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VSYS > SEC Filings for VSYS > Form 10-K on 27-Mar-2013All Recent SEC Filings

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Form 10-K for VISCOUNT SYSTEMS INC


27-Mar-2013

Annual Report


Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION

The following discusses the Company's financial condition and results of operations based upon its 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 the Company's 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 years ended December 31, 2012 and 2011 were $3,602,569 and $3,470,848, respectively, an increase of $131,721 or 3.8%. These two comparative years were consistent. MESH/Freedom sales for the years ended December 31, 2012 and 2011 were $2,016,701 and $1,770,202, respectively, an increase of $246,499 or 13.9%. MESH sales for the year ended December 31, 2011 were 55.8% of total sales, as compared to 51.0% of total sales for the year ended December 31, 2011. MESH/Freedom is a convergent technology developed by Viscount that increases security at a reduced cost of hardware, cabling and installation, and with simplified database management. Enterphone 2000 sales for the years ended December 31, 2012 and 2011 were $343,113 and $394,039, respectively, a decrease of $50,926 or 12.9%. Enterphone 2000 sales for the year ended December 31, 2012 were 9.5% of total sales, as compared to 11.4% of total sales for the year ended December 31, 2011. As an older technology, Enterphone sales are no longer a significant part of our total sales. MESH EPX is the replacement for our old Enterphone system. MESH EPX is the next generation of Enterphone systems but with features that are compatible with high speed internet and other newer technologies. The Company has also started selling MESH Freedom, the new IT platform. The MESH Freedom IT platform can turn any card reader into an IP device by connecting the Freedom IP device with built-in I/O to a POE switch and then every card usage is processed on a redundant MESH server either in your building or anywhere in the world. The software component of MESH Freedom is the MESH web browser security operating platform. Unlike control panels, the user database and the door control software is written in IT language located on a server(s), thereby future proofing systems from the traditional issue of proprietary hardware version obsolescence and improving scalability by eliminating the need for additional hardware every time a reader is added to the system.


The Company also provides Enterphone support and maintenance services pursuant to service contracts that were assigned to the Company from Telus Corporation in 2003. Sales from the 1,344 existing service contracts continue to be steady. On average, each service contract represents ongoing revenues of approximately $38 per month, inclusive of parts and labor. 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 twelve months ended December 31, 2012, customer service contracts and new equipment sales generated aggregate sales revenues of $1,097,714, as compared to $1,117,522 for the year ended December 31, 2011, a decrease of $19,808 or 1.8%. These two comparative periods were consistent.

The intangible assets held by the Company are comprised primarily of service contracts for our Enterphone 2000 product line. The number of service agreements held by the Company was 1,344 at December 31, 2012, as compared to 1,428 at December 31, 2011. During the first three quarters of 2012, the Company performed a test for impairment 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. Accordingly, the Company continued to amortize the cost of the service agreements on a straight-line basis over an estimated useful life of 10 years, which became effective as of April 1, 2005. At December 31, 2012, the cost of the service agreements, net of accumulated amortization, was $47,008.

The cost of sales as a percentage of sales was 40.3% for the year ended December 31, 2012, as compared with the cost of sales as a percentage of sales of 42.4% for the year ended December 31, 2011. Costs of sales as a percentage of sales has decreased slightly, as a result of using lower cost input materials in the MESH and Freedom Bridge products. Management has continued to focus on controlling the input costs by using multiple suppliers to ensure that the best and most cost effective raw materials are used in all of our products.

Gross profit for the year ended December 31, 2012 was $2,149,734, as compared to $1,997,663 for the year ended December 31, 2011, an increase of $152,071 or 7.6%. This increase corresponds with increased sales and reduced cost of sales for the year ended December 31, 2012.

Selling, general and administrative expenses for the years ended December 31, 2012 and 2011 were $3,165,030 and $3,379,100, respectively, a decrease of $214,070 or 6.3%. For the years ended December 31, 2012 and 2011, selling, general and administrative expenses, as a percentage of sales, were 87.9% and 97.4%, respectively. Consulting fees for the years ended December 31, 2012 and 2011 were $746,556 and $404,948, respectively, an increase of $341,608. Consulting fees, in part, increased due to paying a consultant US$113,320 to raise US$1,000,000 on June 7, 2012 and US$100,000 on October 19, 2012. Other increases were related to Board of Directors fees which were $68,817 and $12,600 for the years ended December 31, 2012 and 2011, respectively. We have also added consultants to provide strategic advice and alliances for key markets including the US Federal Government for Freedom projects.

