UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-KSB

[x] ANNUAL REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2006

[ ] TRANSITION REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from   n/a  to  n/a

Commission file number: 333-90031

Northstar Electronics, Inc.

Name of small business issuer in its charter

                                                    Delaware                                                       #33-0803434                                       

State or other jurisdiction of incorporation or organization      IRS Employer Identification No.

Suite # 1455- 409 Granville Street,

Vancouver, British Columbia,

Canada V6C 1T2

Address of principal executive offices and Zip Code

 

Issuer’s telephone number (604) 685-0364

Securities registered pursuant to section 12(b) of the Act

None

Securities registered pursuant to section 12(g) of the Act:

100,000,000 shares of common stock with a par value of $0.0001 each

Check whether the issuer is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act [ ]

Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.      (1) [x] Yes [  ] No        (2) [x] Yes  [  ] No                          

             

Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B contained in this form, and no disclosure will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB.     [x]   

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  [  ]   No  [ X ]

 

State issuer’s revenues for its most recent fiscal year: $1,460,508

State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was sold, or the average bid and asked prices of such common equity, as of a specified date within the past 60 days. (See definition of affiliate in Rule 12b-2 of the Exchange Act).  

 

Note – If determining whether a person is an affiliate will involve an unreasonable effort and expense, the issuer may calculate the aggregate market value of the common equity held by non-affiliates on the basis of reasonable assumptions, if the assumptions are stated.

 

Aggregate market value of voting common equity held by non-affiliates as of March 31, 2007:  $1,470,000 approximately

Aggregate market value of non-voting common equity held by non-affiliates as of March 31, 2007:  Not Applicable

State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date.

 

Outstanding shares of common stock as of March 31, 2007: 25,019,632

 

Outstanding shares of preferred stock as of March 31, 2007: Nil

Documents incorporated by reference: None

Transitional Small Business Disclosure Format (Check one): Yes  [  ]  No  [ X ]

Northstar Electronics, Inc.

 

Index to Registration Statement on Form 10-KSB

ITEM NUMBER and CAPTION                                                 

PAGE

PART I.

Risk Factors                                           

2

 

ITEM 1.  Description of Business                                           

3

 

 

ITEM 2.  Description of Property                                             

7

 

ITEM 3.  Legal Proceedings                                                   

7

 

ITEM 4.  Submission of Matters to a Vote of Security Holders        

8

 

PART II

 

ITEM 5.  Market Price for Registrant's Common Equity and

             Related Stockholders Matters                                     

8

ITEM 6.  Management's Discussion and Analysis of Financial Condition and

               Results of Operations                                            

8

 

ITEM 7.  Financial Statements                                            

F-1 to F-18

 

ITEM 8.  Changes in and Disagreements with Accountants                       

12

 

ITEM 8a.Controls and Procedures

12

PART III

 

ITEM 9.  Directors, Executive Officers, Promoters and Control Persons        

12

ITEM 10.  Executive Compensation - Remuneration of Directors and Officers     

12

ITEM 11.  Security Ownership of Certain Beneficial Owners and Management      

13

 

ITEM 12.  Certain Relationships and Related Transactions                      

13

 

ITEM 13.  Index to Exhibits                                                   

14

 

ITEM 14.  Principal Accountant Fees and Services

14

 

SIGNATURES

14

 

 

1

Note Regarding Forward Looking Statements

 

Except for statements of historical fact, certain information contained herein constitutes ‘forward looking statements’ within the meaning of Section 27A of the securities Act and Section 21E of the Securities Exchange Act. Forward looking statements address our current plans, intentions, beliefs and expectations and are statements of our expected future economic performance. Statements containing terms like ‘believes’, ‘does not believe’, ‘plans’, ‘expects’, ‘intends’, ‘estimates’, ‘anticipates’, and other phrases of similar meaning or the negative or other variations of these words or other comparable words or phrases are considered to imply uncertainty and are forward looking statements.

Such forward looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results or achievements of the Company to be materially different from any future results or achievements of the Company expressed or implied by such forward looking statements. Such factors include, but are not limited to changes in economic conditions, government regulations, contract requirements and abilities, behavior of existing and new competitor companies and other risks and uncertainties discussed in this annual report on Form 10-KSB.

We cannot guarantee our future results, level of activity, performance or achievements. Neither we nor any other person assumes responsibility for the accuracy and completeness of these forward looking statements. We are under no duty to update any of the forward looking statements after the date of this report.

Risk Factors

Investment in our common stock involves a high degree of risk. Prospective investors should carefully consider the following risk factors in addition to other information in this annual report before purchasing our common stock.

Because we have a net loss from operations of $969,286 for the year ended December 31, 2006 and have accumulated losses of $6,124,233 from inception, we face a risk of insolvency.

We have never earned substantial operating revenue. We have been dependent on equity financing to pay operating costs and to cover operating losses.

Because we have no significant sales history and are substantially dependent on a major contractor to generate future sales, our future is uncertain if our relationship with that major contractor fails.

 

2

The auditor’s report for our December 31, 2006 consolidated financial statements includes an additional paragraph that identifies conditions which raise substantial doubt about our ability to continue as a going concern. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

PART I

Item 1. Description of Business

 

The Company was incorporated May 11, 1998 as Scientific Technologies, Inc. under the laws of the State of Delaware. The name of the Company was changed to Northstar Electronics, Inc. (NEI) September 1999. Subsequently, there has been no material reclassification, merger, consolidation, purchase or sale of any significant amount of assets other than in the ordinary course of business. There have been no bankruptcy, receivership or similar proceedings.

The business of the Company is primarily that of its wholly owned subsidiaries, Northstar Technical Inc. (NTI) and Northstar Network Ltd. (NNL). NTI develops, manufactures and sells undersea wireless sonar communications systems and produces, under contract, defense and aerospace electronic systems. NNL was incorporated to pursue defense, aerospace and homeland security contract manufacturing opportunities.

Sonar Products and Technologies

 

NTI developed a wireless communications technology with undersea applications. The technology is used in underwater sensing devices to take certain measurements that are then transmitted using underwater sound waves to a receiving unit, which processes the data and displays it on a computer monitor. The technology has many potential uses in a variety of industries including offshore oil and gas, defense, marine transportation, oceanography, environmental and fishing.

Homeland Security and Military Defense

 

The Company expects that design and manufacture of homeland security and anti-terrorism systems will grow to become a major component of Northstar’s business over the next five years as the United States Department of Homeland Security and the United States Navy launches and ramps up its efforts to protect ports, on shore high value assets and ships from terrorists. Northstar Electronics has designed and is manufacturing sonar hardware for homeland security and military defense systems.  These systems are designed to detect and track combat divers and explosive laden underwater vehicles and are intended to provide warning to naval ships, harbors and ports.

Research and Development - AQUACOMM

 

AQUACOMM was a multi year fully funded in-house research and development program at Northstar that was created specifically to develop new, leading edge multiple application sonar technologies and products for a variety of industries, including: defense, offshore oil and gas, commercial fishing, oceanography, marine environment and marine transportation.    The AQUACOM program was completed during 2006 with new hardware and software technologies resulting. Northstar expended $3,318,633 on this development program and recovered $1,997,144.

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Northstar has used its Venture Technology Business Model to maximize the success of its new WideBand Sonar Projector (WBSP) technology.  In this model, a technology developed by the Company is partnered with an established company in a specific industry sector.  In the case of the WBSP, Northstar developed the “wet” end and an established defense contractor was responsible for the “dry” end.  Since the defense contractor is established in the field, it is the defense contractor that undertakes the product introduction, marketing and sales efforts.  

The NETMIND System  

 

The Company’s first underwater sonar product based on our core technology was the NETMIND system. NETMIND is both a conservation tool as well as an efficiency tool. Electronic sensors attached to a fishing trawl measure the height and width of the net opening, the water temperature, the depth of the net and the amount of fish caught plus other parameters. The sensor information is transmitted via a wireless communications link back to the ship.

