FIBER OPTIC SYSTEMS TECHNOLOGY, INC. CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2010

Transcription

1 CONSOLIDATED FINANCIAL STATEMENTS

2 CONSOLIDATED FINANCIAL STATEMENTS CONTENTS Page Independent Auditor s Report 1 Consolidated balance sheet 2 Consolidated statements of operations, comprehensive loss and deficit 3 Consolidated statements of cash flow 4 Notes to the consolidated financial statements 5-29

3 Deloitte & Touche LLP 5140 Yonge Street Suite 1700 Toronto ON M2N 6L7 Canada Independent Auditor s Report Tel: Fax: To the Shareholders of Fiber Optic Systems Technology, Inc.: We have audited the accompanying consolidated financial statements of Fiber Optic Systems Technology, Inc. which comprise the consolidated balance sheet as at December 31, 2010 and the consolidated statements of operations, comprehensive loss and deficit and cash flows for the period from April 28, 2010 (date of incorporation) to December 31, 2010, and a summary of significant accounting policies and other explanatory information. Management's Responsibility for the Consolidated Financial Statements Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with Canadian generally accepted accounting principles, and for such internal control as management determines is necessary to enable the preparation of consolidated financial statements that are free from material misstatement, whether due to fraud or error. Auditor's Responsibility Our responsibility is to express an opinion on these consolidated financial statements based on our audit. We conducted our audit in accordance with Canadian generally accepted auditing standards. Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditor's judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity's preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity's internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that the audit evidence we have obtained in our audit is sufficient and appropriate to provide a basis for our audit opinion. Opinion In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of Fiber Optic Systems Technology, Inc., as at December 31, 2010 and the results of its operations and its cash flow for the period from April 28, 2010 (date of incorporation) to December 31, 2010 in accordance with Canadian generally accepted accounting principles. Chartered Accountants Licensed Public Accountants Toronto, Ontario May 1,

4 CONSOLIDATED BALANCE SHEET AS AT DECEMBER 31 (expressed in thousands of Canadian dollars) ASSETS Current Cash and cash equivalents (note 5) 1,089 Accounts receivable 1,198 Inventory (note 6) 445 Deferred costs 64 Tax credits receivable (note 4) 137 Prepaid expenses and other assets 176 Total current assets 3,109 Capital and intangible assets (note 7) 215 Goodwill (note 2) 2,327 5,651 LIABILITIES Current Bank indebtedness (note 11) 84 Accounts payable and accrued liabilities 825 Due to related party (note 16) 975 Deferred revenue 102 Current portion of long-term debt (note 12) 20 Convertible debentures (note 10) 237 Total current liabilities 2,243 Long term debt (note 12) 23 Total liabilities 2,266 Commitments and contingencies (note 13) SHAREHOLDERS' EQUITY Share capital (note 8 (a)) 2,630 Warrants (note 8(b)) 845 Contributed surplus (note 8 (d)) 352 Deficit (442) 3,385 5,651 Approved by the board: (signed) "Gerry Feldman" (signed) "Allen Lone" Director Director The accompanying notes are an integral part of these consolidated financial statements - 2 -

5 CONSOLIDATED STATEMENT OF OPERATIONS, COMPREHENSIVE LOSS AND DEFICIT FOR THE PERIOD APRIL 28, 2010 (DATE OF INCORPORATION) TO (expressed in thousands of Canadian dollars) Revenues (note 15) 1,681 Cost of sales 1,263 Gross profit 418 Expenses Engineering 74 Selling 59 General and administrative 316 Amortization 19 Foreign exchange loss 8 Total operating expenses 476 Loss before under noted items (58) Other expenses Interest and accretion interest (94) Stock based compensation (Note 8(c)) (290) Net loss and comprehensive loss for the period (442) Deficit, beginning of period Deficit, end of period - (442) Basic and diluted weighted average loss per share (note 9) 0.00 Basic and diluted weighted average number of common shares outstanding 111,645 The accompanying notes are an integral part of these consolidated financial statements - 3 -

6 CONSOLIDATED STATEMENT OF CASH FLOW FOR THE PERIOD APRIL 28, 2010 (DATE OF INCORPORATION) TO (expressed in thousands except per share amounts) Cash used in operations: Net loss for the period (442) Add items not involving cash Amortization of capital assets 19 Convertible debenture accretion (note 10) 82 Provision for allowance for doubtful accounts (note 17) 20 Stock based compensation (note 8(c)) 290 (31) Net changes in non-cash working capital accounts (note 19) (1,240) Cash used in operating activities (1,271) Financing activities: Proceeds from issuance of common shares and warrants(note 8) 1,401 Financing costs related to the issuance of common shares (note 8) (73) Bank indebtedness (437) Long-term debt repayments (8) 883 Investing activities: Cash acquired from the Fox Tek RTO transaction ( note 2) 125 Cash acquired from the Marcon transaction (note 2) 1,375 Purchase of equipment (23) 1,477 Net increase in cash and cash equivalents for the period 1,089 Cash and cash equivalents beginning of period - Cash and cash equivalents end of period (note 5) 1,089 Supplemental cash flow information Operating activities Cash interest paid 9 The accompanying notes are an integral part of these consolidated financial statements - 4 -

