LOREX TECHNOLOGY INC.

Transcription

1 Consolidated Financial Statements (Expressed in thousands of U.S. dollars) LOREX TECHNOLOGY INC.

2 KPMG LLP Telephone (416) Chartered Accountants Fax (416) Bay Adelaide Centre Internet Bay Street Suite 4600 Toronto ON M5H 2S5 Canada INDEPENDENT AUDITORS' REPORT To the Shareholders of LOREX Technology Inc. We have audited the accompanying consolidated financial statements of LOREX Technology Inc., which comprise the consolidated balance sheets as at September 30, 2011 and 2010, the consolidated statements of operations and comprehensive income, shareholders' equity and cash flows for the years then ended, and notes, comprising 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. Auditors' Responsibility Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits 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 our 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, we consider 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 audits 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 consolidated financial position of LOREX Technology Inc. as at September 30, 2011 and 2010, and its consolidated results of operations and its consolidated cash flows for the years then ended in accordance with Canadian generally accepted accounting principles. Chartered Accountants, Licensed Public Accountants January 23, 2012 Toronto, Canada KPMG LLP is a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. KPMG Canada provides services to KPMG LLP.

3 Consolidated Balance Sheets (Expressed in thousands of U.S. dollars) September 30, 2011 and 2010 Assets (Note 1(m)) Current assets: Cash $ 995 $ 192 Accounts receivable 8,374 6,653 Inventory (note 3) 17,153 10,500 Prepaid expenses and deposits 1,414 1,769 Current portion of deferred financing costs (note 6) Future income taxes (note 11) 1, ,619 19,582 Capital assets (note 4) Intangible assets (note 5) Future income taxes (note 11) Deferred financing costs (note 6) Goodwill Liabilities and Shareholders' Equity $ 30,945 $ 21,445 Current liabilities: Bank indebtedness (note 6) $ 4,168 $ 2,724 Accounts payable and accrued liabilities 11,356 8,412 Current portion of long-term debt (note 7) ,671 11,136 Long-term debt (note 7) 94 Shareholders' equity: Capital stock (note 8) 15,055 11,272 Contributed surplus 1,513 1,223 Accumulated other comprehensive income (loss) (2,250) 1,593 Retained earnings (deficit) 862 (3,779) 15,180 10,309 Commitments (note 17) Subsequent events (notes 6 and 18) $ 30,945 $ 21,445 See accompanying notes to consolidated financial statements. On behalf of the Board: Director Director 1

4 Consolidated Statements of Operations and Comprehensive Income (Expressed in thousands of U.S. dollars, except per share information) Revenue $ 62,662 $ 46,767 Cost of sales 40,174 29,928 Gross profit 22,488 16,839 Expenses: Marketing, selling and operations 11,759 9,145 Administration (note 13) 3,568 2,601 Research and development (note 10) 1,229 1,068 Interest Amortization Gain on foreign exchange (36) (1) 16,992 13,409 Earnings before income taxes 5,496 3,430 Income taxes (recovery) (note 11): Current 1, Future (404) (659) 855 (546) Net earnings 4,641 3,976 Other comprehensive income (note 1(b)): Unrealized gains on foreign currency translation of self-sustaining operations 94 Comprehensive income $ 4,641 $ 4,070 Earnings per share (note 12): Basic $ 0.15 $ 0.13 Diluted See accompanying notes to consolidated financial statements. 2

