AISYSTEMS, INC. (A development stage company)
NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS (UNAUDITED)
1. Organization
Airline Intelligence Systems Inc. (“AIS”) was incorporated on December 7, 2005 under Delaware General Corporation Law. Since its inception, AIS’s efforts have been devoted to the development of the unique proprietary operating system jetEngine™, which management believed would be a new paradigm for strategic airline management that enables the integration and control of an airline’s schedule planning, revenue management, and irregular operations functions, amongst other things. AIS has two wholly owned Canadian subsidiaries Airline Intelligence Systems Corp. and AIS Services Canada Inc. The subsidiaries provide management services and corporate services to the parent company.
AIS completed a 2 for 1 stock split on June 11, 2007. All amounts shown and incorporated in these condensed consolidated interim financial statements are shown on a post-split basis as if the stock split had occurred on the earliest reported date.
On March 19, 2010, AISystems, Inc. (the “Company”), formerly Wolf Resources Inc. (a publicly listed shell company incorporated in Nevada on February 22, 2005), acquired AIS. In accordance with the Share Exchange Agreement, each issued and outstanding common share of AIS was converted for 0.95767068 common share of the Company and each issued and outstanding Series A preferred share of AIS was converted for one Series B preferred share of the Company (“reverse merger”). As a result of the transaction, the Company is no longer considered to be a shell company for reporting purposes.
The reverse merger has been accounted for as a recapitalization of the Company whereby the historical financial statements and operations of AIS became the historical financial statements of the Company, with no adjustment to the carrying value of the assets and liabilities. The accompanying condensed consolidated interim financial statements reflect the recapitalization of the stockholder’s equity as if the transaction occurred as of the beginning of the first period presented. Accordingly, the Company has reflected the issuance of 38,754,000 common shares for the total net monetary liabilities of the shell company in the amount of $52,990 in the condensed consolidated statement of changes in stockholders' equity (deficit).
On September 7, 2011, Dynamic Intelligence Inc. (“Dynamic”) provided the Company with a Notice of Non-Renewal, pursuant to an Intellectual Property Agreement (the “Agreement”) entered into by the parties on December 9, 2005. Pursuant to the terms of the Agreement, the term of the Agreement would be automatically and continuously extended in one (1) year increments unless either party provided notice of non-renewal at least ninety (90) days before the end of the then-current term. Due to Dynamic’s Notice of Non-Renewal, the Agreement will not renew on December 9, 2011.
The Agreement provided the Company with an exclusive and perpetual license to Dynamic’s intellectual property, which permitted the Company to use such proprietary technology to develop a unique proprietary business platform for the airline industry that is comprised of systems and mathematical algorithms capable of generating significant improvements in strategic planning capabilities, resource scheduling, revenue management and integrated operations.
2. Going concern and management’s plans
The accompanying unaudited condensed consolidated interim financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”) which contemplate continuation of the Company as a going concern. The Company has yet to fully commercialize its technologies and consequently has incurred significant losses since its inception. At September 30, 2011, the Company’s deficit accumulated during the development stage is approximately $72.0 million, and the Company had utilized cash in operating activities of approximately $29.2 million. The Company has funded these losses and cash flows through the sale of equity securities, the issuance of debt and from credit granted by vendors. The Company is also in arrears to certain creditors and in default under certain agreements which may have a material adverse effect on operations or lead to the ceasing of operations.
There is no assurance that the Company will be able to raise the necessary funds to continue operations as envisioned or that such funds can be raised on favorable terms to existing stockholders. This could result in significant dilution or a loss of investment to any current or future stockholders. Any funds raised will be used to engage potential customers, to fund product development, to offer working capital, to repay debt and for other corporate purposes. If the Company is unable to raise sufficient funds on the required timelines its ability to implement its vision will be hindered and this could result in the entire loss of any investment in the Company.
These factors raise substantial doubt about the ability of the Company to continue as a going concern. There can be no assurance that the Company will have adequate capital resources to fund planned operations or that any additional funds will be available to the Company when needed, or if available, will be available on favorable terms in the amounts required by the Company. If the Company is unable to obtain adequate capital resources to fund operations, it may be required to delay, scale back or eliminate some or all of its operations, which may have a material adverse effect on the Company’s business, results of operations and ability to continue as a going concern. These unaudited condensed consolidated interim financial statements do not include any adjustments that might result from the outcome of these uncertainties.
3. Interim Financial Statements
These unaudited condensed consolidated interim financial statements as of September 30, 2011 and for the three and nine months ended September 30, 2011 and 2010 and for the period from December 7, 2005 (inception) to September 30, 2011 have been prepared in accordance with the instructions to quarterly reports on Form 10-Q. These unaudited condensed consolidated interim financial statements have been prepared on the same basis as the annual financial statements and reflect all adjustments, which include only normal recurring adjustments, necessary to present fairly the financial position of the Company as at September 30, 2011, and the results of its operations and its cash flows for the three and nine month periods ending September 30, 2011 and 2010 and for the period from December 7, 2005 (inception) to September 30, 2011. The financial data and other information disclosed in these notes to the unaudited condensed consolidated interim financial statements related to these periods are unaudited and certain information and footnote data necessary for fair presentation of financial position and results of operations in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. Therefore it is suggested that these unaudited condensed consolidated interim financial statements be read in conjunction with the financial statements and notes thereto, included in a Form 10-K filed April 15, 2011. The results for the three and nine months ended September 30, 2011 are not necessarily indicative of the results to be expected for any subsequent quarter of the entire year ended December 31, 2011. The balance sheet as at December 31, 2010 has been derived from the audited financial statements at that date.