NETMIND helps prevent over fishing and allows fishermen to fill and empty their nets more efficiently with a cost effective benefit on profits. This gives regulators flexibility in reducing quotas when attempting to conserve limited   fishstocks.

The NETMIND Market

 

NETMIND was introduced to the fishing industry in late 1990’s. To date, approximately 265 systems have been sold in North America and internationally. The targeted customers have been strategic in that they are industry leaders and government agencies. They include the National Oceanic and Atmospheric Administration (NOAA) in the United States, the United States Department of the Interior and the Federal Department of Fisheries and Oceans and Fishery Products International in Canada. Customer feedback has shown that the NETMIND system enhances efficiency, reduces gear damage and improves catch quality.

Raw Material Sources and Availability

Raw materials for the manufacture of the NETMIND system are available from various sources. The principal suppliers are as follows:

Compass Ltd. - stainless steel chamber and end caps for sensors, mounting flanges for hull mounted hydrophone and other miscellaneous stainless steel parts

MF Composites - polyurethane, resin and hardener

Battery Specialists - battery chargers

Mercury Wire Products - tow cable for hydrophone

Electrosonic - electronic components

Future Active Inc. - electronic components

UPE - circuit boards

Enerpower - battery packs

To date, NTI has received parts, supplies and materials from these suppliers in a timely fashion and has met its production schedules. In our efforts to reduce costs, we now produce transducers and other components in house.

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Major Customer Dependency – NETMIND

 

NTI has sold approximately 265 NETMIND systems to over 180 different customers with no dependence on one or a few major customers.

Competition – NETMIND

 

The system has one main competitor, Scanmar in Norway, which is a private company. The NETMIND and Scanmar systems consist of wireless acoustic sensors used underwater and both systems operate by illustrating how the fishing net is behaving while being towed. However, NETMIND sensors are fully serviceable. The electronic circuitry is contained in stainless steel cylinders within each component and is easily removed for repair by opening the end cap.

 

 

We believe that NETMIND components have a longer battery life and a more effective communication over a longer distance than its competitor. We believe the rugged design of various NETMIND components has surpassed competitor’s designs in that NETMIND’s unique sensors require very little maintenance.

While NETMIND continues to attempt to expand its market presence, we believe the Company is smaller in size and resources when compared to its competitor. As a consequence NETMIND pricing is competitive.

 

Distribution of the NETMIND System

 

NETMIND is sold directly to customers by our own sales staff and through marine electronics dealers. We have dealer representation in Canada, the United States and internationally. We support all sales efforts with product brochures, pamphlets, and customer testimonials and with booths at trade shows in Seattle, Boston, Providence Rhode Island, Copenhagen Denmark and other locations. We also advertise in trade magazines, notably ‘The Navigator’ and ‘Fishing News International’. Articles on NETMIND have appeared in ‘National Fisherman’, Alaskan Fisherman’s Journal’ and ‘SEA Technology’, amongst other publications.

Technology Protection – NETMIND

 

Since commercializing NETMIND, NTI has made continual enhancements to its system. These activities have resulted in an optimum design for which a patent application may be submitted. The technology is difficult to replicate because it consists of custom, linked, assembler language software running on custom hardware and, regardless of patent protection, it is expected it would take several years for a new entry to reach parity with the present system.

 

 

The Company has obtained Canadian trademark rights to the name NETMIND effective for fifteen years from August 24, 1999. No other intellectual property related applications have been filed or prepared. In the meantime, NTI continues to develop new and innovative NETMIND products.

Need for Government Approvals – NETMIND

 

Government approvals are not required for the NETMIND system in the areas it is currently sold.

Effect of Existing or Probable Government regulations – NETMIND

 

There is no effect on the Company’s sales arising from government regulations and the Company does not anticipate any change to this in the future.

Research and Development Expenditures – NETMIND

 

NTI continues to carry out research and development activities on NETMIND enhancements. None of these costs were borne directly by customers nor did these costs directly affect NTI’s pricing structure.

Costs and Effects of Compliance with Environmental Laws – NETMIND

 

NTI has incurred no costs nor suffered any effects to maintain compliance with any environmental laws.

CONTRACT MANUFACTURING (CM)

NEI’s second business activity, conducted through both its subsidiary companies (NTI and NNL) is contract manufacturing where the Company assembles electronic systems under contract to the defense and aerospace industry (called ‘build to print’). We build products according to designs provided by our customers.   The Company’s main customer is currently Lockheed Martin, for whom Northstar provides production engineering, sourcing and procurement of parts, assembly of parts into systems, testing and shipping.    The Company has manufactured submarine control consoles under several contracts with Lockheed Martin Naval Electronics in Manassas, Virginia and is working on a $1.2M command and control console contract awarded by Lockheed to the Company in the fourth quarter of 2005, originally expected to be substantially completed during 2006 and extended into 2007.

5

The Company markets its services in this area primarily through a network of contacts in the industry, attendance at trade shows and at conferences and special missions sponsored by the Department of Defense.  In the past Northstar has attended defense and aerospace exhibitions in the United States and Canada and has participated in several missions to meet prime contractors involved in major defense contracts.

The CM Market

 

NTI has focused attention on the North American military market. The United States and Canada have many programs where NTI’s services could be used. This includes programs to manufacture control consoles for submarines, helicopters and fixed wing aircraft.

NTI signed a contract with Lockheed Martin, Manassas, Virginia in 1999 to assemble, test and deliver control consoles for the Canadian Navy’s Victoria Class submarines. Since NTI successfully completed the project to the satisfaction of both Lockheed Martin and the Navy, Lockheed Martin has awarded follow-on contracts to NTI. In 2003, Lockheed Martin and NTI signed a Manufacturing License Agreement approved by the US State Department. The Agreement allows for NTI to manufacture command and control consoles for Lockheed Martin on projects they have anywhere in the world. As well, NTI is permitted to offer Lockheed Martin’s console technology directly to the Canadian Armed Forces. The current control console contract was awarded pursuant to the manufacturing license agreement.

Competition – CM

                                                                                                                         

For control consoles produced for Lockheed Martin, NTI’s competition would be primarily similar sized companies as NTI in the United States, Canada or abroad. We are not aware, at this time, of any companies in particular that are direct competitors. However, we expect that, dependent upon the economic and political factors influencing Lockheed Martin, there will indeed be strong competition for future contracts. NTI’s main competitive advantages are price (our labor and overhead rates are low compared to many other jurisdictions) and quality (we have proven performance) based on the success to date of the submarine control console contract.

Marketing – CM

 

With respect to other Lockheed Martin divisions and with other prime contractors, we expect to use our success on the submarine console contract to showcase our expertise. The benefits of our marketing efforts are contacts made through networking in the industry and attendance at trade shows, conferences and special missions sponsored by the department of defense. We continue to attend defense and aerospace exhibitions in Canada and the United States.

Technology Protection – CM

 

NTI currently owns no proprietary technology requiring protection with respect to its CM activities.

Raw Material Sources and Availability – CM

 

Materials and parts are available on an as needed basis from a variety of sources in the United States and Canada.

Dependence on One or a Few Major Customers – CM

 

NTI currently depends to a great extent on Lockheed Martin for its contracts. Lockheed Martin is comprised of many semi-autonomous divisions, which have many customers. We are dealing with four divisions, similar to dealing with four independent companies, regarding contract opportunities. We are attempting to reduce our dependency on these Lockheed Martin divisions by contacting other large prime contractors about CM opportunities with them. We expect this activity will result in NTI developing new business in addition to business with Lockheed Martin in the future.