7 1. NATURE OF OPERATIONS Fiber Optic Systems Technology, Inc. (the Company or Fox Tek ) incorporated on October 13, 1999 under the laws of the State of Delaware,was formed to develop, integrate and sell fiber optic sensing systems for the rapidly expanding strain/temperature sensing market. The target market includes the monitoring, communication, alarming and prediction of safe/unsafe conditions in structures and facilities. Marcon International Inc. ( Marcon ), a wholly-owned subsidiary of Fox Tek, is in the business of selling equipment to foreign multinational companies operating primarily in the Middle East and to the United States government. The equipment is purchased from various suppliers in Canada, the United States and Europe. Marcon was incorporated under the laws of the Province of Ontario on April 28, On August 1, 2010, Marcon entered into an Asset Purchase Agreement with Knoxbridge Corp ( Knoxbridge ), whereby Knoxbridge transferred certain net assets, to Marcon in exchange for shares and debt. The Asset Purchase Agreement also resulted in the transfer of all the shares of Marcon International (USA), Inc. and Marcon International (UK) Ltd to Marcon. The net assets and transactions within two entities were not material. On September 24, 2010, the Company completed a reverse take-over transaction ( RTO ) with Marcon. The Company issued 91,815 common shares from treasury to Marcon s sole shareholder, Knoxbridge, in exchange for all of Marcon s outstanding shares. Although legally, the Company is regarded as the parent, Marcon, whose shareholder holds approximately 55.67% of the voting shares of the Company after the reverse takeover, is treated as the acquirer. Consequently, the Company is deemed to have been acquired by Marcon in consideration for the issuance of the shares of the Company

8 2. ACQUISTIONS AND GOODWILL Reverse take-over of Fox Tek A summary of the estimated fair value of the assets and liabilities acquired at the date of acquisition, as a result of the reverse takeover transaction (note 1) are as follows: Assets acquired: Cash 125 Accounts receivable 83 Inventory 346 Due from related party 113 Taxes receivable 40 Prepaid expenses 42 Capital assets 174 Goodwill 2,327 Total assets acquired 3,250 Less: Liabilities assumed Accounts payable (325) Accrued liabilities (136) Deferred revenue (30) Convertible debenture (Debt Portion) (155) Convertible debenture (Equity portion) (120) Convertible debenture (Warrants portion) (107) Warrants (274) Stock options (62) Net assets acquired 2,041 Consideration consisted of: Transaction costs 445 Common shares (91,815 common shares of Fiber Optic Systems Technology, Inc.) 1,596 2,041 The acquisition of the Company constitutes an acquisition of a business and has been accounted for under the purchase method of accounting. The shares issued to Knoxbridge are subject to escrow requirements imposed by the TSX Venture Exchange. The goodwill of 2,722 has been allocated to the Fox-Tek business segment (note 15)

9 2. ACQUISTIONS AND GOODWILL (continued) Acquisition of the net assets of Knoxbridge by Marcon On August 1, 2010, Marcon entered into an Asset Purchase Agreement with Knoxbridge, whereby Knoxbridge transferred certain net assets, to Marcon in exchange for 73,398 shares and debt of 965. This transaction has been recorded in the consolidated financial statements at the carrying amounts of the net assets transferred due to the fact that the consideration included issuance of debt and as all of the companies involved in the Asset Purchase Agreement transaction were companies under common control. The Asset Purchase Agreement also resulted in the transfer of all the shares of Marcon International (USA), Inc. and Marcon International (UK) Ltd to Marcon. The net assets and transactions within two entities were not material. A summary of the combined assets and liabilities transferred are as follows: Assets acquired 2,244 Liabilities acquired 1,279 Net asset acquired 965 Included in assets acquired is 1,375 in cash and cash equivalents. 3. SIGNIFICANT ACCOUNTING POLICIES Basis of consolidation The consolidated financial statements have been prepared in accordance with Canadian generally accepted accounting principles and include the accounts of the Company and its wholly-owned subsidiaries, Fiber Optic Systems Technology (Canada), Inc, Fiber Optic Systems Technology (U.S.A.), Inc., Fox-Tek Canada, Inc., PinPoint FOX-TEK Inc., Marcon International Inc., Marcon International (USA) Inc., and Marcon International (UK) Ltd. All inter-company accounts and transactions have been eliminated. The consolidated statement of operations includes the operations of the Company from September 24, 2010 to December 31, 2010 and includes the operations of Marcon from April 28, 2010 to December 31,