4. Significant accounting policies
Recent accounting pronouncements
Changes to accounting principles generally accepted in the United States of America (U.S. GAAP) are established by the Financial Accounting Standards Board (FASB) in the form of accounting standards updates (ASU’s) to the FASB’s Accounting Standards Codification.
The Company considers the applicability and impact of all ASU’s. ASU’s not listed below were assessed and determined to be either not applicable or are expected to have minimal impact on our consolidated financial position and results of operations.
In October 2009, the Financial Accounting Standards Board (“FASB”) issued a new accounting standard which provides guidance for arrangements with multiple deliverables (ASC 605-25). Specifically, the new standard requires an entity to allocate consideration at the inception of an arrangement to all of its deliverables based on their relative selling prices. In the absence of the vendor-specific objective evidence or third-party evidence of the selling prices, consideration must be allocated to the deliverables based on management’s best estimate of the selling prices. In addition, the new standard eliminates the use of the residual method of allocation. In October 2009, the FASB also issued a new accounting standard which changes revenue recognition for tangible products containing software and hardware elements. Specifically, tangible products containing software and hardware that function together to deliver the tangible products’ essential functionality are scoped out of the existing software revenue recognition guidance and will be accounted for under the multiple-element arrangements revenue recognition guidance discussed above. Both standards were effective for the Company beginning on January 1, 2011. The adoption of these standards did not have a material impact on the Company’s condensed consolidated financial statements.
5. Property and equipment
| | | September 30, 2011 | | | December 31, 2010 | |
| Computer equipment | | $ | 905,117 | | | $ | 905,117 | |
| Office equipment | | | 265,379 | | | | 265,379 | |
| Vehicle | | | 28,706 | | | | 28,706 | |
| Computer software | | | 115,042 | | | | 115,042 | |
| | | | 1,314,244 | | | | 1,314,244 | |
| Less: accumulated depreciation and impairment | | | (1,235,798 | ) | | | (1,015,895 | ) |
| | | $ | 78,446 | | | $ | 298,349 | |
At September 30, 2011, due to the September 7, 2011 notice of non-renewal from Dynamic Intelligence Inc. (“Dynamic”) and the November 9, 2011 assignment of its lease the Company recorded a loss from impairment of property and equipment of $139,522 ($78,298 for computer equipment, $60,977 for office equipment, $237 for computer software and $10 for intellectual property) to reduce the net book value of property and equipment from $217,968 to $78,446, the estimated recovery amount of the respective assets.
Depreciation expense was $26,797 and $46,637 for the three months ended September 30, 2011 and 2010 respectively, and $80,391 and $139,910 for the nine months ended September 30, 2011 and 2010 respectively.
6. Notes payable
Loans payable to Dynamic Intelligence Inc. (“Dynamic”)
The loans payable to the controlling stockholder, Dynamic, at September 30, 2011 are $1,026,802 (December 31, 2010: $1,009,627). The loans carry an interest rate of 5% and are unsecured, with no fixed terms of repayment. Dynamic has substantial voting control by virtue of its common stock and preferred stock ownership.
The Company paid $12,000 interest payable on August 2011, and all other remaining accrued interest on these loans is outstanding at September 30, 2011. Interest expense on these loans was $9,725, for each of the three months ended September 30, 2011 and 2010 and $29,175 for each of the nine months ended September 30, 2011 and 2010.
In addition, the Company owes Dynamic unsecured loans payable of $1,200,000, which is past due and in default, bears interest at rates ranging from 5% to 8%, and is included in notes payable.
Notes payable with detachable warrants
The notes payable to stockholders with detachable warrants at September 30, 2011 are $3,758,750 (December 31, 2010: $3,773,750). The notes carry interest rates ranging from 5% to 18% and are unsecured.
All accrued interest on these notes remains outstanding at September 30, 2011.
Guarantee Notes
The Company entered into a bond agreement during 2009 with a third party to provide a guarantee of notes to be issued by the Company. Under this bond, the Company issued $150,000 of notes bearing interest of 18% that were due August 2010. These notes also included a total of 250,000 common stock warrants with a strike price of $0.001 and fair value of $39,894. Pursuant to the agreement, the Company is required to set aside in a separate bank account 5% of all the future funds raised in excess of $1,000,000. On March 13, 2010, the Company repaid $60,000 of the amounts owing under this note. On April 13, 2010, the Company paid an additional $60,000 of the amounts owing under this note. Between May 3, 2011 and June 27, 2011, an additional $5,000 of the amounts owing were repaid. Between June 30 and September 30, 2011, an additional $3,000 was repaid.
Creditor Forbearance
In October 2009, the Company entered into a forbearance agreement to extend the maturity of debt to September 30, 2010 with certain debt holders whom collectively hold $2,467,500 of debt and accrued interest. In exchange for extending the described debt, the Company issued 2,467,500 warrants with an exercise price of $0.001 each, which expire at the earlier of a public listing, a corporate reorganization or specified expiry dates that range for the period from 2009 to 2014. The forbearance agreements were treated as a modification of the debt and accordingly the associated fees, representing the fair value of the warrants issued by the Company to the creditors, have been recorded as a discount on the debt and amortized over the new term to maturity with an additional charge to interest expense calculated in accordance with the effective interest method. Effective October 1, 2010, the company accrued interest at 12% on the $2,467,500 (previously accrued at 5% and 8%) in accordance with the forbearance agreement. On May 16, 2011, $10,000 of this debt plus accrued interest was converted to common stock.