Research and development costs were $338,853 for the year ended December 31, 2012, as compared to $460,520 for the year ended December 31, 2011, a decrease of $121,667 or 26.4 %. Engineering expenses were reduced due to the substantial completion of the MESH Freedom hardware, butour research and development costs are still ongoing primarily for the development our Freedom product.

Net loss for the years ended December 31, 2012, and 2011 were $2,679,186 and $2,959,539, a decreased loss of $280,353. During the first two quarters of 2012, expenses were controlled to maintain cash flow and to minimize the net loss. The loss during 2011 was due to increased advertising, travel, tradeshow, consulting fees, and various office expenses. The loss in 2011 was increased by $1,091,098 as a result of a fair value adjustment of certain outstanding warrants that are accounted for as a derivative financial instrument. The loss in 2012 was increased by $925,742 as a result of an initial loss on recognition of derivative instruments and $373,271 as a result of a fair value adjustment of certain warrants that are accounted for as a derivative financial instruments. The fair value adjustment has no cash flow impact.

LIQUIDITY, CAPITAL RESOURCES AND GOING CONCERN


Cash as of December 31, 2012, as compared to December 31, 2011 was $406,506 and $169,322, respectively, an increase of $237,184.

On June 7, 2012, Viscount Systems, Inc. completed a sale of 1,000 shares of Series A Convertible Redeemable Preferred Stock, par value US$0.001 per share, at a purchase price of US$1,000 and a stated value of US$1,000 per A Share, and for no additional consideration, an issuance of 12,285,012 share purchase warrants of the Company for gross proceeds of US$1,000,000. Each Warrant is exercisable to acquire a common share of the Company at a price of US$0.08 per share for a period of 5 years from the closing date. The Warrants may be exercised on a cashless basis. The A Shares are convertible, at the option of the holders, into 24,570,024 shares of common stock of the Company at a conversion price of US$0.0407 per share, subject to adjustment provisions.

In connection with the offering, the Company paid to a registered broker-dealer a cash commission of US$100,000 and issued share purchase warrants to acquire 2,457,002 shares of common stock of the Company. Each Agent Warrant is exercisable to acquire one common share of the Company at a price of US$0.05 per share for a period of 5 years from the closing date. The warrants may be exercised on a cashless basis.

On October 19, 2012, Viscount Systems, Inc. completed a sale of 100 shares of Series A Convertible Redeemable Preferred Stock, par value $0.001 per share, at a purchase price of $1,000 and a stated value of $1,000 per A Share, and for no additional consideration, an issuance of 1,000,000 share purchase warrants of the Company for gross proceeds of $100,000. Each Warrant is exercisable to acquire a common share of the Company at a price of $0.08 per share for a period of 5 years from the closing date. The Warrants may be exercised on a cashless basis. The A Shares are convertible, at the option of the holders, into 2,000,000 shares of common stock of the Company at a conversion price of $0.05 per share, subject to adjustment provisions.

In connection with the offering, the Company paid to a registered broker-dealer a cash commission of $10,000 and issued share purchase warrants to acquire 200,000 shares of common stock of the Company. Each Agent Warrant is exercisable to acquire one common share of the Company at a price of $0.05 per share for a period of 5 years from the closing date. The warrants may be exercised on a cashless basis.

On November 26, 2012, Viscount Systems, Inc. completed a private placement of 10,000,000 units at a price of $0.05 per unit for total proceeds of $500,000. Each unit consists of one common share and one-half of one share purchase warrant of Viscount, with each whole warrant exercisable to acquire an additional share of Viscount at a price of $0.10 for a period of 5 years from the closing date.

In connection with the offering, the Company paid to a registered broker-dealer a cash commission of $50,000 and issued share purchase warrants to acquire 1,000,000 shares of common stock of the Company at a price of $0.05 per share for a period of 5 years from the closing date. The warrants may be exercised on a cashless basis.

At December 30, 2011, the Company's credit facility of which the lesser of $500,000 or 75% of accounts receivable less than 90 days at the prime lending rate plus 1.75% could have been drawn was suspended due to the bank's assessment of the Company's financial position. At December 31, 2012 and December 31, 2011, $nil was drawn on this facility.

At December 31, 2012, working capital was $448,029 as compared to a working capital of $133,449 at December 31, 2011. Working capital has increased by $314,580. The current ratio at December 31, 2012 was 1.49 to 1.0, as compared with 1.14 to 1.0 at December 31, 2011.

The Company continues to work on financing operations and future growth through stock-based equity injections. The financing amounts are determined on an operational basis.