5 Consolidated Statements of Shareholders' Equity (Expressed in thousands of U.S. dollars) Accumulated Class B Convertible Total other Retained Common preferred preferred capital Contributed comprehensive earnings shares shares shares (i) stock surplus income (loss) (deficit) Total Balance, September 30, 2009 $ 9,641 $ 105 $ 1,119 $ 10,865 $ 1,329 $ 1,499 $ (7,754) $ 5,939 Net earnings 3,975 3,975 Unrealized gains on foreign currency translation of self-sustaining operations Comprehensive income 94 3,975 4,069 Stock-based compensation expense (note 9) Options forfeited (116) (116) Common shares issued (note 8) Balance, September 30, , ,119 11,272 1,223 1,593 (3,779) 10,309 Change in functional currency (note 1(b)) 3, , (3,843) Balance, October 1, , ,165 15,022 1,316 (2,250) (3,779) 10,309 Net earnings 4,641 4,641 Stock-based compensation expense (note 9) Exercise of stock options (note 8) Conversion of preferred shares (note 8) 335 (335) Balance, September 30, 2011 $ 14,079 $ 146 $ 830 $ 15,055 $ 1,513 $ (2,250) $ 862 $ 15,180 (i) Subscription receipts were issued on August 20, 2009 and the related shares were issued on October 27, See accompanying notes to consolidated financial statements. 3

6 Consolidated Statements of Cash Flows (Expressed in thousands of U.S. dollars) Cash provided by (used in): Operating activities: Net earnings $ 4,641 $ 3,976 Items not involving cash: Amortization of capital and intangible assets Stock-based compensation expense (recovery) 197 (106) Future income taxes (404) (659) Deferred financing costs 92 (209) Change in non-cash operating working capital: Accounts receivable (1,721) 138 Inventory (6,653) (1,992) Prepaid expenses and deposits 355 (942) Accounts payable and accrued liabilities 2,944 2,488 (350) 2,901 Financing activities: Net increase (decrease) in bank indebtedness (note 6) 1,444 (3,438) Exercise of stock options (note 8) Proceeds from long-term debt incurred (note 7) 432 Payments of long-term debt (191) 1,718 (3,031) Investing activities: Purchase of capital and intangible assets (565) (18) Effect of foreign currency translation on cash balances 25 Increase (decrease) in cash 803 (123) Cash, beginning of year Cash, end of year $ 995 $ 192 Supplemental cash flow information: Interest paid $ 164 $ 220 Income taxes paid See accompanying notes to consolidated financial statements. 4

7 Notes to Consolidated Financial Statements LOREX Technology Inc. ("LOREX" or the "Company") (TSXV:LOX) provides businesses and consumers with leading edge video surveillance security solutions and sells its products under the LOREX and Digimerge brands. The LOREX brand, which caters to both small business and consumer markets, is available in thousands of retail locations across North America and in the United Kingdom. The Digimerge division distributes its products through major distributors in North America. Both brands concentrate on the sale of wired, wireless and IP security surveillance and monitoring equipment, including cameras, digital video recorders and all-in-one systems. 1. Significant accounting policies: (a) Basis of consolidation: The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries: LOREX Canada Inc. (an Ontario corporation), LOREX Corporation (a Delaware corporation) and Strategic Vista Corporation Limited (a Hong Kong corporation). On March 1, 2010, the Company amalgamated its then subsidiary, Digimerge Technologies Inc., with LOREX Canada Inc. The business activities of both legal entities continue within the amalgamated subsidiary, LOREX Canada Inc. In the second quarter of 2010, the Company dissolved two subsidiaries: XBL Solutions Inc. and Strategic Vista Direct, Inc. Intercompany transactions and balances are eliminated on consolidation. (b) Foreign currency translation: The Company uses the U.S. dollar as its reporting currency for preparation of its consolidated financial statements. At September 30, 2010, the U.S. dollar was the functional currency for two of the Company's subsidiaries and the Canadian dollar was the functional currency for LOREX and its Canadian subsidiary, LOREX Canada lnc. Effective October 1, 2010, the functional currency of LOREX and its subsidiary, LOREX Canada lnc. was changed from the Canadian dollar to the U.S. dollar. This change is the result of the Company no longer relying on Canadian dollar financing and the continuing increase in U.S.-denominated transactions in these Canadian entities, and the expectation that this increase will continue in future periods. Prior to October 1, 2010, the equity accounts of LOREX were translated into U.S dollars using historic exchange rates for reporting purposes. Due to the change in functional currency, these equity accounts are now translated into U.S. dollars using the October 1, 2010 exchange rate. The impact of this change is an increase in share capital of $3,750, an increase in contributed surplus of $93 and a decrease in accumulated other comprehensive income ("AOCI") of $3,843. Unrealized foreign exchange gains (losses) arising on the translation of non-u.s. dollar revenue, expenses, assets and liabilities are included in earnings in the year in which they occur. 5

