Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended: March 31, 2013

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission File Number: 000-51115

 

 

Avantair, Inc.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   20-1635240

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

4311 General Howard Drive

Clearwater, Florida 33762

(Address of principal executive offices) (Zip Code)

(727) 539-0071

(Registrant’s telephone number, including area code)

N/A

(Former name, former address and former fiscal year, if changed since last report)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 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.    Yes   x     No   ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes   x     No   ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   ¨   (Do not check if a smaller reporting company)    Smaller reporting company   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

As of May 10, 2013, there were 40,901,634 shares of the registrant’s common stock, $0.0001 par value per share, outstanding.

 

 

 


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CERTAIN DEFINITIONS

Unless the context indicates otherwise, the terms “Avantair”, “the Company”, “we”, “our” and “us” refer to Avantair, Inc. and, where appropriate, its subsidiaries. The term “Registrant” means Avantair, Inc.

INFORMATION REGARDING FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward-looking statements relating to future events and the future performance of the Company, including, without limitation, statements regarding the Company’s expectations, beliefs, intentions or future strategies that are signified by the words “expects,” “anticipates,” “intends,” “believes,” or similar language. Our actual results could differ materially from the information contained in these forward-looking statements as a result of various factors, including, but not limited to, the factors outlined in our Annual Report on Form 10-K for the fiscal year ended June 30, 2012, particularly under the heading “Risk Factors,” the factors outlined in our Quarterly Report on Form 10-Q for the quarterly period ended December 31, 2012, particularly under the heading “Risk Factors,” the factors outlined in this Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2013, particularly under the heading “Risk Factors,” and the factors outlined below:

 

  (1) our inability to generate sufficient net revenue in the future;

 

  (2) our inability to fund our operations and capital expenditures;

 

  (3) our inability to raise capital or meet cash flow projections, including our inability to raise funds through the issuance of convertible notes and warrants or through other financings;

 

  (4) extensive government regulation, including, but not limited to, the operational requirements of the Federal Aviation Administration;

 

  (5) our inability to generate sufficient cash flows to meet our debt service obligations or other financial obligations;

 

  (6) our inability to obtain new or retain current acceptable program participant contracts;

 

  (7) the potential impact to our business, financial condition and results of operations as a result of our pilot group unionization;

 

  (8) the inability to strategically eliminate more costly aircraft from our fleet and that such action may not see a corresponding decrease in the cost of flight operations;

 

  (9) the inability to achieve lower maintenance costs through the use of third party maintenance operators;

 

  (10) the loss of key personnel;

 

  (11) our inability to effectively manage our growth;

 

  (12) our inability to acquire additional aircraft and parts from our single manufacturer;

 

  (13) competitive conditions in the fractional aircraft industry;

 

  (14) the failure or disruption of our computer, communications or other technology systems;

 

  (15) changing economic conditions;

 

  (16) increases in fuel costs; and,

 

  (17) our failure to attract and retain qualified pilots and other operations personnel.

The risks described above and in our Annual Report on Form 10-K for the fiscal year ended June 30, 2012 and in our Quarterly Report on Form 10-Q for the quarterly period ended December 31, 2012 are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial may also materially adversely affect our business, financial condition or operating results. We do not undertake, and expressly disclaim, any obligation to update this forward-looking information, except as required by applicable law.

The forward-looking statements relating to future events and the future performance of the Company, include, without limitation, statements regarding: the ability of the Company to meet its primary operating strategy to achieve positive cash flows by continuing the Company’s cost savings initiatives; the timeline for the Company achieving positive cash flows; during the third fiscal quarter of 2013, the Company continued its plans to strategically eliminate more costly aircraft from its fleet, and as a result, the Company’s expectation to see a corresponding decrease in its cost of flight operations, which includes maintenance costs; the Company’s expectation of lower maintenance costs as a result of driving increased efficiencies through the use of third party aircraft maintenance operators to provide increased levels of maintenance contract services of its fleet; the Company’s belief that the effect of the operational stand down will continue to negatively impact its cash receipts, liquidity and retention of program participants in the near term; the Company’s assumption that it will continue as a going concern; the Company’s ability to obtain shareholder approval for increases in the authorized shares of common stock related to the offerings; and the Company’s expectation as the effects of the pilots unionization.


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Table of Contents

 

PART I – FINANCIAL INFORMATION

  

Item 1.

  Financial Statements   
  Consolidated Balance Sheets as of March 31, 2013 (unaudited) and June 30, 2012      1   
 

Consolidated Statements of Operations for the three and nine months ended March 31, 2013 and 2012 (unaudited)

     2   
  Consolidated Statements of Cash Flows for the nine months ended March 31, 2013 and 2012 (unaudited)      3   
  Consolidated Statement of Stockholders’ Deficit for the nine months ended March 31, 2013 (unaudited)      4   
  Notes to Consolidated Financial Statements (unaudited)      5   

Item 2.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations      24   

Item 3.

  Quantitative and Qualitative Disclosures about Market Risk      29   

Item 4.

  Controls and Procedures      30   

PART II – OTHER INFORMATION

  

Item 1.

  Legal Proceedings      31   

Item 1A.

  Risk Factors      31   

Item 2.

  Unregistered Sales of Equity Securities and Use of Proceeds      32   

Item 3.

  Defaults Upon Senior Securities      33   

Item 4.

  Mine Safety Disclosures      33   

Item 5.

  Other Information      33   

Item 6.

  Exhibits      33   


Table of Contents

PART I – FINANCIAL INFORMATION

 

Item 1. Financial Statements.

AVANTAIR, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

(Amounts in Thousands, Except Share Data)

 

     March 31,
2013
(Unaudited)
    June 30,
2012
(Note 2)
 

ASSETS

    

Current Assets

    

Cash and cash equivalents

   $ 2,417      $ 5,302   

Accounts receivable, net of allowance of $1,515 and $1,340, respectively

     9,458        11,707   

Inventory

     82        155   

Current portion of aircraft costs related to fractional share sales

     2,458        8,458   

Prepaid expenses and other current assets

     5,630        3,830   
  

 

 

   

 

 

 

Total current assets

     20,045        29,452   
  

 

 

   

 

 

 

Long-Term Assets

    

Aircraft costs related to fractional share sales, net of current portion

     396        1,691   

Property and equipment, net

     38,838        40,136   

Cash-restricted

     2,015        2,226   

Deposits on aircraft

     7,341        7,193   

Goodwill

     —          1,141   

Other assets

     9,617        9,443   
  

 

 

   

 

 

 

Total long-term assets

     58,207        61,830   
  

 

 

   

 

 

 

Total assets

   $ 78,252      $ 91,282   
  

 

 

   

 

 

 

LIABILITIES AND STOCKHOLDERS’ DEFICIT

    

Current Liabilities

    

Accounts payable

   $ 11,447      $ 9,051   

Accrued liabilities

     9,815        6,393   

Customer deposits

     3,164        3,115   

Short-term debt

     6,853        12,000   

Current portion of long-term debt

     7,657        4,652   

Current portion of deferred revenue related to fractional aircraft share sales

     3,248        9,995   

Unearned management fee, flight hour card and membership revenue

     49,433        60,015   
  

 

 

   

 

 

 

Total current liabilities

     91,617        105,221   
  

 

 

   

 

 

 

Long-Term Liabilities

    

Long-term debt, net of current portion

     12,614        13,753   

Senior secured convertible promissory notes

     3,367        —     

Derivative liabilities

     8,164        —     

Deferred revenue related to fractional aircraft share sales, net of current portion

     6,603        8,179   

Deferred revenue related to membership revenue, net of current portion

     6        213   

Other liabilities

     2,741        2,465   
  

 

 

   

 

 

 

Total long-term liabilities

     33,495        24,610   
  

 

 

   

 

 

 

Total liabilities

     125,112        129,831   
  

 

 

   

 

 

 

COMMITMENTS AND CONTINGENCIES

    

Series A convertible preferred stock, $.0001 par value, authorized 300,000 shares 152,000 share issued and outstanding

     14,867        14,799   
  

 

 

   

 

 

 

STOCKHOLDERS’ DEFICIT

    

Preferred stock, $.0001 par value, authorized 700,000 shares; none issued or outstanding

     —          —     

Common stock, Class A, $.0001 par value, 75,000,000 shares authorized, 40,901,634 and 26,497,468 shares issued and outstanding as of March 31, 2013 and June 30, 2012, respectively

     4        3   

Additional paid-in capital

     61,019        57,830   

Accumulated deficit

     (122,750 )     (111,181 )
  

 

 

   

 

 

 

Total stockholders’ deficit

     (61,727 )     (53,348 )
  

 

 

   

 

 

 

Total liabilities and stockholders’ deficit

   $ 78,252      $ 91,282   
  

 

 

   

 

 

 

The accompanying notes are an integral part of the consolidated financial statements.

 

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AVANTAIR, INC. AND SUBSIDIARIES

Consolidated Statements of Operations

(Amounts in Thousands, Except Share Data)

(Unaudited)

 

     Three Months Ended
March 31,
    Nine Months Ended
March 31,
 
     2013     2012     2013     2012  

Operating Revenue

        

Fractional aircraft shares sold

   $ 2,076      $ 8,126      $ 8,900      $ 21,742   

Lease revenue

     1,065        729        3,046        1,680   

Management and maintenance fees

     21,123        21,355        64,820        62,622   

Flight hour card and club membership revenue

     6,236        7,758        20,088        25,520   

Flight activity and other ancillary billing

     3,662        5,406        13,129        14,841   

Other revenue

     498        2,222        3,040        5,112   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating revenue

     34,660        45,596        113,023        131,517   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses

        

Cost of fractional aircraft shares sold

     1,691        7,771        7,533        20,185   

Cost of flight operations

     21,815        20,371        62,458        58,822   

Cost of fuel

     8,399        9,469        24,417        28,469   

General and administrative expenses

     5,088        5,374        17,223        17,093   

Selling expenses

     708        1,433        2,318        5,010   

Depreciation and amortization

     1,090        1,094        3,679        3,173   

Employee termination and other costs

     —          883        69        883   

Impaired goodwill expense

     1,141        —          1,141        —     

Gain on receipt of used share

     (74 )     —          (254     —     

(Gain) loss on sale of asset

     (37 )     (624     417        (624
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     39,821        45,771        119,001        133,011   
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss from operations

     (5,161 )     (175     (5,978     (1,494
  

 

 

   

 

 

   

 

 

   

 

 

 

Other income (expenses)

        

Interest and other income

     42        33        73        113   

Interest expense

     (1,560 )     (1,080 )     (3,367     (3,376

Change in fair value of derivative liabilities

     (1,291     —          (1,232     —     

Gain on debt extinguishment

     —          —          —          439   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other expenses

     (2,809     (1,047 )     (4,526     (2,824
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

     (7,970     (1,222 )     (10,504     (4,318

Less preferred stock dividend

     361        372        (1,065     1,117   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss attributable to common stockholders

   $ (8,331   $ (1,594 )   $ (11,569   $ (5,435
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss per common share:

        

Basic and diluted

   $ (0.20 )   $ (0.06 )   $ (0.37   $ (0.21
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted-average common shares outstanding:

        

Basic and diluted

     40,901,634        26,489,424        31,420,648        26,454,261   
  

 

 

   

 

 

   

 

 

   

 

 

 

The accompanying notes are an integral part of the consolidated financial statements.