10 3. SIGNIFICANT ACCOUNTING POLICIES (continued) Use of estimates The preparation of financial statements in conformity with Canadian generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts that are reported in the consolidated financial statements and accompanying note disclosures. Although these estimates and assumptions are based on management s best knowledge of current events, actual results may be different from the estimates. Estimates and assumptions are used when accounting for items such as the allowance for doubtful accounts, useful life of capital assets, allowance for inventory obsolescence, assumptions embodied in the valuation of long-lived assets, impairment of goodwill, stock-based compensation, valuation allowances against future income tax assets, valuation of warrants, valuation of convertible debentures, purchase price fair value and recognition of contingencies. Foreign currency translation All the subsidiaries are considered financially and operationally integrated, monetary assets and liabilities denominated in foreign currencies are translated into Canadian dollars at the exchange rate in effect at the balance sheet date, and non-monetary assets and liabilities denominated in foreign currencies are translated into Canadian dollars at historical exchange rates. Revenues and expenses denominated in foreign currencies are translated into Canadian dollars at the average exchange rate for the period except for amortization, which is translated at historical exchange rates. Foreign exchange gains and losses on translation are included in the consolidated statement of operations in the period in which they occur. Cash and cash equivalents Short-term investments, consisting of highly rated and liquid money market instruments with original maturities of three months or less, are considered to be cash equivalents. Financial instruments classification Financial assets and financial liabilities are initially recognized at fair value and their subsequent measurement is dependent on their classification as described below. Their classification depends on the purpose for which the financial instruments were acquired or issued, their characteristics and the Company s designation of such instruments. Settlement date accounting is used

11 3. SIGNIFICANT ACCOUNTING POLICIES (continued) Financial instruments classification (continued) Asset/Liability Classification Measurement Cash and cash equivalents Held for trading Fair value Accounts receivable Loans and receivables Amortized cost Bank indebtedness Other liabilities Amortized cost Accounts payable and accrued liabilities Other liabilities Amortized cost Due to related party Other liabilities Amortized cost Convertible debenture Other liabilities Amortized cost Long-term debt Other liabilities Amortized cost Held for trading Held for trading financial assets are financial assets typically acquired for resale prior to maturity or that are designated as held for trading. They are measured at fair value at the balance sheet date. Fair value fluctuations including interest earned, interest accrued, gains and losses realized on disposal and unrealized gains and losses are included in expenses, and amounted to nil for the period ended December 31, Financial liabilities designated as held for trading are those non-derivative financial liabilities that the Company elects to designate on initial recognition as instruments that it will measure at fair value through interest and fees on loans. These are accounted for in the same manner as held for trading assets. The Company has not designated any non-derivative financial liabilities as held for trading. Loans and receivables Loans and receivables are accounted for at amortized cost using the effective interest method. Other liabilities Other liabilities are recorded at amortized cost using the effective interest method and include all financial liabilities, other than derivative instruments

12 3. SIGNIFICANT ACCOUNTING POLICIES (continued) Effective interest method The Company uses the effective interest method to recognize interest income or expense which includes transaction costs or fees, premiums or discounts earned or incurred for financial instruments. Financial instruments Fair value of financial instruments The Company's financial instruments include cash and cash equivalents, accounts receivable, bank indebtedness, accounts payable and accrued liabilities, due to related party and convertible debentures approximate book values because of their short-term maturities. Fair value hierarchy Financial instruments recorded at fair value on the Balance Sheet are classified using a fair value hierarchy that reflects the significance of the inputs used in making the measurements. The fair value hierarchy has the following levels: Level 1 valuation based on quoted prices (unadjusted) in active markets for identical assets or liabilities; Level 2 valuation techniques based on inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly (i.e., as prices) or indirectly (i.e., derived from prices); Level 3 valuation techniques using inputs for the asset or liability that are not based on observable market data (unobservable inputs). The fair value hierarchy requires the use of observable market inputs whenever such inputs exist. A financial instrument is classified to the lowest level of the hierarchy for which a significant input has been considered in measuring fair value. As at December 31, 2010 cash equivalents were classified as Level 1 using the fair value hierarchy. Inventory Inventory consists of raw materials used in the manufacturing of fiber optics sensing systems, work in process and finished goods. Inventory is recorded at the lower of cost and net realizable value, where cost is determined on a weighted average basis

