MESH Marketing Strategy
We have been using our established distribution channels as well as new distribution channels to access our target markets for the MESH technology. As a unique technology, however, end-users as well as dealers must be educated about MESH benefits. It is our experience that a stronger initial emphasis on end-user decision-makers and large national system integrators will be the most effective in developing the MESH market.
Advertising
Our products are advertised on an ongoing basis in various print publications, which we will continue to do. We have been testing new publications on a regular basis to evaluate response, sales and readership. All leads are followed up and magazines are rated based on a dollar sales per advertising dollar spent ratio. While the sales cycle is sometimes fairly long, this approach has given us a very accurate measure of the effectiveness of various publications and individual ads.
Trade Shows
We have experienced that the marginal dollar benefit of trade show participation is much less than other promotional media (print ad, direct mail etc.). Therefore, we intend to be very selective in choosing which tradeshows would introduce MESH most effectively.
Direct Marketing
One of the most effective ways to market security systems is to identify major institutional and corporate users and market directly to key individuals. We hired additional sales representatives in the U.S. to continue marketing our MESH technology. We have started educating customers about our MESH technology by holding MESH training seminars throughout the U.S. and at hour head office.
Pricing Strategy
Our system provides features never before available in a building control security system. The MESH technology is built on an architecture which can reduce user costs significantly. The modular nature of the technology amplifies this effect the larger the system becomes.
With a unique product and a position of product leadership, we have devised a strategy of building market share. This strategy involves selling MESH at reasonable 50-60% margins. With the telephony component, we have been targeting a price which provides MESH panels at a price that is competitive with similar products, but with newer enhanced features.
COMPETITION
Competitive Summary
11
The security and building control industry is undergoing a rapid period of consolidation. Large multi-national companies are integrating vertically by acquiring equipment providers to build house brands. Recent examples are the purchase of Cardkey by Johnson Controls, Guardall by Chubb and ADI/Northern Computers by Honeywell. The access control industry is very segmented with no company having a dominant market position. Canada has approximately six access control product manufacturers, while the U.S. has at least fifty. There is a certain amount of vertical integration in the business and several large multinational companies own their own house brands. Many branches of these multinational companies often have their own brand preferences and buy outside their internal distribution channels.
Almost all manufacturers build control hosts based on Wiegand technology. Due to these limitations, most research and development is focused on cost reducing hardware and making the control hosts more network capable. In all cases, the manufacturer using traditional Wiegand technology are limited from 1 to 8 doors per host.
Competitive Threats
We have a strong dealer and distribution plan in place, and MESH has positioned us in a market dominated by much larger players. The higher security MESH applications are also somewhat outside of our traditional scope of business and therefore, we are rapidly trying to develop a market for MESH and in the process, educating users of MESH through our training seminars. We believe that our marketing strategies and training seminars will provide benefits that will help us achieve market share that will allow us to be competitive. There is no guarantee that we will be able to successfully compete against our larger competitors.
While MESH is still a new product in an established growing market, technological change can be met with resistance. Some buyers are nervous about new products, and new protocols even more so. Most buyers are familiar with the benefits of addressable fire alarms and we have marketed MESH from this point of view; that is to stress the inevitability of all access control systems evolving this way.
A key concern is the ability of competitors to imitate the product and the ability of large imitators to more easily commercialize their product. We have estimated that we still have a three-year market lead. Fortunately, the wide range of MESH software applications should provide us with an ongoing lead, as long as we are aggressive with research and development.
INTELLECTUAL PROPERTY
We will rely on a combination of patent laws, trade secret laws, non-disclosure and other contractual agreements, and technical measures to protect the confidential information, know-how, and proprietary rights relating to our Enterphone, MESH and other Viscount products. We have contractual rights with respect to registered North American trademarks and tradenames including the following: Viscount, Enterphone, Enterchek, InfraClick, RadioClick, and EmerPhone. We are still considering and evaluating the need for a North American patent for our MESH technology, and registering North American tradenames for MESH.
We have registered active Internet domain names for www.viscount.com and www.enterphone.com.
Our standard employment agreements and license agreements contain provisions that protect the confidentiality of our proprietary property. All our employees and sales agents are required to sign these agreements prior to their employment or engagement.
To date we have not received notification that our services or products infringe the proprietary rights of third parties. Third parties could however make such claims of infringement in the future. We cannot be certain that others will not develop substantially equivalent or superseding proprietary technology, or that equivalent services will not be marketed in competition with our services, thereby substantially reducing the value of our proprietary rights. Furthermore, there can be no assurance that any confidentiality agreements between us and our employees or any license agreements will provide meaningful protection for our proprietary information in the event of any unauthorized use or disclosure of such proprietary information.
12
GOVERNMENT REGULATIONS
All of our Enterphone and OEM products are FCC and IC approved as well as ADA approved where required by law depending specifically on particular products and place of installation. We are still in the process of considering and obtaining UL certifications for our MESH products.
Some of our products are still under government regulation. The Enterphone is an interposition technology which in U.S. states can only be installed where the local public service commission has designated the original point of entry of a building as the demarcation point between the telephone company and building owner’s responsibility. Conversely, it can also be installed where the telephone company has given consent to allow Enterphone to share the telephone backbone.
The history of government deregulation for us mainly relates to the demarcation point in a building. Until government deregulation came to the access control industry, Enterphone type systems could only be installed by telephone companies.
Historically, Enterphone was approved by MA Bell. After the break-up each regional telephone company began to make its own decisions. As a result of this, Chicago, New York, and Boston became strong markets for the Enterphone. Another result of government deregulation was that many telephone companies withdrew from the access control systems industry, which resulted in our using direct dealers in those regions.
OUR SOURCES OF REVENUES
The majority of the Company’s revenues are derived from the Enterphone product line. Historically, the Enterphone product sales represented approximately 60% to 80% of total revenues. In fiscal 2005, this percentage decreased to 62% due in part to new sources of revenues, including service contracts purchased from Telus Corporation, and the commercial launch of MESH, which collectively represented 62% of revenues in fiscal 2005. The balance of the Company’s revenues are derived from other products such as access tracking and control, closed circuit monitors, infrared and radio frequency remotes.
EMPLOYEES
Viscount employs twenty-eight full time staff at its production facility and head office located in Burnaby, British Columbia, Canada.
Item 2. DESCRIPTION OF PROPERTY
PROPERTY
Our executive office and central factory is located in Burnaby, British Columbia, where we currently lease 12,040 square feet. We lease this space under an industry standard operating lease with a term expiring May 31, 2007, renewable at the option of Viscount. Current monthly lease obligations are $7,425. We believe that our current facilities are adequate and are suitable for our current use, and that suitable additional facilities will be available, when needed, upon commercially reasonable terms. Our facilities are adequately insured against perils in a manner consistent with industry practice.
Item 3. LEGAL PROCEEDINGS
Viscount was named as a third party defendant in litigation that involved the alleged malfunction of certain equipment installed in a residential rental building. This litigation was first reported in its Form 10QSB filed for the period ended June 30, 2004, identified as follows: Joyce M. Smith, Administrator of Estate of Helen Delaney, deceased v. Metroplex, Inc., et al. Docket No. 03 L 7595 (Law Division, Circuit Court of Cook County, Illinois). The plaintiff named Metroplex, Inc. and Kenwood Housing Opportunity Corp. as defendants. Metroplex and Kenwood then filed a third party complaint against Seal-Tight Security, Inc. and Viscount Systems, Inc., seeking contribution as to any judgment entered against Metroplex and Kenwood. The plaintiff was recently allowed leave
13
to amend the complaint to add Seal-Tight and Viscount as direct defendants. Viscount has filed a defense to the third party claim and is actively defending both the third party claim and the plaintiff’s direct claim.