 

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AVANTAIR, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(Amounts in Thousands)

(Unaudited)

 

     Nine Months Ended
March 31,
 
     2013     2012  

CASH FLOWS FROM OPERATING ACTIVITIES:

    

Net loss

   $ (10,504   $ (4,318 )

Adjustments to reconcile net loss to net cash (used in) provided by operating activities:

    

Depreciation and amortization

     3,679        3,173   

Amortization of deferred interest related to capital lease obligation

     —          109   

Capitalized interest

     —          35   

Gain on receipt of used share

     (254     —     

Gain on debt extinguishment

     —          (439

Accretion of discount on indebtedness

     189        —     

Change in fair value of derivative liabilities

     1,232        —     

Goodwill impairment

     1,141        —     

Loss on sale of assets, net of gain

     417        (624

Stock-based compensation

     470        534   

Bad debt expense

     503        559   

Other

     30        —     

Changes in operating assets and liabilities:

    

Accounts receivable

     (356     1,329   

Inventory

     325        56   

Aircraft costs related to fractional share sales

     7,295        18,892   

Prepaid expenses and other current assets

     19        505   

Cash-restricted

     211        136   

Deposits on aircraft

     (148     914   

Other assets

     628        (2,844 )

Accounts payable

     3,344        2,863   

Accrued liabilities

     3,429        5,722   

Customer deposits

     49        1,342   

Deferred revenue related to fractional aircraft share sales

     (8,000     (18,387 )

Unearned management fee, flight hour card and club membership revenue

     (10,789     (884

Other liabilities

     590        (40 )
  

 

 

   

 

 

 

Net cash (used in) provided by operating activities

     (6,500     8,633   
  

 

 

   

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

    

Proceeds from the sale of asset

     —          628   

Capital expenditures

     (1,645     (3,110 )
  

 

 

   

 

 

 

Net cash used in investing activities

     (1,645     (2,482 )
  

 

 

   

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

    

Borrowings under long-term debt

     —          2,000   

Proceeds from issuance of senior secured convertible promissory notes

     7,732        —     

Dividends paid

     —          (1,026 )

Principal payments on short-term debt

     (250     (500 )

Principal payments on long-term debt

     (2,222     (5,122 )
  

 

 

   

 

 

 

Net cash provided by (used in) financing activities

     5,260        (4,648 )
  

 

 

   

 

 

 

Net (decrease) increase in cash and cash equivalents

     (2,885     1,503   

Cash and cash equivalents, beginning of the period

     5,302        5,643   
  

 

 

   

 

 

 

Cash and cash equivalents, end of the period

   $ 2,417      $ 7,146   
  

 

 

   

 

 

 

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:

    

Interest paid

   $ 3,336      $ 3,377   

SUPPLEMENTAL DISCLOSURE OF NONCASH FINANCING AND INVESTING ACTIVITIES:

    

Accretion of Series A convertible preferred stock

   $ 68      $ 68   

Dividends accrued on Series A convertible preferred stock

   $ 1,065      $ 342   

Common shares surrendered in lieu of payroll taxes

   $ —        $ 15   

Aircraft acquired through capital lease

   $ 4,770      $ 6,100   

Shares acquired in exchange for fractional lease

   $ 754      $ —     

Shares acquired in noncash, reciprocal transfer

   $ 1,348      $ —     

Shares acquired in noncash, non-reciprocal transfer

   $ 180      $ —     

Warrants/restricted stock/convertible senior promissory note issued in connection with capital/operating leases

   $ 5,960      $ —     

Additional aircraft cost in connection with modification of capital lease

   $ 151      $ —     

Conversion of short-term note payable to capital lease

   $ —        $ 5,200   

Conversion of short-term note payable to operating lease

   $ 5,750      $ —    

Flight hour cards issued in consideration for repurchase of fractional aircraft shares

   $ —        $ 119   

Short-term notes payable repayment upon completion of aircraft delivery rights transfer

   $ —        $ 1,300   

The accompanying notes are an integral part of the consolidated financial statements.

 

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AVANTAIR, INC. AND SUBSIDIARIES

Consolidated Statement of Changes in Stockholders’ Deficit

For the Nine Months Ended March 31, 2013

(Amounts in Thousands)

(unaudited)

 

     Common Stock      Additional
Paid-In
    Accumulated     Total
Stockholders’
 
     Shares      Amount      Capital     Deficit     Deficit  

Balance at June 30, 2012

     26,497       $ 3       $ 57,830      $ (111,181   $ (53,348

Stock-based compensation

           470          470   

Dividend on Series A convertible preferred stock

             (1,065     (1,065

Accretion of preferred stock issuance costs

           (69       (69

Issuance of shares in connection with vested restricted stock, net

     5                —     

Issuance of shares in connection with financing transactions

     14,400         1         2,788          2,789   

Net loss

             (10,504     (10,504
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Balance at March 31, 2013

     40,902       $ 4       $ 61,019      $ (122,750 )     $ (61,727 )  
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

The accompanying notes are an integral part of the consolidated financial statements.

 

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AVANTAIR, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

NOTE 1 – OPERATIONS AND MANAGEMENT’S PLANS

Avantair, Inc. and its subsidiaries (the “Company” or “Avantair”) are in the business of providing private aviation services through three primary flight service programs:

 

  (i) the sale of fractional ownership interests through the Fractional Ownership program;

 

  (ii) the lease of fractional interests through the Axis Lease program; and

 

  (iii) the sale of flight hour cards through the Edge Card program.

Collectively, participants in each of these programs are referred to herein as “program participants”. These services are provided to program participants on the Company’s managed aircraft fleet for business and personal use. Avantair’s core strategic focus is providing its program participants with the highest level of safety, service and satisfaction. In addition to providing private aviation services, Avantair provides limited fixed based operation (“FBO”) services in Clearwater, Florida. In January 2013, the Company ceased its FBO operations at its Camarillo, CA facility and entered into a sublease agreement with an unrelated third party. The Company will retain a portion of one hangar which may be used for maintenance of the Company’s aircraft. The sublease agreement transferred all FBO operations to the unrelated third party and established a base rent schedule that reflects the reduced occupancy of the facility. Effective December 2011, the Company closed its limited FBO services in Caldwell, New Jersey. The Company also leases a facility in Dallas, Texas, which is used to perform maintenance on the Company’s aircraft.

The Company’s primary operating strategy is to achieve positive cash flows by continuing the Company’s cost savings initiatives, flight operation cost reductions associated with strategically eliminating more costly aircraft from its fleet and lowering maintenance costs as a result of driving increased efficiencies through the use of third party aircraft maintenance operators to provide increased levels of maintenance contract services for its fleet. Revenue by product category can be found in the accompanying consolidated statements of operations for the three and nine months ended March 31, 2013 and 2012, respectively. Sales units by product category are as follows:

 

     Unit Sales for the Three Months
Ended
     Unit Sales for the Nine Months
Ended
 
     March 31,
2013
     March 31,
2012
     March 31,
2013
     March 31,
2012
 

New Fractional Ownership program shares sold

     10         6.5         10         8.5   

Axis Lease program shares leased

     —           11.5         25         54   

Axis Club Memberships (1)

     —           —           —           1   

Flight hour cards

     74         81         198         271   

 

(1)  

Replaced by Axis Lease program in March 2011 .

As of March 31, 2013, Avantair managed 56 aircraft within its fleet, which is comprised of 43 fractionally-owned aircraft, 6 company-owned core aircraft and 7 leased and company-managed aircraft.

On October 25, 2012, the Company made an announcement regarding the voluntary stand down of its operations in order to complete a comprehensive review of records and supporting maintenance documentation and an inspection of its aircraft fleet. This voluntary action was taken in coordination with the Federal Aviation Administration. During the stand down, which lasted approximately three weeks, the Company furloughed a portion of its employees. Beginning November 8, 2012 the Company started recalling its employees and commenced operating some of its aircraft on November 11, 2012 with a return to service of a majority of its fleet by November 19, 2012. The effect of the operational stand down negatively impacted the Company’s cash receipts, liquidity and retention of program participants. Separate of charter and costs associated with retention of program participants, the Company incurred approximately $1.2 million for consulting, Federal Aviation Administration, furlough, legal, communication and other costs.

        Beginning in the second quarter of fiscal year 2013, the Company initiated steps to raise additional capital through multiple offerings of securities. On November 30, 2012, the Company entered into a Note and Warrant Purchase Agreement (the “Purchase Agreement”) providing for the issuance of an aggregate of up to $10.0 million in principal amount of senior secured convertible promissory notes (the “Notes”) and warrants to purchase up to an aggregate of 40,000,000 shares of common stock (the “Warrants”). The securities offered will not be and have not been registered under the Securities Act of 1933, as amended, and may not be offered or sold in the United States absent registration or an applicable exemption from the registration requirements. At the initial closing, which occurred on November 30, 2012, the Company issued to certain members of the Company’s Board of Directors and their affiliates Notes in an aggregate principal amount of $2.8 million and Warrants to purchase an aggregate of 11,200,000 common shares (the “Initial Closing”). On February 1, 2013, February 28, 2013 and March 20, 2013, the Company issued to eleven accredited investors, that are also participants in the fractional ownership program, Notes in an aggregate principal amount of $2.96 million and Warrants to purchase an aggregate of 11,850,000 shares of common stock. At an additional closing on March 29, 2013, the Company issued to an accredited investor a Note in an aggregate principal amount of $1.97 million and Warrants to purchase an aggregate of 7,880,000 shares of common stock (the “Additional Closing”). In addition, on January 17, 2013, the Company, the holders of the Notes and Warrants and Barry Gordon, as collateral agent, entered into the Amendment to Note and Warrant Purchase Agreement, Senior Secured Convertible Promissory Notes, Warrants, Security Agreement and Registration Rights Agreement (the “Note Financing Amendment”). The Notes bear interest at an initial rate of 2.0% per annum, which increased to 12.0% per annum since the Company was unsuccessful in obtaining stockholder approval by March 31, 2013 to increase the Company’s authorized shares of common stock so that a sufficient number of shares are reserved for the conversion of the Notes. Holders of the Notes may, at their option, elect to convert all outstanding principal and accrued but unpaid interest on the Notes into shares of common stock at a conversion price of $0.25 per share, but may convert only a portion of such Notes if an inadequate number of authorized shares of common stock is available to effect such optional conversion. Holders of the Notes are entitled to certain anti-dilution protections. As part of certain note and warrant agreements, the Company has provided holders with the option to convert the note or exercise the warrant into the Company’s common stock at a specified strike price. In order to prevent dilution, if the new strike price is lower than the original strike price on the day of conversion or exercise, the strike price would be lowered to the new conversion or exercise price. The Company has determined that these types of down round protection terms are considered derivatives.

 

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The Company may prepay the Notes on or after November 28, 2014. The Notes have a maturity date of November 28, 2015, unless the Notes are earlier converted or an event of default or liquidation event occurs. The Warrants are exercisable at an exercise price of $0.50 per share, which exercise price is subject to certain anti-dilution protections, however the Warrants may not be exercised unless a sufficient number of authorized shares of common stock are available for the exercise of the Warrants. The Warrants expire on November 30, 2017. If the Company is unable to raise additional capital or the amount raised is not adequate, there can be no assurance that the Company can continue operations or meet its ongoing obligations and commitments. In addition, the Company is working with its vendors, lessors and lenders, to extend payment terms as the Company seeks to raise additional capital.

NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Interim Reporting

The accompanying unaudited interim consolidated financial statements were prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) and the interim financial statement rules and regulations of the Securities and Exchange Commission. In the opinion of management, these financial statements include all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of the consolidated financial statements as required by Regulation S-X, Rule 8-03. The interim consolidated operating results are not necessarily indicative of the results for a full year or any interim period. The consolidated balance sheet as of June 30, 2012 has been derived from the audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2012.