13 3. SIGNIFICANT ACCOUNTING POLICIES (continued) Capital assets Capital assets are recorded at cost. Amortization is provided using the following methods at rates intended to amortize the cost of the assets over their estimated useful lives. The annual rates are as follows: Method Rate Automobile declining balance 30% Computer hardware declining balance 30% Scientific equipment declining balance 30% Office equipment declining balance 20% Computer software declining balance 50% 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. Impairment is assessed by comparing the carrying amount of an asset with its expected future net undiscounted cash flows from use together with its residual value. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds their net recoverable value. Goodwill Goodwill represents the excess of the price paid over the fair value attributed to the net assets, acquired including tangible and identifiable intangible assets, upon acquisition of a business. Goodwill resulting from the acquisition of a business is not amortized but tested for impairment annually or more frequently if changes in circumstances indicate a potential impairment. The Company has elected to perform its annual impairment test as at October 1. The impairment test for goodwill is a two-step process. Step one consists of a comparison of the fair value of a reporting unit with its carrying amount, including the goodwill allocated to the reporting unit. Measurement of the fair value is based on the present value of estimated future cash flows. In estimating the fair value of the reporting unit, the Company is also required to make a number of assumptions, including estimates about future revenue, income taxes, net earnings, overhead costs, capital expenditures, and the cost of capital. Given the variability of the future-oriented financial information, a sensitivity analysis of the goodwill impairment test is performed by varying the discount and growth rates to enable management to conclude whether or not the goodwill balance has been impaired. If the carrying amount of the reporting unit exceeds the fair value, step two requires the fair value of the reporting unit to be allocated to the underlying assets and liabilities of that reporting unit, resulting in an implied fair value of goodwill. If the carrying amount of the reporting unit s goodwill exceeds its implied fair value, an impairment loss equal to the excess of carrying value over fair value is recorded in the statement of operations

14 3. SIGNIFICANT ACCOUNTING POLICIES (continued) Revenue recognition The Company recognizes revenue when it is realized and earned. The Company considers revenue realized or realizable and earned when the product has been delivered or the services have been provided to the customer, the sale price is fixed or determinable and collectability is reasonably assured. In addition to this general policy, the following paragraphs describe the specific revenue recognition policies for each major category of revenue. Equipment Revenues from the sale of equipment is recognized when there is evidence that an arrangement exists, the products have been shipped to the customer, in accordance with the terms of the contract, when significant risks and rewards relating to ownership are transferred. Equipment and installations Revenues from the sale of equipment and installations are recognized when title is transferred to the customer, installation has been completed and all significant contractual obligations that affect the customer s final acceptance have been fulfilled. Data analysis reports Revenue from this service is recognized on a monthly basis when the data analysis report is provided. In instances where the Company bills the customer prior to performing the data analysis report, the prepayment amount is recorded as deferred revenue. Multiple-element arrangements The Company enters into transactions that represent multiple-element arrangements which may include any combination of equipment, installation and data analysis. These multiple-element arrangements are assessed to determine whether they can be separated into more than one unit of accounting or element for the purpose of revenue recognition. When the appropriate criteria for separating revenue into more than one unit of accounting is met and there is vendor specific objective evidence of fair value for all units of accounting or elements in an arrangement, the arrangement consideration is allocated to the separate units of accounting or elements based on each unit s relative fair value. This vendor specific objective evidence of fair value is established through prices charged for each revenue element when that element is sold separately. The revenue recognition policies described above are then applied to each unit of accounting. If the criteria of separate units of accounting are not met, revenue is deferred until such criteria are met or until the period when the last undelivered element is delivered

15 3. SIGNIFICANT ACCOUNTING POLICIES (continued) Income taxes The Company follows the liability method of accounting for income taxes, whereby future income tax assets and liabilities are recognized at substantively enacted rates for the difference between the tax bases of assets and liabilities and the carrying amounts in the consolidated financial statements. Future income tax assets are recognized when it is more likely than not that the Company will realize these assets. The effect of a change in income tax rates on future income tax assets and future income tax liabilities is recognized in the consolidated statement of loss in the period the change occurs. Valuation allowances are established when necessary to reduce future income tax assets to the amounts expected to be realized. Tax credit receivable Government assistance and tax credits relating to qualifying expenditures, to the extent that there is reasonable assurance of realization, are accounted for using the cost reduction method, whereby the government assistance and tax credits recorded as reductions against the related expenses or the carrying value of the related assets. Tax credits are subject to audit by the tax authorities and any adjustments that may result could reduce the tax credit recorded. For the period ended December 31, of eligible investment tax credits were recorded as a reduction in general and administrative expense. Stock-based compensation The Company has an Employee Stock Option Plan, which is described in note 8(c). The company uses the fair value method to measure stock based compensation expense at the date of grant of stock options to employees, officers and directors. The fair value of options is determined using the Black-Scholes option pricing model and is amortized to operations over the vesting period with an offset to contributed surplus. When options are exercised, the corresponding contributed surplus and the proceeds received by the Company are added to share capital. The Company accounts for the forfeiture of stock options as they occur. Research and development Research costs are expensed as incurred. Development costs are also expensed as incurred unless technical and market viability of a development project has been established. No development costs have been deferred to date

