QuStream Corporation
TSX VENTURE : QVC

QuStream Corporation

May 30, 2006 16:19 ET

QuStream Corporation Announces First Quarter Fiscal 2006 Results

TORONTO, ONTARIO--(CCNMatthews - May 30, 2006) - QuStream Corporation ("QuStream") (TSX VENTURE:QVC) announces its first quarter fiscal 2006 results.

In United States ("US") dollars, revenues were US$3.1 million for the first quarter of fiscal 2006 compared to US$4.3 million in the same period last year.

Including the effects of translation to the Canadian dollar, sales for the first quarter of fiscal 2006 were $3.6 million, compared to $5.3 million in the same period last year.

Despite the fact that the Company had weak first quarter revenues as a result of delays in the US government budget being passed, the Company had the strongest bookings (note 1) quarter in its history recording orders of US$6.1 million (note 1) and finished the quarter with US$4.0 million of backlog (note 1).

Gross margin for the first quarter was 50% compared to 46% in the same period last year and 57% in the fourth quarter of fiscal 2005. Gross margin decreased compared to the fourth quarter primarily as a result of lower revenues which resulted in reduced overhead absorption. We estimated that the under absorption of overheads reduced our first quarter gross margins by 5% however, we expect to achieve our full year goal of gross margins in the 55% to 60% range.

Net income (loss) for the first quarter of fiscal 2006 was $(1.0) million or $(0.05) per share compared with a loss of $(0.1) million or $(0.01) per share for the same period last year.

"While I am disappointed with our first quarter revenues, I continue to be encouraged by the progress being made in the commercial markets" said Frederick L. Godard, Chairman, President and Chief Executive Officer of QuStream. "The recent National Association of Broadcasters conference ("NAB") was a very successful show for our Company. Several new products were shown, including our highly acclaimed DRS audio routing system (the winner of two separate broadcast industry awards) and our CWDM fiber systems. This was also the first year when we showed all of our routing and conversion products together on the same booth. Customer reaction has been swift and positive.

The US Federal Government side of the business remained weak in the first quarter in terms of bookings, however the applicable budgets have now been passed into law and the level of activity from this segment has stepped up markedly as the various procurement processes engage. This has historically been a good indication of pending orderflow. With this anticipated spending coming on line and the continued strength of our commercial business, we remain confident that we will achieve our fiscal 2006 goals."

Significant achievements made in the first quarter and shortly thereafter:

1. On January 26, 2006 we announced that we were expanding our international revenue opportunities by entering into a joint development and marketing partnership with Dayang International Limited ("Dayang") for the Asia Pacific region.

2. On February 28, 2006 we announced that our new Cheetah DRS audio router helped us secure a long-term commitment to provide PESA routing solutions to Game Creek Video. The first order under the agreement was valued at approximately US$1.1 million.

3. On March 28, 2006 we announced that PESA had received the largest order in the company's history valued at approximately US$2.0 million. The order included our new Cheetah DRS audio router.

4. On April 18, 2006 we announced a bought deal financing for approximately $10 million. This financing will allow QuStream to fully fund our pension obligation and notes payable as well as to continue to pursue both organic and acquisitive growth opportunities.

Note 1:

In this press release we use the terms bookings, shipments and backlog. These terms are not defined by generally accepted accounting principles (GAAP). Our usage of these terms may vary from the usage adopted by other companies. We believe that the combination of bookings (purchase orders received by the company), shipments (orders shipped by the company and invoiced) and closing backlog (opening backlog, plus bookings less shipments) provides a useful indictor for determining how our products are being received by the market and the economic health of the market as it relates to demand for our products. Closing backlog is not a guarantee of future revenues and provides no information about the timing on which future revenue may be recorded. We report our bookings, shipments and backlog in US dollars to reflect the underlying currency of the majority of such contracts and, therefore, reduce the volatility that would result from converting the measure to Canadian dollars.