Demand Loan
During the period ended June 30, 2011, the Company settled in full a $264,000 promissory note that was due on demand, with principle plus accrued interest of $272,184, for 1,088,736 common shares. This resulted in a gain on extinguishment of debt of $54,437.
Promissory Notes
From January to March 2011, the Company issued $52,500 in 8% unsecured promissory notes.
In June 2011, the Company issued a 30 day promissory note of $50,000. The principle plus $5,000 in interest and the issuance of 100,000 common shares were due at the end of the 30 day term (July 2011). The principle amount plus interest was repaid on the due date however the shares have not yet been issued.
In July 2011, the Company issued a 10 percent interest rate convertible note of $505,655.19. The maturity date is on March 5, 2012. A group of notes and accrued interest which total $505,655.19 owed to various debt holders were cancelled. This transaction was treated as a modification of the debt and accordingly the related $366,264 beneficial conversion feature was recorded as a discount on the debt and is being amortized over the new term to maturity with an additional charge to interest expense ($131,132 for the period July 5, 2011 to September 30, 2011).
In July 2011, the Company issued a 10 percent convertible promissory note of $150,000. The maturity date is on March 5, 2012. The related $108,621 beneficial conversion feature was recorded as a discount on the debt and is being amortized over the new term to maturity with an additional charge to interest expense ($38,889 for the period July 5, 2011 to September 30, 2011).
In 2011, the Company converted $10,000 plus accrued interest of the 5% promissory notes for 22,764 common shares yet to be issued, in accordance with the conversion ratio as stipulated in the agreement.
In 2011, the Company converted $237,000 plus accrued interest of the 8% promissory notes for 4,178,543 common shares, already issued, and 3,780,000 common shares, yet to be issued, in accordance with the conversion ratio as stipulated in the agreement.
In 2011, the Company converted $32,115 including interest of the 10% promissory notes for 2,071,567 common shares issued, in accordance with the conversion ratio as stipulated in the agreement.
In summary, from January to September 2011, the Company issued in connection with the demand loans and promissory notes above, a total of 8,250,110 common shares with a total value of $377,815 in connection with conversions of notes payable to stockholders.
7. Lease obligations, commitments and Contingencies
(A) Lease obligations
The Company previously leased office space in Kirkland, Washington and currently leases office space in Bellevue, Washington and Toronto. The Toronto office lease is due to expire on May 2014 and the Bellevue office lease began on February 14, 2011 and ended May 31, 2011. From June 1, 2011 this lease reverted to a month to month lease. Total lease expense was $10,380 and $510,723 for the nine months ended September 30, 2011 and 2010. In April 2011, the Company terminated its Kirkland Agreement and agreed to a settlement amount of $180,000 payable in monthly installments over a 36 payment period starting in July 2011. The $180,000 has been reflected as a loss on termination of lease in the statement of operations for the nine months ended September 30, 2011 and the remaining $170,000 due at September 30, 2011 has been included in notes payable.
The Company is currently in default under the conditions of this settlement agreement.
The Company also leases photocopiers, computer equipment and previously leased an apartment, expiring at various dates from 2011 to 2014.
The total future minimum lease payments by year for all operating leases are as follows:
| Lease obligations | | | |
| | | | |
| December 31, | | Total | |
| | | | |
| 2011 | | | 24,768 | |
| 2012 | | | 99,031 | |
| 2013 | | | 99,031 | |
| 2014 | | | 44,364 | |
| Thereafter | | | - | |
| | | $ | 267,184 | |
7. Lease obligations, commitments and contingencies (continued)
(B) Contingencies
Except as noted below, there are no outstanding judgments against the Company or any consent decrees or injunctions to which the Company is subject or by which its assets are bound and there are no claims, proceedings, actions or lawsuits in existence, or to the Company’s knowledge threatened or asserted, against the Company or with respect to any of the assets of the Company that would materially and adversely affect the business, property or financial condition of the Company, including but not limited to environmental actions or claims. However, from time to time, the Company is involved in various lawsuits and legal proceedings which arise in the ordinary course of business. Litigation is subject to inherent uncertainties, and an adverse result in these or other matters may arise from time to time that may harm our business.
In 2010, the Company entered into consulting agreements with various investor relations firms and business development service firms in exchange for fees and/or common shares of the Company to be issued subsequent to December 31, 2010. Compensation for such services is to be expensed over the respective terms of the agreements, as services are rendered.
The summons and complaint that was outstanding with Devon James Associates Inc. and Colleen Aylward against AIS was settled on July 13, 2011. AIS is currently in default with respect to the Settlement Agreement executed with Devon James Associates Inc. and Colleen Aylward and the Company has been notified that Judgment may be filed in respect to this action.
8. Deferred and Recognized Revenue
The Company entered into a contract with an airline customer in June 2007, wherein the customer provided the Company with a $1,000,000 initial fee. The Company deferred recognition of revenue for this initial fee until deployment and acceptance of its product. The contract terms of the jetEngine Software License Agreement with this customer ended effective June 7, 2011 at which point, the initial fee of $1,000,000 was recognized as revenue as there were no further obligations to deliver any products or services.
9. Stockholders’ deficiency
The authorized capital of the Company consisted of: (i) 300,000,000 common shares (as amended on March 25, 2010), 160,441,305 shares of which were issued and outstanding at September 30, 2011 (December 31, 2010 – 147,732,455) and (ii) 20,000,000 shares of preferred stock of the Company, which have been designated as Series B Preferred Stock (“Series B Preferred”), with 2,329,905 issued at September 30, 2011 (December 31, 2010 – 2,329,905), and Series C Preferred Stock, with 1 share issued at September 30, 2011. The common shares issued to the former stockholders of AIS became free trading shares one year following the completion of the merger.