Need for Government Approvals – CM

 

There are no government approvals applicable to our CM activities, except any required as part of a contract. In that event, the requirement would be passed down from the prime contractor as a part of the statement of work

Effect of Existing or Probable Government Regulations – CM

 

Commerce between the United States and Canada in the defense and aerospace industry is governed by some general rules and regulations. These typically require a prime contractor, such as Lockheed Martin, to obtain certain United States government clearances before providing NTI with potentially sensitive information. Similarly, a Canadian prime contractor would need Canadian government clearances to give classified information to a United States subcontractor. To date, these clearances have not caused any problems for our CM activities and we do not anticipate any in the foreseeable future.

6

Research and Development Expenditures – CM

 

NTI has incurred no expenditures in fiscal 2006 on CM research and development activities.

Costs and Effects of Compliance with Environmental Laws – CM

The Company has incurred no costs or adverse effects in its compliance with any environmental laws.

SYSTEM INTEGRATION

NNL carries out multifaceted contracts that require several subcontractors to perform specialized tasks.  This ability to integrate the work of several components to create one complete system is one of Northstar’s main areas of business – system integration.

As a result of its capabilities and expertise, NNL has developed a unique approach to securing and executing large defense contracts. NNL brings together a number of Small Medium Size Enterprises (SME) affiliate companies thereby presenting a broad capability to prime defense contractors.  Because NNL offers ‘one stop shopping’ for approximately 25 companies with a wide range of relevant expertise, it is anticipated that contract work for various Canadian government procurements will flow to NNL.  Verbal commitments have been made to NNL by contractors bidding programs in Canada to include NNL under the Industrial Regional Development Plan (IRB).

 

NNL has carried out several contracts for Lockheed Martin on the development and production of an underwater intruder detection system and is pursuing new contracts in the defense and homeland security areas. Subsequent to December 31, 2006 NNL received two defense related contracts, one in underwater technology and the other in aeronautics.

EMPLOYEES

 

As of December 31, 2006 the Company had a total of 18 employees.

PUBLIC INFORMATION

 

The Company electronically files with the Securities and Exchange Commission (SEC) all its reports, including but not limited to, its annual and quarterly reports. The SEC maintains an internet site (http://www.sec.gov) that contains reports and other information regarding issuers that do file electronically. The Company maintains a web site address at www.northstarelectronics.com  

Item 2. Description of Properties

 

The Company leases its corporate offices located at: 1455 – 409 Granville Street, Vancouver, British Columbia, Canada    V6C 1T2

Northstar Technical Inc. and Northstar Network Ltd share leased offices and operations facilities at: 1 Duffy Place, Unit #6, St. John’s, Newfoundland, Canada A1B 4M6

Item 3. Legal Proceedings

 

The Company is a defendant in a lawsuit commenced against them in 1999 by their former master distributor.  The former distributor has alleged that the Company has interfered with the ability of the former distributor to sell products. The Company has filed a counter claim for monies owing by the former distributor to the Company.

 

7

Item 4.Submission of Matters to a Vote of Security Holders

 

No change since previous filing.

 

The Company has filed with the SEC an SB-1 registration statement April 20, 2000, an S-8 registration November 2000 and quarterly reports (form 10QSB) for June and September 2000 and for March, June and September 2001, 2002, 2003, 2004, 2005 and 2006 and annual reports (form 10KSB) for December 31, 2000, 2001, 2002, 2003, 2004 and 2005.

PART II

Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters

 

No change since previous filing

Item 6. Management’s Discussion and Analysis or Plan of Operation

 

The following discussion, comparison and analysis should be read in conjunction with the Company’s accompanying audited consolidated financial statements for the years ended December 31, 2006 and 2005 and the notes related thereto. The discussion of results, causes and trends should not be construed to infer conclusions that such results, causes or trends necessarily will continue in the future.

DISCUSSION

The following table sets forth for the years indicated items included in the Company’s consolidated statement of operations:

                                                2006            2005            2004            2003           2002                                            

Total revenue                      $1,460,508  $1,629,594  $1,461,528  $1,641,960    $976,234   

Cost of goods sold                  614,444       583,870        245,305       230,213      253,377        

Discounts                                116,241         94,066        129,111       198,950      148,425        

                                               730,685       677,936        374,416       429,163      401,802                   

Gross margin                           729,823       951,658     1,087,112    1,212,797      574,432        

Expenses                              1,699,109    1,936,426     1,918,653    1,905,942   1,366,567        

Net (loss)                           $ (969,286)    $(984,768)   $(831,541)  $(693,145)  $(792,135)   

Net (loss) per share            $      (0.05)   $      (0.06)    $     (0.05)   $     (0.05)   $     (0.08)         

As a result of its design engineering program expenditures, which directly impact the Company’s losses, Northstar Electronics, Inc. is building an infrastructure to position itself for significant growth.  In each of its core areas of business, the Company has proven itself with an ability to deliver high quality projects on time and within budget.

The Company’s total revenues for 2006 were $1,460,508 ($1,629,594 for 2005 and $1,461,528 for 2004) and we incurred a net loss of $(969,286) [$(984,768) for 2005 and $(831,541) for 2004]. Total revenue includes sales of $1,148,810 and $311,698 in recovery of research and development costs (2005: $957,874 and $671,720 respectively).  Although the Company’s 2006 and 2005 performance did not meet management’s expectations, management remains confident that the steps taken in 2006 and over the past several years can provide the basis for substantially increased revenues and profitability over the ensuing years.

8

 

Sonar Products and Technologies

 

The loss is attributable in part to the Company’s expenditures on development projects to design and develop sonar products, sonar systems and leading edge sonar technologies. The development program has taken on two complementary directions, one aimed at defense and Homeland Security, the other aimed at civilian markets in offshore petroleum, environment and commercial fishing industries.

During 2002 to 2006 we carried out work on underwater sonar systems designed to protect ports, offshore oil platforms and ships from underwater threats and other applications. We designed and built sonar and mechanical hardware components for these systems for a major defense contractor, which markets the systems.

Our second development program was AQUACOMM for which we received financial support from the federal government of Canada. The commercialization of products from this program has begun and includes a digital signal processing sonar receiver and associated software algorithms. The receiver supports the display of net symmetry information from the NETMIND trawl monitoring application and allows the fishing boat to optimize net towing dynamics, thereby increasing fishing efficiency.

The Company also developed sensor control hardware including direct digital synthesis of sonar frequencies to support multi function sensors while lowering manufacturing costs and supporting a move of the NETMIND products into new markets not currently exploited by similar technologies.

Results of the AQUACOMM work has positioned the Company to extend its NETMIND role on board vessels beyond its current Subsea monitoring function and allows the addition of features and capabilities to the system that would extend the NETMIND use to a vessel management role. This would include applying sensing and systems design to network with and access data from other on board subsystems for analysis and display, taking advantage of the existing NETMIND bridge mounted system and adding new functionality.

NETMIND

 

Sales projections for NTI’s fiscal year ending December 31, 2006 totaled $625,000. Northstar realized sales for the year of $575,203.  The primary reason for this shortfall was because more time than expected was required for customers to become familiar with NETMIND’s new digital technology.

Swimmer Detection System (SDS)

 

The Company is a subcontractor on Lockheed Martin’s anti terrorism Swimmer Detection System (SDS). The SDS is a wide band high frequency sonar system designed specifically to detect and classify underwater terrorist threats.

 

The Company, in collaboration with Lockheed Martin Canada, is also involved in the design of a wide band sonar projector.  Northstar and Lockheed Martin are considering utilizing its design in several military sonar products.

9

 

 

Contract Manufacturing

 

Northstar remained active pursuing contract manufacturing opportunities during 2006.  As mentioned, during the fourth quarter of 2005 we were awarded a US$1.2M Command and Control Console Contract to perform a technology update and test command and control consoles for the Canadian Navy’s Victoria class submarines as well as the refurbishment of the Victoria class submarine’s command display. This contract is covered under the Manufacturing License Agreement we signed with Lockheed Martin in 2003. We realized the majority of the revenue from this project during 2006. Subsequent to the year end NNL received a contract in aeronautics.