Forward-Looking Statements

The statements made in this press release that are not historical facts contain forward-looking information that involves risk and uncertainties. All statements, other than statements of historical facts, which address QuStream's expectations, should be considered forward-looking statements. Such statements are based on management's exercise of business judgment as well as assumptions made by and information currently available to management. When used in this document, the words "may", "will", "anticipate", "believe", "estimate", "expect", "intend" and words of similar import, are intended to identify any forward-looking statements. You should not place undue reliance on these forward-looking statements. These statements reflect our current view of future events and are subject to certain risks and uncertainties as contained in the Company's filings with Canadian securities regulatory authorities, which in relation to this press release include, but are not limited to, our expected fiscal 2006 revenue growth rate of at least 25%, our expected future design wins, and our expected market share across various customers and product segments. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, our actual results could differ materially from those anticipated in these forward-looking statements. We undertake no obligation, and do not intend, to update, revise or otherwise publicly release any revisions to these forward-looking statements to reflect events or circumstances after the date hereof, or to reflect the occurrence of any unanticipated events. Although we believe that our expectations are based on reasonable assumptions, we can give no assurance that our expectations will materialize.



QuStream Corporation
Condensed Consolidated Balance Sheets
(In thousands of Canadian dollars)
Unaudited
March 31, December 31,
2006 2005
Assets

Current assets:
Cash and cash equivalents $ 1,664 $ 2,510
Accounts receivable 2,069 3,900
Inventories 4,948 4,690
Future income taxes 332 131
Prepaid expenses & other current
assets 484 427
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9,497 11,658

Property, plant and equipment, net 1,781 1,742
Licences, net 39 45
Deferred financing costs 82 104
Future income taxes 1,503 565
Intangible assets, net 4,767 6,010
Goodwill 599 866

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$ 18,268 $ 20,990
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Liabilities and Shareholders' Equity

Current liabilities:
Accounts payable $ 1,538 $ 1,840
Accrued liabilities 1,368 2,388
Deferred revenue - -
Warranty reserve 678 680
Future income taxes 268 267
Current portion of obligations
under capital lease 10 14
Current portion of notes payable 3,228 227
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7,090 5,416

Notes payable, net of current
portion 158 3,206
Future income taxes 871 1,226
Accrued pension obligation 2,803 2,794
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10,922 12,642
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Shareholders' equity:
Share capital 8,367 8,367
Retained earnings (deficit) (784) 251
Contributed surplus 194 162
Cumulative translation account (431) (432)
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Commitments and contingencies 7,346 8,348

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$ 18,268 $ 20,990
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The accompanying notes form an integral part of these consolidated
financial statements.


QuStream Corporation
Condensed Consolidated Statements of Earnings
(In thousands of Canadian dollars, except share and per share amounts)
Unaudited



Three months Three months
ended ended
March 31, March 31,
2006 2005

Revenues $ 3,558 $ 5,332
Cost of goods sold 1,784 2,893
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Gross profit 1,774 2,439
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Operating expenses:
Research and development 1,103 613
Selling and marketing 1,173 1,094
General and administrative 795 596
Amortization of intangibles 280 212
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Total operating expenses 3,351 2,515
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Earnings (loss) from operations
before the following (1,577) (76)
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Other income (expense):
Interest income 20 14
Interest expense - notes payable (107) (75)
Interest expense - capital lease (1) (1)
Foreign exchange gain (loss) - (2)
Other - (1)
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(88) (65)
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Earnings (loss) from operations
before income taxes (1,665) (141)
Provision for (recovery of)
income taxes (630) (19)
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Net earnings (loss) $ (1,035) $ (122)
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Earnings (loss) per share:
Basic & Diluted $ (0.05) $ (0.01)

Weighted average number of shares
outstanding (000s):
Basic & Diluted 19,277 13,614


The accompanying notes form an integral part of these consolidated
financial statements.



QuStream Corporation
Condensed Consolidated Statements of Retained Earnings
(In thousands of Canadian dollars)
Unaudited
March 31, March 31,
2006 2005

Retained earnings, beginning
of period $ 251 $ 139
Net earnings (loss) (1,035) (122)
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Retained earnings (deficit),
end of period $ (784) $ 17
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The accompanying notes form an integral part of these consolidated
financial statements.


QuStream Corporation
Condensed Consolidated Statements of Cash Flows
(In thousands of Canadian dollars)
Unaudited



Three months Three months
ended ended
March 31, March 31,
2006 2005

Cash flows provided by (used in):

Operating activities:
Net earnings (loss) for the period $ (1,035) $ (122)
Add (deduct) items not affecting
cash:
Depreciation and amortization of
Property plant and equipment 152 125
Amortization of licences 6 9
Amortization of intangible assets 280 212
Stock-based compensation 32 11
Future income taxes (55) (153)
Loss on disposal of capital assets - 2
Net change in non-cash working capital
balances related to operations 21 (760)
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Cash flows (used in) operating
activities (599) (676)
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Investing activities:
Purchase of property, plant and
equipment (185) (501)
Deferred acquisition costs - (62)
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Cash flows (used in) investing
activities (185) (563)
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Financing activities:
Capital lease payments (4) (6)
Repayment of notes payable (52) -
Issuance of common shares, net
of issuance costs - 258
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Cash flows provided by (used in)
financing activities (56) 252
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Effect of exchange rate changes
on cash (6) 9
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Increase in cash & cash equivalents (846) (978)