On September 15, 2011 the Company issued 1 share of its newly designated Series C Preferred Stock to Dynamic Intelligence Inc. (Dynamic), its controlling stockholder and a debtholder (see Note 6). The transaction has been reflected as other expense in the amount of $100,000. Series C Preferred Stockholders are entitled to 3 times Y votes (3xY) where Y equals the sum of all shares issued at the time of voting. The Series C Preferred Stock is redeemable at the option of the Preferred Stockholders at a price of $0.001 per share.
The holders of C Preferred Stock are not entitled to receive any dividends with respect to their shares of Series C Preferred Stock. In the event of liquidation, the holders of the Series C Preferred Stock are entitled to receive $0.001 per share in preference to any distribution of any of the assets of the Corporation to the holders of Common Stock or any other series of Preferred Stock that is not expressly senior to or paripassu with the Series C Preferred Stock.
Exchange Right Agreement
In January 2010, the Company and Merus Capital I, L.P. (“Merus”) entered into an exchange right agreement (the “Agreement”), whereby Merus provided funding to the Company in exchange for, amongst other things, a right in liquidation for Merus to exchange common shares held by Merus at the time of the conversion (“Merus Securities”) into an unsecured promissory note with aggregate principal up to $5,000,000 paying interest at a rate of 5.00% per annum. The term of the Agreement is the earlier of: (i) 36 months following a Going Public Transaction (as defined in the Agreement); (ii) Merus receiving the Note after exercising their rights under the Agreement; and (iii) Merus transferring any of the Merus Securities without the prior authorization of the Company. Management has reviewed the terms of the exchange right agreement and has determined that permanent equity classification is appropriate because all conditions under which the exchange right could be enforced are solely within the control of the Company.
10. Income taxes
The Company has made no provision for income taxes since inception and for the periods presented as the Company has incurred net losses. Based on statutory rates, the Company’s expected income tax benefit from these losses based on the accounting loss for the nine months ended September 30, 2011 and 2010 and for the period from December 7, 2005 (inception) to September 30, 2011 would be $1,207,585, $2,158,258 and $25,127,359 respectively.
The future benefit of net operating loss carry forwards to the Company may be limited by on an annual basis and in total by Section 382 of the United States Internal Revenue Code as a result of prior ownership changes and depending on future ownership changes.
11. Stock option plans
The Company has issued stock options to employees, consultants and advisors under three Stock Option Plans, (i) The 2005 Stock Option Plan, (ii) The 2008 Stock Option Plan and (iii) The 2010 Equity Incentive Plan. The Company has also issued Non-Plan stock options to certain consultants and advisors.
The Company’s 2005 Stock Option Plan, dated December 8, 2005 (as amended from time to time) has reserved 6,000,000 Common Shares for issuance. The Company’s 2008 Stock Option Plan, dated May 30, 2008, has reserved 5,000,000 Common Shares for issuance and the Company’s 2010 Equity Incentive Plan dated October 4, 2010 has reserved 25,000,000 Common Shares for issuance. Additionally, the Company has reserved 841,500 Common Shares for outstanding non-plan stock options.
(A) Consolidated Schedule of Stock Option Plans
A summary of the Company’s stock options from December 31, 2010 to September 30, 2011 is presented below:
| | | Shares under option | | | Weighted Average Exercise Price | | | Average Remaining Contractual Life (Years) | | | Weighted Average Grant Date Fair Value | |
| Outstanding at December 31, 2009 (post conversion) | | | 9,004,977 | | | $ | 0.26 | | | | 5.20 | | | $ | 2.18 | |
| Exercisable at December 31, 2009 (post conversion) | | | 5,884,246 | | | $ | 0.26 | | | | 5.00 | | | $ | 2.54 | |
| | | | | | | | | | | | | | | | | |
| Granted | | | 5,871,025 | | | $ | 0.27 | | | | 9.23 | | | $ | 0.07 | |
| Exercised | | | - | | | | - | | | | - | | | | - | |
| Expired | | | | | | | - | | | | - | | | | - | |
| Cancelled | | | (3,607,784 | ) | | $ | 0.26 | | | | - | | | | - | |
| Forfeited | | | - | | | | - | | | | - | | | | - | |
| Outstanding at December 31, 2010 | | | 11,268,218 | | | $ | 0.27 | | | | 5.80 | | | $ | 1.67 | |
| Exercisable at December 31, 2010 | | | 9,168,806 | | | $ | 0.27 | | | | 5.02 | | | $ | 1.86 | |
| | | | | | | | | | | | | | | | | |
| Granted | | | 15,043,068 | | | $ | 0.13 | | | | 9.74 | | | $ | 0.03 | |
| Exercised | | | - | | | | - | | | | - | | | | - | |
| Expired | | | (3,481,133 | ) | | | 0.29 | | | | | | | | - | |
| Cancelled | | | (949,931 | ) | | | 0.54 | | | | - | | | | - | |
| Forfeited | | | - | | | | - | | | | - | | | | - | |
| Outstanding at September 30, 2011 | | | 21,880,222 | | | $ | 0.17 | | | | 8.90 | | | $ | 0.13 | |
| Exercisable at September 30, 2011 | | | 20,154,422 | | | $ | 0.17 | | | | 9.04 | | | $ | 0.09 | |
The fair value of stock options granted during the period ended September 30, 2011 was estimated using the Black-Scholes option pricing model with the assumption that no dividends are to be paid on common shares, a weighted average volatility factor for the Company’s share price of 20% (2010 – 20%), a weighted average risk free interest rate of 3.4% (2010 – 2.5%) over an expected term of 10 years (2010 - 10 years).