Item 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
None.
PART II.
Item 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND PURCHASES OF EQUITY SECURITIES
Trades in our common shares are quoted on the Over-the-Counter Bulletin Board (OTC Bulletin Board) which is a quotation service administered by the National Association of Securities Dealers (NASD). Our trading symbol on this service is “VSYS”.
The OTC Bulletin Board has a limited and sporadic trading market and does not constitute an established trading market. Our shares began trading on February 12, 2002. The following table sets forth the range of high and low price information of the common shares as reported on the OTC Bulletin Board for the last two fiscal years and the subsequent period ending January 31, 2006. The price information available reflects inter-dealer prices, without retail mark-up, mark-down or commission and may not represent actual transactions.
| High (U.S. $) | Low (U.S. $) | ||
| 2006 | First Quarter (through January 31, 2006) | $0.55 | $0.52 |
| 2005 | Fourth Quarter | 0.71 | 0.52 |
| Third Quarter | 0.96 | 0.61 | |
| Second Quarter | 0.97 | 0.68 | |
| First Quarter | 1.07 | 0.85 | |
| 2004 | Fourth Quarter | 1.48 | 0.75 |
| Third Quarter | 2.68 | 1.20 | |
| Second Quarter | 2.22 | 1.21 | |
| First Quarter (beginning February 12, 2002) | 2.05 | 0.59 |
As of January 31, 2006 there were 31 holders of record of our common stock, holding a total of 16,075,575 shares, and an unknown number of beneficial holders.
We have not declared any dividends in the last two fiscal years.
The following table sets forth information respecting our compensation plans as at December 31, 2005, under which shares of our common stock are authorized to be issued.
Plan Category |
Number of securities to be issued upon exercise of outstanding options, warrants and rights (a) | Weighted-average exercise price of outstanding options, warrants and rights (b) | Number of securities remaining available
for future issuance under equity compensation plans
(excluding securities reflected in column (a)) (c) |
| Equity compensation plans approved by security holders | 3,146,925 | US$0.28 | 0 |
| Equity compensation plans not approved by security holders | N/a | N/a | N/a |
| Total | 3,146,925 | US$0.28 | 0 |
14
Item 6. MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
The following discusses our financial condition and results of operations based upon our consolidated financial statements which have been prepared in conformity with accounting principles generally accepted in the United States of America. It should be read in conjunction with our financial statements and the notes thereto included elsewhere herein. All dollar amounts are in Canadian dollars unless otherwise noted.
RESULTS OF OPERATIONS
Sales revenues for the year ended December 31, 2005 have increased by $621,834 or 14.2% to $5,013,492, as compared to sales revenues of $4,391,658 for the year ended December 31, 2004. Sales continued to improve due to increased MESH (Multimedia Embedded Security Hub) sales. MESH was a new technology developed by Viscount that converged voice (intercom, emergency communications), data (access control, elevator control, alarm) and some video to provide increased security at a reduced cost of hardware, cabling and installation and with simplified database management. MESH sales for the year ended December 31, 2005 were 19.9% of total sales, as compared to 10.2% of total sales for the year ended December 31, 2004. Sales from our existing 1,780 assigned service agreements continue to be steady. On average, each service agreement acquired represents ongoing revenues of approximately $33 per month, inclusive of parts and labour. These agreements allow us to provide Enterphone support and maintenance services to these assigned customers. Typical customers include strata management and building owners as well as various residential, business and industrial users of Enterphone access control and security systems. During the year ended December 31, 2005, customer service agreements and new equipment sales generated aggregate sales revenues of $1,561,434. This included MESH sales by the service division. Sales of our core Enterphone product lines have continued to be stable.
The intangible assets held by the Company are comprised primarily of service agreements for our product known as “Enterphone 2000”. The number of service agreements held by the Company decreased from 1,868 at December 31, 2004 to 1,829, 1,797, 1,786, and 1,780 at March 31, June 30, September 30, and December 31, 2005, respectively. During the second, third and fourth quarter of 2005, the Company performed a test for impairment in accordance with Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”) and evaluated the status of service agreements. Management determined that no charge for impairment was required but the continuing reduction in the number of service contracts held, including the 2% reduction in the second quarter, indicated that the intangible asset should be deemed to have a definitive life based on the provisions of SFAS 142. Accordingly, the Company began, effective as of April 1, 2005, to amortize the cost of the service agreements on a straight-line basis over an estimated useful life of 10 years. At December 31, 2005, the cost of the service agreements, net of accumulated amortization, was $193,252.
The cost of sales as a percentage of sales was 42.4% for the year ended December 31, 2005, as compared with the cost of sales as a percentage of sales of 42.6% for the year ended December 31, 2004. Costs of sales as a percentage of sales had remained consistent due to management’s commitment of reviewing input costs regularly. Our policy of managing cost of sales remains the same. We are continuously focusing on controlling costs, by using multiple suppliers to ensure that the best and most inexpensive raw materials are used in our products.
Gross profit for the year ended December 31, 2005 was $2,836,385, an increase of $314,000 or 12.4%, as compared to a gross profit of $2,522,385 for the year ended December 31, 2004. This increase corresponds with the improved sales revenues and consistent cost of sales percentage for the year ended December 31, 2005.
Selling, general and administrative expenses decreased by $239,337 or 9.1% during the year ended December 31, 2005, in comparison to the prior year comparative period. This decrease was due to management’s cost reduction plan to control variable costs such as advertising, tradeshow and various office expenses. As a percentage of sales, selling, general and administrative expenses were 47.7% and 59.9% for the years ended December 31, 2005 and 2004, respectively.
15
Research and development costs were $361,983 for the year ended December 31, 2005, as compared to $209,028 for the year ended December 31, 2004. Research and development costs increased due to costs incurred in designing our new Enterphone 3000 unit and additional costs incurred to complete the next phase of MESH.
Income before income tax for the year ended December 31, 2005 was $404, as compared to the loss before income tax of $(398,565) for the year ended December 31, 2004. This is an increase in income of $398,969.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents decreased as of December 31, 2005, as compared to December 31, 2004. At December 31, 2005, cash and cash equivalents totaled $246,563, as compared with the cash and cash equivalents of $290,850 at December 31, 2004. During the year ended December 31, 2005, cash disbursements increased due to the increased advertising and promotional costs associated with the MESH product. At December 31, we had a bank credit facility available for an operating loan of up to a maximum of $300,000 at the prime lending rate plus 1.0% . In anticipation of increased inventory purchases for MESH, management has increased the operating loan by $200,000 to a maximum of $500,000 at the prime lending rate plus 1.0% . Amounts drawn are repayable on demand. At December 31, 2005, $11,063 was drawn on this facility. The facility is secured by a general security agreement.
At December 31, 2005, working capital was $869,442, as compared to a working capital of $770,798 at December 31, 2004. Working capital has increased by $98,644. The current ratio at December 31, 2005 was 1.82 to 1.0, as compared with 1.72 to 1.0 at December 31, 2004.