8 1. Significant accounting policies (continued): Prior to this change in functional currency, the U.S. dollar was the functional currency of certain of the Company's subsidiaries, LOREX Corporation and Strategic Vista Corporation Limited. For other subsidiaries that were considered fully-integrated foreign operations up to the date of amalgamation or dissolution, non-canadian dollar monetary assets and liabilities were translated into Canadian dollars at the rate of exchange prevailing as at the consolidated balance sheet dates, while non-monetary assets and liabilities were translated at historical rates of exchange. Revenue and expenses were translated into Canadian dollars at the rate in effect at the date of transaction. Realized and unrealized foreign exchange gains and losses were included in earnings for the year in which they occurred. (c) Inventory: Inventory is stated at the lower of cost and net realizable value. Cost is determined on a weighted average basis. The Company performs a quarterly assessment of its inventory value, taking into consideration factors, such as future demand for the inventory, expected new product introductions, competitive pressures and numerous other factors. A change to these assumptions could impact the valuation of inventory and have a resulting impact on margins. (d) Capital and intangible assets: Capital and intangible assets are stated at cost. Amortization is calculated on a straight-line basis, not to exceed the estimated useful life, over the following terms: Property, plant and equipment: Furnishings and equipment Computer hardware and software Leasehold improvements Product development: Tooling Intangible assets: Management information system Website Patents, trademarks and licenses Purchased trademarks 3 years 3 years 3 years 3 years 5 years 3 years 3 years 5 years 6

9 1. Significant accounting policies (continued): (e) Impairment of long-lived assets: The Company conducts its impairment test on long-lived assets, including capital and intangible assets, when events or changes in circumstances indicate that the carrying amount may not be recoverable. Management reviews the carrying value of the assets and considers whether an impairment charge should be recorded. The review is based on the assessment of the Company's intended use and projected estimated undiscounted cash flows expected from the underlying assets. Any impairment amount is measured as the amount by which the carrying amount of the asset exceeds its fair value, calculated using discounted cash flows when quoted market prices are not available. (f) Goodwill: Goodwill is the residual amount that results when the purchase price of an acquired business exceeds the sum of the amounts allocated to the assets acquired, less liabilities assumed, based on their fair values. Goodwill is not amortized and is tested for impairment annually, at the reporting unit level, or more frequently, if events or changes in circumstances indicate that the asset might be impaired. The impairment test is carried out in two steps. In the first step, the carrying amount of the reporting unit is compared with its fair value. When the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered not to be impaired and the second step of the impairment test is unnecessary. The second step is carried out when the carrying amount of a reporting unit exceeds its fair value, in which case, the implied fair value of a reporting unit's goodwill is compared with its carrying amount to measure the amount of the impairment loss, if any. The implied fair value of goodwill is determined in the same manner as the value of goodwill is determined in a business combination, using the fair value of the reporting unit as if it was the purchase price. When the carrying amount of reporting unit goodwill exceeds the implied fair value of the goodwill, an impairment loss is recognized in an amount equal to the excess and is presented as a separate line in the consolidated statements of operations and comprehensive income. The Company conducted its annual goodwill assessments in the fourth quarter of fiscal 2011 and 2010 and concluded there was no impairment in the recorded value of the goodwill. 7

