10-K 1 form10k.htm FORM 10-K Viscount Systems Inc.: Form 10-K - Filed by newsfilecorp.com

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Form 10-K

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2013

[   ] 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 registrant as specified 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
  (Title of class)

Check whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes [   ] No [X]

Check whether the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act.
Yes [   ] No [X]

Check whether the registrant (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 whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes [X] No [   ]

Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-K 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-K or any amendment to this Form 10-K. [X]

Check whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.



Large accelerated filer [  ] Accelerated filer [   ]
Non-accelerated filer [   ]
(Do not check if a smaller reporting company)
Smaller reporting company [ X ]

Check whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
YES [   ] NO [X]

State issuer’s revenues for its most recent fiscal year: $3,887,633 as at December 31, 2013 ($4,134,886 in Canadian dollars converted at an exchange rate of US$1.0636/CDN$ 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 the last business day of the registrant’s most recently completed second fiscal quarter: $9,400,375 as at June 30, 2013.

State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date: 105,408,332shares of common stock as at March 28, 2014.

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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-K, which Proxy Statement will be filed within 120 days after the end of the Registrant's fiscal year ended December 31, 2013.

 

 

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Form 10-K

Table of Contents

Part Item No.    
I 1 Business 6
  1A Risk Factors 19
  2 Properties 20
  3 Legal Proceedings 20
  4 Mine Safety Disclosures 21
II 5 Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 21
  6 Select Financial Data 22
  7 Management’s Discussion and Analysis of Financial Condition and Results of Operation 22
  7A Quantitative and Qualitative Disclosures About Market Risk 27
  8 Financial Statements and Supplementary Data 28
9 Changes in and Disagreements With Accountants on Accounting and Financial Disclosure 28
  9A Controls and Procedures 28
  9B Other Information 29
III 10 Directors, Executive Officers, and Corporate Governance 29
  11 Executive Compensation 29
12 Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 29
  13 Certain Relationships and Related Transactions, and Director Independence 29
  14 Principal Accounting Fees and Services 29
  15 Exhibits, Financial Statement Schedules 29
    Signatures 30

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FORM 10-K

VISCOUNT SYSTEMS, INC.

PART I.

Forward-Looking Statements

ALL STATEMENTS IN THIS DISCUSSION THAT ARE NOT HISTORICAL ARE FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. STATEMENTS PRECEDED BY, FOLLOWED BY OR THAT OTHERWISE INCLUDE THE WORDS "BELIEVES", "EXPECTS", "INTENDS", "PROJECTS", "ESTIMATES", "PLANS", "MAY INCREASE" AND SIMILAR EXPRESSIONS OR FUTURE OR CONDITIONAL VERBS SUCH AS "SHOULD", "WOULD", "MAY" AND "COULD" ARE GENERALLY FORWARD-LOOKING IN NATURE AND NOT HISTORICAL FACTS. THESE FORWARD-LOOKING STATEMENTS WERE BASED ON VARIOUS FACTORS AND WERE DERIVED UTILIZING NUMEROUS IMPORTANT ASSUMPTIONS AND OTHER IMPORTANT FACTORS THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE IN THE FORWARD-LOOKING STATEMENTS. FORWARD-LOOKING STATEMENTS INCLUDE THE INFORMATION CONCERNING OUR FUTURE FINANCIAL PERFORMANCE, BUSINESS STRATEGY, PROJECTED PLANS AND OBJECTIVES. THESE FACTORS INCLUDE, AMONG OTHERS, THE FACTORS SET FORTH BELOW UNDER THE HEADING "RISK FACTORS." ALTHOUGH WE BELIEVE THAT THE EXPECTATIONS REFLECTED IN THE FORWARD-LOOKING STATEMENTS ARE REASONABLE, WE CANNOT GUARANTEE FUTURE RESULTS, LEVELS OF ACTIVITY, PERFORMANCE OR ACHIEVEMENTS. MOST OF THESE FACTORS ARE DIFFICULT TO PREDICT ACCURATELY AND ARE GENERALLY BEYOND OUR CONTROL. WE ARE UNDER NO OBLIGATION TO PUBLICLY UPDATE ANY OF THE FORWARD-LOOKING STATEMENTS TO REFLECT EVENTS OR CIRCUMSTANCES AFTER THE DATE HEREOF OR TO REFLECT THE OCCURRENCE OF UNANTICIPATED EVENTS. READERS ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE ON THESE FORWARD-LOOKING STATEMENTS. REFERENCES IN THIS FORM 10-K, UNLESS ANOTHER DATE IS STATED, ARE TO DECEMBER 31, 2013. AS USED HEREIN, THE "COMPANY," "VISCOUNT," "WE," "US," "OUR" AND WORDS OF SIMILAR MEANING REFER TO VISCOUNT SYSTEMS, INC.

Currency of Financial Information and Exchange Rate Table

The Company maintains its 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 U.S. dollars per one (1) Canadian dollar. The high and low exchange rates for each month during the previous 12 months were as follows:

    High     Low  
December 2013   0.9458     0.9314  
November 2013   0.9617     0.9408  
October 2013   0.9736     0.9527  
September 2013   0.9803     0.9480  
August 2013   0.9732     0.9462  
July 2013   0.9761     0.9426  
June 2013   0.9865     0.9473  
May 2013   0.9983     0.9614  
April 2013   0.9946     0.9713  
March 2013   0.9857     0.9668  
February 2013   1.0048     0.9696  
January 2013   1.0188     0.9900  

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The following table sets out the exchange rate information as at each of the years ended December 31, 2013 and 2012.

    Year Ended December 31  
             
    2013     2012  
Rate at end of Period   1.0636     0.9949  
Average Rate during Period   1.0299     0.9996  
Low   0.9314     0.9576  
High   1.0188     1.0371  

Item 1. BUSINESS

GENERAL

Viscount Systems Inc. is a manufacturer, developer and service provider of access control security products. The Company’s primary products are Freedom, Liberty, MESH, EPX and Axess. EPX and Axess are the latest models of the Enterphone line of telephone entry systems, first introduced in 1966. Until 2012, MESH referred to Viscount’s line of computerized touch screen intercom systems and accessories that included card access systems. With the expansion of Viscount’s capabilities to provide leading edge building access solutions independently of intercom systems the Company has now split the MESH product line into MESH Intercom solutions and Freedom Access control solutions. Freedom is being deployed in a large array of industrial and government sites and is expected to be the growth engine for Viscount in the coming years.

In addition to its manufacturing division Viscount has a service division that covers the Province of British Columbia. The primary revenue source for the service division are 1,254 maintenance agreements on Enterphone, EPX and other systems that are billed on a monthly basis.

The Company’s website address is www.viscount.com. All periodic and current reports are available, free of charge, on the Company’s 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 the Company’s filings are also available, free of charge, upon request.

BUSINESS OVERVIEW

The Company has been designing, manufacturing and servicing access control and security products, including intercom and door access control systems and emergency communications systems since 1969. With the release of MESH in 2003 and then Freedom in 2011 the Company has been migrating away from telecommunications based systems to large IP based building access systems. Through this transition, the Company is migrating from a hardware based business model to software based. To this end, the Company is investing heavily in mobile and Cloud software applications for the Freedom platform. To support its investments, the Company has filed numerous patents since 2010 with a total of approximately 60 patent claims currently pending.

Freedom is a new building security technology that represents a departure from traditional access control and security systems. Traditional systems use controllers that have a capacity to control from 1 to 8 door access points per controller. Each controller has embedded software to create door open commands that are programmed through a PC system user software interface. Freedom does not include an embedded decision-making software platform. Instead, with Freedom, building security decisions are done in the same PC software, thereby dramatically simplifying the architecture of systems. The hardware piece of Freedom is the Freedom IP encryption bridge. Each bridge includes circuitry to trigger locks and monitor alarms and is connected to networks using switches.

The Company has recognized for several years that the sales of its traditional Enterphone/EPX products would continue to be stagnant or would fall and they accounted for only 9.5% of total sales for the year ended December 31, 2012. In 2013, sales actually increased significantly again, due to the construction resurgence after many years of falling sales. Enterphone is a building access control system that uses a building’s internal phone wiring thereby avoiding use of telephone utility services. The reason for the diminished sales of the product mainly relates to new digital telecommunications alternatives. The Enterphone technology requires access to a dedicated set of inside wires and is difficult to install and service with the existence of phone over cable or TV over phone systems. Therefore, the popularity of the technology has begun to wane.

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The Company has a number of additional technologies in development. This includes Facility Friend visitor management and photo-id software and ABC business continuity software.

COMPANY HISTORY

The Company’s current business is operated primarily through its wholly owned subsidiary Viscount Communication and Control Systems Inc. The business of the Company’s 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 and was 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 the Company’s products. Blue Mountain Technologies Inc. simultaneously assigned its contractual rights to acquire all of the business assets, except for certain leasehold interests, to the Company’s subsidiary, Viscount Communication. BC Tel consented to the assignment and accordingly the business was acquired by the Company’s subsidiary, Viscount Communication and Control Systems Inc.

The Company was incorporated on May 24, 2001 under the laws of the State of Nevada under the name OMW4 Corp. The Company’s subsidiary, Viscount Communication was incorporated in 1997 under the laws of British Columbia, Canada, for the purposes of carrying on the present access control business. The Company acquired all of the issued and outstanding shares in the capital of Viscount Communication on July 27, 2001, in exchange for 10,000,000 shares of the Company’s 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, the Company changed its name to Viscount Systems Inc. effective August 27, 2001.

In 2003, the Company acquired certain inventory and 2,165 service agreements from Telus Corporation. The service agreements related to the maintenance of 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.

The Company now focuses on several key products and markets. EPX is the latest generation of Enterphone and was released in 2009. MESH, released in 2003, is a digital platform for providing touch screen intercom and signage solutions. Freedom was released in 2011 and represents the primary focus for the future, IP based building security systems. Viscount has also expanded the capabilities of Freedom to focus on US Federal Government opportunities by making Freedom FIPS 201 compliant and is now upgrading Freedom further to expand into mobile applications and the Cloud.

INDUSTRY OVERVIEW

The Company competes 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. The Company’s 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 gates, parking garages, doors or elevators in order to gain access.

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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.

Freedom and MESH mark a very different business model from the traditional approach. The building control and security industry has traditionally been highly segmented based on specific functions designed into proprietary electronic hardware. 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, installed, and maintained. 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. Integration is the use of a host computer and custom software to tie separate and distinct systems, typically from different manufacturers, together on a common software platform. However, because Freedom and MESH are based on a single software platform and database architecture, different systems such as intercom and building security can be run as a single platform. Furthermore, with Viscount’s new Active Directory platform, logical and physical security can run as a unified platform and creates much more secure and flexible systems that provided with the integration model.

Along with certain other industry participants, the Company has turned to current high-technology solutions in order to reduce costs of ownership of security systems, while improving functionality. The Company has developed new system platforms that will permit convergence of the control of various building functions, such as access control, intercom, 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 enterprise access control industry has traditionally used a communication technology known as Wiegand. Most of the worlds installed access systems are based on Wiegand technology. This also includes most Smart Card and biometric systems since these devices typically must be converted to some form of Wiegand to be processed on control panels. 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 Sensor Engineering as an access card technology. The card technology used a special patented process whereby wires are imbedded in a plastic access card to encode its data. This data format became a standard for other readers including RFID. Most access control readers are connected to control panels. Each panel holds a card databases and software that creates door unlock and alarm decisions. Panels are typically networked using RS 485, CANBUS or a similar technology. A host controller is programmed to receive information from the card reader in order to permit access to a building.

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 host server also holds the card holder database to store information and issue cards to users.

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.