The accounts receivable turnover ratio for year ended December 31, 2005 was 61 days, as compared to 57 days for the year ended December 31, 2004, an increase of 4 days. This increase was due to certain slower paying accounts which are closely being monitored by management. The accounts receivable reserve was $92,421 at December 31, 2005, as compared to $73,573 for the year ended December 31, 2004, an increase of $18,484. The reserve was increased to be conservative in recognizing some of the slower paying accounts. Management continues to recognize and remove older doubtful customer accounts from the accounts receivable sub-ledger, as well as more regular follow-up on certain customer accounts to improve the collection process. There had been no significant or material business conditions that would warrant additional increases to the reserve at this time.
For the year ended December 31, 2005, there were no capital expenditures other than the purchase of equipment.
To date, we have not invested in derivative securities or any other financial instruments that involve a high level of complexity or risk. We expect that in the future, any excess cash will continue to be invested in high credit quality, interest-bearing securities.
We will likely require additional funds to support the development and marketing of our new MESH product. There can be no assurance that additional financing will be available on acceptable terms, if at all. If adequate funds are not available, we may be unable to develop or enhance our products, take advantage of future opportunities, respond to competitive pressures, and may have to curtail operations.
There are no legal or practical restrictions on the ability to transfer funds between parent and subsidiary companies.
We do not have any material commitments for capital expenditures as of December 31, 2005.
There are no known trends or uncertainties that will have a material impact on revenues.
Related Party Transactions
There were no related party transactions for the period covered by this report.
Critical Accounting Policies:
16
The Company’s discussion and analysis of its financial condition and results of operations, including the discussion on liquidity and capital resources, are based upon the Company’s financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, management re-evaluates its estimates and judgments, particularly those related to the determination of the estimated recoverable amounts of investment tax credits, trade accounts receivable, and deferred tax assets. The Company believes the following critical accounting policies require its more significant judgment and estimates used in the preparation of the consolidated financial statements.
The Company follows the cost reduction method of accounting for investment tax credits and recognizes the estimated net recoverable amount when reasonable assurance exists as to their collectability. Investment tax credits claimed are ultimately subject to finalization of a review by Canada Customs and Revenue Agency. No assurances can be provided that the Company’s investment tax credit claims will be accepted as filed.
The Company maintains an allowance for doubtful accounts for estimated losses that may arise if any of its customers are unable to make required payments. Management specifically analyzes the age of customer balances, historical bad debt experience, customer credit-worthiness, and changes in customer payment terms when making estimates of the uncollectability of the Company’s trade accounts receivable balances. If the Company determines that the financial conditions of any of its customers deteriorated, whether due to customer specific or general economic issues, increases in the allowance may be made.
The Company reviews its intangible assets on an annual basis for impairment. The intangible assets are comprised of Enterphone service contracts. Management specifically reviews the number of contracts on hand and if there will be significant future cash flows to be generated from these contracts. If the Company determines that there is an impairment, then a writedown will be made.
The Company maintains an allowance for inventory obsolescence. Management reviews the inventory on a quarterly basis by directly testing for obsolete inventory. If management determines that obsolete inventory has increased, then an increase in the allowance will be made.
Income taxes are accounted for under the asset and liability method. Under this method, to the extent that it is not more likely than not that a deferred tax asset will be recovered, a valuation allowance is provided. In making this determination, the Company considers estimated future taxable income and taxable timing differences expected to reverse in the future. Actual results may differ from those estimates.
RECENTLY ISSUED ACCOUNTING STANDARDS
In December 2004, the FASB issued SFAS No. 123R, “Share-Based Payment” (“SFAS 123R”), a revision of SFAS No. 123, “Accounting for Stock-Based Compensation,” requiring that the compensation cost relating to share-based payment transactions, including grants of employee stock options, be measured and recognized in the financial statements using the fair value of the compensation awards. The provisions of SFAS 123R are effective for the Company for the first interim or annual period that begins after December 15, 2005; therefore, the Company will adopt the new requirements no later than the beginning of the first quarter of its year ending December 31, 2006. Adoption of the expensing requirements will reduce the Company’s reported earnings. Management is currently evaluating the two methods of adoption allowed by SFAS 123R; the modified-prospective transition method and the modified-retrospective transition method.
In November 2004, the FASB issued SFAS No. 151, “Inventory Costs, an amendment of ARB No. 43, Chapter 4” (“SFAS 151”). SFAS 151 clarifies that abnormal inventory costs such as costs of idle facilities, excess freight and handling costs, and wasted materials (spoilage) are required to be recognized as current period charges. The provisions of SFAS 151 are effective for fiscal years beginning after June 15, 2005. The adoption of SFAS 151 is not expected to have a significant impact on the Company’s consolidated financial position or results of operations.
Item 7. FINANCIAL STATEMENTS
The financial statements are attached to this report following the signature page.
17
Item 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
Item 8A. CONTROLS AND PROCEDURES
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports filed pursuant to the Securities Exchange Act of 1934 are recorded, processed, summarized and reported within the time periods specified in the rules and forms promulgated under such Act, and that such information is accumulated and communicated to management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
As of the end of the period covered by this report, management carried out an evaluation, under the supervision and with the participation of the management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based upon the foregoing, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective in connection with the filing of this Annual Report on Form 10-KSB for the year ended December 31, 2005.
Such evaluation did not identify any change in our internal controls over financial reporting that occurred during the three months ended December 31, 2005 that has materially affected or is reasonably likely to materially affect the Company’s internal control over financial reporting.
Item 8B. OTHER INFORMATION
Not applicable.
PART III.
Items 9 – 12, 14
Information with respect to Items 9 – 12 and 14 is set forth in the Proxy Statement to be filed with the Securities and Exchange Commission on or before May 1, 2006 and is incorporated herein by reference.
Item 13. EXHIBITS
| Exhibit No. | Description of Exhibit | Manner of Filing |
| 3.1 | Articles of Incorporation | Incorporated by reference to Exhibit 3.1 to the Form SB-2 of the Company, SEC File No. 333- 68998 (the “Form SB-2) |
| 3.2 | Amendment to the Articles of Incorporation | Incorporated by reference to Exhibit 3.2 to the Form SB-2 |
| 3.3 | Bylaws | Incorporated by reference to Exhibit 3.1 to the Form SB-2 |
| 10.1 | Employment Agreement with Stephen Pineau | Incorporated by reference to Exhibit 10.2 to the Form SB-2 |
| 10.2 | Employment Agreement with Greg Chen | Incorporated by reference to Exhibit 10.3 to the Form SB-2 |
| 10.3 | 2001 Stock Option Plan | Incorporated by reference to Exhibit A to the Proxy Statement on Schedule 14A filed with the SEC on April 30, 2002 |
18
| 10.4 | 2003 Stock Option Plan | Incorporated by reference to Exhibit A to the Proxy Statement on Schedule 14A filed with the SEC on April 30, 2003 |
| 21.1 | Subsidiaries of the registrant | Incorporated by reference to Exhibit 21.1 to the Form SB-2 |
| 23.1 | Consent of Davidson & Company LLP | Filed herewith |
| 23.2 | Consent of J.H. Cohn LLP | Filed herewith |
| 31.1 | Rule 13a-14(a)/15d-14(a) Certification of the Chief Executive Officer | Filed herewith |
| 31.2 | Rule 13a-14(a)/15d-14(a) Certification of the Chief Financial Officer | Filed herewith |
| 32.1 | Section 1350 Certification of the Chief Executive Officer and Chief Financial Officer | Filed herewith |
19
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on March 30, 2006.
| VISCOUNT SYSTEMS, INC. By: /s/ Stephen Pineau Stephen Pineau President and Chief Executive Officer |
In accordance with the requirements of the Exchange Act, this report has been signed by the following persons on behalf of the registrant and in the capacities indicated on the dates indicated.
| Signature | Title | Date | |
| By: | /s/ Stephen Pineau | President, Secretary, | March 30, 2006 |
| Stephen Pineau | Chief Executive Officer and | ||
| Director | |||
| By: | /s/ Greg Shen | Chairman of the Board and | March 30, 2006 |
| Greg Shen | Director | ||
| By: | /s/ Les Fong | Chief Financial Officer | March 30, 2006 |
| Les Fong |
20
VISCOUNT SYSTEMS, INC.
CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in Canadian Dollars)
DECEMBER 31, 2005
F-i
| DAVIDSON & COMPANY LLP | A Partnership of Incorporated Professionals | |
| Chartered Accountants |
REPORT OF INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM
To the Stockholders of
Viscount Systems, Inc.
We have audited the accompanying consolidated balance sheet of Viscount Systems,
Inc. as at December 31, 2005 and the related consolidated statements of operations,
stockholders' equity and cash flows for the year then ended. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based
on our audit.
We conducted our audit in accordance with the 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. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of the Company as at
December 31, 2005 and the results of its operations and its cash flows for the
year then ended in conformity with generally accepted accounting principles
in the United States of America.
"DAVIDSON & COMPANY LLP"
| Vancouver, Canada | Chartered Accountants |
| February 23, 2006 |
A Member of SC INTERNATIONAL
1200 - 609 Granville Street, P.O. Box 10372, Pacific Centre,
Vancouver, BC, Canada, V7Y 1G6
Telephone (604) 687-0947 Fax (604) 687-6172
F-ii
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders
Viscount Systems, Inc.
We have audited the accompanying consolidated balance sheet of Viscount Systems, Inc. and Subsidiary as of December 31, 2004 and the related consolidated statement of operations, stockholders’ equity and cash flows for the year 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 audit.
We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Viscount Systems, Inc. and Subsidiary at December 31, 2004, and their results of operations and cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America.
/s/ J. H. Cohn LLP
San Diego, California
February 14, 2005
F-iii
| VISCOUNT SYSTEMS, INC. Consolidated Balance Sheets (Expressed in Canadian dollars) As at December 31 |
| 2005 | 2004 | |||||
| Assets | ||||||
| Current assets | ||||||
| Cash and cash equivalents | $ | 246,563 | $ | 290,850 | ||
| Trade accounts receivable, less allowance for doubtful accounts | ||||||
| of $92,421 at December 31, 2005 and $73,573 at December 31, 2004 | 797,284 | 656,527 | ||||
| Inventory (note 3) | 881,166 | 898,843 | ||||
| Prepaid expenses | 6,028 | 1,391 | ||||
| Lease receivable (note 4) | 902 | 198 | ||||
| Total current assets | 1,931,943 | 1,847,809 | ||||
| Lease receivable (note 4) | 2,936 | 4,680 | ||||
| Equipment (note 5) | 98,468 | 115,848 | ||||
| Intangible assets (note 6) | 193,252 | 208,921 | ||||
| Total assets | $ | 2,226,599 | $ | 2,177,258 | ||
| Liablilities and stockholders' equity | ||||||
| Current liabilities | ||||||
| Bank indebtedness (note 7) | $ | 11,062 | $ | 104,670 | ||
| Accounts payable and accrued liabilities | 491,922 | 415,146 | ||||
| Deferred revenue | 32,115 | 29,793 | ||||
| Due to stockholders (note 8) | 292,402 | 292,402 | ||||
| Notes payable (note 9) | 235,000 | 235,000 | ||||
| Total current liabilities | 1,062,501 | 1,077,011 | ||||
| Commitments and contingencies (note 13) | ||||||
| Stockholders' equity | ||||||
| Capital stock (note 10) | ||||||
| Authorized: | ||||||
| 100,000,000 common shares with a par value of US$0.001 per share | ||||||
| 20,000,000 preferred shares with a par value of US$0.001 per share | ||||||
| Issued and outstanding: | ||||||
| 16,053,075 and 15,903,075 common shares | 23,645 | 23,494 | ||||
| Additional paid-in capital | 1,883,109 | 1,819,813 | ||||
| Accumulated deficit | (742,656 | ) | (743,060 | ) | ||
| Total stockholders' equity | 1,164,098 | 1,100,247 | ||||
| Total liabilities and stockholders' equity | $ | 2,226,599 | $ | 2,177,258 |
See accompanying notes to consolidated financial statements.
F-1
| VISCOUNT SYSTEMS, INC. Consolidated Statements of Operations (Expressed in Canadian dollars) Years ended December 31 |
| 2005 | 2004 | |||||
| Sales | $ | 5,013,492 | $ | 4,391,658 | ||
| Cost of sales | 2,177,107 | 1,869,273 | ||||
| Gross profit | 2,836,385 | 2,522,385 | ||||
| Expenses | ||||||
| Selling, general and administrative | 2,392,903 | 2,632,240 | ||||
| Research and development (note 11) | 361,983 | 209,028 | ||||
| Depreciation and amortization | 37,641 | 39,629 | ||||
| 2,792,528 | 2,880,897 | |||||
| Income (loss) before other items | 43,857 | (358,512 | ) | |||
| Other items | ||||||
| Other income | 2,262 | 2,509 | ||||
| Interest and bank charges | (45,716 | ) | (42,562 | ) | ||
| (43,454 | ) | (40,053 | ) | |||
| Income (loss) before income taxes | 404 | (398,565 | ) | |||
| Provision for income taxes (note 12) | - | - | ||||
| Net income (loss) | $ | 404 | $ | (398,565 | ) | |
| Basic net income (loss) per common share | $ | 0.00 | $ | (0.03 | ) | |
| Diluted net income (loss) per common share | $ | 0.00 | $ | (0.03 | ) | |
| Weighted average number of common shares outstanding | ||||||
| Basic | 15,997,606 | 15,645,729 | ||||
| Diluted | 17,996,630 | 15,645,729 |
See accompanying notes to consolidated financial statements.
F-2
| VISCOUNT SYSTEMS, INC. Consolidated Statements of Stockholders' Equity (Expressed in Canadian dollars) Years Ended December 31, 2005 and 2004 |
| Additional | |||||||||||||||
| Common Stock | paid-in | ||||||||||||||
| Shares | Amount | capital | Accumulated deficit | Total | |||||||||||
| Balance, January 1, 2004 | 15,201,250 | $ | 22,792 | $ | 1,552,419 | $ | (344,495 | ) | $ | 1,230,716 | |||||
| Stock issued for cash upon | |||||||||||||||
| exercise of stock options | 701,825 | 702 | 222,235 | - | 222,937 | ||||||||||
| Stock-based compensation (note 10) | - | - | 45,159 | - | 45,159 | ||||||||||
| Net loss | - | - | - | (398,565 | ) | (398,565 | ) | ||||||||
| Balance, December 31, 2004 | 15,903,075 | 23,494 | 1,819,813 | (743,060 | ) | 1,100,247 | |||||||||
| Stock issued for cash upon | |||||||||||||||
| exercise of stock options | 150,000 | 151 | 33,075 | - | 33,226 | ||||||||||
| Stock-based compensation (note 10) | - | - | 30,221 | - | 30,221 | ||||||||||
| Net income | - | - | - | 404 | 404 | ||||||||||
| Balance, December 31, 2005 | 16,053,075 | $ | 23,645 | $ | 1,883,109 | $ | (742,656 | ) | $ | 1,164,098 | |||||
See accompanying notes to consolidated financial statements.