Northstar Network has submitted quotes on the following Canadian and US Programs, amongst others:

 

- Multi mode fiber optic cables for the Joint Strike Fighter airplane

- Sonar equipment design and manufacture

- Manufacture of Swimmer Detection systems

We are attempting to expand our electronic contract manufacturing business with our current customers, as well as with customers in the offshore oil and gas, transportation and communication industries

Systems Integration

 

During 2002 and 2003 we carried out the development of the sonar hardware and mechanical housing for the Swimmer Detection system (SDS), as mentioned above. We conducted the project as a system integration in that Northstar Network was the project manager and engineering manager and contracted other companies to perform sub-tasks. Northstar then brought all the sub-tasks together to build and test the final system.  The Company continues to pursue further contract systems integration business in 2007.

 

Results of Operations

 

Gross margins declined to 54% for 2006 compared with 58% for 2005, 73% for 2004, 74% for 2003, 59% in 2002 and 44% in 2001. The margin for 2006 is comparable to 2005. The percentage decrease from 2004 and 2003 was created by an increase in the lower margined contract sales volume included in revenue during 2006. A significant cause of any fluctuation in the gross margin percentages would be due to changes in the revenue mix where the Company is now generating revenue with significantly more direct costs attached.

In 2006 the Company spent $ 598,971 on design engineering and prototype development related to the development of underwater sonar technology ($816,622 in 2005, $707,697 in 2004, $848,277 in 2003 and $609,299 in 2002). The Company received contract revenues of $577,237 in 2006 (2005 - $492,810, 2004 - $122,489, 2003 - $325,000 and 2002 -$179,269) and government incentive research and development recoveries of $311,698 included in revenues (2005 - $671,720, 2004 - $547,338, 2003 - $626,496 and 2002 -$218,597) during the current year to offset certain of these costs. The direct result of extensive spending on design engineering and prototype development during the current year has been a loss of $(969,286) for 2006 compared to losses of $(984,768) for 2005 $(831,541) for 2004 $(693,145) for 2003 $(792,135) in 2002 and $(441,924) in 2001.

10

 

The Company expects that design and manufacture of defense systems will continue to be a major component of its business over the next five years.

Liquidity and Capital Resources

 

The Company used cash in operations of $( 607,410 ) in 2006 compared to cash used by operations of $(311,237) in 2005, $(634,218) in 2004, $(368,708) in 2003, $(589,419) during 2002 and cash used by operations of $(138,931) during 2001.  In 2006, the Company was successful in raising equity financing of $ 304,325 compared to $87,191 equity funding during 2005. The net cash was used to fund operations.

The Company’s working capital and capital requirements will depend on many factors, including the ability of the Company to increase sales from marketing of the NETMIND system in order to generate sufficient funds to cover the current level of operating expenses. The Company further intends to create working capital from the business to be generated pursuant to the Manufacturing License Agreement with Lockheed Martin. During the most recent fiscal year the Company increased its long-term debt by $198,327 (2005 - $107,540). The Company is negotiating to secure an equity financing in the short term and is in discussions with several financing firms. The Company also expects to increase revenues in 2007 from sales of its NETMIND system and related products. During 2006 the Company enhanced its net symmetry system, the first commercial product resulting from the Aquacomm program. As well, the Company has tendered proposals and price quotations on submarine control console manufacturing contracts, a naval anti terrorist system manufacturing contract and other manufacturing contracts, all of which are anticipated to be awarded in 2007.

The availability of sufficient future funds will depend to an extent on product sales and the obtaining of manufacturing contracts on a timely basis. Accordingly, the Company may be required to issue securities to finance any working capital requirements. There can be no assurance whether or not such future financings will be available or on satisfactory terms.

Working Capital and Operations

The Aquacomm research and development program was completed in 2006 and the Company’s focus is now on converting the results of the program into commercial products and therefore reducing non recoverable research and development expenses for 2007. During 2006 the Company implemented measures to reduce annual costs by approximately $450,000 per annum, including reduced research and development the net benefits of which are expected to accrue in 2007.

 

The Company has approximately 18% remaining on the submarine command and control console contract with Lockheed Martin to complete in 2007.  

During 2006 we provided price quotations to Lockheed Martin for console contracts, we have bid on a defense contract to provide parts for the retrofitting of military airplanes and we have bid on a defense underwater system contract. (see comments under ‘Contract Manufacturing’)

Over the next twelve months the Company will require approximately $400,000 to cover the costs associated with contracts and an additional approximately $350,000 for working capital. The Company is attempting to secure financing of $750,000 by way of private placement and is in discussions with several interested parties thereto.

Certain statements in this report and elsewhere (such as in other filings by the Company with the Securities and Exchange Commission ("SEC"), press releases, presentations by the Company of its management and oral statements) may constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995.  Words such as "expects," "anticipates," "intends," "plans," "believes," "seeks," "estimates," and "should," and variations of these words and similar expressions, are intended to identify these forward-looking statements. Actual results may materially differ from any forward-looking statements.  Factors that might cause or contribute to such differences include, among others, competitive pressures and constantly changing technology and market acceptance of the Company's products and services.  The Company undertakes no obligation to publicly release the result of any revisions to these forward-looking statements, which may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

 

11

 

Item 7. Financial Statements

 

NORTHSTAR ELECTRONICS, INC.

Consolidated Financial Statements

December 31, 2006 and 2005

(US Dollars)

Index

Page

Report of Independent Registered Public Accounting Firm

F-1

 

Consolidated Financial Statements

Consolidated Balance Sheets

F-2

Consolidated Statements of Operations

F-3

Consolidated Statements of Changes in Stockholders’ Equity (Deficit)

F-4

Consolidated Statements of Cash Flows

F-5

Notes to Consolidated Financial Statements

F6 - 18

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

TO THE DIRECTORS AND STOCKHOLDERS OF NORTHSTAR ELECTRONICS, INC.

We have audited the consolidated balance sheets of Northstar Electronics, Inc. as at December 31, 2006 and 2005 and the consolidated statements of operations, changes in stockholders' equity (deficit) and cash flows for each of the three years ended December 31, 2006.  These financial statements are the responsibility of the Company's management.  Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in Canada and the standards of the Public Company Accounting Oversight Board (PCAOB) (United States of America).  Those standards require that we plan and perform an audit to obtain reasonable assurance whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements.  An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as at December 31, 2006 and 2005 and the results of its operations and its cash flows for each of the three years ended December 31, 2006 in accordance with accounting principles generally accepted in the United States of America.

The accompanying consolidated financial statements have been prepared assuming the Company will continue as a going-concern. As discussed in note 1 to the financial statements, the Company has a working capital deficiency and has sustained operating losses for each of the past three years. These matters raise substantial doubt about the Company’s ability to continue as a going-concern. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

As discussed in note 2(l) to the consolidated financial statements, in 2006 the Company adopted SFAS No. 123R, which relates to accounting for stock-based compensation.

/s/ Pannell Kerr Forster

Chartered Accountants

(registered with the PCAOB as “Smythe Ratcliffe”)

 

Vancouver, Canada

April 14, 2007

F-1

NORTHSTAR ELECTRONICS, INC.

Consolidated Balance Sheets

December 31

(US Dollars)

See notes to consolidated financial statements.

F-2

NORTHSTAR ELECTRONICS, INC.

Consolidated Statements of Operations

Years Ended December 31

(US Dollars)

 

See notes to consolidated financial statements.

F-3

NORTHSTAR ELECTRONICS, INC.

Consolidated Statements of Changes in Stockholders’ Equity (Deficit)

Years Ended December 31

(US Dollars)

 

 

See notes to consolidated financial statements.

F-4

 

NORTHSTAR ELECTRONICS, INC.