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There are numerous limitations with the older technology. Systems are proprietary and expensive. In many ways physical and logic access control are identical but the existence of control hardware has precluded proper unification and convergence. New concerns about the vulnerabilities of control panels to cyber-attack are prompting some end users to look at alternatives.

Compliance driven change

The Company is participating in this advance in the access control industry with its proprietary MESH and Freedom intelligent access control and communication technology systems. Viscount believes the answer to the issues with the traditional access control model is the Freedom software application based approach. After 9-11, the US Department of Homeland Security was created. An evaluation concluded that control panels and cards were not secure. With it came FIPS 201, an expansion of processes and regulations designed to update security. An expanded standard, “FIPS-201-2,” is now in active drafting for future implementation. These regulations state that the vast majority of the existing access control infrastructure needs to be replaced or upgraded. This presents an enormous opportunity for new lower cost and more conformant technologies such as Freedom.

PRODUCTS

The Company is a manufacturer, developer, reseller and service provider of intercom and access control systems. The Company’s 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, tracking and intercom; elevator access and tracking; garage or perimeter gate control, and emergency communications.

Enterphone Access Control Products

Historically, the Company’s principal product was the Enterphone intercom and access control system. The model of the current generation of Enterphone is EPX. Enterphone is the Company’s 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 the Company’s 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 the Company’s Enterphone system distinct from other “dial-up” telephone entry systems that use telephone company lines.

The 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.

The Company also manufactures electronic entry access panels that can operate using either the Enterphone system, or dial-up telephone company lines. The Company’s panels are manufactured in various sizes and with various features in order to accommodate varying purposes and building types. For example, the Company manufactures 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 the Company manufactures incorporate the Enterphone technology, however most panels can also be installed to use telephone company lines.

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. The Company purchases these technologies from other manufacturers and resells them under the Company’s brand names. Most of the products that the Company resells can be integrated into our Enterphone access control system.

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We have no material principal suppliers with regards to the Enterphone system..

Enterphone X

The next generation of Enterphone systems, called Enterphone X, “EPX”, was released during the second quarter of 2008. The EPX product line has replaced the EP2000 product line. EPX, also a no phone line system like EP2000, is the next generation of Enterphone. EPX is more cost effective because it requires less assembly and material input costs. EPX improves compatibility with MESH and other newer telephony technologies. EPX sales are classified as a source of MESH revenue.

The Enterphone 2000 design dates back to 1990 and the architecture has created complications for both manufacturing and installation. The new universal controller eliminates the need for Viscount to manufacture and carry inventory for 10 different circuit boards. Overall, EPX reduces cost, produces higher margins, and improves the Company’s ability to market MESH.

Our principal suppliers for EPX and MESH are Arrow Electronics Canada Inc., Digi-Key Corporation, Electro Sonic Inc., and Metalcraft Technology Inc.

MESH and Freedom Access Control Systems

Overview

MESH is a software-based building management system designed to replace traditional systems that are more hardware intensive. The Company continues to develop technology that was initially conceptualized in 1998. MESH was commercially released in late 2003. MESH applications include touch screen intercoms, building directories and physical card access and alarms. The first MESH product releases were touch screen intercoms designed as an accessory for the Enterphone/EPX product line. Viscount subsequently enhanced MESH to include physical card access. For traditional markets such as high-rise condominiums MESH intercom systems as well as access control systems have proven to be complementary. However, in 2012, Viscount split MESH into two components; the intercom component will continue to be branded as MESH and the access control component will be branded as Freedom. The purpose of this was to eliminate market confusion whereby end users looking for a highly secure physical access system were presented with MESH, which appeared to be primarily an intercom system.

MESH intercoms use a regular computer motherboard and off the shelf computer accessories such as touch screens to create computerized building intercom systems and building directories. MESH Touch Panels are intercom accessories for the MESH access control and facility management system. MESH panels can be surface or flush mounted. MESH allows building tenants to communicate with visitors and grant or deny entry. Units can display residential or commercial building directory listings with a building specific screen saver. Options include built-in cameras, card access, and elevator control. Multiple panels can be connected on a shared database or to central MESH Servers for complete card access and facility management. MESH panels come with 15, 19 or 32” touch screens and can come for wall mounting or as floor mounted kiosks.

MESH panels, located at entrance doors for visitor access, can operate independently or as slaves off the MESH server. The basic MESH panel that the Company has 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.

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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 the Company’s staff in large campus wide and enterprise wide installations.

MESH has many additional benefits, both in terms of building security and particularly relative to the legacy Wiegand protocol. It is the Company’s 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. The Company has developed various modules for our MESH technology, and intends to develop further modules which will be released in a series of phases. Some of these product enhancement modules are described below:

  • The MESH server provides new opportunities to host video on the unified platform with voice and data. This product enhancement would represent an entirely new concept in the security industry.
     
  • The nature of the MESH server makes MESH telephony products inherently Internet enabled. Future MESH appliances may include the MESH television line, which allows residents to view visitors at the door. MESH panels will be able to connect to web enabled set top boxes being promoted as part of the web TV market. MESH may be able to connect to videoconferencing telephones that would compete in the large offshore video intercom business but at a fraction of the cost by saving on conduit and cable.
     
  • The distributed intelligence of MESH makes the product suited to the growing emergency call/nurse call industry.
     
  • MESH networks are built on a proprietary architecture platform which is functional to integrate with any existing automation network.

Freedom

Freedom is the new IT platform developed and released during the last quarter of 2010. This 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.

Viscount has upgraded Freedom to include unified physical/logical access control using Microsoft Active Directory, both public and private Cloud hosted solutions as well as mobile solutions.

Liberty

Liberty is a derivation of Freedom, using the same software and hardware, but downsized for the smaller market, and sold exclusively through security distribution channels. The functionality is limited and the product line limited to the 1-12 door market, where 80% of access control systems are sold. By utilizing the exact same database and software, with features removed, Viscount was able to easily enter the market without significant additional support costs, and the ability to upgrade and freshen both Freedom and Liberty with one set of software code. Liberty was launched in Q4, 2013.

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Other products

Facility Friend:

Facility Friend is a web based Enterprise class software platform for managing visitors, creating visitor and employee badges and assisting security personnel in tracking packages, vehicles, and incidents. This product was released during the second quarter of 2012. The system allows users to manage an unlimited number of global sites within a single web tool. Each site can assign multiple entry points. For commercial multi-tenant users, visitors can be assigned to unlimited numbers of corporate clients within the site.

Facility Friend is designed for a large array of applications including: security stations, residential concierge and gated communities, hospital reception, commercial enterprises, and government facilities. The system will create logs of current visitors, scheduled visitors, overdue visitors and a history of all visitors who have visited a facility. Visitors can also be assigned temporary access cards for secure doors. Visitors who have been identified as unwelcome can be tagged as banned across the Enterprise.

Scanners:

Facility Friend can improve enrollment of visitors, the issuance of employee badges and security by using passport, driver license, and signature capture scanning technology.

Photo ID:

Facility Friend has the ability to create full color ID cards for both employees and visitors. The system supports all major brands of card printers to print either onto RFID cards or onto adhesive labels to attach to existing cards. For visitors, the system can print inexpensive visitor labels.

Special Functions:

Facility Friend has a number of predefined special applications to assist in building management as well as the ability to create user defined fields.

Package Tracking:

The Package Tracking function allows security to receive packages at reception for staff/hosts with tracking numbers and email notification.

For high security facilities the system also has fields to track items brought into a facility by visitors and whether items being removed are authorized.

Security Message Board:

Facility Friend has the capability to create custom messages for security and reception personnel. Typical message types include Incident Reports to define incident types and create security logs and Lost and Found to track lost and found items or to track items left at security by visitors. Other applications include tracking unregistered or improperly parked vehicles.

ABC – As Built Compiler:

ABC is an online web program that allows uses to use pre-configured templates to design the layout of facility security systems. Users select a type of door or gate and add any type of door hardware to their drawing. The system automatically populates the drawing with cable and conduit requirements. The drawings can then be used to simplify bid specifications or to simplify the installation process. All drawings are stored as archived “as built” drawings in the event the security at a particular door needs to be revisited in the future.

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Other products also include RadioClick and InfraClik. These are remote control access control products for doors and parking gates. They are sold separately or as complementary to the Enterphone, Entercheck and MESH systems. The Company also manufactures and sells EmerPhone, an intercom system that is sold in elevator phone, emergency phone and entry phone applications.

OTHER SERVICES

In addition to sales of the Enterphone, MESH and OEM products, the Company also services approximately 1,344 existing Enterphone installations within Western Canada.

PRODUCTION

Viscount has facilities for circuit board manufacture and mechanical assembly. The Company uses a range of processes to produce its products. Some products including Enterphone, InfraClik, and Axess are completely manufactured in-house. The Company maintains full facilities to assemble through-hole circuit boards and limited facilities for assembling surface mount circuits. The Company has a policy of supporting old products as long as parts are available for servicing and replacement. We have designed EPX to be backwards compatible with the 2000 series to improve the longevity and serviceability of both products. Freedom, MESH, EPX, MESH Freedom and EmerPhone are manufactured using surface mount technology so are outsourced with final assembly and software installed at Viscount. This includes all Freedom IP Encryption bridges.

Some access control, card readers, Elektra panels, InfraClik and various product accessories are purchased from other manufacturers and resold under the Company’s brand-names.

Our principal suppliers of card readers is HID Global Corporation.

The MESH and Freedom software platform is loaded on standard industrial computer chassis. The Company is 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 commercial off-the-shelf (COTS) components, the Company improves time to market, eliminate hardware debugging and increases the Company’s ability to be technologically flexible in the future. The Company is primarily executing final mechanical assembly of the MESH systems.

RESEARCH AND DEVELOPMENT

Research and development continues to be focused on enhancing the Freedom/MESH product line. A number of these enhancements were identified in the “MESH Structure”, Freedom and “Other products” section of this document. Specific custom Freedom/MESH applications are being considered, evaluated and implemented. An example of this process would be active directory integration. Expenditures in connection with research and development for the years ended December 31, 2013 and 2012 were $425,016 or $278,514 net of a $146,502 government grant, and $338,853, respectively.

MARKET AND MARKETING

The Market

MESH Market:

The Company’s traditional market for the 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 the Company’s first in-house product that addresses these multiple requirements. The modular nature of MESH also provides the Company with an excellent opportunity to design additional products on the MESH platform to provide enhanced options for a comprehensive building security package.

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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 the Company’s core business, while allowing the Company to find applications where the new features expand the traditional market for such systems.

The Company is targeting upgrades and retrofits to existing apartments and various government agencies that use traditional telephone wire intercom access control systems. New construction projects are also part of the MESH installation market. 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.

Freedom market:

Freedom moves Viscount into an entirely new market, door security for enterprise clients. This market has been estimated from $5-10B and includes a range of technologies for securing facilities including both RFID and biometrics. The access control market can generally be described as the market for any equipment used to control passage through a door, gate, parking garage, 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 the Company competes in involves computerized access control systems that typically control access through multiple access points.

The physical access control industry was once highly fragmented but through a process of consolidation has come to be generally dominated by a number of multi-nationals. Physical access control typically involves two groups – the electronic reader suppliers (RFID readers, Biometrics) and the control suppliers. The control suppliers are typically the top of the food chain and resell electronic reader devices as part of the control platform. This is the core segment in which Viscount competes. The electronic reader part of this industry grew out of old-fashioned door locks. It is not surprising that at this level the most common companies are ASSA ABLOY and Stanley. ASSA ABLOY has been the most aggressive over the years and is now fairly dominant in the area of door control and “entrance systems.” Key acquisitions included HID (in 2000), which is a leading provider of access control cards and electronic readers. ASSA ABLOY has made over 20 acquisitions in the space and has almost 40,000 employees worldwide.