10 1. Significant accounting policies (continued): (g) Research and development costs: Research costs are expensed as incurred. Development costs are expensed as incurred unless the development project is for a technically feasible product that management intends to produce and market, the intended market for the product is clearly defined and adequate resources exist to complete the project. Deferred development costs will be amortized on a straight-line basis over a three-year period commencing with commercial production or use of the products under development. (h) Stock-based compensation: The Company accounts for stock option payments using the fair value method. Under the fair value method, stock-based payments are measured at the fair value of equity instruments determined using the Black-Scholes option pricing model and are amortized over the vesting period. The offset to the determined cost is recorded in contributed surplus. (i) Revenue recognition: The Company earns all of its revenue from the sale of products to its customers. Revenue is recognized when title passes to customers, which is generally at the time goods are received by the customer, and when there is reasonable assurance of the consideration that will be received, taking into account the extent to which goods may be returned. Cash discounts, volume discounts and certain marketing programs provided to customers are deducted from revenue when it is recognized. (j) Income taxes: The Company provides for income taxes using the asset and liability method of accounting for income taxes. Under this method, future income tax assets and liabilities are determined based on differences between financial statement values and tax values of assets and liabilities and are measured using substantively enacted income tax rates and laws expected to be in effect when the differences are expected to reverse. The effect on future income tax assets and liabilities of a change in income tax rate is recognized in income tax expense when enacted or substantively enacted. The Company establishes a valuation allowance against future income tax assets if, based on available information, it is more likely than not that some or all of the future income tax assets will not be realized. 8

11 1. Significant accounting policies (continued): (k) Earnings per share: Basic earnings per share is calculated using the weighted average number of common shares outstanding during the year. The computation of diluted earnings per share assumes the basic weighted average number of shares outstanding during the year is increased to include the number of additional common shares that would have been outstanding if the potentially dilutive common shares had been issued. The dilutive effect of warrants, Class B preferred shares, convertible preferred shares and stock options is determined using the treasury stock method. (l) Use of estimates: The preparation of the consolidated financial statements requires management to make estimates and assumptions that affect the amounts and disclosures made in the consolidated financial statements and accompanying notes. Significant estimates are used in determining, but are not limited to, the allowance for doubtful accounts, provision for returns, inventory valuation, income tax valuation allowances, the useful lives and valuation of capital and intangible assets and product development and the fair value of the reporting units for purposes of goodwill impairment. Actual results could differ from those estimates. (m) Comparative figures: Certain 2010 figures have been reclassified to conform with the financial statements presentation adopted in

12 2. Recent Canadian accounting pronouncements: (a) Consolidated financial statements: In October 2008, The Canadian Institute of Chartered Accountants ("CICA") issued Section 1582, Business Combinations ("Section 1582"), concurrently with Section 1601, Consolidated Financial Statements ("Section 1601"), and Section 1602, Non-Controlling Interests ("Section 1602"). Section 1582, which replaces Section 1581, Business Combinations, establishes standards for the measurement of a business combination and the recognition and measurement of assets acquired and liabilities assumed. Section 1601, which replaces Section 1600, carries forward the existing guidance on aspects of the preparation of consolidated financial statements subsequent to acquisition other than non-controlling interests. Section 1602 establishes guidance for the treatment of non-controlling interests subsequent to acquisition through a business combination. These new standards are effective for fiscal years beginning on or after January 1, 2011 with earlier adoption permitted. (b) International financial reporting standards: In February 2008, the CICA announced that Canadian public companies will be required to prepare their financial statements in accordance with International Financial Reporting Standards ("IFRS") for fiscal years beginning on or after January 1, The Company will issue its financial statements for the first quarter of fiscal 2012 in accordance with IFRS, including comparative data for fiscal Inventory: Goods on hand $ 14,390 $ 6,755 Goods in transit 2,763 3,745 $ 17,153 $ 10,500 The Company makes routine assessments to ensure that all inventory is recorded at the lower of cost and net realizable value and, in 2011, recorded in its cost of sales an amount of $757 ( $438) in relation to amounts for certain items determined to exceed their net realizable value. 10