16 3. SIGNIFICANT ACCOUNTING POLICIES (continued) Basic and diluted loss per share Basic loss per share is computed using the weighted average number of common shares outstanding during the year. Diluted loss per share is computed using the weighted average number of common and common share equivalent outstanding during the period using the treasury stock method. Common share equivalent consist of the incremental common shares issuable upon the exercise of stock options and warrants and are excluded from the computation if their effect is anti-dilutive. 4. FUTURE ACCOUNTING POLICIES International Financial Reporting Standards The Canadian Accounting Standards Board has determined that profit-oriented publicly accountable enterprises will be required to adopt International Financial Reporting Standards ( IFRS ). IFRS will replace current Canadian generally accepted accounting principles for those enterprises. The Company will adopt IFRS effective for interim and annual periods commencing January 1, CASH AND CASH EQUIVALENTS Cash and cash equivalents consist of the following: 2010 Cash 124 Cash equivalents 965 1, INVENTORY 2010 Raw materials 122 Work in process 28 Finished goods During the period inventory recognized as a cost of sale was 1,

17 7. CAPITAL AND INTANGIBLE ASSETS December 31, 2010 Accumulated Net book Cost amortization value Capital assets Automobile Computer hardware Scientific equipment Office equipment Intangible assets Computer software TOTAL SHAREHOLDERS EQUITY a) Share capital Authorized: 180,000 shares of voting common stock, par value of US0.01 per share. Issued and outstanding: Common Stock # of Shares Balance at date of RTO 48,932 21,653 Share capital eliminated on RTO - (21,653) Shares issued is escrow pursuant to RTO (i) 91,815 1,596 Share issued as transaction cost for RTO (i) Equity portion of convertible debenture (iii) Share issued on private placement (ii) 23,348 1,401 Share issuance costs (ii) - (73) Allocation of warrants issued on private placement (b) (iii) - (464) Balance at December 31, ,928 2,

18 8. SHAREHOLDERS EQUITY (continued) i. On September 24, 2010, the Company completed a reverse take-over transaction and issued 91,815 common shares from treasury to Marcon s sole shareholder Knoxbridge in exchange for all of Marcon s outstanding shares for a consideration of 1,596 (note 2). Total transaction costs include the issuance of 833 common shares as a transaction cost valued at 50. ii. Subsequent to the closing of the RTO, the Company completed a brokered private placement of 23,348 units at a price of 0.06 per unit for gross proceeds of 1,401. Each unit consisted of one common share of the Company and one common share purchase warrant, with each warrant entitling the holder to acquire an additional one common share of the Company for a price of Each common share purchase warrant has an exercise price of 0.15 for the first two years and 0.20 for the third year from the date of closing. Total share issuance cost was 73, inclusive of 37 of share issuance cost allocated to the common share purchase warrants. iii. As at the date of the RTO the fair value of the conversion option was estimated to be 120 (see note 10). The fair value of the conversion option was determined using the Black-Scholes option price model assuming an expected life of 0.62 years, annualized volatility of 107%, a nil dividend payment rate and a risk free rate of 1.1%. b) Common stock purchase warrants: Warrants # Balance, April 28, Warrant outstanding at date of RTO (i) 5, Issued on convertible debenture (ii) 4, Issued on private placement (iii) 24, Balance, December 31, , i. As of the date of the RTO (note 2) the warrants outstanding were 5,207 with an exercise price of 0.10, expiring March 5, The fair value of the warrants were estimated as at the date of the RTO using the Black-Scholes option pricing model assuming an expected life of 2.45 years, annualized volatility of 107%, a nil dividend payment rate and a risk free rate of 1.59%