Behind the door itself is access management and control. There are specialized companies in this segment but most are now part of massive conglomerates that provide a broad range of related industrial products. Major players include Lenel, which is part of United Technologies Corporation (NYSE: UTX), Software House, which is part of Ty- co International (NYSE: TYC), Honeywell (NYSE: HON), Schneider Electric (SU:EN Paris), Johnson Controls (NYSE: JCI) and Cisco (NASDAQ: CSCO).

Not only does a Freedom type unified system represent a viable adjacent market opportunity that is large enough to be of interest, it may in fact become critical that these companies move in the direction of Freedom. The logic is simple; if Freedom can apply logical security rules to physical access it can also apply physical security rules to logical access. If unified platforms become the trend, any of the large identity management companies will be at a severe disadvantage if they don’t enter the market.

The most obvious and clearly focused player so far is Microsoft, which is now in a position to combine the most popular enterprise user-management tool, Active Directory, with the Cloud (Azure in their terminology) to provide a solution for both logical and physical access control with one infrastructure using Freedom.

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Liberty Market

Liberty is sold through security distributors such as ADI (a division of Honeywell) and Tri-Ed North America. Starting in Q4, 2013, Viscount established long term relationships with both of these large, first tier security distributors. All of their major stocking hubs hold Viscount inventory, as well as key branches. Viscount also established a full set of 14 manufacturer’s representatives covering the United States and Canada to roll out and support the new Liberty product line. The sales projections for 2014 are unknown, since the product is revolutionary and new to distribution, so forecasting will not be attempted until 2015.

Distribution Plan

The Company currently has approximately 450 dealers for its existing products throughout North America and 50 certified integrators for its Freedom product line. The Company’s distribution network is not static and the Company is constantly seeking additional sales channels.

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, employees may be directly involved with the customer in designing, installing and servicing the product. In other cases, personnel may be involved on a co-op basis with large national security, building automation and heating/ventilation and air-conditioning contractors.

With the addition of our Liberty product line, new security distributors were added, who sell the Liberty line in the open security market, to smaller dealers on a non-exclusive basis. These new distribution deals, along with the existing dealer base, gave the Company immediate access to the largest networks of dealers in the US, Canada and Mexico.

During the past year, the Company has been targeting its existing markets as well as targeting the US Federal Government and large corporate end users for the sale of Freedom technology. The Company is concentrating on North America at this time. All sales remain through these indirect channels, with minimal sales to the end users of the product. First line installation and technical support is provided by our dealers and certified integrators to the end users.

Marketing Strategy

The Company has been using its established distribution channels, as well as new distribution channels to access its target markets for the MESH, Freedom, and Liberty technology. As a unique technology, however, end-users as well as dealers must be educated about Freedom benefits and capabilities. It is the Company’s experience that a stronger initial emphasis on influencing end-user decision-makers and large national system integrators will be the most effective in developing the Freedom market. The Company sells through authorized dealers, integrators, VARS, and distributors, and does not typically sell direct to End Users.

Webinars

Viscount has been concentrating on webinars to educate the industry about Freedom. The response has been excellent with audiences from several hundred up to 800 registered attendees per webinar.

Advertising

Products are advertised on an ongoing basis in various print publications, which the Company 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 sale per advertising dollar spent ratio. While the sales cycle is sometimes fairly long, this approach has given the Company a very accurate measure of the effectiveness of various publications and individual ads.

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Trade Shows

During 2013, the Company continued participating at tradeshows to increase the awareness of MESH and Freedom. During 2014, we will continue to attend tradeshows to keep up the exposure for MESH, Freedom, and Liberty.

Direct Marketing

The Company continued educating customers about Freedom technology by holding Freedom and Liberty training seminars throughout the U.S. and at our head office, via the internet.

Pricing Strategy

The Freedom 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. The Company has been actively pursuing a pricing model based on substantive margins but at a price point that can promote market disruption. Many traditional companies focus on recurring revenue for software licenses. Viscount has chosen to forgo this in the short term with a view to creating recurring revenue through Cloud sources. In 2013, the Company introduced a low cost version of Freedom to address small and mid-size sites. The access control industry is fragmented with a wide variation on pricing depending on the size of system and supplier. The new product will be introduced to allow Viscount to compete for all system sizes.

With a unique product and a position of product leadership, the Company has devised a strategy of building market share. With the telephony component, the Company has 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

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. This began with the purchase of Cardkey by Johnson Controls, Guardall by Chubb and ADI/Northern Computers by Honeywell. More recent acquisitions include the purchase of Kantech and Software House by Tyco and the purchase of Lenel and GE Security by UTC. 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 or Smart Card technology that converts data to Wiegand. Due to these limitations, most research and development is focused on reducing hardware costs and making the control hosts more network capable. In most cases, the manufacturers using traditional Wiegand technology are limited from 1 to 8 doors per control host.

Competitive Threats

The Company has a strong dealer and distribution plan in place and Freedom has positioned it in a market dominated by much larger players. The higher security Freedom applications are also somewhat outside of the traditional scope of business and therefore, the Company is rapidly trying to develop a market for Freedom and in the process, educating users of Freedom through training seminars. The Company believes that marketing strategies and training seminars will provide benefits that will help it achieve market share that will allow it to remain competitive. There is no guarantee that the Company will be able to successfully compete against its larger competitors.

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While Freedom 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 IP based cameras and the Company has marketed Freedom 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 the Company still has a three-year market lead. Fortunately, the wide range of Freedom software applications should provide the Company with an ongoing lead, as long as it is aggressive with research and development.

INTELLECTUAL PROPERTY

Viscount actively protects its intellectual property. The Company has filed numerous patents since 2010, encompassing close to 60 patent claims under six (6) major patent filings. The Viscount patent pending stable includes patents relating to Freedom, unified identity management systems, cyber security, and the use of mobile devices to perform security functions. These patents have not yet been awarded but the Company intends to vigorously defend each patent as they are awarded.

The Company relies on a combination of non-disclosure and other contractual agreements, and technical measures to protect the confidential information, know-how, and proprietary rights relating to Enterphone, MESH and other Viscount products. The Company has contractual rights with respect to registered North American trademark and trade name for Enterphone (word alone). The Company is still considering or in the process of registering North American trade names for MESH and Freedom.

The Company has registered active Internet domain names for www.viscount.com , www.libertyacess.net, www.enterphone.net, and www.enterphone.org.

Standard employment agreements and license agreements contain provisions that protect the confidentiality of proprietary technology. All our employees and sales agents are required to sign these agreements prior to their employment or engagement.

To date the Company has not received notification that its services or products infringe the proprietary rights of third parties. Third parties could however make such claims of infringement in the future. The Company 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 the Company’s services, thereby substantially reducing the value of its proprietary rights. Furthermore, there can be no assurance that any confidentiality agreements between the Company and its employees or any license agreements will provide meaningful protection for its proprietary information in the event of any unauthorized use or disclosure of such proprietary information.

GOVERNMENT REGULATIONS

There are a number of regulatory and related issues that affect Viscount’s business. In order to comply with Sarbanes-Oxley and other rules and regulations, every large public corporate entity is required to have adequate security measures in place for the purpose of protecting IT data from tampering by unauthorized personnel. A component of this includes properly securing physical facilities as well as IT networks. Unfortunately, since control panels typically use a separate security database from IT, it is very difficult to relate usage of the systems for the purposes of audit and compliance. With the Freedom unified platform using Microsoft Active Directory, audits and compliance issues are simplified using a single set of IT logs.

For US Government facilities, Viscount must conform with FIPS-201 and other federal requirements. A newer standard FIPS 201-2 is under final discussion and a release is expected shortly. The new regulations positively impact Viscount through our ability to perform control panel functions is software and may negatively impact existing supplier since their existing technology and hardware is non-conformant.

In addition, some of the Company’s Enterphone 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.

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The history of government deregulation for the Company 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.

SOURCES OF REVENUES

The majority of the Company’s revenues were derived from the MESH and Freedom product lines. In fiscal 2013, MESH sales represented 47.8% of total revenue, while Freedom product sales represented 24.0% of total revenue. The balance of the Company’s revenue was derived from service agreements, and other products such as access tracking and control, closed circuit video, infrared and radio frequency remotes.

EMPLOYEES

Viscount employs 26 staff at its production facility and head office located in Burnaby, British Columbia, Canada, as well as sales and support personnel in the United States.

Board of Directors

Viscount has a current board of 5 members. Viscount’s board is comprised of its CEO and independent directors with senior security industry experience.

Stephen Pineau

Mr. Stephen Pineau, Steve has been the President, Chief Executive Officer, Principal Accounting Officer and Secretary of Viscount Systems Inc. since July 27, 2001 and serves as its Principal Financial Officer. Mr. Pineau has been the President of Viscount Communication & Control Systems Inc. since July 1997. He has served as Officer of Viscount since July 27, 2001. He served at Viscount Communication & Control Systems Inc., a predecessor entity which, at the time, was a subsidiary of BC Tel, as Marketing Director from 1992 to 1995. He left Viscount Communication to start Blue Mountain Technologies Inc, where he held office as President from 1995 to 1997. Since 1997, Mr. Pineau has held office as President of Viscount Communication. He has been a Director of Viscount Systems Inc. since July 27, 2001 and Viscount Communication & Control Systems Inc. since July 1997.

Paul Brisgone

Paul Brisgone has had a long and distinguished career in the security industry. Most recently, he served as Vice President of the Federal Systems Division for ADT Security, responsible for selling and managing Federal Government projects. Mr. Brisgone built the division from $20 million to over $300 million in annual sales, eventually managing a staff of over 200 sales and technical support personnel. While at ADT, he managed the security industry’s largest GSA schedule, using it to generate over $50M in sales annually, built a transportation security business from the ground up into a group that provides services to over 60 airports nationally, and developed and built the Integrated Systems Business unit within ADT’s Fed Systems group.

Paul Goldenberg

Paul Goldenberg has built a distinguished career as a highly decorated criminal justice executive with extensive and broad-based experience in a wide variety of politically sensitive government and NGO environments. In February 2010, U.S. Department of Homeland Security (“DHS”) Secretary Janet Napolitano appointed Mr. Goldenberg to the President¹s Homeland Security Advisory Council¹s Countering Violent Extremism Working Group. He is the creator of the Secure Community Network (SCN), which is a DHS funded organization that advises churches, synagogues and mosques as to security risks and solutions. Mr. Goldenberg is currently the Principal Counterterrorism and Homeland Security Advisor to the American Hotel and Lodging Association, representing over 1,000 hotels in the U.S. and abroad. He is also the Senior Director of National Security for the County Executives of America, representing over 700 county mayors and executives.” Mr. Goldenberg is currently the Chairman and CEO of Cardinal Point Strategies, a consulting firm that provides strategic solutions on high profile and confidential matters for governments and businesses around the world.

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Robert Liscouski

Robert Liscouski was the first Assistant Secretary for Infrastructure Protection for the Department of Homeland Security, serving from March 2003 to February 2005, and reporting directly to then Secretary Tom Ridge. He commanded over a $500 million budget and was responsible for coordinating authority over the protection of all sectors of the nation’s critical infrastructure, including agriculture, food, water, public health, transportation, and hazardous materials, as well as key assets such as national monuments, nuclear power plants, and dams. His private sector experience includes Director of Information Assurance for The Coca-Cola Company and V.P., Law Enforcement Division, for ORION Scientific Systems. His government experience includes 11 years with the Diplomatic Security Service of the U.S. Department of State and five years criminal investigative experience as a homicide and narcotics investigator in Bergen County, N.J. He is a Senior Fellow at the Center of Strategic and International Studies in Washington, D.C. and is an advisor to the U.S. Government on technology matters. Mr. Liscouski holds a B.S. degree in Criminal Justice from John Jay College of Criminal Justice in New York, and a Masters of Public Administration from the Kennedy School of Government, Harvard University.