Certain information and footnote disclosures normally included in the financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to such rules and regulations relating to interim financial statements. These consolidated financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2012.

Basis of Presentation

All material intercompany accounts and transactions have been eliminated in the consolidated financial statements.

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. This basis of accounting contemplates the successful recovery of the Company’s assets and the satisfaction of its liabilities in the normal course of business. As of March 31, 2013, the Company’s recurring net losses resulted in a working capital deficit of approximately $71.6 million and a stockholders’ deficit of approximately $61.7 million. In addition to the cost of acquiring aircraft, the Company’s primary expenses are related to fuel, aircraft repositioning (i.e., moving an aircraft from one location to another location to accommodate a program participant’s requirements), flight operations and pilot expenses, maintenance, charters, insurance and selling, general and administrative expenses.

Going Concern

The accompanying financial statements have been prepared on a going concern basis, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. As reflected in the accompanying financial statements, the Company has incurred recurring losses prior to the current period, has used significant cash in support of its operating activities and, based upon current operating levels, requires additional capital or significant reconfiguration of its operation to sustain its operations for the foreseeable future. For the nine months ended March 31, 2013, the Company has incurred losses of $10.5 million and had an accumulated deficit of $122 million since inception.

For the next twelve months, the Company anticipates significant cash and capital needs to finance its business and cover its ongoing working capital needs in order to continue operations. The Company is currently in the arrears on various lease and vendor payments. The Company is funding monthly operations with cash receipts and incremental equity on an as needed basis. In order to cover its daily cash needs, the Company is considering raising additional funds in the form of equity of capital, senior loans through private placements, loan applications or any other alternative approach. The Company’s ability to obtain needed financing may be impaired by factors such as the capital markets, and the fact it is not profitable, which could impact the availability or cost of future financings. If the Company does not secure these funds, it may be forced to suspend or terminate operations.

On June 6, 2013, the Company commenced visual inspections and records review of the time controlled parts on its aircraft by voluntarily ceasing flying each aircraft during the period until the inspection with respect to such aircraft is completed in order to ensure the highest degree of compliance and safety. An audit of the time controlled parts was already underway during scheduled maintenance checks as part of its new safety system; however, the Company was notified of an anonymous call received questioning the adequacy of the system for monitoring time controlled parts. As such, it is the Company’s policy to fully investigate such claims. The Company anticipates that it will begin release of aircraft back into service on a continual basis this week following the completion of these inspections. The Company believes that the effect of the aircraft inspections may negatively impact its cash receipts, its liquidity and retention of program participants in the upcoming two to three month period.

The unaudited interim consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty. The continuation of the Company as a going concern is dependent upon the ability of the Company to generate sufficient cash flow to meet its obligations on a timely basis and ultimately to attain profitability and obtaining additional funding.

Reclassifications

Management has reclassified various expenses within the operating expense section of the accompanying consolidated statements of operations for the three and nine months ended March 31, 2012. These reclassifications are primarily as follows:

 

   

Payroll taxes and benefit costs of approximately $1.2 million and $3.1 million have been reclassified and apportioned to cost of flight operations and selling expenses from general and administrative expenses for the three and nine months ended March 31, 2012;

 

   

Third-party fuel sale costs of approximately $0.4 million and $1.3 million have been reclassified to cost of fuel from general and administrative expenses for the three and nine months ended March 31, 2012; and

 

   

Cost of used shares of less than $0.7 million and $0.9 million have been reclassified to cost of fractional aircraft share sales from general and administrative expenses for the three and nine months ended March 31, 2012.

Use of Estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make certain estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying disclosures. These estimates and assumptions are based upon management’s best knowledge of current events and actions that the Company may take in the future. The Company is subject to uncertainties such as the impact of future events, economic, environmental and political factors and changes in the Company’s business environment. Therefore, actual results could differ from these estimates. Accordingly, the accounting estimates used in the preparation of the Company’s consolidated financial statements will change as new events occur, as more experience is acquired, as additional information is obtained and as the Company’s operating environment changes. Changes in estimates are made when circumstances warrant. Such changes in estimates and refinements in estimation methodologies are reflected in the reported financial condition and results of operations. If material, the effects of changes in estimates are disclosed in the notes to the consolidated financial statements. Significant estimates and assumptions by management affect: the recording of revenue arrangements with multiple deliverables, the allowance for doubtful accounts, the carrying value of long-lived assets, the amortization period of long-lived assets, the provision for income taxes and related deferred tax accounts, certain accrued expenses and contingencies, warrant valuations and management’s assessment of its ability to continue as a going concern.

In January 2011, the Company changed its estimate of its depreciable life of its core aircraft to 20 years from its original seven year life. This change in estimate was based upon an evaluation of the aircrafts’ actual service life. This change in estimate was adopted prospectively, in accordance with Accounting Standards Codification (“ASC 250”) “Accounting Changes and Error Corrections” (“ASC 250”).

The Company’s strategy is to maintain and operate its aircraft for at least 10 years. The 20 year life is representative of the full service life of the aircraft, not an increase in the period that the Company intends to maintain and operate the aircraft.

 

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Cash-restricted

Restricted cash includes cash where the Company’s ability to use the funds at any time is contractually limited or is generally designated for specific purposes arising out of certain contractual or other obligations. The Company agreed to restrict approximately $2.0 million and $2.2 million in cash at March 31, 2013 and June 30, 2012, respectively, to secure letters of credit related to deposits for leases, provide security for credit card charge backs and to secure fuel purchases. Management believes that these amounts will be restricted for at least one year and, accordingly, has classified such cash as long-term.

Accounts Receivable

Accounts receivable are stated at the amount management expects to collect from outstanding balances. The Company provides an allowance for doubtful accounts equal to the estimated uncollectible amounts.

Allowance for Doubtful Accounts

The Company maintains allowances for doubtful accounts of approximately $1.5 million and $1.3 million as of March 31, 2013 and June 30, 2012, respectively, for estimated losses arising from the inability of its program participants to make required payments. For the nine months ended March 31, 2013, the Company increased the allowance for doubtful accounts by $0.5 million and wrote off $0.3 million of accounts receivable balances against the allowance for doubtful accounts. The Company’s estimate is based on factors surrounding the credit risk of certain clients, historical collection experience and a review of the current status of accounts receivable. The Company’s estimate of the allowance for doubtful accounts is subject to change if the financial condition of the Company’s program participants were to deteriorate resulting in a reduced ability to make payments.

Inventory

Fuel inventory is valued at the lower of cost (determined by the first-in, first-out method) or market.

Concentration of Credit Risk and Sources of Supply

Financial instruments that potentially subject the Company to significant concentrations of credit risk consist of cash. At times, the Company’s cash balances may be uninsured or in deposit accounts that exceed the Federal Deposit Insurance Corporation (“FDIC”) insurance limits. As of March 31, 2013, the Company had cash and cash equivalent balance of $2.2 million in excess of the federally insured limit of $250,000. All the Company’s cash in banks at March 31, 2013 was deposited in non-interest checking accounts.

The Company relies on three third-party fuel suppliers and generally relies on several suppliers for maintenance and other repairs for its aircrafts.

Property and Equipment

Property and equipment is recorded at cost and primarily consists of aircraft which are not fractionalized. Depreciation and amortization is computed using the straight-line method over the following useful lives:

 

Aircraft

   5 - 20 years

Office equipment and furniture and fixtures

   5 - 7 years

Flight management software/hardware

   5 years

Vehicles

   5 years

Improvements

   Lesser of estimated useful life or the term of the lease

Cost and related accumulated depreciation on assets retired or disposed of are removed from the accounts and any resulting gains or losses are credited or charged to income.

Expenditures for maintenance and repairs of property and equipment are expensed as incurred. Major improvements and interest costs relating to borrowings made for the acquisition of aircraft are capitalized. Modifications that enhance the operating performance or extend the useful lives of airframes or engines on core aircraft are capitalized and depreciated over the remaining estimated useful life of the asset or the remaining lease term, whichever is shorter.

The carrying value of property and equipment to be held and used is evaluated for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable in accordance with ASC 360 “Property, Plant and Equipment” (“ASC 360”). Although the Company has had net losses and a current goodwill impairment charge, long-lived assets are not impaired because cash flow from use or ultimate sale of such aircraft support net book value.

Goodwill

During the third quarter of fiscal 2013, the Company experienced weaker operating performance and lowered its financial outlook. Taking these factors into account, the Company reassessed its financial outlook and consequently reevaluated the recoverability of goodwill. The Company performed the two-step impairment test and concluded that the Company’s carrying value exceeded its fair value. Based on the Company’s analyses, the implied fair value of goodwill was substantially lower than the carrying value of goodwill for the reporting unit. As a result, in the third quarter of fiscal 2013, the Company recorded a goodwill impairment charge of $1.1 million, representing all of the remaining goodwill for the Company.

Impairment of Long-Lived Assets

Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset.

If the carrying amount of an asset exceeds its undiscounted estimated future cash flows, an impairment review is performed. An impairment charge is recognized in the amount by which the carrying amount of the asset exceeds the fair value of the asset. Assets to be disposed of would be separately presented in the balance sheet and reported at the lower of the carrying amount or fair value less costs to sell, and are no longer depreciated. The assets and liabilities of a disposed group classified as held for sale would be presented separately in the appropriate asset and liability sections of the balance sheet. The Company concluded that there was no impairment to be recorded for its long-lived assets as of March 31, 2013.

 

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Revenue Recognition

The Company is engaged in the sale, lease and management of fractional ownership interests of professionally piloted aircraft for personal and business use and access to its aircraft fleet through 15, 25 or 50 hour flight hour cards. When a program participant purchases a fractional share or enters into a lease of a fractional share through the Company’s Axis Lease program (introduced in March 2011), they are also required to enter into a management and maintenance agreement, which grants the program participant the right to the use of the aircraft for a specified number of hours each year. Under the terms of the management and maintenance agreement, the Company agrees to manage, operate and maintain the aircraft on behalf of the program participant in exchange for a fixed monthly fee.

Flight activity and other ancillary billing includes revenue related to billings to the program participants for reimbursable costs incurred by the Company. These reimbursable costs include, but are not limited to, fuel, flight fees, maintenance costs required by Airworthiness Directives or Service Bulletins as mandated by the Federal Aviation Administration (“FAA”) and not covered by the regular maintenance provided for in the management and maintenance agreement, aircraft upgrades and other ancillary charges. Flight activity and other ancillary billing are recorded on a gross basis as revenue in accordance with ASC 605-45 “Principal Agent Considerations” (“ASC 605-45”).

Fractional Aircraft Shares Sold

Fractional shares are typically sold as one-sixteenth shares and require upfront payment for an undivided interest in the aircraft. Upon the purchase of a fractional share, the owner receives title to their interest in the aircraft. The ownership period is indefinite. Revenue for these types of transactions is included in fractional aircraft shares sold in the accompanying consolidated statements of operations.

Revenue from the sale of fractional aircraft shares sold before July 1, 2010 was deferred at the time of sale and is recognized ratably over the term of the related management and maintenance agreement in accordance with ASC 605-25 “Multiple-Element Arrangements” (“ASC 605-25”). Revenue from the sale of fractional shares sold after June 30, 2010 are recognized at the time of sale upon adoption of Accounting Standards Update (“ASU”) 2009-13 “Multiple-Deliverable Revenue Arrangements”, (“ASU 2009-13”) which updates ASC 605-25. There were no fractional aircraft shares sold during the three months ended March 31, 2013 requiring recognition under this guidance.