Consolidated Statements of Cash Flows

Years Ended December 31

(US Dollars)

See notes to consolidated financial statements.

F-5

 

 

NORTHSTAR ELECTRONICS, INC.

Notes to Consolidated Financial Statements

Years Ended December 31, 2006, 2005 and 2004

(US Dollars)

1.

ORGANIZATION, BASIS OF PRESENTATION AND NATURE OF OPERATIONS

These financial statements include the accounts of Northstar Electronics, Inc. ("the Company") and its wholly owned subsidiaries Northstar Technical Inc. ("NTI") and Northstar Network Ltd. ("NNL").  All inter-company balances and transactions are eliminated.  The parent company was incorporated on May 11, 1998 in the state of Delaware and had no operations other than organizational activities prior to the January 26, 2000 acquisition of 100% of the shares of NTI for the issuance of 4,901,481 shares of treasury stock with the former shareholders of the subsidiary receiving a majority of the total shares of the Company then issued and outstanding.  The transaction was accounted for as a reverse take over resulting in the consolidated financial statements including the results of operations of the acquired subsidiary prior to the merger.

The Company, through its subsidiaries, develops, produces and sells an undersea wireless communications system ("Netmind") and manufactures, under contract, defence and aerospace electronic systems.  The Company also carries out research and development activities for customers on specific fixed price contract bases.

The Company's business activities are conducted principally in Canada and the financial statements are prepared in accordance with accounting principles generally accepted in the United States of America with all figures translated into United States dollars for financial reporting purposes.

The accompanying financial statements have been prepared assuming the Company will continue as a going-concern, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. During 2006 the Company incurred a net loss of $969,286 and at December 31, 2006 had a working capital deficiency (an excess of current liabilities over current assets) of $865,169, including $165,624 of long-term debt due within one year and $279,696 in deferred revenue which will be included in revenue in 2007. Management has undertaken initiatives for the Company to continue as a going-concern. For example, the Company is negotiating to secure an equity financing in the short-term and is in discussions with several financing firms. The Company also expects to increase revenues in 2007 from contract manufacturing revenues and sales of its NETMIND system and related products. The Company has tendered proposals and price quotations on an aircraft carrier anti terrorism system manufacturing contract along with other anti terrorist and military contracts originally anticipated to be awarded in 2006, and now anticipated in 2007. These initiatives are in recognition that for the Company to continue as a going-concern it must generate sufficient cash flow to cover its obligations and expenses. In addition, management believes these initiatives can provide the Company with a solid base for profitable operations, positive cash flows and reasonable growth. Management is unable to predict the results of its initiatives at this time. Should management be unsuccessful in its initiative to finance its operations, the Company’s ability to continue as a going-concern is uncertain.

F-6

NORTHSTAR ELECTRONICS, INC.

Notes to Consolidated Financial Statements

Years Ended December 31, 2006, 2005 and 2004

(US Dollars)

2.

SIGNIFICANT ACCOUNTING POLICIES

(a)

Revenue recognition

Revenue from the sales of the NETMIND system is recognized on an accrual basis based on agreed terms with the customers.  Sales are recorded when the systems are delivered and the customer is invoiced at the agreed terms and collection is reasonably assured.  

Contract manufacturing revenues from sales are recorded as each contracted unit is delivered to the contracting customer.

Revenue or loss from fixed price research and development contracts is recognized using the percentage of completion method whereby revenue or loss is recognized at the same percentage that contract costs to date is of total costs at contract completion.

Total revenue includes sales of $1,148,810 and recovery of research and development costs of $311,698: (2005 - $957,874 and $671,720, respectively, and 2004 - $828,260 and $633,268, respectively). Recovery of research and development costs is recognized on a periodic basis as cost recovery is applied for.

(b)

Inventory

Inventories consist of components valued at the lower of average cost and net realizable value.

(c)

Research and development

Research and development costs are expensed to operations as incurred.

(d)

Investment tax credits

Investment tax credit refunds arising from the incurrence of qualifying research and development expenditures are not recognized until the applicable project is approved as a qualifying research and development project by Canada Revenue Agency. The refunds are recorded as a reduction of the applicable research and development expense.

(e)

Equipment

Equipment is recorded at cost less any government assistance received and is being amortized over their estimated useful lives or term of lease, whichever is shorter, using the following rates:

Computer equipment

30% declining-balance

Computer software

30% declining-balance

Furniture and equipment

20% declining-balance

Manufacturing equipment

20% declining-balance

Leasehold improvements

20% straight-line

F-7

 

NORTHSTAR ELECTRONICS, INC.

Notes to Consolidated Financial Statements

Years Ended December 31, 2006, 2005 and 2004

(US Dollars)

 

2.  

SIGNIFICANT ACCOUNTING POLICIES (Continued)

(f)

Long-lived assets

SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, establishes a single accounting model for long-lived assets to be disposed of by sale including discontinued operations.  SFAS 144 requires that these long-lived assets be measured at the lower of carrying amount or fair value less cost to sell, whether reported in continuing operations or discontinued operations.

As such, these long-lived assets of the Company are reviewed when changes in circumstances require as to whether their carrying value has become impaired, pursuant to SFAS 144.  Management considers assets to be impaired if the carrying value exceeds the future projected cash flows from related operations (undiscounted and without interest charges).  If impairment is deemed to exist, the assets will be written down to fair value, less cost to sell.

(g)

Government assistance

The Company’s subsidiaries have been awarded assistance under certain Government of Canada assistance programs.  Amounts received or receivable under these programs are recorded as revenue at the time the amounts are approved for payment by the government agency. Advances for expenses, which the Company has yet to incur are included in deferred revenue (2006 - $92,264, 2005 -$232,443).

(h)

Foreign currency translation

The Company's operations and activities are conducted principally in Canada; hence the Canadian dollar is the functional currency.

Amounts incurred in U.S. dollars are translated into the functional currency as follows:

(i)

Monetary assets and liabilities at the rate of exchange in effect as at the balance sheet date;

(ii)

Non-monetary assets and liabilities at the exchange rates prevailing at the time of the acquisition of the assets or assumption of the liabilities; and

(iii)

Revenues and expenditures at rates approximating the average rate of exchange for the year.

For reporting purposes, assets and liabilities of non - U.S. subsidiaries that operate in a local currency environment are translated to U.S. dollars at year end exchange rates. Profit and loss accounts are translated at the average rates for the year. Translation adjustments are recorded as other Comprehensive income or (loss) not affecting deficit within stockholders’ equity.

(i)

Other comprehensive income (loss)

The Company has other comprehensive income (loss) arising from foreign currency translation of the subsidiary companies financial statements to US funds.  Accordingly, other comprehensive income (loss) is shown as a separate component of stockholders' equity (deficit).

F-8

NORTHSTAR ELECTRONICS, INC.

Notes to Consolidated Financial Statements

Years Ended December 31, 2006, 2005 and 2004

(US Dollars)

2.  

SIGNIFICANT ACCOUNTING POLICIES (Continued)

(j)

Use of estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Significant areas requiring the use of management estimates relate to revenue recognition, the determination of the impairment of assets, the estimation of useful lives, rates and methods for amortization, inventory valuation and realization, recognition of bad debt allowances, the calculation of stock based compensation, accounts payable and accrued liabilities and deferred revenue.  Management believes the estimates are reasonable, however, actual results could differ from those estimates and would impact future results of operations and cash flows.  

(k)

Net loss per share

Net loss per share calculations are based on the weighted average number of common shares outstanding during the year.  Diluted loss per share is not shown as the effects of the outstanding stock options and warrants are anti-dilutive.