Dennis Raefield

Dennis Raefield has a long and distinguished career in the access control and security industry. Most recently, Mr. Raefield was CEO and President of Mace Security International, Inc. (OTC: MACE). Mr. Raefield was President of Honeywell Access Systems, a $100M+ division of Honeywell International, which manufactures enterprise level access control systems for Fortune 100 client. Prior, Mr. Raefield was President of Pinkerton Systems Integration (now Securitas), a $70M+ security system integration business installing video, access control and alarms to Fortune 500 clients. During his career, he was CEO or President of startups Reach Systems, an access control manufacturer, and Ortega InfoSystems, an early PSIM manufacturer. He was also Founder and CEO of Omega Corporate Security, a west coast premier systems integrator based in the San Francisco Bay area. Mr. Raefield holds a BS degree in Mechanical Engineering from Santa Clara University, and is a member of ASIS, SIA, ESA, ISIO, CAA, and CSAA. Mr. Raefield also acts as the Company’s Chief Operating Officer (COO).

On February 17, 2014, Mr. Stephen Pineau resigned as the President, Chief Executive Officer, Chief Financial Officer and Corporate Secretary of Viscount Systems, Inc.

On February 17, 2014, Mr. Dennis Raefield was appointed as the President, Chief Executive Officer, Chairman, and Corporate Secretary of Viscount Systems, Inc. Mr. Raefield entered into an employment agreement with the Company pursuant to which he will receive an initial annual salary of $175,000, an annual bonus of up to 50% of his base salary, and stock options equal to 3.99% of the Company’s issued and outstanding on a fully diluted basis.

Mr. Raefield has been a director of Viscount Systems, Inc. since May 2012. Mr. Raefield has acted as the Chief Executive Officer of Mace Security International Inc., President of Honeywell Access Systems, and President of Pinkerton Systems Integration.

Item 1A. RISK FACTORS

Risks related to the business and the Company’s shares:

Other companies with greater resources than we have are currently developing or have commercially available products that use similar technology to Freedom technology and the Company may lose potential market share as a result.

Viscount has filed numerous patents in relation to Freedom access control technology. There is no guarantee that all patents will be awarded. While the Company has no immediate knowledge of closely similar products in the market or under development the possibility exists that larger companies are in the process of developing similar products. These competitors may have substantially greater financial, technical, marketing and management resources than the Company has. They may also be willing to risk possible patent infringement issues by leaving such matters to the courts. The Company’s ability to compete successfully will depend on its ability to educate and use existing sales channels and develop new sales channels. To the extent that competitors have more resources to market products based on similar technology, the Company may lose market share which would decrease the value of an investment in its common stock, or may cause the value of an investment in the Company’s common stock to decrease.

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Because our common stock trades at prices below US$5.00 per share, and because the Company is not listed on a national exchange, there are additional regulations imposed on broker-dealers trading in the Company’s shares that may make it more difficult for you to resell the Company’s shares.

Because of rules that apply to shares with a market price of less than US$5.00 per share, known as the “penny stock rules”, investors holding shares in the Company will find it more difficult to sell their securities. The penny stock rules currently apply to trades in the Company’s shares. These rules in most cases require a broker-dealer to deliver a standardized risk disclosure document to a potential purchaser of the securities, along with additional information including current bid and offer quotations, the compensation of the broker-dealer and its salesperson in the transaction, monthly account statements showing the market value of each penny stock held in the customer’s account, and to make a special written determination that the penny stock is a suitable investment for the purchaser and receive the purchaser’s written agreement to the transaction.

Directors and officers hold approximately 6.62% of the Company’s common stock and acting together, do not have the ability to control management and affairs of Viscount and to deter changes in control.

The Company’s directors and officers collectively hold approximately 6.62% of our current issued and outstanding voting shares. As a result, such persons, acting together, do not have the ability to control matters submitted to our stockholders for approval, including the election and removal of directors, and the control of management and affairs of Viscount. In addition, Articles of Incorporation include provisions that management can use to retain control over Viscount. Accordingly, such concentration of ownership, coupled with management friendly anti-takeover provisions, may have the effect of delaying, deferring or preventing a change in control of Viscount, impeding a merger, consolidation, takeover or other business combination or discouraging a potential acquirer from making a tender offer or otherwise attempting to obtain control of the Company, which limits the ability of stockholders to participate in opportunities that may increase the value of their stock.

Item 2. DESCRIPTION OF PROPERTY

PROPERTY

The Company’s executive office and central factory is located in Burnaby, British Columbia, where the Company currently leases 12,040 square feet. The Company leases this space under an industry standard operating lease with a term expiring May 31, 2016, renewable at the option of Viscount. Current monthly lease obligations are $11,729. The Company believes that its current facilities are adequate and are suitable for its current use, and that suitable additional facilities will be available, when needed, upon commercially reasonable terms. The Company’s facilities are adequately insured against perils in a manner consistent with industry practice. The Company’s current location is the location for its manufacturing and service divisions.

Item 3. LEGAL PROCEEDINGS

None.

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Item 4. MINE SAFETY DISCLOSURES

Not applicable.

PART II.

Item 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Trades in the Company’s common shares are quoted on the Over-the-Counter Bulletin Board (OTC Bulletin Board) which is a quotation service administered by the Financial Industry Regulatory Authority (FINRA). The Company’s 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. The Company’s 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 March 28, 2014. 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. $)
       
2014 First Quarter (through March 19, 2014) $.09 $.15
2013 Fourth Quarter 0.12 0 06
  Third Quarter 0.11 0.07
  Second Quarter 0.12 0.08
  First Quarter 0.13 0.06
2012 Fourth Quarter 0.07 0.03
  Third Quarter 0.06 0.05
  Second Quarter 0.06 0.05
  First Quarter 0.06 0.04

As of March 19, 2014, there were 79 holders of record of the Company’s common stock, holding a total of 97,075,003 shares, and an unknown number of beneficial holders.

As of March 19, 2014, there were 1,629,375 stock options fully vested and convertible into common shares. As of March 28, 2014, there were 58,672,014 warrants convertible into common shares.

The Company has declared quarterly Series A Dividends in the last two fiscal years.

The Company’s significant liquidity risk materially limits the Company’s ability to pay future dividends

The Company may consider paying cash dividends in the foreseeable future as its liquidity risk decreases.

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The following table sets forth information detailing the Company’s compensation plans as at December 31, 2013, 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 1,629,375 US$0.08 0
Equity compensation plans not approved by security holders 58,672,014 US$0.09 N/A
Total 60,301,389 N/A 0

Under Item 701 of Regulation S-K, no securities were sold by the Company within the past three years which were not registered under the Securities Act of 1933 and that were not previously disclosed in a Form 8-K or Form 10-Q.

Item 6. SELECTED FINANCIAL DATA

Not applicable.

Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS 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 for the years ended December 31, 2013 and 2012 were $4,134,886 and $3,602,569, respectively, an increase of $532,317 or 14.8%. This increase was due to increased MESH, Liberty and Freedom Sales. Sales for the quarters ended March 31, June 30, September 30 and December 31, 2013 were $828,320, $1,041,088, $1,075,815 and $1,189,663, respectively. Sales for the quarters ended March 31, June 30, September 30 and December 31, 2012 were $867,001, $901,088, $858,128 and $976,352, respectively. Sales fluctuated quarterly due to increased and decreased MESH and Freedom sales. These fluctuations occurred due to inventory shortages throughout the year. Freedom and Liberty sales for the years ended December 31, 2013 and 2012 were $991,831 and $358,084, respectively, an increase of $633,747 or 277.0%. This increase was due to the Company promoting Freedom and Liberty products as its main product to all it’s customers. MESH sales for the years ended December 31, 2013 and 2012 were $1,974,482 and $1,658,617, respectively, an increase of $315,865 or 19.0%. MESH continued to provide an alternatiave solution to Liberty and Freedom for many of our customers during 2013. MESH is a convergent technology developed by Viscount that increases security at a reduced cost of hardware, cabling and installation, and with simplified database management. The 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 the building or anywhere in the world. The software component of 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.

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For the years December 31, 2013 and 2012, Freedom and Liberty sales were 24.0% and 9.9%, respectively, of total sales. For the years ended December 31, 2013 and 2012, MESH sales were 47.8% and 46.0%, respectively, of total sales. The improved sales for Freedom, Liberty and MESH was due to hiring additional sales representatives to promote these products.

The Company also provides Enterphone support and maintenance services pursuant to service contracts that were assigned to us from Telus Corporation in 2003. Sales from the 1,254 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, 2013 and 2012, customer service contracts and new equipment sales generated aggregate sales revenues of $1,083,481 and $1,097,714, respectively, a decrease of $14,233 or 1.3%. These two years 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 1,254 at December 31, 2013, as compared to 1,344 at December 31, 2012. The Company continues 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, 2013, the cost of the service agreements, net of accumulated amortization, was $26,116.

Cost of sales and services as a percentage of sales was 35.61% and 40.3% for the years ended December 31, 2013 and 2012, respectively. Cost of sales decreased due to a downward adjustment to the obsolete inventory provision, which was a non-cash transaction. Had this adjustment not occurred, Cost of sales and services as a percentage of sales would have been 40.89% for the year ended December 31, 2013, which is comparable to 40.3% for the year ended December 31, 2012. We expect cost of sales to remain constant until Freedom Bridge sales increase substantially. 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 years ended December 31, 2013 and 2012 was $2,662,590 and $2,149,735, respectively, an increase of $512,856 or 23.9%. This corresponds with the increased sales and decreased cost of sales for the years ended December 31, 2013 and 2012.

Selling, general and administrative expenses for the years ended December 31, 2013 and 2012 were $3,334,767 and $3,165,030, respectively, an increase of $169,737 or 5.4%. For the twelve months ended December 31, 2013 and 2012, selling, general and administrative expenses, as a percentage of sales, were 80.6% and 87.9%, respectively. Consulting fees for the years ended December 31, 2013 and 2012 were $966,776 and $746,556, respectively, an increase of $220,220 or 29.5%. Consulting fees, in part, increased due to paying additional consultants $109,270 to provide strategic sales and marketing advice and alliances for key markets including the US Federal Government for Freedom projects. Other increases were related to Board of Directors fees.

Research and development costs for the year ended December 31, 2013 were gross $425,016. Government grants for the year ended December 31, 2013 totaled $146,502, resulting in net research and development costs of $278,514. Research and development costs for the year ended December 31, 2012 were gross $338,853. Government grants for the year ended December 31, 2012 was $nil. Research and development costs have increased during the twelve months ended December 31, 2013, as compared to the twelve months ended December 31, 2012, due to hiring an engineer to improve the Freedom design.

Net loss for the year ended December 31, 2013 was $974,515, as compared to a net loss of $1,379,447 for the year ended December 31, 2012, a decreased loss of $404,932. During the twelve months ended December 31, 2013, expenses were controlled to maintain cash flow and to minimize the net loss.

Total assets at December 31, 2013 was $1,340,370and total financial liabilities consisting of derivative financial liabilities were $6,160,211. Total commons shares issued as the dividend payment of the Company’s Series A Convertible Redeemable Preferred Stock for the year ended December 31, 2013 and 2012 were 1,257,523 and 1,060,131 common shares, respectively.