During fiscal year 2011, the Company initiated a promotion that offered the sale of select fractional shares which provided a repurchase guarantee at the expiration of the related seven year management and maintenance agreements. The guarantee may be exercised at the owner’s option for a determined percent of the original purchase price. The Company discontinued this residual guarantee program in October 2011. Sales through this promotion have been accounted for as operating leases in accordance with ASC 840 “Leases” (“ASU 840”) and the related revenue earned (less the guaranteed residual value) is recognized ratably over the term of the management and maintenance agreement. At March 31, 2013, guarantees under this program totaled approximately $4.9 million and are included in deferred revenue related to fractional aircraft share sales.

Lease Revenue

Lease revenue includes fractional share lease revenue from the Company’s Axis Lease program. The lease of a fractional share allows a program participant to lease an interest in the aircraft from the Company in exchange for a monthly lease charge. Unlike the purchase of a fractional ownership interest, program participants do not take title to the aircraft at any point in time. Lease terms typically range from two to ten years.

Axis Lease program lease revenue is a contractual monthly fee charged over the term of the lease. Under this program, lessees are permitted to fly a set number of hours divided evenly over the number of months in the term, resulting in the Company recognizing revenue ratably over each month. In the event lessees fly more than their monthly allocated hours, the Company recognizes additional lease revenue based on the overflown hours in that month. However, the cumulative amount recognized over the lease term shall not exceed the total annual lease payment per the lease agreement.

Management and Maintenance Agreements

Fractional owners and lessees are required to enter into a management and maintenance agreement, which grants the program participant the right to use the aircraft for a specified number of hours each year for a fractional owner, and each month for a fractional lessee.

Revenue earned in connection with the management and maintenance agreements with fractional share owners is recognized monthly over the term of the agreement. If a fractional share owner prepays their management and maintenance fee for a period of one year or longer, the prepayment is recorded as unearned revenue and amortized into revenue on a monthly basis.

Revenue earned in connection with the management and maintenance agreements with Axis Lease program lessees is recognized monthly over the lease term. If an Axis Lease program lessee prepays their management and maintenance fee for a period of one year or longer, the prepayment is recorded as unearned revenue and amortized monthly over the lease term.

Under either circumstance, revenue is recognized ratably over each month. In the event lessees fly more than their monthly allocated hours, the Company recognizes additional management and maintenance revenue based on the overflown hours in that month; however, the cumulative amount recognized over the lease term shall not exceed the total annual management and maintenance fee payment per the lease agreement.

Flight Hour Card and Axis Club Membership Revenue

Flight hour card revenue . The Company sells access to its aircraft fleet through either 15, 25 or 50 hour flight hour cards for flight time without the requirement to purchase an ownership interest in an aircraft. The card holder pays the Company the entire amount in advance of access to the aircraft fleet. The Company defers the entire amount paid and recognizes revenue on an incremental basis as flight hours are flown.

 

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Axis Club Membership revenue . In February 2009, the Company initiated the Axis Club Membership program. The Axis Club Membership program offered program participants access to blocks of flight time at a discount from standard flight hour card rates for a set, three year membership fee. The program required that Axis Club members purchase a minimum of three, 25-hour blocks of flight hour cards. Axis Club Membership fees were paid in advance, deferred and recognized as revenue over the shorter of the three year membership term or the period of time it took the maximum number of cards to be purchased. Payment for flight hour cards sold through the Axis Club Membership program were collected from members in advance of access to the aircraft fleet, deferred and recognized as revenue on an incremental basis as flight hours were flown. The Axis Club Membership program was replaced by the Axis Lease program effective March 2011.

Flight Activity and Other Ancillary Billing

Flight activity and other ancillary billing include revenue related to billings to the program participants for reimbursable costs incurred by the Company. These reimbursable cost include, but are not limited to, fuel, flight fees, maintenance costs required by Airworthiness Directives or Service Bulletins as mandated by the FAA and not covered by the regular maintenance provided for in the management and maintenance agreement, aircraft upgrades and other ancillary charges. The Company accounts for flight activity and other ancillary billing on a gross basis in accordance with ASC 605-45 as the Company meets the specified criteria as a principal in transactions between the Company and its program participants.

Other Revenue

Other revenue is comprised primarily of revenue from demonstration flights, the sale of the Company’s previously owned fractional aircraft shares, remarketing fees, and revenue from the sale of fuel and rental of hangar space at the Company’s FBO facilities. Demonstration revenue is earned when the prospective program participants are flown on an aircraft to demonstrate the quality and capabilities of the aircraft. The Company charges the prospective program participant an hourly rate and requires payment prior to the demonstration flight. The Company recognizes revenue related to these demonstration flights when the flight is completed. Revenue from the sale of the Company’s previously owned fractional aircraft shares are recorded similar to the sale of new fractional aircraft shares. Remarketing fees are recognized when the Company sells third party, used aircraft shares on a program participant’s behalf. FBO related revenue from fuel sales and hangar rentals are recorded when goods are delivered or services are rendered.

Referral Incentive Hours

The Company accounts for the additional hours granted to program participants under the referral incentive program by expensing costs as they are incurred. Such costs have not been material to date.

Aircraft Costs Related To Fractional Sales

Aircraft costs relating to the sale of fractional aircraft shares sold before July 1, 2010 were deferred at the time of sale and are recognized ratably over the term of the related management and maintenance agreement in accordance ASC 605-25. The short-term portion of these costs represents twelve months of unamortized expenses for the twelve month period following the period being filed. The long-term portion of these costs represents unamortized expenses greater than 12 months following the period being filed.

Aircraft costs relating to the sale of fractional shares sold after June 30, 2010 are recognized at the time of sale upon adoption of ASU 2009-13. There were no fractional aircraft shares sold during the three months ended March 31, 2013 requiring recognition under this guidance.

During fiscal year 2011, the Company initiated a promotion that offered the sale of select fractional shares which provided a repurchase guarantee at the expiration of the related seven year management and maintenance agreements. The guarantee may be exercised at the owner’s option for a determined percent of the original purchase price. The Company discontinued this residual guarantee program in October 2011. Sales through this promotion have been accounted for as operating leases in accordance with ASC 840 and the related costs were capitalized to property and equipment and depreciated over the 20 year useful life of the aircraft.

Maintenance Expense Policy

Costs related to maintenance performed on both fractionalized and core aircraft related to engine overhauls, landing gears, refurbishments and other maintenance services that enhance the useful life of the aircraft are capitalized and depreciated or amortized over the useful life of the improvement. Other maintenance activities that do not enhance the useful life of the aircraft are expensed as incurred. Maintenance is performed in-house or by third party vendors, as applicable.

Fractionalized aircraft improvements are capitalized as other assets in the accompanying consolidated balance sheets and amortized over the lesser of the useful life of the improvement or the aircraft. The amortization of these costs is expensed in cost of flight operations in the accompanying consolidated statements of operations.

Core aircraft improvements are capitalized as property and equipment in the accompanying consolidated balance sheets and depreciated over the lesser of the useful life of the improvement, life of the aircraft or lease term. The depreciation of these costs is expensed in depreciation and amortization in the accompanying consolidated statements of operations.

The change in depreciable lives from 7 to 20 years will not lead to increased maintenance costs. Therefore no increases have been factored into the Company’s most recent impairment analysis. See the Property and Equipment section above.

Income Taxes

Income taxes are accounted for under the asset and liability method in accordance with ASC 740 “Income Taxes” (“ASC 740”). Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

 

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A valuation allowance is established to reduce deferred tax assets to the amounts expected to be realized. The Company calculated an annual effective tax rate to determine the interim period income tax provisions. However, no tax liability was accrued for the three or nine months ended March 31, 2013, as the Company expects to have sufficient operating loss and tax credit carryforwards to cover any taxable income.

Effective July 1, 2007, the Company adopted the provisions of ASC 740 relating to uncertain tax positions. ASC 740 prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. For those benefits to be recognized, a tax position must be more-likely-than-not to be sustained upon examination by taxing authorities. The Company has identified its federal tax return and State of Florida tax return as “major” tax jurisdictions, as defined in ASC 740. The Company evaluations were performed for the tax years ended 2005 through 2011. The Company believes that its income tax positions and deductions would be sustained on audit and does not anticipate any adjustments that would result in a material change to its financial position. The Company recognizes accrued interest and penalties related to unrecognized tax benefits as income tax expense.

Stock-Based Compensation

The Company has one stock-based compensation plan, the Amended and Restated 2006 Long-Term Incentive Plan (“2006 Long-Term Incentive Plan,” or the “Plan”), which the Company’s shareholders approved, for employees, certain non-employees and non-employee directors. Stock-based awards under this plan may consist of common stock, common stock units, stock options, cash-settled or stock-settled stock appreciation rights, restricted stock and other stock-based awards. The Company issues common stock to satisfy stock option exercises or vesting of stock awards.

The Company accounts for stock-based compensation to employees and directors in accordance with ASC 718 “Compensation-Stock Compensation” (“ASC 718”), which requires the recognition of compensation expense for employee stock options and other stock-based payments. Under ASC 718, expense related to employee stock options and other share-based payments is recognized over the relevant service period based on the fair value of each stock option grant. In addition, the Company recognizes in its consolidated statements of operations the grant-date fair value of stock options and other equity-based compensation issued to employees and directors. Compensation expense for stock-based awards is recognized over the requisite service period, usually the vesting period on a straight-line basis, while compensation expense for liability-based awards (those usually settled in cash rather than stock) is measured at fair-value at each balance sheet date until the award is settled.

Stock-based compensation expense related to the Plan, which is included in general and administrative expenses in the accompanying consolidated statements of operations, was $157,068 and $470,065 for the three and nine months ended March 31, 2013, respectively, and was $178,876 and $533,531 for the three and nine months ended March 31, 2012, respectively. There were no related income tax benefits recognized in the accompanying consolidated statements of operations for the three months ended March 31, 2013 and 2012. As of March 31, 2013, the Company had 774,174 shares of restricted stock and 1,619,267 stock options outstanding.

Accounting for Derivative Instruments

The Company accounts for derivative instruments in accordance with ASC 815 “Derivatives and Hedging” (“ASC 815”), which establishes accounting and reporting standards for derivative instruments and hedging activities, including certain derivative instruments embedded in other financial instruments or contracts. The Company also considers ASC 815, which provides criteria for determining whether freestanding contracts that are settled in a company’s own stock, including common stock warrants, should be designated as either an equity instrument, an asset or as a liability under ASC 815.

The Company evaluated the conversion feature embedded in its Series A Convertible Preferred Stock based on the criteria of ASC 815 to determine whether the conversion feature would be required to be bifurcated from the Preferred Stock and accounted for separately as a derivative. Based on management’s evaluation, the embedded conversion feature for the preferred stock was valued at $1.8 million as of March 31, 2013 using the binomial-lattice method. The assumptions included initial strike price, reset price, market price at the valuation and measurement date, risk free rate, probability and volatility. See Note 4 Equity Transactions .

Additionally, the Company evaluated the conversion feature embedded in its senior secured convertible promissory notes based on the criteria of ASC 815 to determine whether the conversion feature would be required to be bifurcated from the senior secured convertible promissory note and accounted for separately as a derivative. Based on management’s evaluation, the embedded conversion feature meets the requirements of derivative accounting under ASC 815. The Company recorded this conversion feature at its fair value in accordance with ASC 820 “Fair Value Measurements and Disclosures” (“ASC 820”). The embedded conversion feature was valued at $0.07 per Note using the Monte Carlo method. Increases or decreases in the fair value of the conversion feature are included as a component of other income (expense) in the accompanying consolidated statements of operations for the respective period.