13 4. Capital assets: Accumulated Net book 2011 Cost amortization value Property, plant and equipment: Furnishings and equipment $ 233 $ 183 $ 50 Computer hardware and software Leasehold improvements Product development: Tooling $ 1,314 $ 1,037 $ 277 Accumulated Net book 2010 Cost amortization value Property, plant and equipment: Furnishings and equipment $ 222 $ 135 $ 87 Computer hardware and software Leasehold improvements Product development: Tooling $ 1,296 $ 1,105 $ Intangible assets: Accumulated Net book 2011 Cost amortization value Management information system $ 308 $ 49 $ 259 Website (note 17) Patents, trademarks and licenses 6 6 Purchased trademarks $ 591 $ 309 $

14 5. Intangible assets (continued): Accumulated Net book 2010 Cost amortization value Patents, trademarks and licenses $ 6 $ 5 $ 1 Purchased trademarks $ 260 $ 258 $ 2 6. Bank indebtedness: In October 2011, the Company negotiated an amendment to the Credit Facility, which increased availability to $15,000 from $10,000. The Company's credit facility (the "Credit Facility") bears interest at the U.S. floating base rate plus 1.75% for loan balances denominated in U.S. dollars or the Canadian floating prime rate plus 1.75% for loan balances denominated in Canadian dollars. The Credit Facility has a three-year term expiring on December 21, The credit line is secured by the accounts receivable and inventory of the Company's subsidiaries. The amount available for borrowing under the Credit Facility is subject to certain financial and non-financial covenants, as defined by the agreement. The Credit Facility imposes a debt covenant, which consists of a quarterly minimum fixed charge coverage ratio, as well as a covenant on capital expenditures in any fiscal year. The Company was in compliance with the covenants at September 30, At September 30, 2011, the Company had $4,168 outstanding under the Credit Facility ( $2,515) and $400 ( nil) in letters of credit outstanding. The Company incurred $277 of financing fees associated with the new credit facility and recorded it as deferred financing costs to be amortized over the term of the facility. $160 ( $68) of this total was amortized at September 30, During 2010, the Company also amortized approximately $77 of deferred financing fees related to a former credit facility. For the year ended September 30, 2011, the weighted average interest rate on the Company's borrowings was 5.1% ( %). 12

15 6. Bank indebtedness (continued): The Company, as at October 1, 2009, was in default on both of its credit facilities under its loan agreement. These credit facilities were refinanced on December 22, 2009 with a new lender. The Company used the proceeds of the new loan to repay its old credit facilities outstanding of $4,200,000 and incurred a prepayment fee of $260,000. In relation to the credit facilities entered into during 2007, the Company issued 500,000 warrants at a strike price of Cdn. $ to the lender with a fair value at the time of issuance of $105,567. The fair value of the warrants was recorded to contributed surplus. As a result of the replacement of the facility on December 22, 2009, the unexercised warrants expired on January 21, Long-term debt: Long-term debt relates to the Company's installation of a new management information system and computer equipment as follows: Capital lease obligation in connection with computer equipment, bearing interest at 7.7%, requiring blended monthly payments of Cdn. $1 to November 2014 $ 42 $ Capital lease obligation in connection with software license fee and implementation services, requiring an initial payment of Cdn. $73 and monthly principal payments thereafter of Cdn. $9 plus interest to November Capital lease obligation in connection with computer equipment, bearing interest at 2.5%, requiring blended monthly payments of Cdn. $3 to August Less amounts due within one year 147 $ 94 $ 13

16 7. Long-term debt (continued): Principal payments on the long-term debt are due as follows: $ $ Capital stock: (note 1(b)) Authorized: 200,000 Class A preferred shares with an 8% cumulative dividend accruing from January 1, 1998, redeemable at the option of the Company at $1 per share 150,000 Class B preferred shares with an 8% cumulative dividend accruing from January 1, 1998, redeemable at the option of the Company at $1 per share 12,500,000 convertible preferred shares, convertible by the holder into common shares on a one-to-one ratio Unlimited common shares Issued: 150,000 Class B preferred shares $ 146 $ 105 8,759,990 convertible preferred shares ( ,500,000) 816 1,119 35,130,288 common shares ( ,290,278) 14,093 10,048 $ 15,055 $ 11,272 No dividends have been declared or paid on the common shares, convertible preferred shares or Class B preferred shares. At September 30, 2011, there was $159 (Cdn. $165) ( $149 (Cdn. $153)) in unpaid cumulative dividends on the Class B preferred shares. These dividends must be paid before any dividends are declared or paid on the convertible preferred shares or the common shares. 14