In 2011, the Company granted 993,068 stock options with strike prices ranging from $0.10 to $0.25 per common share and fair values ranging from $0.03 to $0.06 to employees. The fair values of these options get expensed over their vesting periods through 2014.
Also, in 2011, the Company granted 14,050,000 stock options with strike prices ranging from $0.10 to $0.25 per common share and fair values ranging from $0.01 to $0.06 to management and advisors. The fair values of these options are expensed over their vesting periods through 2014.
12. Financial instruments
The Company, as part of its operations, carries a number of financial instruments. The Company is not exposed to significant interest, credit or currency risks arising from these financial instruments except as otherwise disclosed.
The Company’s financial instruments, including cash, accounts payable and accrued liabilities, notes payable to stockholders and loans payable to the controlling stockholder are carried at values that approximate their fair values due to their relatively short maturity periods. The estimated fair value of related party loans is not practical to estimate, due to the related party nature of the underlying transactions.
Notes payable are carried at face value plus accrued interest in accordance to the agreements except where noted otherwise.
13. Subsequent events
On October 14th, 2011 AIS terminated all of its remaining employees except for its CEO/CFO as it was unable to meet payroll commitments. Based on the notice of termination on October 14, 2011, the Company is responsible for approximately $50,000 in severance payments by virtue of employment agreements with 4 key employees that provide for one month salary in lieu of notice requirements. The Company will incur a charge to operations of approximately $50,000 in the three months ending December 31, 2011.
On November 9, 2011, the Company entered into an agreement with a third party (with the consent of the landlord) to assign its rights relating to its Toronto office lease for the remaining term through May 2014 at the same monthly rate. The assignment provides that, in the event that the third party is unable to meet the rent obligations, the Company will continue to be responsible for the amounts due under the original lease (aggregating $242,110 at November 9, 2011).
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with the information contained in the unaudited condensed consolidated financial statements of the Company and the related notes thereto, appearing elsewhere herein, and in conjunction with the Management’s Discussion and Analysis of Financial Condition and Results of Operations set forth in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010, filed with the Securities and Exchange Commission (“SEC”) on April 15, 2011.
Forward Looking Information
This Quarterly Report on Form 10-Q (the “Report”) contains certain “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Exchange Act of 1934, as amended, that 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 noted in the Company’s Annual Report on Form 10K for the year ended December 31, 2010, filed with the SEC, and as noted below. 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.
COMPANY OVERVIEW
On March 19, 2010, AISystems, Inc., formerly Wolf Resources Inc. (the “Company”) acquired Airline Intelligence Systems Inc. (“AIS”), a development stage software development company based in the State of Washington, focused on software for the airline industry. In accordance with the Share Exchange Agreement upon delivery of 100% of AIS stock, the Company issued a total of 116,250,000 shares which represented 75% of the issued and outstanding common stock on a fully diluted basis and a total of 2,329,905 shares or 100% of the issued and outstanding Series B preferred stock. As a result of the merger transaction, the Company is no longer considered to be a shell company for reporting purposes.
The transaction has been accounted for by the Company as a reverse merger. For accounting purposes, AIS is the acquirer in the reverse acquisition transaction, and consequently, the financial results have been reported on a historical basis as if AIS had acquired the Company. As the acquisition of the net monetary liabilities of the Company did not constitute a business, the transaction has been accounted for as a reverse merger (i.e. capital transaction). Accordingly, the Company has reflected the issuance 38,754,000 shares for the total net monetary liabilities of the shell company in the amount of $52,990 in the consolidated statement of changes in stockholders' equity.
The exchange ratio on the merger was 0.95767068 Company shares for each share of AIS. The historical issuances of equity by AIS are reflected by applying the exchange ratio to the earliest reporting period.
The Company also filed a Form 14C on April 7, 2010 wherein amongst other things; the Company amended its year-end to December 31, to coincide with the year-end of AIS.
Business History
Airline Intelligence Systems Inc. was incorporated in Delaware in December 2005. The business was initiated by Stephen Johnston and Roy Miller, with the intention of solving one of the most difficult planning and scheduling problems facing the commercial airline industry today enabling the integration and control of an airline’s Planning, Revenue Management and Operations functions in real time. Stephen Johnston remained as the Chief Executive Officer and has assumed the role of Chief Financial Officer as of June 23, 2010 until a successor has been elected and qualified.
On September 16th, 2011 Mr. Stephen C. Johnston resigned from the Company’s Board of Directors.
On September 23rd, 2011, Mr. Johnston resigned as President and Chief Executive Officer of the Company.
The Board has appointed David Haines to serve as Chief Executive Officer and Chief Financial Officer on an interim basis.
Business background
The Company negotiated an exclusive licensing right to develop and market a proprietary business platform called jetEngine™ (“jetEngine”) for the airline industry and is in the process of building a software program while simultaneously creating an infrastructure for sustainable growth prepared to enter the commercial stage of its business life cycle.
The Company has received a Notice of non-renewal with regard to this technology license.