F-3
| VISCOUNT SYSTEMS, INC. Consolidated Statements of Cash Flows (Expressed in Canadian dollars) Years ended December 31 |
| 2005 | 2004 | |||||
| Operating activities: | ||||||
| Net income (loss) | $ | 404 | $ | (398,565 | ) | |
| Items not involving cash: | ||||||
| Depreciation and amortization | 37,641 | 39,629 | ||||
| Selling, general and administrative expenses paid by stock options | 30,221 | 45,159 | ||||
| Changes in non-cash working capital balances (note 14) | (47,579 | ) | 155,372 | |||
| Net cash provided by (used in) operating activities | 20,687 | (158,405 | ) | |||
| Investing activities: | ||||||
| Purchase of equipment | (4,592 | ) | (17,684 | ) | ||
| Net cash used in investing activities | (4,592 | ) | (17,684 | ) | ||
| Financing activities: | ||||||
| Proceeds from (repayment of) bank indebtedness | (93,608 | ) | 18,555 | |||
| Repayment of stockholder loans | - | (156,000 | ) | |||
| Repayment of notes payable | - | (30,000 | ) | |||
| Proceeds from exercise of stock options | 33,226 | 222,937 | ||||
| Net cash provided by (used in) financing activities | (60,382 | ) | 55,492 | |||
| Decrease in cash and cash equivalents | (44,287 | ) | (120,597 | ) | ||
| Cash and cash equivalents, beginning of year | 290,850 | 411,447 | ||||
| Cash and cash equivalents, end of year | $ | 246,563 | $ | 290,850 | ||
| Supplementary information: | ||||||
| Interest paid | $ | 22,833 | $ | 20,332 | ||
| Income taxes recovered | - | (67,352 | ) |
See accompanying notes to consolidated financial statements.
F-4
| VISCOUNT SYSTEMS, INC. Notes to Consolidated Financial Statements (Expressed in Canadian dollars) December 31, 2005 |
| 1. | Operations |
|
| Viscount Systems Inc. (the “Company”) was incorporated on May 24, 2001. The Company manufactures, distributes, and provides services for electronic premises access and security equipment. The functional currency for the Company and its wholly-owned subsidiary is the Canadian dollar. |
||
| 2. | Significant accounting policies |
|
| These consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America. The significant accounting policies adopted by the Company are as follows: |
||
| (a) | Principles of consolidation |
|
| The consolidated financial statements include accounts and results of the Company and its wholly-owned subsidiary, Viscount Communication and Control Systems Inc. (“VCCS”). All material intercompany transactions and balances have been eliminated in consolidation. |
||
| (b) | Use of estimates |
|
| Management of the Company has made a number of estimates and assumptions relating to the reporting of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities to prepare these consolidated financial statements in conformity with accounting principles generally accepted in the United States of America. Significant areas of estimate are the amount of recoverable investment tax credits (notes 11 and 12(a)), the allowance for doubtful accounts, and the deferred tax valuation allowance. Actual results could differ from those estimates. |
||
F-5
| VISCOUNT SYSTEMS, INC. Notes to Consolidated Financial Statements (Expressed in Canadian dollars) December 31, 2005 |
| 2. | Significant accounting policies (cont’d…) |
|
| (c) | Foreign currency translation and transactions |
|
| Monetary items denominated in a foreign currency are translated into Canadian dollars at exchange rates in effect at the balance sheet date. During the year ended December 31, 2005, the aggregate foreign currency transaction gain recognized in determining net income (loss) was $184,432 (2004 loss - $24,967). |
||
| (d) | Cash and cash equivalents |
|
| The Company considers cash held at banks and all highly liquid investments with original maturities of three months or less when acquired to be cash and cash equivalents. At December 31, 2005 and 2004, cash and cash equivalents consisted of cash held at banks. |
||
| (e) | Allowance for doubtful accounts |
|
| The Company establishes an allowance for doubtful accounts on a specific account basis based on the credit risk of specific customers, historical trends and other information that management believes will adequately provide for credit losses. |
||
| (f) | Inventory |
|
| Raw materials and supplies are stated at the lower of cost or market (replacement cost). Cost is generally determined on the first-in, first-out basis. Work in process and finished goods are stated at the lower of average cost or market (net realizable value). An inventory reserve is recorded based upon a physical count of all obsolete inventory. |
||
| (g) | Equipment |
|
| Equipment is stated at cost. Depreciation is recorded based on the estimated useful lives of the assets as follows: |
||
| Asset | Basis | Rate |
| Computer equipment | declining balance | 30% |
| Office furniture and equipment | declining balance | 20% |
| Manufacturing equipment | declining balance | 20% |
| Leasehold improvements | straight-line | 20% |
F-6
| VISCOUNT SYSTEMS, INC. Notes to Consolidated Financial Statements (Expressed in Canadian dollars) December 31, 2005 |
| 2. | Significant accounting policies (cont’d…) |
|
| (h) | Intangible assets |
|
| Intangible assets, consist of intercom service agreements, and have a definitive life based on provisions of SFAS 142. They are recorded at cost and are reviewed annually for impairment. Commencing on April 1, 2005, the Company is amortizing the cost on a straight-line basis over an estimated useful life of 10 years. |
||
| (i) | Impairment of long-lived assets |
|
| Long-lived assets are continually reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. |
||
| (j) | Revenue recognition |
|
| Revenue is recognized when there is persuasive evidence of an arrangement and delivery to the customer has occurred, provided the product does not require significant customization, the fee is fixed and determinable, and collectibility is considered probable. Cash received from customers prior to these criteria being met is recorded as deferred revenue. Amounts billed related to shipping and handling, which are not significant, are included in revenue. The related shipping and handling costs, which are also not significant, are included in cost of sales. |
||
| Service revenue is recognized on a straight-line basis over the period covered by the service agreement only after there is a signed agreement to provide service to the Enterphone 2000 system, the service fee is fixed or determinable, and collectibility is probable. Cash received from customers, in advance of the service period, is recorded as deferred revenue. The Enterphone 2000 system is a building access control system that uses a building’s internal phone wiring thereby avoiding the use of telephone utility services. |
||
| (k) | Research and development costs |
|
| Research and development costs are expensed as incurred and are shown net of investment tax credits (note 11). |
||
| (l) | Advertising costs |
|
| Advertising costs are expensed as incurred. Advertising costs amounted to $289,257 (2004 - $305,171). |
||
F-7
| VISCOUNT SYSTEMS, INC. Notes to Consolidated Financial Statements (Expressed in Canadian dollars) December 31, 2005 |
| 2. | Significant accounting policies (cont’d…) |
|
| (m) | Government assistance and investment tax credits |
|
| The Company follows the cost reduction method of accounting for government assistance and investment tax credits, whereby, the estimated net recoverable amount of the benefit of the tax credits is recognized, when reasonable assurance exists as to their collectibility, as a reduction in the cost of the related capital asset or expenditure. |
||