19 8. SHAREHOLDERS EQUITY (continued) b) Common stock purchase warrants: (continued) ii. The fair value of warrants issued as part of the convertible debenture financing was estimated by management to be 107 (note 2). Management as allocated 107 to the warrants valued using the Black-Scholes option pricing model assuming an expected life of 0.62 years, annualized volatility of 107%, nil dividend payment rate and a risk free rate of 1.1%. iii. The fair value of warrants issued on the private placement was estimated to be 464 (inclusive of 37 of share issue costs). The fair value was determined using the Black- Scholes option pricing model assuming an expected life of 3 years, annualized volatility of 107%, a nil dividend payment rate and a risk free rate of 1.70%. The 24,494 warrants issued include 23,348 issued to the participants in the private placement and 1,146 issued to the Broker as transaction cost (note 8(a)(ii). c) Stock option plans: The Company has a stock option plan open to directors, officers, full-time employees and consultants of the Company. Under this plan, the Company may grant total options to a maximum of 10% of the issued and outstanding common shares of the Company on a nondiluted basis. A summary of the Company s stock option plan is presented below: December 31, 2010 Number Weighted of average Changes to stock options: options exercise price Options outstanding as of the RTO (note 3 and note 8(d)) 2, Granted 11, Forfeited (10) 0.10 Expired (987) 1.01 Ending balance 12, Exercisable 4, At December 31, 2010 the range of exercise prices of the outstanding options were as follows:

20 8. SHAREHOLDERS EQUITY (continued) Options outstanding Options exercisable Weighted average Weighted Weighted remaining average average Number contractual exercise Number exercise Range of exercise prices outstanding life years price outstanding price , , The Company issued 11,250 stock options under the 2010 Stock Option Plan, of these, 3,750 vested in The fair value at the date of grant was 643 or 0.06 per option granted. The fair value was estimated using the Black-Scholes pricing model assuming a risk free interest rate of 1.56%, dividend yield of 0%, expected life of 3 years and a volatility factor using a weighted average of similar proxy companies and the Company s market price over the period of the Company s traded stock of 107%. d) Contributed surplus: The following is a continuity of the contributed surplus: 2010 Balance at date of RTO 62 Stock based compensation expense recognized in the period (note 8(c)) 290 Balance, December 31, As of the date of the RTO, the vested stock options outstanding were 2,178. The fair value of the options were estimated at the date of the RTO at a value of 62 using the Black-Scholes option pricing model assuming an expected life of 3 years, annualized volatility of 107%, a nil dividend payment rate and a risk free rate of 1.28%

21 9. LOSS PER SHARE Basic loss per share for the period ended December 31, 2010 is calculated based on the weighted average number of shares of 164,928 outstanding during the period. Diluted and basic loss per share are the same, as the conversion of warrants and options is anti-dilutive. 10. CONVERTIBLE DEBENTURES Amount Convertible debentures 365 Fair value of conversion option at the date of RTO (note 8(a)(iii)) (120) Fair value of detachable warrants (note 8(b)(ii)) (107) Interest owing as at date of RTO 17 Interest accretion 82 Total 237 The Company completed a non-brokered private placement of secured convertible debentures of 365 with 4,056 detachable warrants on May 7, The debentures bear interest at a rate of 12% per annum payable in cash at maturity. Each warrant entitles the holder to purchase one common share at 0.10 for a period of 12 months from the closing date of the offering. All or any part of the principal of the debenture can be converted into common shares by the holder prior to maturity. The debentures will mature on the earlier of one year from the date of issuance or the completion of an equity financing with gross proceeds to the Company in excess of 1,500. The debentures are secured by a first charge on the assets the Company. As of the date of the RTO the fair value of the convertible debentures was estimated using the residual method after allocating the fair value of the attached warrants and conversion option of 155. Interest accretion for the period was 82 and was calculated using the effective interest rate method

22 11. BANK INDEBTEDNESS Dec 31, 2010 Line of credit line - prime plus 1.3% due on demand, guaranteed by a shareholder 65 Demand loan - prime plus 2.45%, due July 2012, repayable in monthly instalments of principal of 1, plus interest, guaranteed by a shareholder The line of credit and the demand loan are secured by a general security agreement covering all assets of Marcon. At December 31, 2010, the Company had unutilized credit capacity under line of credit of 535. Principal repayments on the demand loan are 11 in 2011 and 8 in LONG-TERM DEBT Dec 31, 2010 Loan payable % floating base rate plus 2%, due February 2013, repayable in monthly instalments of principal of 1.5 plus interest, guaranteed 43 by the controlling shareholder Less: current portion Principal payments required in each of the next three years are as follows: During the period the Company was in breach of a non-financial loan covenant for which the bank has provided a waiver

23 13. COMMITMENTS AND CONTINGENCIES The Company is committed under operating lease agreements for the rental of its premises. Minimum annual future lease payments are approximately as follows: Total INCOME TAXES As of December 31, 2010, the Company has incurred cumulative non-capital losses in Canada totalling 2,572 and in the United States totalling 13,538 which expire between 2020 and These losses may be used to reduce taxable income in future taxation years. The tax-effected temporary differences on future income tax assets are as follows: 2010 Income tax losses 6,125 Less: valuation allowance (6,125) Total NIL