On September 7, 2011, Dynamic Intelligence Inc. (“Dynamic”) provided the Company with a Notice of Non-Renewal, pursuant to an Intellectual Property Agreement (the “Agreement”) entered into by the parties on December 9, 2005. Pursuant to the terms of the Agreement, the term of the Agreement would be automatically and continuously extended in one (1) year increments unless either party provided notice of non-renewal at least ninety (90) days before the end of the then-current term. Due to Dynamic’s Notice of Non-Renewal, the Agreement will not renew on December 9, 2011.
The Agreement provided the Company with an exclusive and perpetual license to Dynamic’s intellectual property, which permitted the Company to use such proprietary technology to develop a unique proprietary business platform for the airline industry that is comprised of systems and mathematical algorithms capable of generating significant improvements in strategic planning capabilities, resource scheduling, revenue management and integrated operations.
The Company currently anticipates the implementation of its business plan would require additional investment capital. The Company has attempted to complete $5 million to $10 million in equity financing in 2011. These funds would be used to engage potential customers, to fund product development, for working capital purposes, for repayment of debt and for other corporate purposes.
There is no assurance that the Company will be able to raise the necessary funds to continue operations as envisioned or that such funds can be raised on favorable terms to existing stockholders. This could result in significant dilution or a loss of investment to any current or future stockholders. If the Company is unable to raise sufficient funds on the required timelines its ability to implement its vision will be hindered and this could result in the entire loss of any investment in the Company. The Company has limited resources at this time, in the annual financial statements a reference to the Company’s ability to continue as a going concern assumption is rendered, see Liquidity and Capital Resources section below.
At this time it is possible that, 1) The Company will not complete sales with potential customers, 2) that those sales will not be completed on terms favorable to the Company 3) that the Company will not have sufficient or the appropriate resources to complete the development of its product 4) that a competitive product will address the needs of the market before the Company is able to commercialize thereby significantly reducing the expected market opportunity, 5) the product as envisioned and developed by the Company will not meet the needs of customer and therefore never get deployed or achieve acceptance in the market place, 6) that the Company will be unable to engage with additional customers without access to the technology license, for which they received a notice of Non-renewal on September 7, 2011.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Critical Accounting Policies
Management’s Discussion and Analysis of Financial Condition and Results of Operations discusses our unaudited condensed consolidated interim financial statements, which have been prepared in accordance with generally accepted accounting principles (“GAAP”) in the United States. This requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the 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 estimates required for the preparation of the unaudited condensed consolidated financial statements included in Item 1 of this Report were those related to revenue recognition, stock based compensation, deferred income tax assets, liabilities, notes payable issued with warrants and contingencies surrounding litigation. These estimates are considered significant because of the significance of the financial statement item to which they relate, or because they require judgment and estimation due to the uncertainty involved in measuring, at a specific point in time, events that are continuous in nature. Management bases its estimates and judgments on historical experience and various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. On an on-going basis, management evaluates its estimates and judgments, including those related to intangible assets, contingencies, and litigation. Actual results could differ from these estimates.
The critical accounting policies used in the preparation of our interim condensed consolidated financial statements are discussed in our Form 10-K for the year ended December 31, 2010 filed with the SEC on April 15, 2011. To aid in the understanding of our financial reporting, it is suggested that the condensed consolidated interim financial statements be read in conjunction with the financial statements and notes thereto, included in our Form 10-K filed April 15, 2011.
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
Results of Operations for the nine months ended September 30, 2011 and 2010 and for the period from December 7, 2005 (inception) to September 30, 2011.
The following tables set forth key components of our results of operations for the periods indicated in dollars. The discussion following the table is based on these unaudited results.
| | | Three Months Ended September 30, 2011 | | | Three Months Ended September 30, 2010 | | | Nine Months Ended September 30, 2011 | | | Nine Months Ended September 30, 2010 | | | For the period from December 7, 2005 (inception) to September 30, 2011 | |
| | | | | | | | | | | | | | | | |
| Deferred fee revenue recognized on expiration of Aeromexico Software License Agreement | | $ | - | | | $ | - | | | $ | 1,000,000 | | | $ | - | | | $ | 1,000,000 | |
| Operating expenses | | | | | | | | | | | | | | | | | | | | |
| Salary and benefits | | | (492,871 | ) | | | (558,098 | ) | | | (1,380,939 | ) | | | (1,834,896 | ) | | | (18,185,578 | ) |
| Outside services | | | (132,443 | ) | | | (1,119,701 | ) | | | (968,140 | ) | | | (2,637,270 | ) | | | (12,704,463 | ) |
| Travel, meals and entertainment | | | (29,677 | ) | | | 11,564 | | | | (81,655 | ) | | | (101,991 | ) | | | (2,702,410 | ) |
| Office and general expense | | | (69,513 | ) | | | (268,114 | ) | | | (132,603 | ) | | | (775,004 | ) | | | (5,127,872 | ) |
| | | | (724,504 | ) | | | (1,934,349 | ) | | | (2,563,337 | ) | | | (5,349,161 | ) | | | (38,720,323 | ) |
| | | | | | | | | | | | | | | | | | | | | |
| Depreciation and amortization | | | (26,798 | ) | | | (46,637 | ) | | | (80,392 | ) | | | (139,910 | ) | | | (1,185,694 | ) |