The Company evaluated the detachable Warrants based on the criteria of ASC 815 to determine whether the Warrants would be required to be accounted for separately as a derivative. Based on management’s evaluation, the detachable Warrants meet the requirements of derivative accounting under ASC 815. The Company recorded the detachable Warrants at their fair value in accordance with ASC 820. The detachable Warrants were valued at $0.09 per warrant using the Monte Carlo method. Increases or decreases in the fair value of the Warrants are included as a component of other income (expense) in the accompanying consolidated statements of operations for the respective period.

The Company is currently a party to various lease agreements with Midsouth, Mr. Fuller, or other entities controlled by Mr. Fuller for the lease of seven aircraft (“Aircraft Leases”). The original terms of the Aircraft Leases range from fifteen (15) months to one hundred twenty (120) months and the aggregate monthly lease payments for the Aircraft Leases total approximately $454,000.

On November 30, 2012, the Company entered into an Amended and Restated Restricted Stock Agreement with Mr. Fuller (the “Amended HF Restricted Stock Agreement”), which amended and restated the Restricted Stock Agreement dated August 16, 2012 with Mr. Fuller pursuant to which the Company previously issued to Mr. Fuller 200,000 shares of fully-vested restricted stock at a price of $1.50 per share to reduce the principal balance of an aircraft to be financed by $0.3 million. Under the Amended HF Restricted Stock Agreement, Mr. Fuller agreed to a reduction in the interest portion of the lease payments under the Aircraft Leases in the aggregate amount of approximately $1.8 million over fifteen months, with a reduction in lease payments in the amount of approximately $0.2 million per month beginning in November 2012 through January 2013, and approximately $0.1 million per month for twelve consecutive months thereafter, ending on January 31, 2014. Pursuant to Amendment No. 1 to the N180HM lease agreement, Mr. Fuller also agreed to extend the term of the lease for an additional sixty (60) months, or until November 30, 2017, on similar terms, except that Mr. Fuller will have the sole option to terminate the lease agreement and sell the aircraft and the Company agrees that it will issue to Mr. Fuller a number of units (as defined below) equal to the result of dividing (A) the difference between $1.5 million and the numerical value of the then current payoff amount as outlined in the lease agreement for the aircraft by (B) 0.25. For purposes of this provision, a unit will consist of one share of the Company’s common stock (the “Issued Stock”) (subject to adjustment as described below) and one warrant to purchase a share of the Company’s common stock at $0.50 (a “Warrant Share”). Mr. Fuller also agreed to extend the term of the Floor Plan Agreement originally entered into in September 2011 for an additional eight (8) months, or until August 30, 2013. In consideration of the foregoing, the Company issued 8,200,000 shares of fully-vested restricted stock to Mr. Fuller, 1,000,000 shares of which related to the $0.3 million reduction in the principal balance of an aircraft to be financed and 7,200,000 shares related to the approximate $1.8 million reduction in the interest portion of the lease payments of the aircraft leases and Amendment No. 1 to the N180HM lease agreement, as well as a warrant (the “HF Warrant”) to purchase 8,400,000 shares of common stock in substantially the same form as the Warrants. The Amended HF Restricted Stock Agreement also contains certain antidilution protections. The Company evaluated the HF Warrant based on the criteria of ASC 815 to determine whether the warrants would be required to be accounted for separately as a derivative. Based on management’s evaluation, the warrants issued in connection with the HF Warrant meet the requirements of derivative accounting under ASC 815. The Company recorded the warrants at their fair value in accordance with ASC 820. The warrants were valued at $0.03 per warrant using the Monte Carlo method. Increases or decreases in the fair value of the warrants are included as a component of other income (expense) in the accompanying consolidated statements of operations for the respective period.

 

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Effective September 28, 2012, the terms of the Company’s management agreements with certain entities (collectively, “LW Air”), controlled by Lorne Weil, a director of the Company, were amended so that the Company was not required to pay the owner additional amounts unless usage of the aircraft exceeds 1,350 hours per year, retroactive to the beginning of each management agreement. Simultaneous with this transaction, the Company issued an Amended and Restated Warrant (the “LW Warrant”) to Lorne Weil, a director of the Company, to purchase 2,373,620 shares of common stock at an exercise price of $1.00 per share.

On November 30, 2012, the Company entered into Amendment No. 1 to the LW Warrant (the “Warrant Amendment”) with Lorne Weil. The LW Warrant provided certain anti-dilution protections, which would have been triggered in connection with the issuance of the Notes and Warrants. The Warrant Amendment provides for, among other things, revised antidilution rights so the antidilution provisions set forth in the LW Warrant would not apply in connection with the issuance of the Notes and Warrants; a reduction in the exercise price to $0.50 per share; and an increase in the number of shares of common stock issuable upon exercise of the LW Warrant to 3,560,430 shares of common stock. The Company evaluated the Warrant Amendment based on the criteria of ASC 815 to determine whether these warrants would be required to be accounted for separately as a derivative. Based on management’s evaluation, the Warrant Amendment meets the requirements of derivative accounting under ASC 815. The Company recorded these warrants at their fair value of $0.02 per warrant using the Monte Carlo method, in accordance with ASC 820. Increases or decreases in the fair value of these warrants are included as a component of other income (expense) in the accompanying consolidated statements of operations for the respective period.

Effective September 28, 2012, the terms of the Company’s management agreements with LW Air were amended to irrevocably reduce the owner’s monthly proceeds pursuant to each of the aircraft management agreements by $25,000 per month for a period of twelve consecutive months beginning in August 2012, or $0.3 million per aircraft, the aggregate reduction of LW Air’s monthly proceeds totaling $1.5 million, with respect to all five of the aircraft owned by LW Air. Simultaneous with this transaction, the Company entered into a Restricted Stock Agreement (the “LW Restricted Stock Agreement”), dated as of September 28, 2012, pursuant to which the Company issued to LW Air 2,000,000 shares of fully-vested restricted stock at a price of $0.75 per share, subject to certain antidilution rights, for an aggregate value of $1.5 million.

On November 30, 2012, the Company entered into Amendment No. 1 to the LW Restricted Stock Agreement with LW Air (“Amendment No. 1”). The LW Restricted Stock Agreement provided that the shares issued would be entitled to antidilution protections, which would have required the issuance of additional shares to LW Air in connection with the issuance of the Notes and Warrants. Amendment No. 1 provides for, among other things, revised antidilution rights so the antidilution provisions in the LW Restricted Stock Agreement would not apply in connection with the issuance of the Notes and Warrants; the issuance of 4,000,000 additional shares of fully-vested restricted stock to LW Air on November 30, 2012 and warrants to purchase an aggregate of 6,000,000 shares of common stock (the “Additional LW Warrant”) on November 30, 2012, in substantially the same form as the Warrants. The Company evaluated the Additional LW Warrant based on the criteria of ASC 815 to determine whether these warrants would be required to be accounted for separately as a derivative. Based on management’s evaluation, the Additional LW Warrant met the requirements of derivative accounting under ASC 815. The Company recorded the Additional LW Warrant at their fair value of $0.06 per warrant using the Monte Carlo method, in accordance with ASC 820. Increases or decreases in the fair value of these warrants are included as a component of other income (expense) in the accompanying consolidated statements of operations for the respective period.

On November 30, 2012, the Company issued a Warrant (the “HF Overfly Warrant”) to Mr. Fuller, to purchase 645,200 shares of common stock at an exercise price of $0.50 per share. The HF Overfly Warrant was issued in lieu of paying additional amounts owed to Mr. Fuller pursuant to certain Aircraft Leases as a result of the aircraft exceeding certain hourly usage limitations. The Company evaluated the HR Overfly Warrant based on the criteria of ASC 815 to determine whether these warrants would be required to be accounted for separately as a derivative. Based on management’s evaluation, the HF Overfly Warrant met the requirements of derivative accounting under ASC 815. The Company recorded the warrants at their fair value of $0.02 per warrant using the Monte Carlo method, in accordance with ASC 820. Increases or decreases in the fair value of these warrants are included as a component of other income (expense) in the accompanying consolidated statements of operations for the respective period.

Redeemable Securities

The Company accounts for Series A Preferred common stock in accordance with ASC 480-10-599-34, Classification and Measurement of Redeemable Securities which provides that securities that are optionally redeemable by the holder for cash or other assets are classified outside of permanent equity in temporary equity.

Fair Value Measurements

The Company has adopted the provisions of ASC 820 which defines fair value, establishes a framework for measuring fair value in accordance with U.S. GAAP, and expands disclosures about fair value measurements. ASC 820 clarifies that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. ASC 820 provides guidance on how to measure certain financial assets and financial liabilities at fair value. The requirement to measure an asset as liability at fair value is determined under the U.S. GAAP.

Certain of the Company’s assets and liabilities are considered to be financial instruments and are required to be measured at fair value in the consolidated balance sheets. Certain of these financial instruments, including cash and cash equivalents, accounts receivable, restricted cash, accounts payable, accrued liabilities, short-term debt and unearned management fees and flight hour card revenue, are measured at cost, which approximates fair value due to the short-term maturity of these instruments. Long-term obligations are measured at approximates fair value, given management’s evaluation of the instruments’ current rates compared to market rates of interest and other factors. Derivative liabilities are measured at fair value.

The Company measures fair value basis based on the following key objectives:

 

   

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date;

 

   

A three-level hierarchy (“Valuation Hierarchy”) which prioritizes the use of observable pricing data (Level 1 and Level 2 inputs as defined below) over unobservable pricing data (Level 3 inputs as defined below) is used in measuring value; and

 

   

The Company’s creditworthiness is considered when measuring the fair value of liabilities.

The valuation hierarchy used in measuring fair value is defined as follows:

 

   

Level 1 inputs are observed inputs such as quoted prices for identical instruments inactive markets;

 

   

Level 2 inputs are inputs other than quoted prices in active markets that are either directly or indirectly observable such as quoted prices for similar instruments inactive markets or quoted prices for identical or similar instruments in markets that are not active; and

 

   

Level 3 inputs are unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions, such as valuations derived from valuation techniques in which one or more significant inputs are unobservable. Level 3 requires significant management judgment or estimation.

All items measures at fair value are required to be classified and disclosed as a Level 1, 2 or 3 asset or liability based on the inputs used to measure for value of an asset or liability in its entirety. An asset or liability classified as Level 1 is measured by quoted prices in active markets for identical instruments. An asset or liability classified as Level 2 is measured using significant observable inputs and an asset or liability classified as Level 3 is measured using significant unobservable inputs. Refer to Note 5 Fair Value Disclosure for the fair value classification table.

 

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Loss Per Share

Basic and diluted loss per share applicable to common stock is computed using the weighted average number of common shares outstanding during the period. Shares used in calculating basic and diluted loss per share exclude common stock equivalents for warrants, stock-based compensation, senior secured convertible promissory notes and Series A Convertible Preferred Stock, as these common stock equivalents are anti-dilutive. In future periods, if the Company reports net income attributable to common stockholders and the common stock equivalents for the warrants, stock-based compensation, senior secured convertible promissory notes and Series A Convertible Preferred Stock are dilutive, the common stock equivalents will be included in the weighted average shares computation and dividends related to our Series A Convertible Preferred Stock will be added back to net income attributable to common stockholders to calculate diluted earnings per share.