| (n) | Income taxes |
|
| Income taxes are accounted for under the asset and liability method. Deferred income tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred income tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred income tax assets and liabilities of a change in tax rates is recognized in earnings in the period that includes the enactment date. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. |
||
| (o) | Net income (loss) per share |
|
| Net income (loss) per common share is computed by dividing the net income (loss) by the weighted average number of common shares outstanding for the period. Diluted net income (loss) per common share reflects the potential dilution that could occur if stock options were exercised. |
||
| The weighted average number of common shares outstanding for computing basic net income (loss) per common share was 15,997,606 (2004 – 15,645,729). The weighted average number of common shares outstanding for computing diluted net income (loss) per common share was 17,996,630 (2004 – 15,645,729). For the year ended December 31, 2005, no shares attributable to the assumed exercise of outstanding options were excluded from the calculation of diluted net income per share. For the year ended December 31, 2004, 3,296,925 shares attributable to the potential exercise of outstanding options were excluded from the calculation of diluted net income per common share because the effect was antidilutive. |
||
F-8
| VISCOUNT SYSTEMS, INC. Notes to Consolidated Financial Statements (Expressed in Canadian dollars) December 31, 2005 |
| 2. | Significant accounting policies (cont’d…) |
|
| (p) | Stock-based compensation |
|
| The Company accounts for its employee stock-based compensation arrangements using the intrinsic value method in accordance with provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”), and related interpretations. As such, compensation expense would be recorded on the date of grant of stock options only if the market value of the underlying stock at the date of grant exceeded the exercise price. Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”), requires entities that continue to apply the provisions of APB 25 for transactions with employees to provide pro forma net income (loss) and pro forma net income (loss) per share disclosures for employee stock option grants made as if the fair-value-based method defined in SFAS 123 had been applied to these transactions. Pro forma net loss was $(37,939) and $(494,927) and basic and diluted pro forma net loss per share was $(0.00) and $(0.03) per share in 2005 and 2004, respectively (see note 10). |
||
| Pursuant to SFAS 123, the Company recognizes compensation expense for stock options, common stock and other equity instruments issued to non-employees, based upon the fair value of the equity instruments issued, adjusted through the vesting date, as the services are provided and the options earned. |
||
| Effective January 1, 2006, the Company adopted SFAS No. 123 (R), which requires entities to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. | ||
| (q) | Recent accounting pronouncements |
|
| In May 2005, FASB issued Statement of Financial Accounting Standards No. 154 “Accounting Changes and Error Corrections – A replacement of APB Opinion No. 20 and FASB Statement No. 3” (“SFAS 154”), which is effective for fiscal years ending after December 15, 2005. SFAS 154 requires that changes in accounting policy be accounted for on a retroactive basis. |
||
| In November 2004, the FASB issued SFAS No. 151, “Inventory Costs, an amendment of ARB No. 43, Chapter 4” (“SFAS 151”). SFAS 151 clarifies that abnormal inventory costs such as costs of idle facilities, excess freight and handling costs, and wasted materials (spoilage) are required to be recognized as current period charges. The provisions of SFAS 151 are effective for fiscal years beginning after June 15, 2005. |
||
| The adoption of these new pronouncements are not expected to have a material effect on the Company’s consolidated financial position or results of operations. |
||
F-9
| VISCOUNT SYSTEMS, INC. Notes to Consolidated Financial Statements (Expressed in Canadian dollars) December 31, 2005 |
| 3. | Inventory |
| 2005 | 2004 | ||||||
| Raw materials | $ | 575,820 | $ | 564,710 | |||
| Work in process | 60,035 | 58,632 | |||||
| Finished goods | 245,311 | 275,501 | |||||
| $ | 881,166 | $ | 898,843 |
| 4. | Lease receivable |
| Lease receivable includes an amount due from a customer in monthly installments on a five- year leasing contract expiring in 2009. The contract bears an interest rate of 7% per annum and is secured by the equipment under lease. |
|
| 5. | Equipment |
| Accumulated | Net book | |||||||||
| 2005 | Cost | depreciation | value | |||||||
| Computer equipment | $ | 110,838 | $ | 68,754 | $ | 42,084 | ||||
| Office furniture and equipment | 68,713 | 23,680 | 45,033 | |||||||
| Manufacturing equipment | 28,360 | 28,263 | 97 | |||||||
| Leasehold improvements | 46,814 | 35,560 | 11,254 | |||||||
| $ | 254,725 | $ | 156,257 | $ | 98,468 | |||||
| Accumulated | Net book | |||||||||
| 2004 | Cost | depreciation | value | |||||||
| Computer equipment | $ | 106,246 | $ | 56,864 | $ | 49,382 | ||||
| Office furniture and equipment | 68,713 | 18,815 | 49,898 | |||||||
| Manufacturing equipment | 28,360 | 26,218 | 2,142 | |||||||
| Leasehold improvements | 46,814 | 32,388 | 14,426 | |||||||
| $ | 250,133 | $ | 134,285 | $ | 115,848 |
F-10
| VISCOUNT SYSTEMS, INC. Notes to Consolidated Financial Statements (Expressed in Canadian dollars) December 31, 2005 |
| 6. | Intangible assets |
| On May 16, 2003, the Company consummated an agreement for the purchase of certain assets of Telus Corporation (“Telus”) comprised primarily of service agreements for a product sold by Telus known as “Enterphone 2000”. The Enterphone 2000 is a building access control system that uses a building’s internal phone wiring thereby avoiding the use of telephone utility services. Each customer that entered into a service agreement with Telus had to agree to assign the service agreement to the Company. The Company had agreed to pay Telus a specified amount from time to time through September 15, 2003, based on the number of customers that agreed to assign service agreements to it and, accordingly, the aggregate purchase price varied based on the number of assignments. At December 31, 2003, the Company had acquired 2,215 service agreements for which it paid a total of $208,921. The cost of the service agreements was included in intangible assets. The service agreements were initially deemed to have an indefinite life and were not amortized through March 31, 2005. The number of service agreements held by the Company decreased to 1,868 at December 31, 2004 and 1,780 at December 31, 2005. During the second, third and fourth quarter of 2005, the Company performed a test for impairment in accordance with Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”) and evaluated the status of service agreements. Management determined that no charge for impairment was required but the continuing reduction in the number of service contracts held indicated that the intangible asset should be deemed to have a definitive life based on the provisions of SFAS 142. Accordingly, the Company began, effective as of April 1, 2005, to amortize the cost of the service agreements on a straight-line basis over an estimated useful life of 10 years. At December 31, 2005, the cost of the service agreements, net of accumulated amortization of $15,669 (2004 - $nil) was $193,252 (2004 - $208,921). |
|
| 7. | Bank indebtedness |