| Stock-based compensation | | | (398,126 | ) | | | (144,939 | ) | | | (1,053,647 | ) | | | (429,745 | ) | | | (28,605,256 | ) |
| Loss from impairment of property and equipment expense | | | (139,522 | ) | | | - | | | | (139,522 | ) | | | - | | | | (139,522 | ) |
| Total Operating Expense | | | (1,288,950 | ) | | | (2,125,925 | ) | | | (3,836,898 | ) | | | (5,918,816 | ) | | | (68,650,795 | ) |
| | | | | | | | | | | | | | | | | | | | | |
| Loss from operations | | | (1,288,950 | ) | | | (2,125,925 | ) | | | (2,836,898 | ) | | | (5,918,816 | ) | | | (67,650,795 | ) |
| | | | | | | | | | | | | | | | | | | | | |
| Other income(expenses) | | | | | | | | | | | | | | | | | | | | |
| Fair value of series C preferred stock issued to Dynamic on September 15, 2011 | | | (100,000 | ) | | | - | | | | (100,000 | ) | | | - | | | | (100,000 | ) |
| Interest(expenses), including accretion of debt discounts of $170,021 in the three and nine months ended September 30, 2011 | | | (294,707 | ) | | | (70,476 | ) | | | (617,806 | ) | | | (227,398 | ) | | | (4,259,126 | ) |
| Interest income | | | - | | | | - | | | | - | | | | -- | | | | 114,610 | |
| Gain on extinguishment of debt | | | - | | | | - | | | | 54,437 | | | | | | | | 54,437 | |
| Loss on termination of lease | | | (180,000 | ) | | | - | | | | (180,000 | ) | | | - | | | | (180,000 | ) |
| Other income(expense) | | | 116,638 | | | | (46,678 | ) | | | 60,004 | | | | (25,028 | ) | | | 58,398 | |
| Other income(expenses) -net | | | (458,069 | ) | | | (117,154 | ) | | | (783,365 | ) | | | (252,426 | ) | | | (4,311,681 | ) |
| Net loss for the period | | | (1,747,019 | ) | | | (2,243,079 | ) | | | (3,620,263 | ) | | | (6,171,242 | ) | | | (71,962,476 | ) |
| | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| Net loss per share attributable to common stockholders | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| Basic and fully diluted | | $ | (0.01 | ) | | $ | (0.02 | ) | | $ | (0.02 | ) | | $ | (0.05 | ) | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| Number of weighted average common shares outstanding basic and diluted | | | 159,003,285 | | | | 141,767,342 | | | | 155,229,606 | | | | 127,974,981 | | | | | |
Revenues.
The Company is a development stage company and has earned $1 million in revenue from its inception in 2005 through September 30, 2011. At this time, the Company’s product remains under development and the Company has deployed products to beta customers but has yet to convert those beta customers to commercial customers.
On June 7, 2007, the Company signed AeroMexico as its first customer. The Company received $1 million in fees from AeroMexico but, since that contract term has ended, the Company does not expect any future revenues from AeroMexico.
Operating Expenses
For the nine months ended September 30, 2011, the Company’s loss from operations was $2,836,898 as compared to approximately $5,918,816 in the same period in 2010. The Company’s losses from operations from inception (December 7, 2005) through September 30, 2011 are $67,650,795. In the first three quarters of 2011, losses from operations were lower than in the same period in 2010 as the Company adjusted its business to align its business progress with financing available in the market to continue operations. Costs incurred for the nine months ended September 30, 2011 and in the comparative periods related primarily to staff, facilities, consultants, advisors, legal, travel and other costs associated with seeking customers, investors and the continued development of software as the Company aims to establish a market for its technology rights. Since inception, the Company has expanded and contracted based upon access to capital, the availability of key resources and traction with potential customers.
Income tax expense
The income tax expense for the nine months ended September 30, 2011 and 2010 was Nil as the Company has incurred operating losses since inception.
Equity Issuances in 2011
From January 1, 2011 to September 30, 2011, the Company issued 12,708,849 common shares for gross proceeds of $1,039,560. $55,676 of the proceeds relate to subscriptions advanced prior 2011, $366,000 were cash proceeds and $617,884 of the proceeds related to the conversion of debt plus accrued interest. Of the proceeds related to the conversion of debt, $54,437 was attributed to a gain on the extinguishment of debt.
As of September 30, 2011, the Company has collected $432,746 of proceeds in advance of shares being issued. $382,746 of this amount was collected from the period January to June 30, 2011, of which $276,864 were cash proceeds and $105,882 related to debt conversions.
Between June 30, 2011 and September 30, 2011, the company collected $520,656.50 of proceeds in advance of shares being issued. The Company will issue 1,386,313 shares as a result of these subscriptions.
On September 8, 2011 The Company’s Board of Directors approved the Designation and Issuance of one (1) Series C Preferred Share that holds specific voting powers in the Company.
LIQUIDITY AND CAPITAL RESOURCES
Capital required to continue operations and substantial doubt about ability to continue operations
The Company requires capital to continue operations. The Company is in arrears with its creditors and any of its creditors may petition the Company in receivership. In this regard, management is planning to raise necessary additional funds through loans and additional sales of its common stock. There is no assurance that the Company will be successful in raising additional capital.
The Company has attempted to raise $5 million to $10 million in equity in 2011, which would be used to fund operations, improve working capital and to reduce maturing and past due debt. Should the Company be unable to raise this amount of capital its operating plans to fund our business and financial performance could be adversely affected. As of the date of this filing, the Company has not been successful in obtaining this equity.
The Company has yet to fully commercialize its technologies and consequently has incurred significant losses since its inception.
At September 30, 2011, the Company’s deficit accumulated during the development stage was approximately $71,962,476 and the Company had utilized cash in operating activities of $29,199,495. The Company has funded these losses and cash flows through the sale of equity securities, the issuance of debt and from credit granted by vendors. The Company is also in arrears to certain creditors and in default under certain agreements which may have a material adverse effect on operations.
