VSYS Viscount Systems Inc (CE)

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

Results of Operations

Sales for the three months ended March 31, 2014 and 2013 were $936,873 and $828,320, respectively, an increase of $108,553 or 13.1% . Freedom sales for the three months ended March 31, 2014 and 2013 were $217,423 and $141,246, respectively, an increase of $76,177 or 53.9% . The bulk of this increase was the rapid growth of Freedom and Liberty sales which were just starting in 2013. MESH sales for the three months ended March 31, 2014 and 2013 were $403,340 and $427,267, respectively, a decrease of $23,927 or 5.6% . MESH sales have continued a slow decline due to the age of our low end product, and a lack of a mid-range product for the marketplace. Only our high end Mesh product is continuing to grow. 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.

For the three months ended March 31, 2014 and 2013, Freedom sales were 23.2% and 17.1%, respectively, of total sales. For the three months ended March 31, 2014 and 2013, MESH sales were 43.4% and 51.6%, respectively, of total sales.

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 1,242 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 three months ended March 31, 2014 and 2013, customer service contracts and new equipment sales generated aggregate sales revenues of $258,988 and $260,293, respectively, a decrease of $1,305 or 0.50% . These two periods comparative periods were consistent.

The intangible assets held by the Company are comprised primarily of service contracts for our Enterphone 2000 product line. The number of service agreements held by the Company was 1,242 at March 31, 2014, as compared to 1,330 at March 31, 2013. 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 March 31, 2014, the cost of the service agreements, net of accumulated amortization, was $20,893.

Cost of sales and services as a percentage of sales was 56.4% and 40.9% for the three months ended March 31, 2014 and 2013, respectively. Cost of sales increased due the inclusion of our Service Division cost, which was included in selling general and administration expenses in quarter ended March 31, 2013.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 three months ended March 31, 2014 and 2013 was $408,578 and $489,429, respectively, a decrease of $80,851 or 16.52% . This corresponds with increased sales and a reclassification of cost of sales for the three months ended March 31, 2014 as compared to three months ended March 31, 2013.

Selling, general and administrative expenses for the three months ended March 31, 2014 and 2013 were $810,146 and $706,813, respectively, an increase of $103,333 or 14.6% . For the three months ended March 31, 2014 and 2013, selling, general and administrative expenses, as a percentage of sales, were 86.5% and 85.3%, respectively. These percentages are consistent with the total selling, general and administrative expenses for the three months ended March 31, 2014 and 2013, respectively. Consulting fees for the three months ended March 31, 2014 and 2013 were $178,142 and $183,709, respectively, a decrease of $5,567 or 3.03% . Consulting fees remained consistent.

Research and development costs for the three months ended March 31, 2014 were $121,243. Government grants for the three months ended March 31, 2013 was $nil. The Company did not apply for a research grant during the first quarter ended March 31, 2014. Research and development costs for the three months ended March 31, 2013 were $104,666. Government grants for the three months ended March 31, 2013 totaled $71,502, resulting in net research and development costs of $33,164. Research and development costs have remained consistent for these two comparative periods.

Net loss for the three month period ended March 31, 2014 was $1,813,779, as compared to a net loss of $1,846,316 for the three month period ended March 31, 2013, a decreased loss of $32,537. During the three months ended March 31, 2014, expenses were controlled to maintain cash flow and to minimize the net loss. This number will change as include the derivative calculations.

Liquidity and Capital Resources

Cash as of March 31, 2014, as compared to December 31, 2013 was $1,986,952 and $172,684, respectively, an increase of $1,814,268. The Increase was mainly due to completing three private placements in March 2014, raising an aggregate of US$2,260,200.

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.

On March 11, 2014, Viscount Systems, Inc. completed a private placement of 8,333,329 shares of common stock at a price of $0.09 per share for total proceeds of $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 $0.20 per share for a period of five years from the closing date.

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

On March 27, 2014, Viscount Systems, Inc. completed a private placement of 16,502,220 shares of common stock at a price of $0.09 per share for total proceeds of $1,485,200. The Company also issued a total of 8,251,107 warrants, each warrant exercisable to acquire an additional share of the Company at an exercise price of $0.20 per share for a period of five years from the closing date.

On March 31, 2014, the Company issued an additional 277,778 shares of common stock at a price of $0.09 per share for total proceeds of $25,000. The Company also issued 138,888 warrants, each warrant exercisable to acquire an additional share of the Company at an exercise price of $0.20 per share for a period of five years from the closing date.

In connection with the offerings, the Company paid to a registered broker-dealer a commission of $35,604 in cash and share purchase warrants to acquire 395,599 shares of common stock of the Company at a price of $0.09 per share for a period of five years from the closing date. The warrants may be exercised on a cashless basis.

At March 31, 2014, the Company had a working capital of $2,106,221, as compared to working capital of $248,877 at December 31, 2013. Working capital had increased by $1,857,344. This increase was due to completing three private placements in March 2014, raising an aggregate of US$2,260,200. The current ratio at March 31, 2014 was 3.26, as compared with 1.24 at December 31, 2013.

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 $13,507,036, reported a loss for the three months ended March 31, 2014 of $1,813,779 and has working capital of $2,106,221 at March 31, 2014. Cash flows used in operating activities for the three months ended March 31, 2014 were $552,302. 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 not need to raise anymore capital to continue normal operations for the next twelve months. If working capital becomes insufficient, 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 hits its sales targets, the Company will have sufficient working capital for 2014. Management continues actively seeking new investors and developing customer relationships. These factors raise substantial doubt about the ability of the Company to continue operations as a going concern.

The accounts receivable turnover ratio was 46 days at March 31, 2014, 61 days at December 31, 2013 and 71 days at March 31, 2013. The outstanding term for our receivables has been decreasing due to more timely payments from a few slower paying customers. The accounts receivable reserve was $272,906 at March 31, 2014, as compared to $250,458 at December 31, 2013. The accounts receivable reserve has increased by $22,448 or 9.0%, since the year ended December 31, 2013. 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 March 31, 2014, the Company’s current assets consist principally of cash, 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 three months ended March 31, 2014, there were no 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 product. There can be no assurance that additional financing will be available on acceptable terms, if at all. If adequate funds are not available, the Company may be unable to develop or enhance its products, take advantage of future opportunities, respond to competitive pressures, and may have to curtail operations.

There are no legal or practical restrictions on the ability to transfer funds between parent and subsidiary companies.

The Company does not have any material commitments for capital expenditures as of March 31, 2014.

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

During the period ended March 31, 2014 a total of US $10,000 was paid to related parties for Director fees. An additional US $36,963 was paid to related parties as consulting fees during the period.

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 increased its provision for obsolete inventory by approximately $100,000 during the first quarter of 2014, 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.