23


Liquidity and Capital Resources

Cash as of December 31, 2013, as compared to December 31, 2012 was $172,684 and $406,506, respectively, a decrease of $233,822. Cash decreased due to increased payments for selling, general and administrative expenses. These expenses consisted mainly of consultant payments.

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.

On May 17, 2013, Viscount Systems, Inc. completed a private placement of 4,750,000 units at a price of $0.10 per unit for total proceeds of $475,000. On May 21, 2013, the Company completed an additional private placement of 2,000,000 units at a price of $0.10 per unit for total proceeds of $200,000. Each unit consists of one common share and one-half of one share purchase warrant of the Company, with each whole warrant exercisable to acquire an additional share of the Company at a price of $0.20 for a period of three years from the closing date.

In connection with the offerings, the Company paid to a registered broker-dealer a cash commission of $7,500 and issued share purchase warrants to acquire 675,000 shares of common stock of the Company at a price of $0.20 per share for a period of three years from the closing date. The warrants may be exercised on a cashless basis.

At December 31, 2013, the Company had a working capital of $248,878, as compared to working capital of $448,029 at December 31, 2012, a decrease of $199,151. Working capital decreased due to increased payments for consultants and various other selling, general and administrative expenses. The current ratio at December 31, 2013 was 1.24, as compared with 1.49 at December 31, 2012.

24


The Company has the ability to finance operations and future growth through a stock-based equity injection of up to $1.5 million. However, the state of the global financial markets and recession fears present significant uncertainties for the timing and successful completion of an equity investment.

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 $11,670,855, reported a loss for the year ended December 31, 2013 of $2,966,853 and has working capital of $248,878 at December 31, 2013. Cash flows used in operating activities for the twelve months ended December 31, 2013 were $924,718. 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 up to $1,600,000 if sales do not improve, 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 $1,600,000 financing and hits its sales targets, the Company does not anticipate requiring any additional financing for 2014. Management has been actively seeking new investors and developing customer relationships;and a financing arrangement of US$750,000 (US$679,000 net of costs)has completed in March, 2014. 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 was 57 days at December 31, 2013 and 51 days at December 31, 2012. The outstanding term for our receivables has been increasing due to a few slower paying customers. The accounts receivable reserve was $250,458 at December 31, 2013, as compared to $105,185 at December 31, 2012. The accounts receivable reserve has increased by $145,273 or 238.1%, since the year ended December 31, 2012. Additional bad debt was recognized for a particular slower paying customer. 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, 2013, the Company’s current assets consist principally of trade accounts receivables and inventory.

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, 2013, 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 Freedom and Liberty products. 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, 2013.

25


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.

Fourth Quarter

During the fourth quarter the Company continued to have cash flow problems. These problems impacted the Company's ability to perform some marketing activities. The Company’s sales continued to show strength through continued demand for MESH Touch Screens, US Federal Government deployments, and the addition of several major distributors of its Liberty access control system. The Company diverted significant engineering resources to the final development of its US Government FICAM solution and its targeted submission of its new FICAM topology application, scheduled for May 2014.

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 decreased its provision for obsolete inventory by approximately $218,599 during the fourth quarter of 2013, 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.

26


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.

Critical Accounting estimates and judgments:

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 decreased its provision for obsolete inventory by $218,599 from $409,845 to $191,246 at December 31, 2013, 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.

Recent accounting pronouncements

The Company has implemented all new accounting pronouncements that are in effect and that may impact its financial statements and does not believe that there are any other new accounting pronouncements that have been issued that might have a material impact on its financial position or results of operations.

Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable.

27


Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The financial statements are attached to this report following the signature page.

Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

Not applicable.

Item 9A. CONTROLS AND PROCEDURES

Management’s Evaluation of Disclosure Controls and Procedures

The Company’s management, including its principal executive officer who is also our principal financial officer, evaluated the effectiveness of disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) as of the end of the period covered by this report. Based on that evaluation, the principal executive officer and principal financial officer concluded that as of the end of the period covered by this report, the Company has maintained effective disclosure controls and procedures in all material respects, including those necessary to ensure that information required to be disclosed in reports filed or submitted with the SEC (i) is recorded, processed, and reported within the time periods specified by the SEC, and (ii) is accumulated and communicated to management, including the principal executive officer and principal financial officer, as appropriate to allow for timely decision regarding required disclosure.

There have been no changes in internal control over financial reporting that occurred during the last fiscal quarter that have materially affected, or are reasonably likely to materially affect, internal control over financial reporting.

Management’s Report on Internal Control over Financial Reporting

The Company’s management is responsible for establishing and maintaining effective internal control over financial reporting as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.

Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2013 using the criteria set forth in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management believes that, as of December 31, 2013, we have inherent deficiencies. Management is working with the audit committee to put processes in place to monitor internal controls and oversee the reporting process. The following are inherent deficiencies that management is aware of but do not believe compromise the internal controls or reporting process.

Inherent Deficiencies:

  a.

Roles and responsibilities for the financial reporting process are not documented in a formalized manner.

  b.

All employees have full access to inventories. Inventories are not adequately secured from employees who do not need access, however, cameras are on site to mitigate any risk of theft.

  c.

The accounting department has unrestricted access to all parts of the general ledger, however, the Controller reviews the ledgers regularly.

  d.

Management has not implemented a formalized IT policy.

Management is addressing these deficiencies. It plans to remain vigilant and to add additional staff and system improvements as resources permit.

28


Item 9B. OTHER INFORMATION

On January 3, 2014, Viscount Systems, Inc. issued a total of 1,114.814 Series A Convertible Redeemable Preferred Stock, par value $0.001 per share (the “A Shares”), to the outstanding holders of A Shares as dividend payments on the A Shares for the periods ended December 31, 2013. The A Shares issued are subject to the conversion and dividend rights as set forth in the Certificate of Designation, Preferences and Rights of the Series A Convertible Redeemable Preferred Stock, as amended.

PART III.

Items 10 –14

Information with respect to Items 10 through 14 is set forth in the Proxy Statement that will be filed with the Securities and Exchange Commission on or before April 30, 2014 and is incorporated herein by reference. If the definitive Proxy Statement cannot be filed on or before April 30, 2014, the issuer will instead file an amendment to this Form 10K disclosing the information with respect to Items 10 through 14.

PART IV.

Item 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES

(a)

The following financial statements are filed as part of this Form 10-K:

   

Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets
Consolidated Statement of Operations and Comprehensive Loss
Consolidated Statement of Stockholders’ Deficit
Consolidated Statement of Cash Flows
Notes to Consolidated Financial Statements

   
(b)

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
4.1 Certificate of Designation, Preferences and Rights of the Series A Convertible Redeemable Preferred Stock   Incorporated by reference to the Form 8-Ks filed with the SEC on June 11, 2012 and October 23, 2012
10.1 Employment Agreement with Stephen Pineau   Incorporated by reference to Exhibit 10.2 to the Form SB-2
10.2 Consulting Agreement with Dennis Raefield   Filed herewith
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

29



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
31.1 Certification Pursuant to Rule 13a-14(a) or 15d-14(a) of the U.S. Securities Exchange Act of 1934   Filed herewith
32.1 Section 1350 Certification of the Principal Executive Officer and Principal Financial Officer   Filed herewith

30


Signatures

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on March 26, 2014.

  VISCOUNT SYSTEMS, INC.
   
  By: /s/ Dennis Raefield
               Dennis Raefield
   
  President, Secretary, Principal Executive
  Officer, Principal Financial Officer,
  Principal Accounting Officer and Director

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on the dates indicated.

  Signature                      Title Date
         
By: /s/ Dennis Raefield   President, Secretary, March 26, 2014
  Dennis Raefield   Principal Executive Officer, Principal  
      Financial Officer, Principal Accounting  
      Officer and Director  
         
By: /s/ Robert Liscouski   Director March 26, 2014
  Robert Liscouski      
         
         
By: /s/ Paul Goldenberg   Director March 26, 2014
  Paul Goldenberg      
         
         
By: /s/ Stephen Pineau   Director March 26, 2014
  Stephen Pineau      
         
         
By: /s/ Paul Brisgone   Director March 26, 2014
  Paul Brisgone      

31


 

 

VISCOUNT SYSTEMS, INC.

CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in Canadian Dollars)

DECEMBER 31, 2013

 

 


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Stockholders and Board of Directors of Viscount Systems Inc:

We have audited the accompanying consolidated balance sheets of Viscount Systems Inc. (the “Company”) as of December 31, 2013 and 2012 and the related consolidated statements of operations and comprehensive loss, stockholders’ deficit and cash flows for the years then ended. These financial stat tements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform an audit to o obtain reasonable assurance whether the financial statements are free of material misstatement. The Company is not required to have, nor were we e engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, these consolidated financial statements present fairly, in all material respects, the financial position the Company as at December 31, 2013 and 2012 and the results of its s operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the financial statements, the Company has an accumulated deficit of $11,670,855 and reported a loss of $3,080,500 for the year ended December 31, 2013 raising substantial doubt about the Company’s ability to continue as a going concern. The Company requires additional funds to meet its obligations and the costs of its operations. These factors raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plans in this regard are described in Note 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

“DMCL”
 
 
DALE MATHESON CARR-HILTON LABONTE LLP
CHARTERED ACCOUNTANTS
Vancouver, Canada
March 24, 2014



VISCOUNT SYSTEMS, INC.
Consolidated Balance Sheets
(Expressed in Canadian dollars)
As at December 31, 2013 and 2012
 

    2013     2012  
             
             
Assets            
             
Current assets            
 Cash and cash equivalents $  172,684   $  406,506  
 Trade accounts receivable, less allowance for doubtful accounts 
      of $250,458 (2012 - $105,185)
  585,153     611,288  
 Inventory (note 3)   532,798     347,978  
Total current assets   1,290,635     1,365,772  
             
Deposits   1,391     1,391  
Equipment (note 4)   22,229     25,161  
Intangible assets (note 5)   26,116     47,008  
             
Total assets $  1,340,371   $  1,439,332  
    .        
Liablilities and stockholders' deficit            
             
Current liabilities            
 Accounts payable $  254,682   $  150,857  
 Accrued liabilities   601,270     566,260  
 Deferred revenue   37,543     38,256  
 Due to related parties (note 7)   33,727     7,468  
 Loans payable (note 6)   114,536     154,902  
Total current liabilities   1,041,758     917,743  
             
Derivative financial liabilities (notes 8 and 9)   5,118,454     3,023,161  
    6,160,211     3,940,904  
             
Stockholders' deficit            
 Capital stock            
     Authorized:            
       300,000,000 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:            
       97,075,003 common shares (2012 - 86,733,750) (note 10)   119,853     109,512  
       1,115 preferred shares (2012 - 1,149) (note 8)   -     -  
 Additional paid-in capital   6,731,161     5,979,271  
 Accumulated deficit   (11,670,855 )   (8,590,355 )
Total stockholders' deficit   (4,819,841 )   (2,501,572 )
             
Total liabilities and stockholders' deficit $  1,340,370   $  1,439,332  

Commitments (note 12)
Subsequent events (note 16)
See accompanying notes to consolidated financial statements.