These factors raise substantial doubt about the ability of the Company to continue as a going concern. There can be no assurance that the Company will have adequate capital resources to fund planned operations or that any additional funds will be available to the Company when needed, or if available, will be available on favorable terms in the amounts required by the Company. If the Company is unable to obtain adequate capital resources to fund operations, it may be required to delay, scale back or eliminate some or all of its operations, which may have a material adverse effect on the Company’s business, results of operations and ability to continue as a going concern.
OFF-BALANCE SHEET ARRANGEMENTS
Exchange Right Agreement
The Company and Merus Capital I, L.P. (“Merus”) entered into an exchange right agreement (the “Agreement”), whereby Merus provided funding to the Company in exchange for, amongst other things, a right in liquidation for Merus to exchange common stock held by Merus at the time of the conversion (“Merus Securities”) into an unsecured promissory note with aggregate principle up to $5,000,000 paying interest at a rate of 5.00% per annum. The term of the Agreement is the earlier of: (i) 36 months following a Going Public Transaction (as defined in the Agreement); (ii) Merus receiving the Note after exercising their rights under the Agreement; and (iii) Merus transferring any of the Merus Securities without the prior authorization of the Company. Management has reviewed the terms of the exchange right agreement and has determined that permanent equity classification is appropriate because all conditions under which the exchange right could be enforced are solely within the control of the Company.
Inflation.
Inflation did not have a significant impact on our results during the quarter and nine months ended September 30, 2011.
Subsequent Events.
On October 14th, 2011, Except for our CEO/CFO, AIS terminated all of its remaining employees as it was unable to meet payroll commitments.
On November 9, 2011, the Company entered into an agreement to assign its last remaining office lease commitment to a third party, and is looking for purchasers of various non-core assets in an attempt to raise capital in order to satisfy its commitments.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are a smaller reporting company as defined by Rule 12b-2 of the Securities Act of 1934 and are not required to provide the information under this item.
ITEM 4. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
Disclosure controls and procedures. Pursuant to Rule 13a-15 under the Securities Exchange Act of 1934 (the “1934 Act”), as of September 30, 2011, we carried out an evaluation, with the participation of the Company’s management, including the Company’s Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”) (the Company’s principal financial and accounting officer), of the effectiveness of the Company’s disclosure controls and procedures (as defined under Rule 13a-15(e) under the Exchange Act) as of the end of the period covered by this report. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that considering the reduced size of the Company, that our disclosure controls and procedures are working effectively to ensure that information required to be disclosed by the Company in the reports that the Company files or submits under the Exchange Act, is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including the Company’s CEO and CFO, as appropriate, to allow timely decisions regarding required disclosure. Management believes that the financial statements included in this report present fairly, in all material respects, the Company’s consolidated financial position, results of operations and cash flows for the periods presented.
Changes in internal control over financial reporting. There were no changes in our internal control over financial reporting that occurred during the last fiscal quarter covered by this Quarterly Report on Form 10-Q that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II – OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Other than as noted below, there are no outstanding judgments against the Company or any consent decrees or injunctions to which the Company is subject or by which its assets are bound and there are no claims, proceedings, actions or lawsuits in existence, or to the Company’s knowledge threatened or asserted, against the Company or with respect to any of the assets of the Company that would materially and adversely affect the business, property or financial condition of the Company, including but not limited to environmental actions or claims. However, from time to time, the Company is involved in various lawsuits and legal proceedings which arise in the ordinary course of business. Litigation is subject to inherent uncertainties, and an adverse result in these or other matters may arise from time to time that may harm our business.
Devon James Associates Inc. and Colleen Aylward – On July 8, 2011, AIS entered into a settlement agreement with Devon James Associates Inc. and Colleen Aylward with regard to potential litigation. AIS is currently in default with respect to this settlement agreement. The potential litigation related to fees outstanding in relation to certain recruiting activities.
Carillon Properties: AIS entered into a settlement agreement on April 4, 2011 with Carillon Properties with respect to potential litigation with regard to unpaid rent. AIS is currently in default with respect to this settlement. The claim related to potential lease obligation with respect to the Company’s Carillon Point location.
ITEM 1A. RISK FACTORS
None.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Between June 30, 2011 and September 30, 2011, the company collected $520,656.50 of proceeds in a private placement transaction. The Company will issue 1,386,313 shares as a result of these subscriptions.
The common shares to be issued to the investors in the private placement transaction was an unregistered sale of securities conducted upon exemptions from registration pursuant to Section 4(2) of the Securities Act of 1933, as amended (the “Securities Act”) and Rule 506 of Regulation D (“Regulation D”) promulgated under the Securities Act.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. (REMOVED AND RESERVED)
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS
(a) Exhibits
| Exhibit No. | | Description |
| 31.1 | | Certification of Principal Executive Officer and Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted under Section 302 of the Sarbanes-Oxley Act of 2002. |
| | | |
| 32.1 | | Certification of Principal Executive Officer and Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| | | |
| 101 | | Interactive Data File (Form 10-Q for the quarterly period ended September 30, 2011 furnished in XBRL). |
In accordance of SEC Release 33-8238, Exhibit 32.1 is being furnished and not filed.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| | AI SYSTEMS INC. |
| | | |
Date: November 25, 2011 | By: | /s/ David Haines |
| | | David Haines |
| | | Chief Executive Officer (Duly Authorized Officer, Principal Executive Officer and Principal Financial Officer) |
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