| Bank indebtedness represents cheques written in excess of funds on deposit and amounts drawn under a bank credit facility available to a maximum of $300,000. Amounts outstanding under the bank credit facility bear interest at the bank’s prime lending rate plus 1% and are repayable on demand. The facility is secured by substantially all of our assets under a general security agreement. The Company is required to maintain a current ratio that is greater than 1.5:1 and a debt to tangible net worth ratio that is less than 1.5:1 under the terms of the demand facility agreement. At December 31, 2005 the Company was in compliance with the ratio requirements. |
|
| Subsequent to the year ended December 31, 2005, the bank credit facility available was increased to a maximum of $500,000. |
F-11
| VISCOUNT SYSTEMS, INC. Notes to Consolidated Financial Statements (Expressed in Canadian dollars) December 31, 2005 |
| 8. | Due to stockholders |
||
| Amounts due to stockholders are non-interest bearing, unsecured and have no fixed terms of repayment. |
|||
| 9. | Notes payable |
||
| The notes payable to individuals bear interest at 8% per annum, are unsecured, and are due December 31, 2006. Principal prepayments are made at the discretion of the Board of Directors. |
|||
| 10. | Capital stock |
||
| (a) | Each share of common stock has the same rights, privileges and preferences. The holders of the outstanding common stock are entitled, in the event of liquidation, to a pro rata share of net assets, subject to any preferences that may be applicable on any preferred stock. The Board of Directors has the authority to determine and amend the designation, preferences, limitations and relative rights of preferred stock. There was no preferred stock issued and outstanding at December 31, 2005 and 2004. |
||
| (b) | During the year ended December 31, 2005, the Company issued 150,000 shares of common stock on the exercise of stock options for gross proceeds of $33,226. |
||
| During the year ended December 31, 2004, the Company issued 701,825 shares of common stock on the exercise of stock options for gross proceeds of $222,937. |
|||
| (c) | The Company has the following stock option plans which serve as equity incentive programs for management, qualified employees, members of the Board of Directors and independent advisors or consultants outstanding as at December 31, 2005: |
||
| (i) | The 2001 Stock Option Plan (the “2001 Plan”), which became effective on December 21, 2001, permits, at any one time, up to 1,500,000 shares of common stock to be reserved for issuance. The maximum term during which a vested option may be exercised is ten years from the date of grant. The vesting period and the option price are determined by the compensation committee. The option price may be set at a discount to the closing price on the date of grant unless it is an incentive stock option. As at December 31, 2005, the total number of stock options outstanding under the 2001 Plan is 999,425. |
||
| (ii) | The 2003 Stock Option Plan (the “2003 Plan”), which became effective on January 3, 2003, permits, at any one time, up to 2,600,000 shares of common stock to be reserved for issuance. The maximum term during which a vested option may be exercised is ten years from the date of grant. The vesting period and the option price are determined by the compensation committee. The option price may be set at a discount to the closing price on the date of grant unless it is |
||
F-12
| VISCOUNT SYSTEMS, INC. Notes to Consolidated Financial Statements (Expressed in Canadian dollars) December 31, 2005 |
| 10. | Capital stock (cont’d…) an incentive stock option. As at December 31, 2005, the total number of stock options outstanding under the 2003 Plan is 2,147,500. A summary of the stock option activity is as follows: |
| Number of options | Weighted average | ||||||
| Exercise price | |||||||
| Outstanding at January 1, 2004 | 3,998,750 | $ | 0.27 | ||||
| Granted | - | - | |||||
| Exercised | (701,825 | ) | 0.23 | ||||
| Expired/cancelled | - | - | |||||
| Outstanding at December 31, 2004 | 3,296,925 | 0.27 | |||||
| Granted | - | ||||||
| Exercised | (150,000 | ) | 0.26 | ||||
| Expired/cancelled | - | - | |||||
| Outstanding at December 31, 2005 | 3,146,925 | 0.33 | |||||
| Weighted average grant-date fair value | |||||||
| during 2004 | $ | 0.00 | |||||
| Weighted average grant-date fair value | |||||||
| during 2005 | $ | 0.00 |
During the year ended December 31, 2005, the Company recognized stock-based compensation expense on the amortization of the intrinsic value of previously issued stock options to employees of $26,883 (2004 - $38,585) and recorded $3,338 (2004 -$6,574) relating to the fair value of stock options previously issued to non-employees. Total stock-based compensation, related to the vesting of previously granted employee and non-employee stock options, of $30,221 (2004 – $45,159) has been recorded in selling, general and administrative expenses in the consolidated statements of operations.
F-13
| VISCOUNT SYSTEMS, INC. Notes to Consolidated Financial Statements (Expressed in Canadian dollars) December 31, 2005 |
| 10. | Capital stock (cont’d…) A summary of the stock options outstanding at December 31, 2005 is as follows: |
| Outstanding Options | Exercisable Options | |||||||||||||||
| Weighted | ||||||||||||||||
| Average | Weighted | |||||||||||||||
| Remaining | Average | Weighted | ||||||||||||||
| Exercise Price | Number | Contractual | Exercise | Number | Average | |||||||||||
| Life | Price | Exercise Price | ||||||||||||||
| $0.12 | 2,171,875 | 7.32 years | $ 0.12 | 2,157,500 | $ 0.12 | |||||||||||
| $0.18 | 8,750 | 1.97 years | $ 0.18 | 8,750 | $ 0.18 | |||||||||||
| $0.20 | 7,500 | 1.97 years | $ 0.20 | 5,625 | $ 0.20 | |||||||||||
| $0.45 | 7,500 | 1.97 years | $ 0.45 | 5,625 | $ 0.45 | |||||||||||
| $0.55 | 5,000 | 1.97 years | $ 0.55 | 3,750 | $ 0.55 | |||||||||||
| $0.60 | 12,500 | 1.97 years | $ 0.60 | 9,375 | $ 0.60 | |||||||||||
| $0.65 | 933,800 | 5.98 years | $ 0.65 | 933,800 | $ 0.65 | |||||||||||
| 3,146,925 | 6.85 years | $ 0.27 | 3,124,425 | $ 0.28 | ||||||||||||
F-14
| VISCOUNT SYSTEMS, INC. Notes to Consolidated Financial Statements (Expressed in Canadian dollars) December 31, 2005 |
| 10. | Capital stock (cont’d…) The following table illustrates the pro forma effect on net income (loss) and net income (loss) per common share as if the Company had applied the fair value recognition provisions of SFAS 123 instead of the intrinsic value method to the options granted to employees under the Company’s stock option plans which assumes that compensation cost had been determined based on the fair value of the options at the date of grant using the Black-Scholes option pricing model and amortized over the vesting period. |
| 2005 | 2004 | ||||||
| Net income (loss), as reported | $ | 404 | $ | (398,565 | ) | ||
| Add: Total stock-based employee compensation expense | |||||||
| included in net income (loss), as reported, determined under | |||||||
| APB 25, net of related tax effects | 26,833 | 38,585 | |||||
| Deduct: Total stock-based employee compensation | |||||||
| expense determined under fair value based | |||||||
| method for all awards, net of related tax effects | (65,176 | ) | (134,947 | ) | |||
| Pro forma net income (loss) | $ | (37,939 | ) | $ | (494,927 | ) | |
| Net income (loss) per common share – | |||||||
| Basic and diluted, as reported | $ | 0.00 | $ | (0.03 | ) | ||
| Basic and diluted, pro forma | (0.00 | ) | (0.03 | ) |
| As a result from amendments to SFAS 123, the Company will be required to expense the fair value of employee options beginning with its fiscal quarter ending March 31, 2006. |