VISCOUNT SYSTEMS, INC.
Consolidated Statements of Operations and Comprehensive Loss
(Expressed in Canadian dollars)
Years Ended December 31, 2013 and 2012
 

    2013     2012  
             
             
Sales $  4,134,886   $  3,602,569  
Cost of sales   1,472,296     1,452,835  
Gross profit   2,662,590     2,149,734  
             
Expenses            
   Selling, general and administrative   3,334,766     3,165,030  
   Research and development   278,514     338,853  
   Depreciation and amortization   23,825     25,298  
    3,637,105     3,529,181  
             
Loss before other items   (974,515 )   (1,379,447 )
             
Other items            
   Interest income   321     34  
   Interest expense   -     (760 )
   Initial loss on recognition of derivative instruments (note 8)   (113,647 )   (925,742 )
   Fair value adjustment of derivative liabilities (note 9)   (1,992,659 )   (373,271 )
    (2,105,985 )   (1,299,739 )
             
Net loss and comprehensive loss $  (3,080,500 ) $  (2,679,186 )
             
Basic and diluted loss per common share $  (0.03 ) $  (0.03 )
             
Weighted average number of common shares outstanding,
 Basic and diluted
  91,969,573     77,686,955  

See accompanying notes to consolidated financial statements.



VISCOUNT SYSTEMS, INC.
Consolidated Statement of Stockholders' Deficit
(Expressed in Canadian dollars)
Years Ended December 31, 2013 and 2012
 

                            Additional                          
    Common Stock     Preferred Stock     paid-in     Obligation to     Deferred     Accumulated        
    Shares     Amount     Shares     Amount     capital     issue shares     Compensation     deficit     Total  
                                                       
                                                       
Balance, December 31, 2011   76,473,750   $  99,252     -   $  -   $  5,767,369   $  20,800   $  (126,855 ) $  (5,845,262 ) $  (84,696 )
                                                       
Units issued for cash from equity securities   -     -     1,100     -     -     -     -     -     -  
Units issued for consulting services   260,000     260     -     -     20,540     (20,800 )   -     -     -  
Units issued for cash from private placement   10,000,000     10,000     -     -     191,362     -     -     -     201,362  
Stock-based compensation - warrants   -     -     -     -     -     -     126,855     -     126,855  
Series A dividends issued   -     -     26     -     -     -     -     (32,956 )   (32,956 )
Series A dividends to be issued   -     -     23     -     -     -     -     (32,951 )   (32,951 )
Net loss   -     -     -     -     -     -     -     (2,679,186 )   (2,679,186 )
                                                       
Balance, December 31, 2012   86,733,750     109,512     1,149     -     5,979,271     -     -     (8,590,355 )   (2,501,572 )
                                                       
Series A dividends issued or to be issued   -     -     91     -     -     -     -     -     -  
Conversion of Series A shares   3,071,253     3,071     (125 )   -     192,404     -     -     -     195,475.00  
Units issued for cash from equity securities, net of costs   6,750,000     6,750     -     -     487,025     -     -     -     493,775  
Stock-based compensation - shares for consulting services   520,000     520     -     -     52,374     -     -     -     52,894  
Stock-based compensation - warrants   -     -     -     -     20,087     -     -     -     20,087  
Net loss   -     -     -     -     -     -     -     (3,080,500 )   (3,080,500 )
                                                       
Balance, December 31, 2013   97,075,003   $  119,853     1,115   $  -   $  6,731,161   $  -   $  -   $  (11,670,855 ) $  (4,819,841 )

See accompanying notes to consolidated financial statements.



VISCOUNT SYSTEMS, INC.
Consolidated Statements of Cash Flows
(Expressed in Canadian dollars)
Years Ended December 31, 2013 and 2012
 

    2013     2012  
             
Operating activities:            
 Net loss $  (3,080,500 ) $  (2,679,186 )
 Items not involving cash:            
     Depreciation and amortization   23,825     25,298  
     Initial loss on recognition of derivative instruments   113,647     925,742  
     Fair value adjustment of derivative liability   1,992,659     373,271  
     Stock-based compensation   72,981     126,855  
 Changes in non-cash working capital balances (note 13)   2,670     (92,847 )
           Net cash used in operating activities   (874,718 )   (1,320,867 )
             
             
Financing activities:            
 Proceeds from private placement   681,262     442,351  
 Proceeds from Series A Preferred shares, net   -     1,133,200  
 Repayment of short term loans payable   (40,366 )   (17,500 )
           Net cash provided by financing activities   640,896     1,558,051  
             
Increase (decrease) in cash   (233,822 )   237,184  
             
Cash and cash equivalents, beginning of year   406,506     169,322  
             
Cash and cash equivalents, end of year $  172,684   $  406,506  
             
             
Supplementary information:            
 Interest paid $  -   $  760  
 Income taxes paid $  -   $  -  

See accompanying notes to consolidated financial statements.



VISCOUNT SYSTEMS, INC.
Notes to Consolidated Financial Statements
(Expressed in Canadian dollars)
December 31, 2013
 

1.

Nature and continuance of operations

   

Viscount Systems Inc. (the “Company”) was incorporated on May 24, 2001 in the State of Nevada. The Company manufactures, distributes, and provides services for electronic premises access and security equipment primarily through its wholly owned Canadian subsidiary Viscount Communication and Control Systems Inc.

   

These 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 $11,670,855, reported a loss of $3,080,500 (2012 - $2,679,186). Cash flows used in operating activities for the year ended December 31, 2013 were $874,718 (2012 - $1,320,867). Although management is confident that the company can access sufficient working capital to maintain operations and ultimately generate positive cash flows from operations, the ability to sustain the current level of operations is dependent upon growing sales and achieving sustainable profits. Management has estimated that the Company will need to raise a minimum of $1,600,000 by way of new debt or equity financing to continue normal operations for the next twelve months. Management has been actively seeking new investors and developing new customer relationships and additional financing of US$750,000 (US$679,000 net of costs) has been completed during the first quarter of 2014. Short-term loan financing is anticipated from related parties; however, there is no certainty that loans or equity will be available when required. These factors raise substantial doubt about the ability of the Company to continue operations as a going concern. The consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or amounts of liabilities that might be necessary should the Company be unable to continue as a going concern.

   
2.

Significant accounting policies

   

These consolidated financial statements have been prepared in conformity with US Generally Accepted Accounting Principles (“GAAP”).

   

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”). Intercompany transactions and balances have been eliminated on consolidation.

     
  (b)

Use of estimates

     
 

Management has made a number of estimates and judgments relating to the reporting of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities in order to prepare these consolidated financial statements in conformity with GAAP. Significant areas involving estimate include 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 and derivative liabilities. Actual results could differ materially from those estimates.




VISCOUNT SYSTEMS, INC.
Notes to Consolidated Financial Statements
(Expressed in Canadian dollars)
December 31, 2013
 

2.

Significant accounting policies (cont’d…)

     
(c)

Foreign currency translation

     

The functional and reporting currency of the Company and its wholly-owned subsidiary is the Canadian dollar. Accordingly, the financial statements are presented in Canadian dollars unless otherwise specified. Monetary assets and liabilities denominated in a foreign currency are translated at the exchange rate in effect at the balance sheet date while non-monetary assets and liabilities denominated in a foreign currency are translated at historical rates. Revenue and expense items denominated in a foreign currency are translated at exchange rates prevailing when such items are recognized in the statement of operations and comprehensive loss. Exchange gains or losses arising on translation of foreign currency items are included in the statement of operations and comprehensive loss.

     
(d)

Allowance for doubtful accounts

     

The Company establishes an allowance for doubtful accounts on a specific account basis based on the credit risk of customers, historical trends and other information that management believes is indicative of future losses on accounts receivable.

     
(e)

Inventory

     

Raw materials, work in process and finished goods are stated at the lower of average cost and net realizable value. Cost includes direct labor utilized in assembly and an allocation of plant overhead.

     
(f)

Equipment

     

Equipment is stated at cost and depreciated over the estimated useful lives of the assets:


  Asset Basis Rate
       
  Computer equipment declining balance 30%
  Office furniture and equipment declining balance 20%

  (g)

Intangible assets

     
 

Intangible assets consist of intercom service agreements that are considered to have a finite useful life. They are recorded at cost and are reviewed annually for impairment. On April 1, 2005, the Company began amortizing the cost on a straight-line basis over an estimated useful life of 10 years.

     
  (h)

Impairment of long-lived assets

     
 

Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability is measured by a comparison of the carrying amount of an asset, or group of assets, to future net cash flows expected to be generated by the asset or group of assets. If such assets are considered to be impaired, an impairment provision is recorded for the amount by which the carrying amount of the assets exceeds fair value.




VISCOUNT SYSTEMS, INC.
Notes to Consolidated Financial Statements
(Expressed in Canadian dollars)
December 31, 2013
 

2.

Significant accounting policies (cont’d…)

     
(i)

Revenue recognition

     

Product revenue is recognized when there is persuasive evidence of a sale arrangement, delivery to the customer has occurred, the fee is fixed and determinable, and collectability is considered probable. Sales or transfers to customers prior to these criteria being met are recorded as deferred revenue. Revenue from the installation of equipment is recognized when the installation has been completed, the fee has been fixed and collectability is considered probable.

     

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, the service fee is fixed or determinable and collectability is probable. Cash received from customers, in advance of the service period, is recorded as deferred revenue.

     
(j)

Research and development costs

     

Research and development costs have been expensed as incurred. Research and development continues to be focused on enhancing the Freedom/MESH product line.

     
(k)

Derivative financial instruments

     

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 laibilities and derviative conversion options liabilities. Subsequent changes to the estimated fair values are recorded in the statement of operations and comprehensive loss. (Notes 8 and 9)

     
(l)

Income taxes

     

The Company follows the asset and liability method of accounting for income taxes. Under this method, deferred income taxes are recognized for the deferred income tax consequences attributable to differences between the financial statement carrying values of existing assets and liabilities and their respective income tax bases (temporary differences). Deferred income tax assets and liabilities are measured using enacted income tax rates expected to be recovered or settled. The effect on deferred income tax assets and liabiliites of a change in tax rates is included in income in the period in which the change occurs. The amount of deferred income tax assets recognized is limited to the amount that is more likely than not to be realized.

     
(m)

Net loss per share

     

Net 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.

     

For the year ended December 31, 2013 and 2012, shares attributable to the assumed exercise of outstanding options and shares attributable to the assumed exercise of outstanding warrants and convertible preferred shares were excluded from the calculation of diluted loss per share because the effect was antidilutive.

     
(n)

Stock-based compensation

     

The Company has adopted the fair value method of accounting for all stock-based compensation expense. Stock-based compensation expense is recognized in the consoldiated financial statements for granted, modified, or settled stock options and compensation warrants issued to employees for services.




VISCOUNT SYSTEMS, INC.
Notes to Consolidated Financial Statements
(Expressed in Canadian dollars)
December 31, 2013
 

2.

Significant accounting policies (cont’d…)

     
(o)

Comprehensive loss

     

The Company has no items of other comprehensive loss in any year presented. Therefore, net loss equals comprehensive loss.

     
(p)

Reclassfications

     

Certain amounts have been reclassifed in the comparative consolidated balance sheet to conform to the current year’s presentation.

     
(p)

Recently issued accounting pronouncements

     

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.

     
(q)

Cash and Cash Equivalents

     

Cash equivalents consist of cash on deposit and term deposits with original maturities of one year or less at the time of issuance. As at December 31, 2013, the Company held $31,900 (2012 - $31,900) in cash equivalents.

     
3.

Inventory


      2013     2012  
  Raw materials $  347,641   $  147,083  
  Work in process   43,177     15,100  
  Finished goods   141,980     185,795  
    $  532,798   $  347,978  

4.

Equipment


            Accumulated     Net book  
  2013   Cost     depreciation     value  
                     
  Computer equipment $  110,838   $  100,758   $  10,080  
  Office furniture and equipment   77,268     65,119     12,149  
                     
    $  188,106   $  165,877   $  22,229  

            Accumulated     Net book  
  2012   Cost     depreciation     value  
                     
  Computer equipment $  110,838   $  99,642   $  11,196  
  Office furniture and equipment   77,269     63,304     13,965  
                     
    $  188,107   $  162,946   $  25,161  



VISCOUNT SYSTEMS, INC.
Notes to Consolidated Financial Statements
(Expressed in Canadian dollars)
December 31, 2013
 

5.