17 8. Capital stock (continued): As a result of the change in functional currency, as described in note 1(b), common shares increased by $3,663, Class B shares increased by $41 and convertible preferred shares increased by $46. On August 20, 2009, the Company issued subscription receipts for 12,500,000 convertible preferred shares. The related convertible preferred shares were issued on October 27, The convertible preferred shares are convertible by the holder into common shares of the Company on a one-to-one basis and rank senior to the common shares of the Company, the non-voting Class A preferred shares and the non-voting Class B preferred shares with respect to a distribution of the Company's assets upon dissolution or wind-up of the Company and otherwise have the same voting and dividend rights as the common shares. In August 2011, 3,740,010 convertible preferred shares were converted into common shares on a one-to-one basis, resulting in $335 being reallocated from convertible preferred shares to common shares. During 2011, 100,000 common shares were issued upon the exercise of stock options for cash proceeds of $33. On October 7, 2009, the Company raised an additional $407, net of issue costs, for working capital needs by issuing 4,336,195 common shares at Cdn. $0.10 per share. 9. Stock-based compensation: The Company's 1999 and 2007 stock option plans have been established for the benefit of the members of the Board of Directors, officers, full-time employees and consultants of the Company and its subsidiaries. The Company has set aside an aggregate of 6,500,000 common shares for issuance arising from the exercise of options under these plans. The exercise price of each option is determined by the Board of Directors but shall not be less than the closing market price on the last trading day prior to the grant date. New options issued under the current plan vest over a period determined by the Board of Directors but shall not exceed 10 years. ln September 2011, the Company granted a total of 1,190,000 stock options to a number of its directors, officers and employees. Each such option is exercisable into one common share within a period of five years from the date of grant at an exercise price of Cdn. $0.55. All of these options vested immediately. 15

18 9. Stock-based compensation (continued): The fair value of the stock options granted in September 2011 was determined to be $197 using the Black-Scholes option pricing model based on the following assumptions: risk-free interest rate %; expected life - 5 years; expected volatility - 40%: and expected dividends - nil. Due to the immediate vesting of the options, the Company recognized an expense of $197 during the year ended September 30, A summary of the status of the Company's stock option plans as at and for the years ended September 30, 2011 and 2010 is presented below: Weighted Weighted average average exercise exercise Options price (Cdn.) Options price (Cdn.) Outstanding, beginning of year 1,354,500 $ ,714,500 $ Exercised (100,000) Forfeited (25,000) (1,360,000) Granted 1,190, Outstanding, end of year 2,419, ,354, Options exercisable, end of year 2,419,500 $ ,322,836 $ The following table summarizes information about stock options outstanding as at September 30, 2011: Options outstanding Options exercisable Weighted average Weighted Weighted remaining average average Number contractual exercise Number exercise Exercise price (Cdn.) outstanding life (years) price (Cdn.) exercisable price (Cdn.) $ , $ ,500 $ $ , , $ ,190, ,190,

19 10. Research and development: Labour $ 1,064 $ 1,001 Materials Subcontractors' costs $ 1,229 $ 1, Income taxes: Income taxes based on Canadian statutory tax rate of 28.75% ( %) $ 1,571 $ 1,089 Effect on recovery attributable to the following items: Benefit of loss carryforwards previously unrecognized (119) (1,211) Foreign operations subject to different tax rates 300 (9) Impact of tax rate changes and other adjustments (226) (205) Permanent items 85 (5) Change in valuation allowance excluding loss carryforwards (756) (205) Income taxes (recovery) $ 855 $ (546) Future income taxes are recognized for future consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their tax basis. 17