(l)

Stock-based compensation

In December 2004, the Financial Accounting Standards Board (the “FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 123R, “Share Based Payment”.  SFAS No. 123R requires companies to estimate the fair value of share-based payment awards on the date of grant using option pricing model.  The value of the portion of the award that is ultimately expected to vest is recognized as an expense over the requisite service period in the Company’s financial statements.  Stock-based compensation expense recognized during the period is based on the value of the portion of the stock-based payment awards that are ultimately expected to vest during the period.  The Company estimates the fair value of stock options using the Black-Scholes valuation model, consistent with the provisions of SFAS No. 123R and the Company’s prior period pro-forma disclosures of net earnings.  The Black-Scholes valuation model requires the input of highly subjective assumptions, including the option’s expected life and the price volatility of the underlying stock.  The expected stock price volatility assumption was determined using historical volatility of the Company’s common stock.

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option valuation model using the following weighted average assumptions and amortized on a straight-line basis over the vesting period..

F-9

 

NORTHSTAR ELECTRONICS, INC.

Notes to Consolidated Financial Statements

Years Ended December 31, 2006, 2005 and 2004

(US Dollars)

2.  

SIGNIFICANT ACCOUNTING POLICIES (Continued)

(l)  

Stock-based compensation (Continued)

The Company previously applied the intrinsic value method of accounting as prescribed by APB Opinion No. 25 “Accounting for Stock Issued to Employees” and related interpretations, in accounting for options granted to employees.  As such, compensation expense was recorded on the date of the grant when the market price of the underlying stock exceeded the exercise price.  SFAS 123 established accounting and disclosure requirements when using the fair value based method of accounting for stock-based compensation plans.

Effective January 1, 2006, the Company adopted the requirements of SFAS 123R and estimates the fair value of share-based payment awards on the date of grant using an option-pricing model.

 

As allowed by SFAS 123, the Company elected to apply the intrinsic value-based method of accounting described above during the comparative years 2005 and 2004 and adopted the disclosure requirements of SFAS 123.  Had compensation expense been determined as provided in SFAS 123 using the Black-Scholes option-pricing model during 2005 and 2004, the pro-forma effect on the Company’s net loss and per share amounts would have been as follows:

The Company granted stock options to directors and consultants and accounted for the options using the Black-Scholes option pricing model resulting in expense of $33,868 recorded by the Company in 2006 ($10,752 in 2005 and $nil in 2004). In addition, during 2006 $3,051 (2005 - $6,865; 2004 - $10,932) relating to stock options granted and vested in a prior year, for legal services have been expensed as professional fees.

(m)

Recent accounting pronouncements

(i)

FIN 46(R), Consolidation of Variable Interest Entities, applies at different dates to different types of enterprises and entities, and special provisions apply to enterprises that have fully or partially applied Interpretation 46 prior to issuance of Interpretation 46(R).  Application of Interpretation 46 or Interpretation 46(R) is required in financial statements of public entities that have interests in variable interest entities or potential variable interest entities commonly referred to as special-purpose entities for periods ending after December 15, 2003.  Application by public entities (other than small business issuers) for all other types of entities is required in financial statements for periods ending after March 15, 2004.  Application by small business issuers to entities other than special-purpose entities and by non-public entities is required at various dates in 2004 and 2005.  There is no impact on the Company’s financial statements.

F-10

NORTHSTAR ELECTRONICS, INC.

Notes to Consolidated Financial Statements

Years Ended December 31, 2006, 2005 and 2004

(US Dollars)

2.  

SIGNIFICANT ACCOUNTING POLICIES (Continued)

(m)  

Recent accounting pronouncements (Continued)

(ii)

In March 2005 FASB issued FASB Interpretation (“FIN”) No. 47, “Accounting for Conditional Asset Retirement Obligations.” FIN 47 clarifies that the term “Conditional Asset Retirement Obligation” as used in FASB Statement No. 143, “Accounting for Asset Retirement Obligation,” refers to a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the entity. Accordingly, an entity is required to recognize a liability for the fair value of a Conditional Asset Retirement Obligation if the fair value of the liability can be reasonably estimated. FIN 47 is effective no later than the end of fiscal years ending after December 15, 2005. The adoption of FIN 47 did not have a material effect on the Company’s financial position, results of operations or cash flows.

(iii)

In May 2005 the Financial Accounting Standards Board (“FASB”) issued SFAS No. 154, Accounting Changes and Error Corrections (“SFAS No. 154”), which replaced Accounting Principles Board Opinion No. 20, Accounting Changes and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements. SFAS No. 154 changes the requirements for the accounting for and reporting of a change in accounting principles. It requires retrospective application to prior periods’ financial statements of changes in accounting principles, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. This statement is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The adoption of SFAS No. 154 had no impact on the Company’s financial statements.

(iv)

In June 2006 the FASB issued interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109”. This interpretation prescribes a recognition threshold and measurement attribute for tax positions taken or expected to be taken in a tax return. This interpretation also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The evaluation of a tax position in accordance with this interpretation is a two step process. In the first step, recognition, the Company determines whether it is more likely than not that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. The second step addresses measurement of a tax position that meets the more likely than not criteria. The tax position is measured at the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement. Differences between tax positions taken in a tax return and amounts recognized in the financial statements will generally result in: a) an increase in a liability for income taxes payable or a reduction of an income tax refund receivable, b) a reduction in a deferred tax asset or an increase in a deferred tax liability, or c) both a and b. Tax positions that previously failed to meet the more likely than not recognition threshold should be recognized in the first subsequent financial reporting period in which that threshold is met.

F-11

NORTHSTAR ELECTRONICS, INC.

Notes to Consolidated Financial Statements

Years Ended December 31, 2006, 2005 and 2004

(US Dollars)

2.  

SIGNIFICANT ACCOUNTING POLICIES (Continued)

(m)  

Recent accounting pronouncements (Continued)

(iv)

(Continued)

Previously recognized tax positions that no longer meet the more likely than not recognition threshold should be de-recognized in the first subsequent financial reporting period in which that threshold is no longer met. Use of a valuation allowance as described in FAS No. 109 is not an appropriate substitute for the de-recognition of a tax position. The requirement to assess the need for a valuation allowance for deferred tax assets based on sufficiency of future taxable income is unchanged by this interpretation. This interpretation is effective for fiscal years beginning after December 15, 2006.

(v)

On September 13, 2006 the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108 (“SAB 108”) which provides interpretive guidance on how the effects of the carry over or reversal of prior year misstatements should be considered in quantifying a current year misstatement. SAB 108 is effective for fiscal years ending after November 15, 2006.

(vi)

In September 2006 FASB issued Statement of Financial Accounting Standard No. 157, “Fair Value Measurements” (“FAS 157”). FAS157 defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles and expands disclosures about fair value measurements. The provisions of FAS 157 are effective for fiscal years beginning after November 15, 2007.

The implementation of these new standards is not expected to have a material effect on the Company’s financial statements.

3.

FINANCIAL INSTRUMENTS

(a)

Fair values

The carrying values of cash, accounts receivable, accounts payable and accrued liabilities and loans payable approximate their fair values because of the short maturity of these financial instruments. The carrying value of long-term debt, net of discount for interest free loans, and the significant portion of long-term debt being interest free, amounts due to directors and Cabot Management, and loans payable all approximate their fair values.

(b)

Interest rate risk

The Company is not exposed to significant interest rate risk due to the short-term maturity of its monetary current assets and current liabilities.

(c)

Credit risk

The Company is exposed to credit risk with respect to its accounts receivable. The Company follows a program of credit evaluations of customers and limits the amount of credit extended when deemed necessary. The Company maintains provisions for

F-12

 

NORTHSTAR ELECTRONICS, INC.

Notes to Consolidated Financial Statements

Years Ended December 31, 2006, 2005 and 2004

(US Dollars)

 

3.

FINANCIAL INSTRUMENTS (Continued)

potential credit losses and any such losses to date have been within management’s expectations.