Intangible assets

   

On May 16, 2003, the Company entered into an agreement for the purchase of certain assets of Telus Corporation (“Telus”). The assets comprised primarily of service agreements for a product sold by Telus known as “Enterphone 2000”. At December 31, 2003, the Company had acquired 2,215 service agreements for which it paid a total of $208,921. At December 31, 2013, the Company held 1,254 service agreements (2012 – 1,344) at a carrying cost, of $26,116 (2012 - $47,008), net of accumulated amortization of $182,805 (2012 - $161,913).

   

The expected amortization expense for each of the next two fiscal years is as follows:


  Year ending December 31, 2014 $  20,892  
  Year ending December 31, 2015 $  5,224  

6.

Short term loans payable

   

Amounts due to third parties totaled $114,536 for outstanding loans and advances (2012 - $154,902). These amounts are non-interest bearing, unsecured and have no fixed terms of repayment.

   
7.

Due to related parties

   

Amounts due to directors for director fees and travel expenses totaled $33,727 at December 31, 2013 (2012 - $7,468). These amounts are non-interest bearing, unsecured and have no fixed terms of repayment.

   
8.

Series A convertible redeemable preferred stock

   

On June 7, 2012, the Company completed the sale of 1,000 shares of Series A Convertible Redeemable Preferred Stock (“Series A shares”), par value US$0.001 per share and stated value of US$1,000 per share, for gross proceeeds of US$1,000,000. The Series A shares contain certain rights and preferences as follows:

  • convertible into shares of common stock of the Company at the rate of US$0.05 per common share or 85% of the previous twenty day volume weighted average pricing;
  • dividends of 8% per annum, payable in cash or Series A Shares quarterly;
  • voting and conversion rights of up to 4.99% of the outstanding common stock of the Company at the time of conversion per holder;
  • registration rights to the holders of the Series A Shares that may be exercised in certain circumstances;
  • holders of Series A Shares are entitled to be paid 125% of the stated value of the Series A Shares, plus all accrued, but unpaid dividends on Series A Shares, upon liquidation or dissolution of the Company, including forms of mergers and acquisitions, in priority to any payments to the holders of shares of common stock; and
  • the Series A Shares may be redeemed by the holders for 150% of their stated value, plus all accrued, but unpaid dividends on Series A Shares, upon the occurrence of a default, which includes performance conditions, delisting or late filing with the SEC.



VISCOUNT SYSTEMS, INC.
Notes to Consolidated Financial Statements
(Expressed in Canadian dollars)
December 31, 2013
 

8.

Series A convertible redeemable preferred stock (cont’d…)

   

In connection with the Series A share issuance, the Company also issued to the investors 12,285,012 shares purchase warrants, each exercisable into one common shares at US$0.065 per share for a period of 5 years. The Company paid a cash comission of US$100,000 and issued 2,457,002 Agents warrants. Each Agent warrant exercisable into one common share of the Company at US$0.05 per share for a period of 5 years. The warrants may be exercised on a cashless basis.

   

The cash proceeds from the Series A convertible preferred stock financing were $1,033,200. The proceeds from the financing were allocated first to the warrants that were issued in the financing and second, to the conversion option embedded in the instrument. As the assigned fair values were greater than the net cash proceeds from the transaction, the excess was treated as an “initial loss on recognition of derivative liability” for accounting purposes and is reported on the Company’s consolidated statement of operations and comprehensive loss for the year ended December 31, 2012. The calculation methodologies for the fair values of the derivative warrant liability and the derivative conversion option liability are described in Note 9 – Derivative Liabilities. The fair values assigned to each component and the calculation of the initial loss on recognition of derivative instruments are as follows:


  Net proceeds $  1,033,200  
  Derivative warrant liability – fair value   (696,928 )
  Derivative conversion option liability – fair value   (1,178,896 )
  Initial loss on recognition of derivative instruments $  (842,624 )

On October 19, 2012, the Company completed a sale of 100 Series A shares at a stated value of $1,000 per share for gross proceeds of $100,000 with the same rights and preferences.

In connection with the Series A share issuance, the Company also issued to the investors 1,000,000 share purchase warrants, each exercisable into one common share at US$0.065 per share for a period of 5 years. The company paid a cash commission of US$10,000 and issued 200,000 Agents warrants. Each Agent warrant is exercisable into one common share of the Company at US$0.05 per share for a period of 5 years. The warrants may be exercised on a cashless basis.

The cash proceeds from the Series A convertible preferred stock financing was $100,000. The proceeds from the financing were allocated first to the warrants that were issued in the financing and second, to the conversion option associated with the financing. As the assigned fair values were greater than the net cash proceeds from the transaction, the excess was treated as an “initial loss on recognition of derivative liability” for accounting purposes and is reported on the Company’s consolidated statement of operations and comprehensive loss for the year ended December 31, 2012. The calculation methodologies for the fair values of the derivative warrant liability and the derivative conversion option liability are described in Note 9 – Derivative Liabilities. The fair values assigned to each component and the calculation of the initial loss on recognition of derivative instruments are as follows:

  Net proceeds $  100,000  
  Derivative warrant liability – fair value   (68,245 )
  Derivative conversion option liability – fair value   (114,873 )
  Initial loss on recognition of derivative instruments $  (83,118 )



VISCOUNT SYSTEMS, INC.
Notes to Consolidated Financial Statements
(Expressed in Canadian dollars)
December 31, 2013
 

8.

Series A convertible redeemable preferred stock (cont’d…)

   

The above Series A shares preferred shares were first assessed under ASC 480, “Distinguishing Liabilities from Equity”, and determined that the contingent redemption provisions associated with the financial instruments made them more akin to debt. The Series A shares are deemed to be a debt host contract and accordingly the conversion option is subject to bifurcation and separate evaluation. The conversion option has been bifurcated and recorded at fair value at each reporting period, with the change in fair value recorded in the consolidated statement of operations and comprehensive loss. The share purchase warrants were further assessed under ASC 815, “Derivatives and Hedging”, and were determined to be derivative liabilities and recorded at their fair value at each reporting period, with the change in fair value recorded in the consolidated statement of operations and comprehensive loss.

   

On September 16, 2013 holders of 125 Series A shares elected to convert into 3,071,253 common shares at a conversion price of $0.0407. As a result, an amount of $195,475 was reallocated from derivative financial liabilities to equity.

   

During the year ended December 31, 2013, the Company issued 91 (2012 – 26) Series A Shares in settlement of dividends with a value of $113,647 (2012 - $65,907) which has been recorded in the statement of operations and comprehensive loss as an initial loss on recognition of derivative instruments. Of these, at December 31, 2013, there were 22 (2012 – 23) Series A Shares issuable in settlement of dividends which were subsequently issued with a value of $35,977 (2012 - $32,951).

   
9.

Derivative liabilities

   

Derivative financial liabilities consist of warrants and the conversion option associated with the Series A Shares (Note 8). The warrants have exercise prices denominated in United States dollars, which differs from the Company’s functional currency.

   

During the year ended December 31, 2012, the Company issued 1,100 Series A shares and a total of 15,942,014 share purchase warrants in connection with issuing the Series A shares and other private placement financings. The Series A shares were determined to be a debt host contract and the warrants are derivative liabilities as they are not indexed to the Company’s own equity in accordance with ASC 815.

   

The table below provides a summary of the changes in fair value, including net transfers, in and/or out, of financial liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during the year ended December 31, 2013:


      Derivative           Derivative        
      liability –     Derivative liability     liability – series        
      warrants     – conversion option     A dividends     Total  
  Balance, December 31, 2011 $  317,003   $  -   $  -   $  317,003  
  Preferred share conversion option   -     1,293,769     -     1,293,769  
  Preferred share dividends   -     -     32,956     32,956  
  Share purchase warrants issued   1,006,162     -     -     1,006,162  
  Total fair value adjustment   146,123     227,106     42     373,271  
  Balance, December 31, 2012   1,469,288     1,520,875     32,998     3,023,161  
  Preferred share dividends   -     -     112,079     112,079  
  Allocation to APIC   186,030     -     -     186,030  
  Conversion to common shares   -     (195,475 )   -     (195,475 )
  Total fair value adjustment   793,462     1,131,059     68,138     1,992,659  
  Balance, December 31, 2013 $  2,448,780   $  2,456,459   $  213,215   $  5,118,454  



VISCOUNT SYSTEMS, INC.
Notes to Consolidated Financial Statements
(Expressed in Canadian dollars)
December 31, 2013
 

9.

Derivative liabilities (cont’d…)

   

During the year ended December 31, 2013, the Company recognized a charge to operations of $1,992,659 (2012 – $373,271) being the change in the fair value of the derivative liability warrants, conversion option and dividends during the period.

   

The fair value of the warrants and dividends were determined using the Black-Scholes option pricing model and the conversion options were valued using the Binomial Lattice model using the following current market assumptions:


    December 31, 2013 December 31, 2012
  Volatility 92% - 186% 157% - 181%
  Dividend yield - -
  Risk-free interest rate 0.63% - 1.39% 0.36% - 0.77%
  Expected life 2.19 – 4.75 yrs 2.93 – 5.00 yrs

10.

Capital stock

   

On November 26, 2012, the Company completed a private placement of 10,000,000 units at a price of US$0.05 per unit, for gross proceeds of $496,350 (US$500,000). Each unit consisted of one common share and one-half share purchase warrant of the Company, with each whole warrant exercisable to acquire an additional share of the Company at a price of US$0.10 for a period of 5 years, expiring November 26, 2017. 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 US$0.05 per share for a period of 5 years from the closing date. The warrants may be exercised on a cashless basis.

   

Upon issuance of the units, $240,988 were allocated to the warrants and recorded as a derivative liability and the balance of $201,362, which is net of share issuance costs of $54,000, was allocated to common stock and additional paid-in capital. The fair value of the warrants was determined using the Black-Scholes option pricing model using the following assumptions; volatility of 178%; a dividend yield rate of 0%; a risk-free interest rate of 0.70% and an expected life of five years and allocated on a relative basis.

   

On May 21, 2013, the Company completed a private placement of 6,750,000 units at a price of US$0.10 per unit, for gross proceeds of US$675,000. Each unit consisted of one common share and one-half share purchase warrant of the Company, with each warrant exercisable to acquire an additional share of the Company at a price of US$0.20 for a period of 3 years, expiring May 17 and 21, 2016. In connection with the offering, the Company paid cash costs of $15,000 and issued share purchase warrants to acquire 675,000 shares of common stock of the Company at a price of US$0.20 per share for a period of 3 years from the closing date. The warrants may be exercised on a cashless basis.

   

Upon issuance of the units, $187,487 were allocated to the warrants and recorded as a derivative liability and the balance of $493,775, which is net of share issuance costs, was allocated to common stock and additional paid-in capital. The fair value of the warrants was determined using the Black- Scholes option pricing model using the following assumptions; volatility of 155%; a dividend yield rate of 0%; a risk-free interest rate of 0.40% and an expected life of three years and allocated on a relative basis.




VISCOUNT SYSTEMS, INC.
Notes to Consolidated Financial Statements
(Expressed in Canadian dollars)
December 31, 2013
 

10.

Capital stock (cont’d…)

   

On May 15, 2013, the Company issued 520,000 common shares in consideration for consulting services with a fair value of $52,894.