20 11. Income taxes (continued): Future income tax assets and liabilities consist of the following as at September 30: Future income tax assets: Current: Provision for returns $ 619 $ 240 Inventory reserve Other ,609 1,095 Less valuation allowance , Long-term: Income tax effect of net operating losses carried forward Investment, capital assets, other ,085 Less valuation allowance Net future income tax assets $ 1,594 $ 1,190 At September 30, 2011, the Company has net operating loss carryforwards for federal income tax purposes of Cdn. $200 in Canada. These losses expire in

21 12. Earnings per share: The computation of basic and diluted earnings per share is as follows: Basic and diluted: Net earnings $ 4,641 $ 3,976 Less preferred share dividends Basic and diluted earnings attributable to common shareholders $ 4,629 $ 3,959 Basic weighted average common shares outstanding 31,634,936 31,207,118 Basic earnings per share $ 0.15 $ 0.13 Diluted weighted average common shares outstanding 44,100,855 43,707,118 Diluted earnings per share $ 0.10 $ Related party transactions and balances: All related party transactions were in the normal course of business and were measured at the exchange amount, which is the amount of consideration which both parties established and to which each party agreed. (a) Accounts receivable included nil ( $22) due from a related company in which a director and officer of the Company had an equity interest. The Company had paid amounts on behalf of the related party for rent during The amount due was non-interest bearing and due on demand. It was fully repaid in

22 13. Related party transactions and balances (continued): (b) Legal fees of nil ( $145) were paid to a law firm during the time one of its partners was a director of the Company. Effective May 13, 2010, this person ceased to be a director of the Company. (c) Advisory fees of nil ( $50) were paid to a company in which one of the directors of the Company is a shareholder. Effective May 13, 2010, this person ceased to be a director of the Company. 14. Financial instruments: (a) Credit risk: Credit risk arises from the possibility that certain parties will be unable to discharge their obligations. The Company routinely assesses the financial strength of its customers and mitigates against identified exposure primarily by lowering credit limits and/or reducing or ending business activity with high-risk accounts. (b) Foreign exchange risk: The Company generates approximately 87% of its revenue and pays for substantially all of its product purchases in U.S. dollars. As a result, the Company reports its financial results in U.S. dollars. However, certain expenses incurred by the Company, primarily salaries to Canadian employees and other operating costs are paid in Canadian dollars. These expenditures exceeded Canadian-denominated revenue in 2011 and 2010, which creates an exposure to Canadian dollar fluctuations. A weakening of the U.S. dollar against the Canadian dollar would result in a relative increase in the cost of Canadian-denominated net expenditures. A 10% change in exchange rate of the Canadian dollar against the U.S. dollar at September 30, 2011 would have increased/decreased equity and net earnings by approximately $302. This analysis assumes that all other variables remain constant. The Company does not currently use any financial instruments to hedge against currency risk, but may do so in the future. 20

23 14. Financial instruments (continued): (c) Fair values: The carrying amounts of cash, accounts receivable and accounts payable and accrued liabilities approximate their fair values due to the relatively short-term maturity of these financial instruments. The carrying value of bank indebtedness approximates its fair value as the interest rate applied to the debt fluctuates with the market interest rate. The fair value of the long-term debt issued during 2011 is not significantly different from its carrying value at September 30, Cash is classified as financial assets held-for-trading, which is recorded at fair value. Accounts receivable are classified as loans and receivables, which are recorded at amortized cost. Bank indebtedness, accounts payable and accrued liabilities and long-term debt are classified as other financial liabilities, which are recorded at amortized cost using the effective interest rate method. CICA Handbook Section 3862, Financial Instruments - Disclosures, was amended to require disclosures about the inputs to fair value measurements, including their classification within a hierarchy that prioritizes the inputs to fair value measurement. The three levels of the fair value hierarchy are: Level 1 - unadjusted quoted prices in active markets for identical assets and liabilities; Level 2 - inputs other than quoted prices that are observable for the asset or liability either directly or indirectly; and Level 3 - inputs are not based on observable market data. The Company's financial assets measured at fair value as at September 30, 2011 consist of cash which is classified as Level 1. 21