24 14. INCOME TAXES (continued) The income tax expense differs from the amount calculated by applying Canadian income tax rates (Federal and Provincial) of 31.0%, to earnings before income taxes as follows: 2010 Loss before income taxes 442 Expected income tax recovery 137 Provincial tax rate difference 3 US tax rate differential 29 Non-recognition of future benefit of losses (192) Other 23 Total NIL Due to the bankruptcy of Fiber Optic Systems Technology (Canada), Inc. a subsidiary, all tax losses of that subsidiary will be permanently impaired where an absolute order of discharge is granted in respect of the corporation. These losses cannot be used to reduce taxable income in future taxation years and are excluded from the determination of tax-effected temporary differences on future income tax assets as shown above. The RTO of the Company as described in notes 1 and 3 of these financial statements triggered an acquisition of control for taxation purposes. As a result, the non-capital losses are restricted in its application to reduce taxable income in future taxation years. 15. SEGMENTED INFORMATION The Company s reportable segments are strategic business units that offer different services and/or products. They are managed separately because each segment requires different strategies and involves different aspects of management expertise. The accounting policies of the segments are the same as those described in the summary of significant accounting policies. The Company carries out its operations through wholly-owned entities. These entities are located in Canada and the United States

25 15. SEGMENTED INFORMATION (continued) For the period from April 28, 2010 to December 31, 2010 Marcon Fox tek Corporate (thousands of dollars) Operations Operations Operations Total Revenue 1, ,681 Cost of sales 1, ,263 Gross profit Expenses Engineering Selling General and administrative Amortization Foreign exchange loss Income (loss) before under noted items (96) 38 - (58) Other expenses Interest (6) (6) (82) (94) Stock based compensation (87) (126) (77) (290) Segment loss (189) (94) (159) (442) Capital Assets and Intangibles 2010 Marcon Fox tek Total Total Assets 1,432 4,614 6,046 Captial and intangible assets Goodwill - 2,722 2,722 All of the Company s capital assets are located in Canada

26 15. SEGMENTED INFORMATION (continued) Revenue by geographic region is detailed as follows: 2010 USA 1,144 Canada 423 Middle East 112 Others 2 Total 1,681 For the period ended December 31, 2010 a customer accounted for 66% of the Company s revenue stream. 16. RELATED PARTY TRANSACTIONS At December 31, 2010, 965 note payable is due to Knoxbridge and was issued as part of the consideration for the transfer of assets to Marcon as described in note 1 and 2 was due to a related party. The note payable is unsecured, non-interest bearing, due on demand, and there are no fixed repayment terms. It is a monetary item measured at the exchange amount. During the period Fox Tek has also purchased office furniture worth 16 from Knoxbridge, a company controlled by the controlling shareholder. These transactions are in the normal course of operations and have been valued in these financial statements at the exchange amount. Amount owing to Knoxbridge at December 31, 2010 is summarized below. These transactions were monetary transactions in the normal course of operations and measured at the exchange amount. A breakdown of these transactions is as follows: 2010 Other transactions (10) Due to related party (10)

27 17. FINANCIAL RISK MANAGEMENT The Company has exposure to counterparty credit risk, liquidity risk and market risk associated with its financial assets and liabilities. The Board of Directors has overall responsibility for the establishment and oversight of the Company s risk management framework. The Board of Directors has established the Audit Committee which is responsible for developing and monitoring the Company s compliance with risk management policies and procedures. The Audit Committee regularly reports to the Board of Directors on its activities. The Company s risk management program seeks to minimize potential adverse effects on the Company s financial performance and ultimately shareholder value. The Company manages its risks and risk exposures through a combination of insurance, a system of internal and disclosure controls, and sound business practices. The Company s financial instruments and the nature of the risks which these instruments may be subject to are set out in the following table. Risks Market Foreign Interest Credit Liquidity exchange rate Cash and cash equivalents Yes Yes Yes Accounts receivable Yes Yes Bank Indebtedness Yes Accounts payable and accrued liabilities Yes Yes Due to related party Yes Yes Convertible debenture Yes Long-term debt Yes Yes Credit risk Credit risk arises from cash held with banks and credit exposure to customers, including outstanding accounts receivables. The maximum exposure to credit risk is equal to the carrying value (net of allowances) of the financial assets. The objective of managing counterparty credit risk is to prevent losses on financial assets. The Company assesses the credit quality of counterparties, taking into account their financial position, past experience and other factors. For many new international clients, the Company demands that equipment costs are prepaid prior to shipment