(a)

Currency risk

The Company translates the results of operations into US currency using rates approximating the weighted average exchange rate for the year. The exchange rate may vary from time to time.

5.

ECONOMIC DEPENDENCE

During 2006, one source accounted for 41% of the Company's revenue (38% 2005 and 45% 2004).  During the year, one other contract accounted for 32% of the Company’s sales revenue. The Company is completing a contract with this customer and has no further contracts in place at this time, although additional orders are anticipated from this customer.

6.

ACCOUNTS RECEIVABLE

		2006		2005
Trade receivables	$	59,922	$	713,581
Investment tax credits receivable		73,742		105,838
	$	133,664	$	819,419

7.

EQUIPMENT

		2006
				Accumulated
		Cost		Amortization		Net
Manufacturing equipment	$	113,118	$	91,866	$	21,252
Furniture and equipment		50,428		37,816		12,612
Computer equipment		52,253		41,867		10,386
Computer software		13,519		10,305		3,214
Leasehold improvements		10,944		9,692		1,252
	$	240,262	$	191,546	$	48,716

 

F-13

NORTHSTAR ELECTRONICS, INC.

Notes to Consolidated Financial Statements

Years Ended December 31, 2006, 2005 and 2004

(US Dollars)

7.  

EQUIPMENT (Continued)

		2005
				Accumulated
		Cost		Amortization		Net
Computer equipment	$	56,314	$	44,561	$	11,753
Computer software		75,474		62,592		12,882
Furniture and equipment		52,257		34,709		17,548
Manufacturing equipment		69,961		36,949		33,012
Leasehold improvements		10,851		7,853		2,998
	$	264,857	$	186,664	$	78,193

Intangible asset

The Company acquired the design rights and tooling for a significant component of its Netmind system at a cost of $37,285 amortized to $26,019.  The asset has an indefinite life and is tested for impairment annually.

8.

LOANS PAYABLE

		2006		2005
10% term loan	$	55,833	$	50,000
Loans – unsecured, non-interest bearing with no fixed terms of repayment		13,595		0
	$	69,428	$	50,000

9.

RELATED PARTY TRANSACTIONS

(a)

The amount due to Cabot Management Limited, an associated private company related by a common shareholder and director, bears no interest, has no set terms of repayment and is subordinated to amounts due to ACOA.

(b)

The amount due to directors has no set terms of repayment and is subordinated to amounts due to ACOA.  Of the total, 75% bears no interest and 25% accrues interest at the rate of $433 (Cdn$500) and 3000 shares per week.

(c)

During the year the Company was charged $52,900 (Cdn$60,000 – 2005:Cdn $60,000) for technical consulting by a company controlled by a director. Of these fees, $79,673 is included in accounts payable and accrued liabilities at December 31, 2006 and has been settled by the commitment to issue shares of common stock.

F-14

NORTHSTAR ELECTRONICS, INC.

Notes to Consolidated Financial Statements

Years Ended December 31, 2006, 2005 and 2004

(US Dollars)

10.

LONG-TERM DEBT

		2006		2005
Atlantic Canada Opportunities Agency (“ACOA”)
Interest-free unsecured loan repayable in monthly payments of Cdn $5,938 commencing April 2005 (Cdn $484,350; 2005 – Cdn $493,350)	$	420,077	$	424,281
Interest-free unsecured loan to a maximum of Cdn $329,375, repayable in monthly payments of Cdn $5,490 commencing July 2007 (Cdn $288,906; 2005 – Cdn $177,001)		250,568		152,221
Interest-free unsecured loan repayable in monthly payments of Cdn $6,469 commencing August 2007 (Cdn $388,156; 2005 – Cdn $172,500)		336,648		148,350
Interest-free unsecured loan repayable annually at 5% of gross annual export sales for the preceding fiscal year commencing August 2008 (Cdn $nil; 2005 – Cdn $28,234)		0		24,280
Interest-free loan repayable in 72 monthly consecutive installments of Cdn $3,119 (Cdn $18,691; 2005 – Cdn $56,119)		16,211		48,262
Interest-free loan repayable in monthly installments of Cdn $867 (Cdn $16,220; 2005 – Cdn $26,624)		14,068		22,897
Interest-free unsecured loan to a maximum of Cdn $102,691, repayable in monthly payments of Cdn $1,712 commencing July 2007 (Cdn $19,262; 2005 – Cdn $14,502)		16,705		12,472
Interest-free loan, monthly principal repayments of Cdn $3,256 (2005 – Cdn $16,252)		0		13,976
12% loan with monthly principal repayments of Cdn $1,786 plus interest (2005 – Cdn $10,710)		0		9,211
		1,054,277		885,950
Less: Current portion		140,232		148,988
		914,045		706,962
Discount on interest-free loans payable		(304,042)		(259,107)
	$	610,003	$	447,885

F-15

NORTHSTAR ELECTRONICS, INC.

Notes to Consolidated Financial Statements

Years Ended December 31, 2006, 2005 and 2004

(US Dollars)

10.  

LONG-TERM DEBT (Continued)

Principal repayment terms are approximately as follows:

2007			$	140,232
2008				199,104
2009				186,260
2010				197,805
2011				195,121
Thereafter				135,755
			$	1,054,277

11.

CONTINGENT LIABILITIES

(a)

The Company is a defendant in a lawsuit which commenced against them in 1999 by the Company’s  former master distributor.  The former distributor has alleged that the Company has interfered with the ability of the former distributor to sell products. The Company has filed a counter claim for monies owing to the Company by the former distributor.

(b)

The Company is contingently liable to repay $1,885,476 in assistance received under the Atlantic Innovation Fund. The assistance is repayable annually at the rate of 5% of gross revenues from sales of products resulting from the Aquacomm research and development project. Gross revenues are to be calculated for the fiscal year immediately preceding the due date of the respective payment. Repayment is to continue until the assistance is repaid in full. To December 31, 2006 gross revenues from resulting products is $48,171 and a liability for repayment of $2,732 has been recognized.

12.

COMMITMENT

The Company is committed to minimum rental payments for property and premises aggregating $315,200 over the terms of leases expiring 2008 and 2011. Commitments over the next five years are approximately as follows:

2007			$	78,000
2008				78,000
2009				59,700
2010				59,700
2011				39,800

 

F-16

NORTHSTAR ELECTRONICS, INC.

Notes to Consolidated Financial Statements

Years Ended December 31, 2006, 2005 and 2004

(US Dollars)

13.

STOCK OPTIONS

The following table summarizes the Company's stock option activity for the years ended December 31, 2006 and 2005:

	Number of Shares		Exercise Price per Share		Weighted Average Exercise Price
Balance, December 31, 2003	3,136,500		$ 0.50 to $ 1.00		$ 0.57
Granted during the year – employees	1,195,000		$ 0.50		$ 0.50
Cancelled/Expired	(1,375,000)		$ 0.50		$ 0.62
Balance, December 31, 2004	2,956,500		$ 0.50		$ 0.50
Granted during the year - employees	137,500		$ 0.50		$ 0.50
Cancelled/Expired	(225,000)		$ 0.50		$ 0.50
Balance, December 31, 2005			$ 0.50		$ 0.50
Granted during the year – directors	500,000		$ 0.25		$ 0.25
consultants	250,000		$ 0.25		$ 0.25
Cancelled/Expired	(525,000)		$ 0.50		$ 0.50
Balance, December 31, 2006	3,094,000		$ 0.25 - $ 0.50		$ 0.46

As at December 31, 2006 and 2005, the outstanding stock options granted to directors, employees and others are as follows:

	Exercise		Number of Shares
Expiry Date	Price		2006		2005
September 17, 2006	$ 0.50		0		50,000
June 25, 2007	$ 0.50		125,000		125,000
June 25, 2007	$ 0.75		175,000		175,000
July 5, 2007	$ 0.50		815,000		815,000
April 30, 2008	$ 0.50		0		150,000
July 8, 2008	$ 0.50		22,500		22,500
February 12, 2009	$ 0.50		590,000		640,000
October 12, 2009	$ 0.50		5,000		20,000
December 31, 2009	$0.50		120,000		120,000
March 1, 2010	$ 0.50		50,000		50,000
December 15, 2010	$ 0.50		169,000		204,000
April 24, 2011	$ 0.50		0		25,000
October 30, 2011 (note 14)	$ 0.25		750,000		0
December 4, 2011	$ 0.50		10,000		10,000
November 17, 2012	$ 0.50		0		25,000
December 19, 2012	$ 0.50		187,500		300,000
May 1, 2013	$ 0.50		25,000		25,000
April 7, 2014	$ 0.50		0		25,000
March 1, 2015	$ 0.50		50,000		87,500
Total outstanding and exercisable			3,094,000		2,869,000
Weighted average outstanding life of options (years)			2.72		3.32

F-17

 

NORTHSTAR ELECTRONICS, INC.