 

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Comprehensive Income (Loss)

The Company adheres to the provisions of ASC 220, “Comprehensive Income” (“ASC 220”). This pronouncement establishes standards for reporting and display of comprehensive income or loss and its components (revenue, expense, gain and loss). In accordance with ASC 220, items requiring recognition as components of comprehensive income (loss) are required to be classified by their nature. Furthermore, the Company is required to display the accumulated balances of other comprehensive income (loss) separately from retained earnings and additional paid-in capital in the equity section of the balance sheet. For the three months ended March 31, 2013 and 2012, there were no items that gave rise to other comprehensive income (loss), and net loss equaled comprehensive loss.

Recently Issued Pronouncements

In July 2012, the FASB issued ASU 2012-02, “Intangibles -Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment” (“ASU 2012-02”) amends ASU 2011-08, Intangibles -Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment and permits an entity first to assess qualitative factors to determine whether it is more likely than not that an indefinite-lived intangible asset is impaired as a basis for determining whether it is necessary to perform the quantitative impairment test in accordance with ASC Topic 350, Intangibles -Goodwill and Other. The amendments are effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. Early adoption is permitted, including for annual and interim impairment tests performed as of a date before July 27, 2012, if a public entity’s financial statements for the most recent annual or interim period have not yet been issued or, for non-public entities, have not yet been made available for issuance. The adoption of ASU 2012-02 is not expected to have a material impact on our financial position or results of operations.

NOTE 3 – COMMITMENTS AND CONTINGENCIES

Operating Lease Commitments

The Company conducts a major part of its operations from leased facilities, which include airplane hangars and administrative offices. The 15 year hangar lease in Clearwater, Florida, which began in April 2006, is classified as an operating lease and was amended in September 2011 under Amendment Number One to the Hangar Lease Agreement (“Amendment Number One”). In accordance with Amendment Number One, the Company renegotiated its Clearwater, Florida lease to reduce its ongoing rent expense and fuel flow fees. Under the terms of Amendment Number One, the initial lease term was extended by five months and expires in September 2021. In January 2011, the Company entered into a three year operating lease agreement for a facility in Dallas, Texas, which is used to perform maintenance on the Company’s aircraft. In December 2011, the Company terminated its Caldwell, New Jersey lease and ceased its limited FBO operations at that facility. Simultaneously, the Company agreed to maintain a portion of an aircraft hangar in Caldwell, New Jersey for $2,000 per month. This hanger lease, which is classified as an operating lease, which would have expired in October 2018, was terminated in August 2012 pursuant to a 90 day mutual termination clause. In January 2013, the Company entered into the Fourth Amendment to Lease (the “Amendment”) on its facility located in Camarillo, California. The Amendment included the establishment of a base rent schedule per month through December 31, 2014 and the return of $250,000 representing one of the letters of credit in effect prior to the Amendment. Further, in January 2013, the Company ceased its FBO operations at the Camarillo facility and entered into a sublease agreement with an unrelated third party. The Company will retain a portion of the hangar which may be used for maintenance of the Company’s aircraft. The sublease agreement transferred all FBO operations to the unrelated third party and established a base rent schedule that reflects the reduced occupancy of the facility. This hangar lease, which is classified as an operating lease, expires in September 2021.

During the second quarter of fiscal year 2010, the Company transferred its rights to purchase four Piaggio Avanti II aircraft to LW Air pursuant to the existing aircraft purchase agreement between the Company and Piaggio America, Inc. Simultaneous with each of these transactions, the Company entered into an eight-year management agreement for each aircraft. Pursuant to each agreement between the parties, the Company manages the aircraft by arranging, on behalf of LW Air, short-term leases for use of the aircraft at a specified dry lease rate per flight hour. In each agreement, the Company guaranteed to LW Air monthly cash proceeds out of rental income and/or advances against future rental income equal to $80,000, and the Company is entitled to retain as a management fee all rental income in excess of the amounts payable to the owner, up to a maximum of $56,500 per month. Because the Company did not begin to fully lease the aircraft in the fractional program for several months, the Company did not make approximately $760,000 in payments to the owner. Accordingly, effective July 1, 2010, the terms of each management agreement were amended to reduce the maximum management fee the Company was entitled to retain to $44,000 per month for each aircraft for the eight months ended February 28, 2011, after which the maximum management fee charged continued to be $56,500 per month for each aircraft. Because management fees under each agreement may be earned only on average rental hours up to 100 hours per month, it is anticipated that actual management fees under each agreement will not exceed $25,000 per month. The Company is also required to pay LW Air additional amounts if usage of the aircraft exceeds 1,200 hours per year at a specified rate per flight hour. The Company accounts for the management agreements as operating leases. The Company accrued $375,000 for services rendered by a third party in connection with these transactions. The fee is being amortized to aircraft lease expense over the term of the agreements.

Effective December 2010, the Company entered into an aircraft rental agreement with a third party to lease a Pilatus aircraft to be used in the Company’s maintenance operations. Pursuant to this agreement, the Company is obligated to pay $12,961 per month for three years, which provides 300 flight hours per year to the Company. The Company accounts for this agreement as an operating lease. Effective July 2012, the parties terminated the aircraft rental agreement and entered into a Settlement Agreement and Mutual Release (“Settlement Agreement”) related to the aircraft. In connection with the Settlement Agreement, the Company is required to pay approximately $0.2 million relative to additional usage of the aircraft, together with maintenance costs required pursuant to the aircraft rental agreement. The costs incurred in conjunction with the Settlement Agreement were accrued and recognized in fiscal year 2012.

During July 2011, the Company entered into an aircraft lease agreement with three third parties for the Company to lease a Piaggio Avanti II aircraft. Pursuant to the aircraft lease agreement, the Company is obligated to pay a total of $50,000 per month for ten years. The Company is also required to pay the owner additional amounts if usage of the aircraft exceeds 1,300 hours per year at a specified rate per flight hour. In addition, the Company is obligated to provide the lessors a total of 125 flight hours per year during the term of the agreement. The Company accounts for this agreement as an operating lease.

In October 2011, the Company transferred its rights to purchase one Piaggio Avanti II aircraft to LW Air pursuant to the existing aircraft purchase agreement between the Company and Piaggio America, Inc. Simultaneous with this transaction, the Company entered into an eight-year management agreement for the aircraft. Pursuant to the agreement between the parties, the Company will manage the aircraft by arranging, on behalf of the owner, short-term leases for use of the aircraft at a specified dry lease rate per flight hour. The Company has guaranteed to the owner monthly cash proceeds out of rental income and/or advances against future rental income equal to $75,000, and the Company will be entitled to retain as a management fee all rental income in excess of the amounts payable to owner, up to a maximum of $51,500 per month. Because management fees may be earned only on average rental hours up to 100 hours per month, it is anticipated that actual management fees will not exceed $30,000 per month. The Company is also required to pay the owner additional amounts if usage of the aircraft exceeds 1,200 hours per year at a specified rate per flight hour. The Company considered various financing alternatives prior to entering into this transaction and believes that this agreement was the most beneficial for the Company. The Company accrued $124,000 for services rendered by a third party in connection with this transaction. The fee is being amortized to aircraft lease expense over the term of the agreement.

 

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Effective March 2012, the Company entered into an aircraft rental agreement with a third party to lease a Pilatus aircraft to be used in the Company’s maintenance operations. Pursuant to this agreement, the Company is obligated to pay $22,000 per month for one year, which provides 500 flight hours to the Company over the one year term. The Company accounts for this agreement as an operating lease. In October 2012, the lease ended.

In August 2012, the Company entered into a seven year Aircraft Lease Agreement with a third party, related to a Piaggio Avanti II previously financed through a Midsouth Floor Plan financing agreement. Pursuant to the Aircraft Lease Agreement, the Company is obligated to provide the lessor a total of 400 flight hours per year during the term of the agreement. The transaction was evaluated in accordance with ASC 840-40 “Sale-Leaseback Transactions” (“ASC 840-40”). Based on the Company’s evaluation, the transaction met the specified criteria requiring immediate loss recognition due to a net difference between the netbook value of the relinquished asset and related liability. The loss is recorded as a loss on sale of asset in the accompanying consolidated statements of operations. Additionally, as consideration for finder’s fee services provided by a third party in connection with this transaction, the Company recorded $115,000 in August 2012 for services and issued warrants to purchase 50,000 shares of common stock. The fee and related value of the warrants are being amortized to aircraft lease expense over the term of the agreement. The warrants were valued using the Black-Scholes option-pricing model.

Effective September 28, 2012, LW Air and the Company amended the management agreements for each aircraft managed by the Company and owned by LW Air so that the Company is not required to pay LW Air additional amounts unless usage of the aircraft exceeds 1,350 hours per year, retroactive to the beginning of each management agreement. Simultaneous with this transaction, the Company issued the LW Warrant to Lorne Weil to purchase 2,373,620 shares of common stock at an exercise price of $1.00 per share. The original warrant issued to LW Air dated October 19, 2009, for the purchase of 2,373,620 shares of the Company’s common stock, was terminated and replaced by the LW Warrant.

On November 30, 2012, the Company entered into the Warrant Amendment with Lorne Weil. The LW Warrant provided certain anti-dilution protections, which would have been triggered in connection with the issuance of the Notes and Warrants. The Warrant Amendment provides for, among other things, revised antidilution rights so the antidilution provisions set forth in the LW Warrant would not apply in connection with the issuance of the Notes and Warrants; a reduction in the exercise price to $0.50 per share; and an increase in the number of shares of common stock issuable upon exercise of the LW Warrant to 3,560,430 shares of common stock. The remaining balance of the original warrant, LW Warrant and the Warrant Amendment will be recognized ratably over the remaining lease term.

Effective September 28, 2012, the terms of the Company’s management agreements with LW Air were amended to irrevocably reduce the LW Air’s monthly proceeds pursuant to each of the aircraft management agreements by $25,000 per month for a period of twelve consecutive months beginning in August 2012, or $0.3 million per aircraft, the aggregate reduction of LW Air’s monthly proceeds totaling $1.5 million, with respect to all five of the aircraft owned by LW Air. Simultaneous with this transaction, the Company entered into the LW Restricted Stock Agreement, dated as of September 28, 2012, pursuant to which the Company issued to LW Air 2,000,000 shares of fully-vested restricted stock at a price of $0.75 per share, subject to certain antidilution rights, for an aggregate value of $1.5 million. The restricted stock had a fair value of $0.40 per share and will be recognized ratably through July 2013 in cost of flight operations.

On November 30, 2012, the Company entered into Amendment No. 1 with LW Air. The LW Restricted Stock Agreement provided that the shares issued would be entitled to certain antidilution protections, which would have required the issuance of additional shares to LW Air in connection with the issuance of the Notes and Warrants. Amendment No. 1 provides for, among other things, revised antidilution rights so the antidilution provisions in the LW Restricted Stock Agreement would not apply in connection with the issuance of the Notes and Warrants; the issuance of 4,000,000 additional shares of fully-vested restricted stock to LW Air at a price of $0.38 per share on November 30, 2012, subject to certain antidilution rights, and warrants to purchase an aggregate of 6,000,000 shares of common stock in accordance with the Additional LW Warrant on November 30, 2012, in substantially the same form as the Warrants. The restricted stock had a fair value of $0.15 per share and will be recognized ratably through December 2017 in cost of flight operations.

In addition, the Company leases transportation equipment and data processing equipment under operating leases with most equipment having three year terms.

Purchase Commitments

As of March 31, 2013, the Company had contractual commitments to purchase 48 additional Piaggio Avanti II aircraft through calendar year 2013 with a mutual understanding that the aircraft delivery dates and any related payments can be extended. The total commitment, if exercised during the period, including a proposed price escalation, is valued at approximately $305.1 million, net of deposits paid on future aircraft deliveries of $6.4 million.