F-15
| VISCOUNT SYSTEMS, INC. Notes to Consolidated Financial Statements (Expressed in Canadian dollars) December 31, 2005 |
| 11. | Research and development |
|
| Research and development expenditures are recorded net of investment tax credits, which totaled $nil for the years ended December 31, 2005 and 2004. |
||
| 12. | Income taxes |
|
| (a) | A reconciliation of income tax recovery at statutory rates with the reported income tax recovery is as follows: |
|
| 2005 | 2004 | ||||||
| Income (loss) before income taxes | $ | 404 | $ | (398,565 | ) | ||
| Income tax expense (recovery) at statutory rates | $ | 138 | $ | (141,968 | ) | ||
| Non deductible expenses and other items | 160,631 | 74,156 | |||||
| Recognized operating losses | - | - | |||||
| Recognized investment tax credits | (160,769 | ) | - | ||||
| Unrecognized benefit of operating losses | - | 67,812 | |||||
| Total income tax recovery | $ | - | $ | - |
F-16
| VISCOUNT SYSTEMS, INC. Notes to Consolidated Financial Statements (Expressed in Canadian dollars) December 31, 2005 |
| 12. | Income taxes (cont’d…) |
|
| (b) | Temporary differences that give rise to the following deferred income tax assets and liabilities are as follows: |
|
| 2005 | 2004 | ||||||
| Deferred income tax assets (liabilities) | |||||||
| Equipment | $ | 1,020 | $ | (6,725 | ) | ||
| Intangible assets | (10,734 | ) | 1,437 | ||||
| Unrecognized investment tax credits (non-refundable) | 198,051 | 253,333 | |||||
| Unrecognized benefit of research and development costs | 317,799 | 254,803 | |||||
| Unrecognized benefit of operating losses | 59,597 | 67,812 | |||||
| Warranty provision | 15,139 | 7,040 | |||||
| Gross deferred income tax assets | 580,872 | 577,700 | |||||
| Valuation allowance | (580,872 | ) | (577,700 | ) | |||
| $ | - | $ | - |
The Company has unutilized operating loss carryforwards of $180,597 (2004 - $190,377) which will begin to expire up to 2014. The Company has non-refundable federal investment tax credits of $136,266 (2004 -$170,432) and provincial investment tax credits of $61,785 (2004 - $82,901) which will begin to expire in 2010. The Company has unutilized scientific research and development costs of $963,027 (2004 - $715,338) which are available to reduce taxable income and income taxes payable in future years. A valuation allowance is applied to the deferred tax asset because it is not more likely than not that the benefits of the future income tax asset will be available to the Company. The Company has a valuation allowance of $580,872 (2004 - $577,700). This represents an increase of $3,172 and $130,921, as compared to December 31, 2004 and 2003. |
F-17
| VISCOUNT SYSTEMS, INC. Notes to Consolidated Financial Statements (Expressed in Canadian dollars) December 31, 2005 |
| 13. | Commitments and contingencies |
The Company is committed to make minimum annual payments on its premises, automobile and office equipment operating leases that expire in 2010 as follows:
| Year ending December 31: | ||||
| 2006 | $ | 215,029 | ||
| 2007 | 89,495 | |||
| 2008 | 24,501 | |||
| 2009 | 12,363 | |||
| 2010 | 6,608 |
Rent expense included in the statements of operations is $114,277 (2004 - $111,317). The Company has been named as a third-party defendant in a complaint for an alleged malfunction of certain equipment installed in a residential rental building in Chicago, Illinois. The Company believes the claim is without merit and intends to vigorously defend its position. An estimate of the claim cannot be made.
| 14. | Changes in non-cash working capital balances |
| 2005 | 2004 | ||||||
| Trade accounts receivable | $ | (140,757 | ) | $ | 87,782 | ||
| Inventory | 17,677 | (41,710 | ) | ||||
| Prepaid expenses | (4,637 | ) | - | ||||
| Income taxes recoverable | - | 67,352 | |||||
| Leases receivable | 1,040 | 11,900 | |||||
| Accounts payable and accrued liabilities | 76,776 | 27,683 | |||||
| Deferred revenue | 2,322 | 2,365 | |||||
| $ | (47,579 | ) | $ | 155,372 |
F-18
| VISCOUNT SYSTEMS, INC. Notes to Consolidated Financial Statements (Expressed in Canadian dollars) December 31, 2005 |
| 15. | Segment information |
|
| (a) | Operating segments: |
|
| Commencing with the acquisition of the servicing agreements from Telus on May 16, 2003, as described in Note 6, the Company has organized its business into two reportable segments: manufacturing and servicing. The manufacturing segment designs, produces and sells intercom and door access control systems that utilize telecommunications wiring to control access to buildings and other facilities for security purposes. The servicing segment provides maintenance to these intercom and door access control systems. |
||
| The segments’ accounting policies are the same as those described in Note 2. Management evaluates performance based on profit or loss from operations before income taxes not including nonrecurring gains and losses, if any. Retail prices are used to report intersegment sales. |
||
| December 31, 2005 | Manufacturing | Servicing | Total | |||||||
| Sales to external customers | $ | 3,452,058 | $ | 1,561,434 | $ | 5,013,492 | ||||
| Depreciation and amortization | 21,972 | 15,669 | 37,641 | |||||||
| Interest expense, net | 26,916 | 18,800 | 45,716 | |||||||
| Segment income (loss) before income taxes | (359,537 | ) | 359,941 | 404 | ||||||
| Total assets | 2,033,347 | 193,252 | 2,226,599 | |||||||
| December 31, 2004 | Manufacturing | Servicing | Total | |||||||
| Sales to external customers | $ | 3,005,505 | $ | 1,386,153 | $ | 4,391,658 | ||||
| Depreciation and amortization | 39,629 | - | 39,629 | |||||||
| Interest expense, net | 23,329 | 19,233 | 42,562 | |||||||
| Segment income (loss) before income taxes | (823,412 | ) | 424,847 | (398,565 | ) | |||||
| Total assets | 1,968,337 | 208,921 | 2,177,258 |
F-19
| VISCOUNT SYSTEMS, INC. Notes to Consolidated Financial Statements (Expressed in Canadian dollars) December 31, 2005 |
| 15. | Segment information (cont’d.) |
||
| (b) | Of the total revenues for the year ended December 31, 2005, $862,929 (2004 - $1,212,766) was derived from U.S.-based customers and $4,150,563 (2004 - $3,178,892) from Canadian-based customers. |
||
| Substantially all of the Company's operations, assets and employees are located in Canada. |
|||
| (c) | Major customers: |
||
| No customer represented more than 10% of total revenues in either of the years ended December 31, 2005 and 2004. |
|||
| (d) | Products: |
||
| Enterphone sales represented 42% of total revenue during the year ended December 31, 2005 (December 31, 2004 – 48%). The balance of the Company’s revenues are derived from service agreements and other products such as access tracking and control, closed circuit monitors, infrared and radio frequency remotes. |
|||
| 16. | Financial instruments |
||
| The Company's financial instruments consist of cash and cash equivalents, trade accounts receivable, lease receivable, bank indebtedness, accounts payable, accrued liabilities, due to stockholders and notes payable. It is management's opinion that the Company is not exposed to significant interest, currency, business concentration or credit risks arising from these financial instruments. The fair values of these financial instruments approximate their carrying values based on their liquidity and short-term nature. |
|||
| 17. | Subsequent event |
||
| Subsequent to the year ended December 31, 2005, the Company issued 26,875 common shares at a value of $0.12 per share pursuant to the exercise of stock options up to February 23, 2006. |
|||
F-20