Cash & cash equivalents, beginning
of period 2,510 3,696

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Cash & cash equivalents,
end of period $ 1,664 $ 2,718
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Supplementary cash flow
information:
Taxes paid - -
Interest paid 80 1
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The accompanying notes form an integral part of these consolidated
financial statements.


QuStream Corporation
Notes to the Condensed Consolidated Financial Statements
(Tabular amounts in thousands of Canadian dollars, except per
share amounts - Unaudited)

March 31, 2006

1. Significant accounting policies

These condensed consolidated financial statements have been prepared in accordance with The Canadian Institute of Chartered Accountants ("CICA") standards for interim financial statements. These condensed consolidated financial statements follow the same accounting policies and methods of their application as the most recent annual financial statements, however, they do not include all of the disclosure requirements for annual financial statements. For a full description of accounting policies, refer to QuStream Corporation's ("QuStream" or the "Company") 2005 Consolidated Annual Financial Statements. These condensed consolidated financial statements should be read in conjunction with the Company's 2005 Consolidated Annual Financial Statements.

The results of operations for the three months ended March 31, 2006 are not necessarily indicative of those to be expected for the entire year ending December 31, 2006.

2. Business acquisitions

Fiscal 2005

Maklyn Venture Capital Corp.:

Effective April 1, 2005, the Company completed a reverse takeover of Maklyn Venture Capital Corp. ("Maklyn"), a Capital Pool Corporation. This transaction resulted in QuStream becoming listed on the Toronto Venture Exchange.

Shareholders of QuStream received 13,904,000 common shares and the shareholders of Maklyn received 5,115,000 shares in the amalgamated entity; accordingly, this transaction was accounted for as a reverse takeover of Maklyn by QuStream. The shares issued in the amalgamation reflect a 2:1 consolidation for the shares that were previously issued and outstanding for both companies.

In accordance with CICA Emerging Issues Committee Abstract 10, "Reverse Takeover Accounting", ("EIC-10") this transaction did not constitute a business combination and has been accounted for as a capital transaction which resulted in share capital increasing by $1,365,000 (gross proceeds of $1,710,000 less costs of $345,000).

Fortel DTV, Inc.:

Effective December 14, 2005, the Company aquired all of the outstanding shares of Fortel DTV, Inc. ("Fortel"). Fortel is involved in the design, manufacture, and distribution of signal processing equipment for the professional video/audio industry. This purchase was funded through the Company's cash resources. The purchase consideration totalled $1,823,000 including acquisition costs of $148,000.

Details of the acquisition are summarized as follows:



$
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Net working capital, excluding cash acquired (374)
Property, plant and equipment 50
Future tax assets - long-term 335
Notes payable (419)
Acquired intangible assets 2,176
Goodwill 601
Future tax liability related to acquired intangible assets (564)
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1,805
Cash acquired 18
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Total cost of acquisition 1,823
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The identified acquired intangible assets include in-process research and development ("IPR&D"), patents, and trade names. The IPR&D will be amortized over three years, the patents will be amortized over their remaining lives which is 15 years, and the trade names will be amortized over a 10 year period. In accordance with CICA Handbook Section 3465, "Income Taxes", the Company has established a future tax liability related to the acquired intangible assets. The future income tax liability will be amortized over the life of the related acquired intangible asset as a reduction in the future income tax provision.

In addition, the Company is obligated to pay up to US$1,000,000 in contingent consideration if Fortel achieves a defined revenue level of US$3,200,000 in the 12-month period following the acquisition. Any payment of contingent consideration will be recorded as goodwill. The goodwill is not deductible for tax purposes.

As part of the acquisition, the Company established a severance liability of $163,000. As at March 31, 2006 the remaining accrual was $155,000 and is included in accrued liabilities. The purchase price allocation is preliminary and will be completed in the second quarter of fiscal 2006 upon the finalization of the integration plan.

This acquisition has been accounted for using the purchase method and accordingly, the results of operations have been included in these condensed consolidated financial statements from the date of acquisition.