Notes to Consolidated Financial Statements

Years Ended December 31, 2006, 2005 and 2004

(US Dollars)

13. 

STOCK OPTIONS (Continued)

Warrants

In 2004, the Company issued 1,428,570 warrants exercisable at $0.50 per share. The warrants provide for a cashless exercise and expire in August 2010.

In 2005, the Company issued 389,170 Class A warrants exercisable at $0.50 per share and 389,170 Class B warrants exercisable at $0.75 per share.  The Class A and Class B warrants expire six months after the closing bid price for the common stock of the Company has been over $0.65 and $1.00 per share respectively for five consecutive trading days.

In 2005, the Company issued 100,000 warrants exercisable at $0.50 per share, 100,000 warrants exercisable at $0.75 per share, 100,000 warrants exercisable at $1.00 per share, and 100,000 warrants exercisable at $1.25 per share.  The warrants expire in May 2009.

In 2006, the Company issued 2,700,000 half share purchase warrants.  One share purchase warrant is exercisable at $0.15 to acquire one share of common stock.  The warrants expire during 2011.

14.

INCOME TAXES

The Company’s subsidiaries have operating losses approximating $3,400,000 that may be carried forward to apply against future year's Canadian taxable income expire in 2008 through 2026.  The tax effect has not been recorded in these consolidated financial statements.  

Components of future income tax assets are:

		2006		2005
Non-capital loss carry-forwards	$	3,400,000	$	2,332,000
Approximate tax rate		31.12%		35.62%
		1,058,000		831,000
Valuation allowance		(1,058,000)		(831,000)
	$	0	$	0

15.

SUBSEQUENT EVENTS

(a)

Subsequent to December 31, 2006 the Company cancelled 250,000 of stock options granted to a director in 2006.

(a)

The Company issued 2,025,000 shares of common stock for proceeds of $150,000 and issued 757,500 shares for services valued at $75,700.

F-18

Item 8. Changes in and Disagreements With Accountants on Accounting and Financial  Disclosure

 

There are no reportable disagreements on accounting or financial disclosure issues

Item 8A.  Controls and Procedures

 

As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s President and Principal Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure and control procedures as referred to in the definition set forth in Rule 13a-15d of the 1934 Act as amended. Based upon that evaluation, the President and Principal Financial Officer concluded that the Company’s disclosure and control procedures are effective. There were no changes in the Company’s internal controls or in other factors that could affect these financial statements subsequent to the date of their evaluation.

PART III

Item 9. Directors, Executive Officers, Promoters and Control Persons;

 

Compliance with Section 16(a) of the Exchange Act

 

            Name of Director

Age

Office

Wilson Russell, PhD

61

President and Principal Financial Officer

            David Buttle, PhD                    58                     Director

Item 10. Executive compensation

 

During the year the Company paid $96,832 (2005 - $131,580; 2004 - $117,030; 2003 - $53,550) to Wilson Russell, the Company’s president, for his services.  

 

12

 

Item 11. Security Ownership of Certain Beneficial Owners and Management

 

Class

Name and Address

    Number of Shares

Percentage of Shares*

Common

Wilson Russell

                 3,361,191

          14.93%

560 West 29^th Avenue

Vancouver, B.C.

Canada    V5Z 2H7

Common

David Buttle

                     89,399

            0.40%

The Well House, Burkham

Wokington, Berkshire

United Kingdom RG114P5

Common

All officers and directors as a group    3,450,590

          15.33%

 *Based on 22,519,132 shares of common stock issued and outstanding December 31, 2006

Item 12. Certain Relationships and Related Transactions

 

No change since previous filing

13

Item 13.Exhibits and Reports on Form 8-K

 

Exhibit 31.1 - Section 906 Certification of Periodic Report of the Chief

      Executive Officer.

 

Exhibit 32.1 - Section 302 Certification of Periodic Report of the Chief

 

 

No Form 8K was filed during the fourth quarter of 2006

Item 14. Principal Accountants Fees and Services

 

During 2006 the Company’s auditors received approximately $52,300 in remuneration for audit and related (quarterly review) services. No other services were provided to the Company by its auditors and principal accountants.

During 2005 the Company’s auditors received approximately $37,500 in remuneration for audit and related (quarterly review) services. At December 31, 2005, the Company accrued an additional $32,379 in fees payable to those same auditors towards  the 2005 audit fees. No other services were provided to the Company by its auditors and principal accountants.

During 2004 the Company’s auditors received approximately $63,620 in remuneration for audit and related (quarterly review) services. At December 31, 2004, the Company accrued an additional $35,310 in fees payable to those same auditors towards  the 2004 audit fees. No other services were provided to the Company by its auditors.

 

SIGNATURES

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

(Registrant)

Northstar Electronics, Inc.

  By (Signature and Title)                   /S/ WILSON RUSSELL

  Date

April 16, 2007

Wilson Russell, PhD, President, Principal Financial Officer

  By (Signature and Title)                     /S/ DAVID BUTTLE

  Date   April 16, 2007                        David Buttle, PhD, Director                                                     

                                 14

 

Exhibit 31.1

302 CERTIFICATION

 

I, Wilson Russell, Principal Financial Officer, certify that:

1. I have reviewed this annual report on Form 10-KSB of  Northstar Electronics, Inc.;

 

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

 

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;

 

4. I am responsible for establishing and maintaining disclosure controls and procedures, as defined in Exchange Act Rules 13a – 14 and 15d – 14, for the registrant and have:

a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its

consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

b)

evaluated the effectiveness of the registrant’s disclosure controls and procedures as of the end of the period covered by this annual report (the “Evaluation Date”); and

c)

presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date.

 

5. I have disclosed, based on my most recent evaluation, to the registrant's auditors and the audit committee of the registrant's board of directors or persons performing the equivalent functions:

 

a)

all significant deficiencies in the design or operation of internal controls which could >adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and

 

b)

         any fraud, whether or not material, that involves management or other employees who have a role in the registrant's internal controls.

 

6. I have indicated in this annual report whether there were changes in internal controls or in other factors that could affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to deficiencies and material weaknesses.

Date: April 16, 2007                   /s/  Wilson Russell________________

                                                       Wilson Russell, President and Principal Financial Officer  

 

EXHIBIT 32.1

CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER PURSUANT TO 18 W.S.C. SECTION 1350 as adopted and PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002, the undersigned Chief Executive Officer and Chief Financial Officer, or persons fulfilling similar functions, each certify:

 

 

(i)

That the financial information included in this Annual Report fairly presents in all material respects the financial condition and results of operations of the Company as of December 31, 2006 and for the periods presented in the report; and

(ii)

That the Annual Report fully complies with the requirements of Sections 13(a) or 15(d) of the Securities exchange Act of 1934

Date:

  April 16, 2007                  By:    /s/ Wilson Russell

                                                       Title:

President and Principal Financial Officer