   

Stock Options:

   

All stock options granted are exerciseable in US$. A summary of the stock option activity is as follows:


      Weighted average
    Number of options exercise price
  Outstanding at December 31, 2011 9,748,125 US$0.06
  Expired/cancelled (1,541,280) US$0.12
  Outstanding at December 31, 2012 8,206,875 US$0.05
  Expired/cancelled (6,577,500) US$0.05
  Outstanding at December 31, 2013 1,629,375 US$0.08

A summary of the stock options outstanding and exercisable at December 31, 2013 is as follows:

      Weighted average Weighted average Aggregate
  Exercise Price Number remaining contractual life exercise price intrinsic value
           
  US$          0.04 65,625 1.97 years          US$          0.04 $    6,222
                   0.06 33,750 1.97 years 0.06 2,154
                   0.08 1,500,000 2.28 years 0.08 63,816
                   0.15 22,500 1.97 years 0.15 -
                   0.20 7,500 1.97 years 0.20 -
    1,629,375 2.26 years        US$          0.08 $  72,192

The aggregate intrinsic value in the preceding table represents the total Canadian dollar intrinsic value, based on the Company’s closing stock price of US$0.12 per share as of December 31, 2013, which would have been received by the option holders had they exercised their options as of that date. The total number of in-the-money options vested and exercisable as of December 31, 2013 was 1,599,375 (2012 – 6,206,250).

Warrants:

On June 22, 2011, the Company issued 2,500,000 warrants to a consultant in connection with a professional services agreement. These warrants have an exercise price of $0.15 and expire on June 22, 2014. The Company estimated the fair value of these warrants at grant to be $260,858 using the Black-Scholes option pricing model with the following assumptions: expected life of 3 years; volatility of 180%; risk-free interest rate of 2.24%; and a dividend rate of 0%. For the period ended December 31, 2013, the Company recorded stock-based compensation expense relating to these warrants of $nil (December 31, 2012 - $126,855).

On May 30, 2013, the Company issued 230,000 warrants to a consultant in connection with a advisory services agreement. These warrants have an exercise price of US$0.20 and expire on May 30, 2016. The Company estimated the fair value of these warrants at grant to be $20,087 using the Black-Scholes option pricing model with the following assumptions: expected life of 3 years; volatility of 157%; risk-free interest rate of 0.49%; and a dividend rate of 0%.



VISCOUNT SYSTEMS, INC.
Notes to Consolidated Financial Statements
(Expressed in Canadian dollars)
December 31, 2013
 

10.

Capital stock (cont’d…)

   

A summary of warrant activity during the years ended December 31, 2013 and 2012 is as follows:


        Weighted average  
    Number of warrants     exercise price  
  Outstanding at December 31, 2011   37,482,650   $  0.09  
  Issued as part of private placement   18,285,012     0.07  
  Issued as compensation to consultant   3,657,002     0.05  
  Expired   (5,032,650 )   0.05  
  Outstanding at December 31, 2012   54,392,014     0.08  
  Issued as part of private placement   4,050,000     0.20  
  Issued as compensation to consultant   230,000     0.20  
         
  Outstanding at December 31, 2013   58,672,014   $  0.09  

A summary of the warrants outstanding and exercisable at December 31, 2013 is as follows:

          Weighted Average
  Weighted Average Exercise Price   Number   Remaining Contractual Life
    US$ 0.080     2,499,999   1.93 years
    $ 0.080     9,500,001   1.93 years
    US$ 0.080     3,000,000   1.98 years
    $ 0.080     3,000,000   1.98 years
    US$ 0.080     3,600,000   2.17 years
    $ 0.080     7,350,000   2.17 years
    $ 0.150     2,500,000   0.47 years
    $ 0.010     1,000,000   0.93 years
    US$ 0.065     12,285,012   3.43 years
    US$ 0.050     2,457,002   3.43 years
    US$ 0.065     1,000,000   3.80 years
    US$ 0.050     200,000   3.80 years
    US$ 0.010     5,000,000   3.90 years
    US$ 0.050     1,000,000   3.90 years
    US$ 0.200     2,375,000   2.38 years
    US$ 0.200     675,000   2.39 years
    US$ 0.200     1,000,000   2.39 years
    US$ 0.200     230,000   2.41 years
    $ 0.09     58,672,014   2.70 years



VISCOUNT SYSTEMS, INC.
Notes to Consolidated Financial Statements
(Expressed in Canadian dollars)
December 31, 2013
 

11.

Income taxes

   

The provision for income taxes differs from the amount that would have resulted in applying the combined Canadian and United States statutory income tax rates as follows:


      Year ended     Year ended  
      December 31,     December 31,  
      2013     2012  
  Net loss before income tax $  (3,080,500 ) $  (2,916,853 )
  Statutory income tax rate   25.75%     25.0%  
  Expected income tax recovery at statutory income tax rate   (793,229 )   (669,797 )
  Non-deductible expenses and other items   493,400     235,106  
  Change in valuation allowance   299,829     434,691  
  Income tax expense $  -   $  -  

Temporary differences that give rise to the following deferred income tax assets are as follows:

      December 31, 2013     December 31, 2012  
  Equipment $  22,850   $  21,238  
  Intangible assets   24,470     20,703  
  Investment tax credits (non-refundable)   1,051,751     1,051,751  
  Losses   616,264     457,368  
  Research and development costs   791,797     663,771  
  Warranty provision   54,712     47,365  
      2,562,026     2,262,197  
  Valuation allowance   (2,562,026 )   (2,262,197 )
  Net deferred income tax assets $  -   $  -  

The Company has non-refundable federal investment tax credits of approximately $812,000 (2012 - $720,000) which will expire over a period up to 2033 and provincial investment tax credits of approximately $433,000 (2012 - $382,000), which will expire over a period up to 2023.

The Company has unutilized scientific research and development costs of $3,046,072 (2012 - $2,655,086) which may be available to reduce taxable income and income taxes payable in future years.

Management has determined that the realization of the potential deferred tax assets resulting from these tax pools and other temporary differences is uncertain at this time, and cannot be viewed as more likely than not. Accordingly, the Company has recorded a full valuation allowance for the potential deferred tax asset.

The Company files income tax returns in Canada and the United States of America. The Company’s Canadian income tax returns for 2007 through 2012 are open tax years. The Company’s United States tax returns are open from 2008 through 2012. The Company has reviewed its tax filings for these years to identify the existence of any uncertain tax positions that would require recognition in the Company’s financial statements. The Company may from time to time be assesed interest or penalties by tax filing jurisdictions, although any such assessments historically have been minimal and immaterial to the Company’s financial results.



VISCOUNT SYSTEMS, INC.
Notes to Consolidated Financial Statements
(Expressed in Canadian dollars)
December 31, 2013
 

12.

Commitments

   

The Company is committed to minimum annual payments for leases on its premises, automobiles, and office equipment as follows in each of the next five years:


  Year ending December 31, 2014 $  448,875  
  Year ending December 31, 2015 $  152,921  
  Year ending December 31, 2016 $  60,648  

Rent expense included in the statements of operations is $140,744 (2012 - $139,739).

The Company has an agreement with a consultant for business development, investor relations and strategic and financial services. As consideration, the Company compensates the consultant at $5,000 per month (subject to increase if funding is raised), and must pay commissions of 10% on funds raised. The agreement may be terminated by 30 days written notice. The commission arrangement shall extend for 12 months beyond termination.

On May 1, 2013, the Company entered into a one year consulting agreement with a consultant for business development and strategic initiatives. As consideration, the Company will compensate the consultant $6,500 per month.

On May 11, 2013, the Company entered into a one year consulting agreement with a consultant for business development and strategic initiatives. As consideration, the Company will compensate the consultant $6,500 per month, including all travel expenses and commission payments.

On May 24, 2013, the Company entered into a one year consulting agreement with a consultant for business development and strategic initiatives. As consideration, the Company will compensate the consultant $3,000 per quarter, and issued 230,000 warrants. These warrants have an exercise price of US$0.20 and expire on May 30, 2016.

13.

Changes in non-cash working capital balances


      2013     2012  
  Trade accounts receivable $  26,134   $  (213,475 )
  Inventory   (184,820 )   175,965  
  Accounts payable   103,825     (2,785 )
  Accrued liabilities   31,985     (33,962 )
  Deferred revenue   (713 )   (11,289 )
  Due to related parties   26,259     (7,301 )
    $  2,670   $  (92,847 )



VISCOUNT SYSTEMS, INC.
Notes to Consolidated Financial Statements
(Expressed in Canadian dollars)
December 31, 2013
 

14.

Segment information

     
(a)

Operating segments:

     

The Company organizes 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 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 described in Note 2. Management evaluates performance based on profit or loss from operations before income taxes and nonrecurring gains and losses, if any. Retail prices are used to report intersegment sales.


  2013   Manufacturing     Servicing     Total  
  Sales to external customers $  3,051,405   $  1,083,481   $  4,134,886  
  Depreciation and amortization   2,933     20,892     23,825  
  Segment income (loss) before other items   (1,306,229 )   331,714     (974,515 )
  Total assets $  1,314,254   $  26,116   $  1,340,370  

  2012   Manufacturing     Servicing     Total  
  Sales to external customers $  2,504,855   $  1,097,714   $  3,602,569  
  Depreciation and amortization   4,406     20,892     25,298  
  Interest expense   760     -     760  
  Segment income (loss) before other items   (1,525,390 )   145,943     (1,379,447 )
  Total assets $  1,392,324   $  47,008   $  1,439,332  

  (b)

Of the total sales for the year ended December 31, 2013, $502,155 (2012 - $405,860) was derived from U.S.-based customers and $3,632,731 (2012 - $3,196,709) 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 sales in either of the years presented.

     
  (d)

Products:

     
 

MESH sales represented 47.8% of total revenue during the twelve months ended December 31, 2013 (2012 – 56.0%). FREEDOM sales represented 24.0% of total revenue during the twelves months ended December 31, 2013 (2012 – 9.9%). 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 and servicing of intercom equipment.




VISCOUNT SYSTEMS, INC.
Notes to Consolidated Financial Statements
(Expressed in Canadian dollars)
December 31, 2013
 

15.

Financial instruments

   

The Company’s financial instruments include cash, trade accounts receivable, accounts payable, and amounts due to related parties. 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 Company’s financial instruments also include derivative liabilities which are measured at fair value and are impacted by changes in interest rates, foreign exchange rates and the price of the Company’s shares.

   

The fair values of all other financial instruments approximate their carrying values based on their liquidity and short-term nature.

   

The Company is subject to significant liquidity risk. At December 31, 2013, 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.

   
16.

Subsequent Events

   

On February 17, 2014, Mr. Stephen Pineau resigned as the President, Chief Executive Officer, Chief Financial Officer, and Corporate Secretary of the Company. The Company is currently in negotiations with Mr. Pineau regarding his severance package.

   

On February 17, 2014, Mr. Dennis Raefield was appointed as the President, Chief Executive Officer, Chairman, and Corporate Secretary of the Company. Mr. Raefield entered into an employment agreement with the Company pursuant to which he will receive an annual salary of US$175,000 and stock options equal to 3.99% of the Company’s balance issued and outstanding on a fully diluted basis.

   

On March 11, 2014, the Company completed a private placement of 8,333,329 shares of common stock at a price of US$0.09 per share for total proceeds of US$750,000. The Company also issued a total of 4,166,659 warrants, each warrant exercisable to acquire an additional share of the Company at an exercise price of US$0.20 per share for a period of five years from the closing date.

   

In connection with the offering, the Company paid a commission of US$71,000 in cash and issued share purchase warrants to acquire 788,888 shares of common stock of the Company at a price of US$0.09 per share for a period of five years from the closing date. The warrants may be exercised on a cashless basis.

   

In March, 2014, holders of 125 Series A shares elected to convert into 3,071,253 common shares at a conversion price of $0.0407.