24 14. Financial instruments (continued): (d) Liquidity risk: Liquidity risk is the risk that the Company cannot meet a demand for cash or fund its obligations as they become due. Liquidity risk also includes the risk of not being able to liquidate assets in a timely manner at a reasonable price. In maintaining a sufficient liquidity level, the Company manages timely accounts receivable collection and inventory turnover to facilitate cash flows and to sustain excess availability. In an environment of economic uncertainty, the Company is subject to an increased risk of customer payment defaults or more delayed customer payment patterns, which could result in a reduced borrowing base and lower availability. The Company actively assesses the creditworthiness of its customers and adjusts credit limits where it considers appropriate. In some cases, this may limit the level of shipments the Company will make to a customer, which would also contribute to reduced cash flow and availability due to lower revenue. (e) Interest rate risk: The Company is exposed to interest rate risks arising from bank indebtedness and its longterm debt, as discussed in notes 6 and 7. Unfavourable changes in the applicable interest rate may result in an increase in interest expense for variable rate debt. The Company does not currently use derivative instruments to reduce its exposure to variable interest rate risk, but may do so in the future. As at September 30, 2011, the Company had $4,168 outstanding under the Credit Facility. Cash flow sensitivity analysis on variable credit facilities is as follows: Net earnings 100 basis 100 basis points increase points decrease Year ended September 30, 2011 $ (42) $ 42 22

25 15. Segmented information: The Company derives over 98% of its revenue from the sale of its products in the North American market. On a geographic basis, the Company's capital and intangible assets and goodwill were incurred in the following regions: Capital and Revenue intangible assets Goodwill United States $ 54,713 $ 40,908 $ $ $ $ Canada 7,300 5, Other $ 62,662 $ 46,767 $ 559 $ 193 $ 739 $ 739 At September 30, 2011, five customers accounted for approximately 62% of consolidated accounts receivable ( five customers accounted for approximately 63% of consolidated accounts receivable). For the year ended September 30, 2011, the Company had two customers ( one customer), contributing greater than 10% and accounting for a total of approximately 27% of consolidated revenue ( % of consolidated revenue). 16. Capital disclosures: The Company's objectives when managing its capital is to maintain a sufficient capital base to preserve investor, creditor and market confidence, to sustain future development of the business and to maximize shareholder value. The Company's strategy is to use positive cash flow to fund growth and reduce bank debt. The Company does not expect to pay dividends in the near term. The Company has defined its capital as common shares, preferred shares and its Credit Facility. The Company manages and monitors the availability of its Credit Facility, as defined under the agreement. The Company is subject to certain financial and non-financial covenants on its Credit Facility, as defined under the agreement. The Company monitors compliance with these covenants and reports to its lenders on a quarterly basis. At September 30, 2011, the Company was in compliance with the covenants (note 6). 23

26 16. Capital disclosures (continued): The Company utilizes annual capital and operating expenditure budgets to facilitate the management of its capital requirements. Budgets are updated if there are significant changes in the fundamental underlying assumptions. There were no changes to the Company's approach to managing capital during the year. 17. Commitments: At September 30, 2011, the Company had entered into contractual obligations of $838 in connection with the development of a new website to be completed in fiscal In addition, the Company had entered into a contractual obligation of $419 for provision of hosting and support services in connection with the new website. At September 30, 2010, the Company had a contractual obligation of $291 in connection with a new management information system installed during fiscal The Company is obligated under an operating lease for office premises. The future minimum commitments are as follows: Future minimum operating lease commitments $ 245 $ 245 $ 184 $ $ Website design services Website hosting and support services Subsequent event: On November 22, 2011, the Company advanced a loan in the amount of $150 to an officer of the Company for the exercise of stock options. The loan is non-interest bearing, is secured by the shares issued for the exercised options, and has a maturity date of November 22,