28 17. FINANCIAL RISK MANAGEMENT (continued) Cash and cash equivalents Cash and cash equivalents consist of bank balances and short-term investments with original maturities of three month or less. Credit risk associated with cash and cash equivalents is minimized substantially by ensuring that these financial assets are invested in debt instruments of highly rated financial institutions. As at December 31, 2010, the Company had cash and cash equivalents consisting of cash on hand and deposits with banks of 124 and investments in securities with financial institutions with terms to maturity of less than three months of 965. As at December 31, 2010, the Company does not expect any counterparties to fail to meet their obligations. Accounts receivable Accounts receivable consists primarily of trade accounts receivable from equipment, installation and reporting services. The Company s credit risk arises from the possibility that a counterparty which owes the Company money is unable or unwilling to meet its obligations in accordance with the terms and conditions in the contracts with the Company, which would result in a financial loss to the Company. This risk is mitigated through established credit management techniques, including monitoring counterparty creditworthiness, setting exposure limits and monitoring exposure against these customer credit limits. The carrying amount of accounts receivable are reduced through the use of an allowance for doubtful accounts and the amount of the loss is recognized in the statement of operations in other expenses. When a receivable balance is considered uncollectible, it is written off against the allowance for accounts receivable. Subsequent recoveries of amounts previously written off reduce other expenses in the statement of operations. Historically, trade credit losses have been minimal. The following table outlines the details of the aging of the Company s receivables and related allowance for doubtful accounts as at December 31, 2010: 2010 Current receivable 866 Over 30 days 352 Allowance for doubtful accounts (20) 1,

29 17. FINANCIAL RISK MANAGEMENT (continued) The following table outlines the details of the allowance for doubtful accounts of the Company s receivables as at December 31, 2010: 2010 Opening balance in period (3) Recovered in period - Increase in reserve in period (17) Closing balance December 31, 2010 (20) (a) Liquidity risk Liquidity risk is the risk that the Company will not be able to meet its financial obligations as they fall due. The Company maintains a strong liquidity and working capital position to meet its obligations as they come due. The following table details the Company s contractual maturities for its financial liabilities and operating lease commitments, as at December 31, 2010: Total Bank Indebtedness Accounts payable and accrued liabilities Operating lease commitments Due to related party Long-term debt Convertible debenture , ,594 Market risk Market risk is the risk that changes in market prices, such as foreign exchange rates and interest rates will affect the fair value of recognized assets and liabilities or future cash flows or the Company s results of operations. To contend with changes in market prices, the Company constantly reviews its current and planned expenditures to ensure it has adequate resources to continue operations. The Company primarily sells goods in Canada and the United States and attempts to limit its exposure by transacting in the local currency and therefore limiting exposure to foreign exchange rates

30 17. FINANCIAL RISK MANAGEMENT (continued) Foreign exchange The Company operates primarily in Canada and the United States. The functional currency of the parent company is the Canadian dollar and the reporting currency is Canadian dollars. As at December 31, 2010, the Company s US-dollar net monetary assets totalled approximately US535. Accordingly a 5% change in the US dollar exchange rate as at December 31, 2010 on this amount would have resulted in an exchange gain or loss and therefore net loss would have increased (decreased) by 27. Interest rate The Company has cash and cash equivalent balances which are exposed to interest rate fluctuations. As at December 31, 2010, cash and cash equivalents net of bank indebtedness and long-term debt totals 962. An increase of 100 basis points in the market interest rate would have on average, increased net income by approximately 10, (a 100 basis point decrease would have had the equal but opposite effect) for the period ended December 31, CAPITAL MANAGEMENT The Company manages the capital structure and makes adjustments to it in the light of changes in economic conditions and the risk characteristics of the underlying assets. In order to maintain or adjust the capital structure, the Company may issue new shares or purchase and cancel shares previously issued. The Company considers its capital to include shareholders equity and long term debt. The Company s objectives when managing capital are to safeguard the Company s ability to continue as a going concern, so that it can provide returns for shareholders and benefits for other stakeholders. The Company is not subject to any statutory capital requirements and has no commitments, other than options and warrants, to sell or otherwise issue common shares. Management reviews its capital management approach on an ongoing basis and believes that this approach, given the relative size of the Company, is reasonable

31 19. CONSOLIDATED STATEMENTS OF CASH FLOWS The consolidated statement of cash flow includes the following changes in non-cash working capital balances related to operations: 2010 Accounts receivable (514) Prepaid expenses and other assets (79) Inventory (60) Tax credit receivable (137) Accounts payable and accrued liabilities (450) Net change in non-cash working capital balances related to operations (1,240) 20. COMPREHENSIVE LOSS The Company is required to report comprehensive loss and its components in the financial statements. The Company has no other comprehensive loss components and, accordingly, the Company s net loss equals comprehensive loss