On June 20, 2008, the Company assigned its rights and obligations to purchase twenty Embraer Phenom 100 (“Phenom 100”) aircraft positions to Share 100 Holding Co., LLC (“Share 100”), a wholly-owned subsidiary of Avantair, Inc. On the same date, the Company entered into a membership interest purchase agreement with Executive Air Shares Corporation (“EAS”), in which EAS purchased the Class A membership of Share 100 and the Company retained the Class B membership. EAS, as Class A member, has the rights and obligations to purchase the Phenom 100 aircraft with positions one through eighteen and to fund payment due in connection with these aircraft. EAS paid Share 100 approximately $2.47 million in connection with these transactions and made an additional $750,000 capital contribution to Share 100 in December 2008, all of which was, immediately distributed to the Company. The Company as Class B member, has the rights and obligations to purchase the Phenom 100 aircraft with positions nineteen and twenty and to fund payment due in connection with these aircraft. EAS had the option to purchase aircraft nineteen and twenty which was to have been exercised by October 1, 2010; if exercised, EAS would reimburse the Company for all payments made relative to these aircraft and provide all remaining funds required. In the event that EAS did not exercise the option to purchase aircrafts nineteen and twenty by October 1, 2010, the Company would have the right and obligation to purchase the nineteenth and twentieth aircraft. The Company entered into agreements with EAS to extend the exercise requirement in November 2010, April 2011, and November 2011, which extended the exercise requirement to April 2011, December 2011 and June 2012, respectively. On May 25, 2012, the exercise requirement was extended an additional twelve months to June 1, 2013. Effective May 30, 2013, EAS has elected not to purchase the remaining two aircrafts. If EAS defaults under its obligations to purchase aircraft positions one through eighteen, EAS will forfeit all deposits paid for the undelivered aircraft, including the funds distributed to the Company. If the Company defaults under its obligations to purchase any undelivered aircraft following a breach by EAS, or if the Company fails to purchase the last two aircraft positions, the Company’s maximum exposure be the amounts due for undelivered aircraft at the time, which as of March 31, 2013 was valued at $43.4 million, net of deposits paid by the Company on undelivered aircraft of $300,000.

Financing Commitments- Short-term

In April 2009, the Company entered into two Floor Plan Agreements with Midsouth Services, Inc. (“Midsouth”) to replace Midsouth’s existing Floor Plan Agreements dated July 31, 2008. The new Floor Plan Agreements extended credit to the Company in an increased amount of $11.6 million to be used towards the purchase of new Piaggio P-180 aircraft. The Floor Plan Agreements covered an amount not to exceed $5.8 million for a term of twelve months. The Company has the sole option to terminate one of the Floor Plan Agreements during the term with ninety days written notice. The Company agreed to pay Midsouth a monthly fee of $82,500 for the first Floor Plan Agreement and $75,000 for a second Floor Plan Agreement. During December 2010, the Company repaid the first Floor Plan Agreement in the amount of $5.8 million and during September 2011, the Company converted the second Floor Plan Agreement in the amount of $5.2 million into a Capital Lease. See Capital Lease Transactions below.

In March 2011, the Company negotiated financing terms pursuant to a Floor Plan Financing Agreement with Midsouth which shall be used towards the purchase

 

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of new Piaggio P-180 aircraft for resale in the fractional program. The March 2011 agreement is similar to the previous arrangements between Midsouth and the Company in that Midsouth agreed to extend credit to the Company for the purchase of fractional aircraft for a term of the later of: (1) twelve months or (2) until the date on which the net purchase price for the aircraft financed pursuant to the Floor Plan Agreement is paid. The Company has agreed to pay Midsouth a monthly fee of $65,000 following the commencement of the term pursuant to the Floor Plan Agreement. The aircraft purchase agreement related to the aircraft currently financed pursuant to the Floor Plan Financing Agreement, which was recently modified by the Company, requires the Company to purchase the aircraft from the lender on or before July 12, 2012. In August 2012, the Company converted the Floor Plan Agreement in the amount of $6.0 million into an Operating Lease with another third party, see Operating Lease Commitments in the preceding paragraphs.

In April 2011, the Company entered into a 12% short-term note payable with Midsouth to finance $0.5 million deposits for one new Piaggio Avanti II aircraft. The Company agreed to pay Midsouth a monthly fee of $5,000 following the commencement of the term pursuant to the Aircraft Deposit Agreement. The term of the agreement, as extended in July 2011, is five months or until the Company takes delivery of the aircraft. During October 2011, the Company repaid the short-term note payable in the amount of $0.5 million.

In September 2011, the Company took delivery of one new Piaggio Avanti P-180 aircraft, for resale in the Fractional Ownership program, financed through a Floor Plan Financing Agreement with Midsouth (the “Floor Plan Agreement”). The Floor Plan Agreement is similar to the previous arrangements between Midsouth and the Company with a term of the later of: (1) fifteen months or (2) until the date on which the net purchase price for the aircraft financed pursuant to the Floor Plan Agreement is paid. The Company initially agreed to pay Midsouth a monthly fee of $72,500 following the commencement of the term pursuant to the Floor Plan Agreement. The aircraft purchase agreement related to the aircraft currently financed pursuant to the Floor Plan Agreement originally required the Company to purchase it from the lender on or before December 31, 2012. On November 30, 2012, Midsouth agreed to extend the term of the Floor Plan Agreement for an additional eight months, or until August 30, 2013. In consideration of the foregoing, the Company issued 8,200,000 shares of fully-vested restricted stock to Mr. Fuller as well as the HF Warrant to purchase 8,400,000 shares of common stock. In connection with the reductions in the capital lease payments pursuant to the Amended HF Restricted Stock Agreement (see Capital Lease Transactions below), Midsouth agreed to a reduction in the monthly fee from $72,500 per month to $25,490 per month beginning November 2012 through January 2013 and to $46,264 per month for twelve consecutive months thereafter, ending on January 31, 2014. As of March 31, 2013, borrowings outstanding under the Floor Plan Agreement totaled $6.0 million.

Financing Commitments – Long-term

Long-term debt consists of the following as of March 31, 2013 (in thousands):

 

Midsouth Services, Inc.

   $ 19,755   

Iberia Bank

     1,204   
  

 

 

 

Subtotal

     20,959   

Less current portion

     (7,657

Less discount on capital leases

     (688
  

 

 

 

Long-term debt

   $ 12,614   
  

 

 

 

Capital Lease Transactions

Midsouth Services, Inc.

The Company has seven Aircraft Leases with Midsouth. On November 30, 2012, the Company entered into the Amended HF Restricted Stock Agreement. Under the Amended HF Restricted Stock Agreement, Midsouth agreed to a reduction in the interest portion of the lease payments for the Aircraft Leases in the aggregate amount of approximately $1.8 million over fifteen months, with reductions in the lease payments of approximately $0.2 million per month beginning in November 2012 through January 2013, and approximately $0.1 million per month for twelve consecutive months thereafter, ending on January 31, 2014. In consideration of the foregoing, the Company issued 8,200,000 shares of fully-vested restricted stock to Mr. Fuller as well as the HF Warrant to purchase 8,400,000 shares of common stock in substantially the same form as the Warrants. The restricted stock had a fair value of $0.15 per share and will be recognized ratably through December 2017 in interest expense. The Amended HF Restricted Stock Agreement also contains certain antidilution protections.

The Company evaluated the Aircraft Leases with Midsouth to determine if they qualified for continued treatment as capital leases under ASC 840. After applying the criteria for treatment as a capital lease, the Company determined that all Aircraft Leases still qualified as capital leases.

In July 2006, the Company entered into a lease agreement, pursuant to which Midsouth leased a core aircraft to the Company. The original lease agreement was accounted for as an operating lease. In April 2009, the Company amended the original lease agreement, pursuant to which the Company was required to pay $74,900 per month, at 11.0% interest per annum until August 2011, the expiration of the amended lease agreement. The Company accounted for this amendment as a capital lease in the accompanying consolidated balance sheets. In addition, the Company agreed to purchase the leased aircraft for approximately $3.0 million from Midsouth within sixty days following the expiration of the amended lease agreement. In August 2011, the Company entered into a second amendment to the aircraft lease agreement to extend the lease term for five years, and decrease monthly payments to $62,500. On November 30, 2012, in accordance with the Amended HF Restricted Stock Agreement, Midsouth agreed to further decrease the monthly payments on the lease to $40,000 beginning in November 2012 through January 2013 and to $40,779 for twelve consecutive months thereafter, ending on January 31, 2014. In accordance with ASC 840, the Company recalculated the net present value of the remaining minimum lease payments which resulted in a discount on the capital lease. The value of the HF Warrant and the fully-vested restricted stock was recognized as a discount against the lease liability. Upon expiration of the five year term, the Company may purchase, at its sole discretion, the aircraft at a purchase price of approximately $0.3 million. The obligation outstanding at March 31, 2013 totaled approximately $2.3 million.

On October 10, 2007, the Company entered into a lease agreement pursuant to which Midsouth leased a core aircraft to the Company. Under the lease agreement, Midsouth provided funding for the $4.7 million purchase of a pre-owned Piaggio P-180 aircraft. Midsouth leases the aircraft exclusively to the Company under a five year lease at 15.0% interest per annum. The monthly lease payments for the term of the lease were originally established at $89,000. On November 30, 2012, pursuant to Amendment No. 1 to the N180HM Lease Agreement, Mr. Fuller agreed to extend the term of the lease for an additional sixty months, or until November 30, 2017, except that Mr. Fuller shall have the sole option to terminate the lease agreement and sell the aircraft and the Company agrees that it shall issue to Mr. Fuller a number of units equal to the result of dividing (A) the difference between $1.5 million and the numerical value of the then current payoff amount as outlined in the lease agreement for the aircraft by (B) 0.25. For purposes of this provision, a unit shall consist of one share of the Company’s Issued Stock (subject to certain adjustments) and one Warrant Share. Additionally, on November 30, 2012, in accordance with the Amended HF Restricted Stock Agreement, Midsouth agreed to decrease the monthly payments on the lease to $40,000 beginning in November 2012 through January 2013 and to $43,850 for twelve consecutive months thereafter, ending on January 31, 2014. In accordance with ASC 840, the Company recalculated the net present value of the remaining minimum lease payments which resulted in a premium on the capital lease. The value of the HF Warrant and the fully-vested restricted stock was recognized as a discount against the lease liability. At the end of

 

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the five year lease term, the lease obligation will be fully satisfied and title shall transfer to the Company free and clear of all liens and encumbrances. The Company also has the option to purchase the aircraft anytime during the lease term at the then current guaranteed residual value as set forth on the amortization schedule without penalty. The Company accounts for this lease as a capital lease in the accompanying consolidated balance sheets. The obligation outstanding at March 31, 2013 totaled approximately $2.2 million.

In April 2009, the Company entered into a lease agreement, pursuant to which Midsouth leases a Piaggio P-180 aircraft to the Company for a ten year lease term at an initial rate of $75,000 per month, at 15.0% interest per annum. The Company is required to provide Midsouth with 100 hours of flight time per year during the lease term. Hours have been accounted for at their fair value and are liquidated as hours are flown. On November 30, 2012, in accordance with the Amended HF Restricted Stock Agreement, Midsouth agreed to decrease the monthly payments on the lease to $45,000 beginning in November 2012 through January 2013 and returning to $75,000 per month thereafter. In accordance with ASC 840, the Company recalculated the net present value of the remaining minimum lease payments which resulted in a discount on the capital lease. The value of the HF Warrant and the fully-vested restricted stock was recognized as a discount against the lease liability. Midsouth has the sole option to terminate the lease at the end of the fifth year of the lease term and require the Company to purchase the leased aircraft for approximately $3.8 million within ninety days of that date. If this option is not exercised by Midsouth, the lease will continue for the remaining five years of the lease term and, at the end of the ten year lease, the Company will be required to purchase the aircraft from Midsouth for $0.3 million. The obligation outstanding at March 31, 2013 totaled approximately $4.1 million.