The Company's financial statements have been prepared on a going concern basis, which assumes the Company will be able to realize its assets and discharge its liabilities in the normal course of business for the foreseeable future. The Company has an accumulated deficit of $8,590,355, reported a loss in 2012 of $2,679,186 and has working capital of $448,029 at December 31, 2012. Cash flows used in operating activities for the year ended December 31, 2012 were $1,320,867. Although management is confident that the company can access, sufficient working capital to maintain operations and ultimately generate positive cash flow from operations, the ability to sustain the current level of operations is dependent upon growing sales and achieving profits. Management has determined that the Company will need to raise a minimum of $1,000,000 before the end of the second quarter of fiscal 2013, by way of debt or equity financing, to continue normal operations for the next twelve months. If this funding is not available the company will have to reduce spending in several key areas including research and development and marketing. This would have a negative impact on the growth prospects of the company. In the event the company completes the required $1,000,000 financing and hits its sales targets, the company does not anticipate requiring any additional financing for 2013. Management has been actively seeking new investors and developing customer relationships, however a financing arrangement has not yet completed. Short-term loan financing is anticipated from related parties, however there is no certainty that loans will be available when required. These factors raise substantial doubt about the ability of the Company to continue operations as a going concern.


The accounts receivable turnover ratio at December 31, 2012 was 52 days, as compared 51 days at December 31, 2011. The accounts receivable reserve was $105,185 at December 31, 2012, as compared to $133,389 at December 31, 2011. The accounts receivable reserve has decreased by $28,204 or 21.1%, since the year ended December 31, 2011. Management continues to follow-up on customer accounts to improve cash flow and to minimize bad debts. There had been no significant or material business conditions that would warrant further increases to the reserve at this time.

The Company is subject to significant liquidity risk. At December 31, 2012, the Company's current assets consist principally of trade accounts receivables and inventory. The Company must liquidate inventories and rapidly increase collection periods on its receivables to ensure that sufficient cash is available to settle payables and operating costs as they come due.

As the Company's liquidity increases, we will be purchasing more inventory and hiring more sales and technical staff to accommodate the expected increased future sales

There are no material unused sources of liquid assets.

For the year ended December 31, 2012, there were no significant capital expenditures.

To date, the Company has not invested in derivative securities or any other financial instruments that involve a high level of complexity or risk. The Company expects that in the future, any excess cash will continue to be invested in high credit quality, interest-bearing securities.

The Company will likely require additional funds to support the development and marketing of its 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, the Company may be unable to develop or enhance its 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.

The Company does not have any material commitments for capital expenditures as
of December 31, 2012. OFF-BALANCE SHEET ARRANGEMENTS

There are no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on the Company's financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.

Related Party Transactions

None.

Critical Accounting Policies:

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 allowance for doubtful accounts, inventory obsolescence, the provision for future warranty costs, the estimated useful lives of equipment and intangible assets, the deferred tax valuation allowance, and assumptions used to determine the fair value of stock-based compensation. Details are provided for critical estimates are as follows:


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 impairment, then a write-down 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. The Company increased its provision for obsolete inventory by approximately $117,042 during the fourth quarter of 2012, as a result of a revised estimate by management.

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.

Derivative financial instruments that are not classified as equity and are not used in hedging relationships are measured at fair value. These include derivative warrant liabilities and derivative conversion option liabilities. Susequent changes to the estimated fair value are recorded in the statement of operations.

RECENTLY ISSUED ACCOUNTING STANDARDS

Recent accounting pronouncements

In July 2012, the FASB issued an update related to annual impairment testing for indefinite-lived intangible assets which provides companies with the option to perform a qualitative impairment assessment for their indefinite-lived intangible assets that may allow them to skip the annual fair value calculation. The qualitative assessment is similar to the screen companies can use to determine whether they must perform the two-step goodwill impairment test. Companies must identify and evaluate changes in economic, industry and company-specific events and circumstances that could affect the significant inputs used in determining the fair value of these assets. This ASU is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012.

In June, 2011, the FASB issued ASU No. 2011-05, which amends ASC Topic 220, Comprehensive Income. Under the amendment, an entity has the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. This ASU eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders' equity. The amendments in this ASU do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. The amendments in this ASU should be applied retrospectively.


Additionally, the FASB issued a second amendment to ASC Topic 220 in December 2011, ASU No. 2011-12, which allows companies the ability to defer certain aspects of ASU 2011-05. For public entities, these amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. The amendments do not require any transition disclosures.

The Company has reviewed recently issued accounting pronouncements and plans to adopt those that are applicable to it. It does not expect the adoption of these pronouncements to have a material impact on its financial position, results of operations or cash flows.

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