Fiscal 2004

PESA Switching Systems, Inc.:

Effective December 9, 2004, the Company through its wholly owned subsidiary, QuStream U.S. Holdings, Inc., acquired all of the outstanding shares of PESA Switching Systems, Inc. ("PESA") along with a U.S. $2,000,000 note receivable from PESA held by Pesa Inc., the parent company of PESA. PESA is involved in the design, manufacture, and distribution of routing and control equipment for the professional video/audio industry. The purchase was funded through the Company's cash resources. The purchase consideration totalled $8,348,000 including acquisition costs of $131,000.

Details of the acquisition are summarized as follows:



$
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Net working capital, excluding cash acquired 4,284
Property, plant and equipment 787
Future tax assets - long-term 1,423
Pension obligations (3,432)
Acquired intangible assets 3,905
Future tax liability related to acquired intangible assets (1,012)
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5,955
Cash acquired 2,393
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Total cost of acquisition 8,348
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The identified acquired intangible assets include existing technology, in-process research and development ("IPR&D") and trade names. The existing technology will be amortized over six year, the IPR&D will be amortized over three years, and the trade names will be amortized over a 10 year period. In accordance with CICA Handbook Section 3465, "Income Taxes", the Company has established a future tax liability related to the acquired intangible assets. The future income tax liability will be amortized over the life of the related acquired intangible asset as a reduction in the future income tax provision.

As part of the acquisition, the Company established a severance liability of $380,000. As at March 31, 2006 the remaining accrual was $106,000 and is included in accrued liabilities.

At the end of the first quarter of fiscal 2006, the Company determined that it was more likely than not that it would be able to recognize the tax benefit of certain future tax assets related to the defined benefit pension plan that previously had a valuation allowance applied to them. The Company has recognized an increase in future tax assets of approximately $957,000. In accordance with CICA HB Section 3465, the Company has applied this amount to first reduce goodwill related to the PESA acquisition to $Nil and applied the remaining amount as a reduction of acquired intangible assets. In addition, the Company has decreased the future tax asset liability related to the acquired intangible assets.

This acquisition has been accounted for using the purchase method and accordingly, the results of operations have been included in these condensed consolidated financial statements from the date of acquisition.

3. Accounts receivable

Details of accounts receivable balances are as follows:



March 31, December 31,
2006 2005

Trade receivables 2,580 4,386
Taxes receivable - -
Other receivables 6 35
Provision for doubtful accounts (517) (521)
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2,069 3,900
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4. Inventories

Details of inventories are as follows:

March 31, December 31,
2006 2005

Raw materials 1,419 1,471
Work in process 2,576 2,374
Finished goods 953 845
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4,948 4,690
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5. Property, plant and equipment

Details of property, plant and equipment are as follows:

March 31, December 31,
2006 2005

Building 365 365
Machinery and equipment 1,475 1,341
Furniture and fixtures 451 417
Leasehold improvements 18 18
Equipment under capital lease 57 57
Accumulated depreciation / amortization (585) (456)
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1,781 1,742
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6. Accrued liabilities

Details of accrued liabilities are as follows:

March 31, December 31,
2006 2005


Payroll and vacation pay 228 190
Accrued severance costs 261 347
Trade payables 764 811
Sales taxes 87 136
Other accruals 28 458
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1,368 1,942
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7. Share capital

The Company has authorizd share capital consisting of an unlimited number of common shares. As at March 31, 2006 the Company has 19,277,000 common shares issued and outstanding, compared with 19,277,000 common shares issued and outstanding at December 31, 2005.

Fully diluted loss per share is the same as basic earnings per share as the effect of all potential common shares is anti-dilutive. Potential common shares include the stock options disclosed in note 8, as well as 317,500 common stock purchase warrants.

8. Stock-based compensation

The Company has established a stock option plan (the "Option Plan") to encourage ownership in the Company's shares by directors, officers and employees of the Company and its subsidiaries.

The maximum number of shares which may be issued under the Option Plan is equal to 10% of the outstanding shares of the Company. The outstanding options granted to a participant on their grant date will vest ratably every three months over five years. Unexercised options will expire 5 years from the date of grant.

Activity under the Company's Option Plan is summarized as follows:



Weighted
average
exercise
Number price
# $

Outstanding, December 31, 2005 1,447,650 1.24
Granted - -
Exercised - -
Forfeited (41,875) 1.71
Expired - -
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Outstanding, March 31, 2006 1,405,775 1.23
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Options exercisable, March 31, 2006 265,475 1.07
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During the first quarter, the Company recognized compensation expense of $32,000 for stock-based compensation (2005 - $11,000). A corresponding amount was credited to contributed surplus. The compensation expense was determined on the grant date by applying the Black-Scholes option pricing model, based on the following weighted average assumptions:



Three months Three months
ended ended
March 31, March 31,
2006 2005
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Risk-free interest rate 3.5% 3.7%
Dividend yield 0.0% 0.0%
Expected life 5 years 5 years
Expected volatility 45.0% 37.0%
Weighted average grant date
fair value of options granted
at market price $ 0.62 $ 0.24
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The estimated fair value of the options is being amortized over their expected life on a straight-line basis.

The Black-Scholes option valuation model requires highly subjective assumptions including expected time until exercise, which greatly affect the calculated values. Accordingly, management believes that the model does not necessarily provide a reliable single measure of the fair value of the Company's stock option awards. The Company plans to grant additional stock options each year. As a result, the compensation expense recognized in the current period is not likely to be representative of the stock-based compensation expense for future periods.

9. Defined benefit pension plan

The Company previously maintained a non-contributory defined benefit pension plan (the "Plan") covering substantially all full-time employees of a subsidiary of the Company.

Effective June 1, 2005, the Company froze the Plan and began the process of terminating and winding up the pension plan. It is anticipated that the termination and windup process will take between 18 and 24 months from June 1, 2005. During the first quarter of fiscal 2006, the Company had pension expense of $Nil (2005 - $126,000).

The amount recorded as accrued pension obligation represents the Company's best estimate of the amount that will ultimately be paid to Plan members less assets currently available in the pension plan. The actual payment is not determinable at this time as there are several variables that will affect the amount of the actual final liability. These variables include but are not limited to the interest rate in effect at the time of final payment as well as whether Plan members elect to receive a lump sum payment or an annuity. Any difference between the actual final payment amount and the amount accrued will be charged to profit and loss at the time the termination payment is made to Plan members.

Each reporting period, the Company will determine its experience gains or losses relative to the termination assumptions made. Any difference will be charged to earnings over the average remaining life expectancy of the employees. As at March 31, 2006 the Company had an unamortized after tax actuarial gain of $209,000.

10. Commitments and contingencies

In the normal course of operations, the Company enters into purchase commitments for inventory with third party contract manufacturers. As at March 31, 2006, the Company had committed to purchasing approximately $1,638,000 (December 31, 2005 - $1,500,000) of inventory from various suppliers.

11. Segmented information

Operating segments

The Company operates in one business segment, that being the design, development, and distribution of routing, switching, interface conversion and distribution products to the global professional video/audio markets. Since the products have the same manufacturing process and distribution based, the Company has determined that it does not have separately reportable operating segments.

Geographic segments

The Company's external revenues by geographic region is based on the region in which the customer is located, property, plant and equipment, other identifiable assets and intangible assets data is based on the geographic areas in which the Company operates.



As at and for the
three months ended
March 31, 2006 Canada USA International Total
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Revenues - 2,752 806 3,558
Property, plant
and equipment 382 1,399 - 1,781
Other identifiable
assets 1,514 9,607 - 11,121
Goodwill and
intangible assets - 5,366 - 5,366
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As at and for the
three months ended
March 31, 2005 Canada USA International Total
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Revenues 6 5,081 245 5,332
Property, plant and
equipment 378 791 - 1,169
Other identifiable
assets 1,017 11,261 - 12,278
Goodwill and
intangible assets - 4,689 - 4,689
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12. Subsequent events

On May 8, 2006, the Company issued 4,200,000 units on a bought deal basis. Each unit was issued at a price of $2.40 and consisted of one common share and one half of one common share purchase warrant. Each whole warrant will entitle the holder to purchase one common share of the Company for a period of 18 months from the closing date at a price of $3.00 per share. The Company also granted the underwriters the option of acquiring 252,000 units any time in the next 18 months at the issue price of $2.40.

Gross proceeds before the deduction of underwriting fees of $605,000 and other issue costs, estimated at $450,000 is $10,080,000. The net proceeds will be allocated between share capital and common stock purchase warrants.

The TSX Venture Exchange Inc. has not reviewed and does not accept responsibility for the adequacy or accuracy of this release.

Contact Information

  • QuStream Corporation
    Investor Contact: Paul Haber
    Chief Financial Officer
    +1 (416) 385-2323 x 201
    phaber@qustream.com