In September 2011, simultaneous with the termination of the Floor Plan Finance Renewal Agreement and Renewal Guaranteed Aircraft Purchase Agreement for a Piaggio P-180 aircraft, the Company entered into a Lease Agreement, pursuant to which Midsouth leases a Piaggio P-180 aircraft to the Company for a five year lease term at an initial rate of $75,000 per month, at 15.0% interest per annum. The termination of the Floor Plan Financing Agreement and subsequent entrance into the Lease Agreement was evaluated in accordance with ASC 470 “Debt” (“ASC 470”). Based on the Company’s evaluation, the debt transaction met the specified criteria causing the transaction to be recorded in accordance with “Debt Modification and Extinguishment” guidance within ASC 470. As a result, the Company recognized a gain on debt extinguishment of $0.4 million, which is included in the accompanying consolidated statements of operations. On November 30, 2012, in accordance with the Amended HF Restricted Stock Agreement, Midsouth agreed to decrease the monthly payments on the lease to $45,000 beginning in November 2012 through January 2013 and returning to $75,000 per month thereafter. In accordance with ASC 840, the Company recalculated the net present value of the remaining minimum lease payments which resulted in a discount on the capital lease. The value of the HF Warrant and the fully-vested restricted stock was recognized as a discount against the lease liability. Following the expiration of the term of the Lease Agreement, the Company has agreed to purchase the leased aircraft for approximately $3.4 million from Midsouth. The Company accounts for this lease as a capital lease in the accompanying consolidated balance sheets. The obligation outstanding at March 31, 2013 totaled approximately $4.4 million.

In October 2011, the Company entered into a five year lease agreement with Midsouth for $2.0 million, related to one used aircraft previously financed by a Wells Fargo Equipment Finance, Inc. promissory note. The lease agreement initially required the Company to make principal payments ranging from $24,000 to $29,500 plus interest of 13% per annum. On November 30, 2012, in accordance with the Amended HF Restricted Stock Agreement, Midsouth agreed to decrease the monthly principal payments on the lease by $16,000 beginning in November 2012 through January 2013 and by $15,781 for twelve consecutive months thereafter, ending on January 31, 2014. In accordance with ASC 840, the Company recalculated the net present value of the remaining minimum lease payments which resulted in a premium on the capital lease. The value of the HF Warrant and the fully-vested restricted stock was recognized as a discount against the lease liability. Following the expiration of the term of the lease agreement, the Company has agreed to purchase the leased aircraft for approximately $0.4 million from Midsouth. The Company accounts for this lease as a capital lease in the accompanying consolidated balance sheets. The obligation outstanding at March 31, 2013 totaled approximately $1.6 million.

In May 2012, the Company entered into a two year lease agreement with Midsouth for $1.2 million, related to one used aircraft previously financed by a Wells Fargo Equipment Finance, Inc. promissory note. Under the terms of the agreement, the Company will make monthly lease payments to Midsouth in the amount of $55,319, which includes variable interest of 9.9% per annum (based on 4.9% over a floor of a 5% prime rate). On November 30, 2012, in accordance with the Amended HF Restricted Stock Agreement, Midsouth agreed to decrease the monthly payments on the lease to $50,000 beginning in November 2012 through January 2013 and to $52,645 for twelve consecutive months thereafter, ending on January 31, 2014. In accordance with ASC 840, the Company recalculated the net present value of the remaining minimum lease payments which resulted in a discount on the capital lease. The value of the HF Warrant and the fully-vested restricted stock was recognized as a discount against the lease liability. Following the expiration of the lease agreement, the Company will receive title to the aircraft. The Company accounts for this lease as a capital lease in the accompanying consolidated balance sheets. The obligation outstanding at March 31, 2013 totaled approximately $0.7 million.

In July 2012, the Company entered into a ten year lease agreement with Midsouth for $4.6 million, related to one used Piaggio Avanti II. The lease agreement initially required the Company to make monthly lease payments to Midsouth in the amount of $55,171, which includes variable interest of 9.9% per annum (based on 4.9% over a floor of a 5% prime rate). Additionally, the Company issued 200,000 shares of fully-vested restricted stock at a price of $1.50 per share in connection with this lease agreement. The restricted stock had a fair value of $0.65 per share and was capitalized into property and equipment, along with the principal amount of the loan of $4.6 million, and will be depreciated over the ten year lease agreement. On November 30, 2012, in accordance with the Amended HF Restricted Stock Agreement, the Company issued 1,000,000 million shares of fully-vested restricted stock at a price of $0.25 per share. The restricted stock had a fair value of $0.15 per share and was recorded as a discount against the principal amount of the loan and will be depreciated over the ten year lease. Additionally, Midsouth agreed to decrease the monthly payments on the lease to $43,000 beginning in November 2012 through January 2013 and returning to $55,171 per month thereafter. In accordance with ASC 840, the Company recalculated the net present value of the remaining minimum lease payments which resulted in a discount on the capital lease. The value of the HF Warrant and the fully-vested restricted stock was recognized as a discount against the lease liability. Following the expiration of the lease agreement, the Company has the option to purchase the aircraft at the then fair market value. The obligation outstanding at March 31, 2013 totaled approximately $4.3 million.

The capital lease obligations are included in long-term debt in the accompanying consolidated balance sheets.

Wells Fargo Equipment Finance, Inc.

In February 2005, the Company entered into financing arrangements for the purchase of two aircraft under two notes payable with Wells Fargo Equipment Finance, Inc. The notes were payable in monthly installments ranging from $10,644 to $38,480 with interest ranging from 5.96% to 6.12% per annum, through 2012. The notes were collateralized by both aircraft. In January 2012, in connection with the sale of one of the collateralized aircraft, the Company repaid one promissory note in the amount of approximately $790,000. In March 2012, the Company repaid the remaining promissory note in the amount of approximately $1.2 million. Accordingly, as of March 31, 2013, there were no obligations outstanding under these financing arrangements.

Iberia Bank

In August 2007, the Company and Iberia Bank, formerly Century Bank F.S.B., executed a $2.2 million note agreement for the purchase of one aircraft. The note is payable in monthly installments of $27,175 with interest of 8.25% per annum, through August 3, 2012. The note is collateralized by the aircraft. In September 2012, the Company extended the term of this loan to December 2013, which reduced the monthly installments to $26,769. The extension of the note agreement was evaluated in accordance with ASC 470. Based on the Company’s evaluation, the transaction did not meet specified criteria causing the transaction to be recorded in accordance with “Debt Modification and Extinguishment” guidance within ASC 470. The obligation outstanding at March 31, 2013 totaled approximately $1.2 million.

 

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Wells Fargo

On October 31, 2007, the Company and Wells Fargo entered into a financing arrangement for the purchase of one used aircraft at a total purchase price of approximately $4.5 million (inclusive of the value of a flight hour card of 100 hours). Financing was obtained from Wells Fargo through a note payable of $3.9 million. This note was to be repaid monthly over 7 years at an interest rate equal to the LIBOR rate plus 4.0%. In October 2011, the Company repaid the promissory note in the amount of $1.4 million. Accordingly, as of March 31, 2013, there were no obligations outstanding under this financing arrangement.

Senior Secured Convertible Promissory Notes

On November 30, 2012, the Company entered into the Purchase Agreement providing for the issuance of an aggregate of up to $10.0 million in principal amount of Notes and Warrants to purchase up to an aggregate of 40,000,000 shares of the Company’s common stock at the Initial Closing and subsequent offerings (together, the “Financing”). At the Initial Closing, which occurred on November 30, 2012, the Company issued $2.8 million in aggregate principal amount of Notes and Warrants to purchase an aggregate of 11,200,000 shares of the Company’s common stock, to certain members of the Company’s Board of Directors and their affiliates. On February 1, 2013, February 28, 2013 and March 20, 2013 the Company issued to a total of eleven accredited investors Notes in an aggregate principal amount of $2,962,500 and Warrants to purchase an aggregate of 11,850,000 shares common stock. At an additional closing on March 29, 2013, the Company issued to an accredited investor Notes in an aggregate of $1,970,000 and Warrants to purchase an aggregate of 7,880,000 shares of common stock (the “Additional Closing”). In addition, on January 17, 2013, the Company, the holders of the Notes and Warrants and Barry Gordon, as collateral agent, entered into the Note Financing Amendment. The Notes and Warrants offered will not be and have not been registered under the Securities Act of 1933, as amended, and may not be offered or sold in the United States absent registration or an applicable exemption from the registration requirements.

The Notes bore interest at an initial rate of 2.0% per annum which increased to 12.0% per annum since the Company was unsuccessful in obtaining stockholder approval by March 31, 2013 to increase the Company’s authorized shares of common stock so that a sufficient number of shares are reserved for the conversion of the Notes. Holders of the Notes may, at their option, elect to convert all outstanding principal and accrued but unpaid interest on the Notes into shares of common stock at a conversion price of $0.25 per share but may convert only a portion of such Notes if an inadequate number of authorized shares of common stock is available to effect such optional conversion. Holders of the Notes are entitled to certain anti-dilution protections. The Company may prepay the Notes on or after November 28, 2014. The Notes have a maturity date of November 28, 2015, unless the Notes are earlier converted or an event of default or liquidation event occurs.

On December 12, 2012, the Company received a letter from Special Situations Fund III QP, L.P., Special Situations Caymans Fund, L.P., Special Situations Private Equity Fund, L.P. and David Greenhouse (collectively, the “SSF Investors”) claiming that liquidated damages were payable by the Company to the SSF Investors under the Registration Rights Agreement dated October 16, 2009 by and among the Company, certain investors and EarlyBird Capital LLC. On February 6, 2013, the Company entered into a Settlement Agreement (the “Settlement Agreement”) with the SSF Investors to resolve the matter and issued to the SSF Investors senior secured convertible promissory notes having an aggregate principal amount of $1,055,537 (the “SSF Notes”) and warrants to purchase an aggregate of 4,222,148 shares of common stock (the “SSF Warrants”). The SSF Warrants are exercisable at an exercise price of $0.50 per share, which exercise price is subject to certain anti-dilution protections, but the SSF Warrants may not be exercised unless a sufficient number of authorized shares of common stock are available for the exercise of the SSF Warrants. In addition, the SSF Warrants may be exercised on a cashless basis if a registration statement covering the shares underlying the SSF Warrants, or an exemption from registration, is not available for the resale of such shares underlying the SSF Warrants. The SSF Warrants expire on November 30, 2017. The Company accrued the settlement amount of $1.1 million to general and administrative expenses during the second quarter of fiscal year 2013.

The SSF Notes bore interest at an initial rate of 2.0% per annum, which increased to 12.0% per annum since the Company was unsuccessful in obtaining stockholder approval by March 15, 2013 to increase the Company’s authorized shares of common stock so that a sufficient number of shares are reserved for the conversion of the SSF Notes. Holders of the SSF Notes may, at their option, elect to convert all outstanding principal and accrued but unpaid interest on the SSF Notes into shares of common stock at a conversion price of $0.25 per share, but may convert only a portion of such SSF Notes if an inadequate number of authorized shares of common stock is available to effect such optional conversion. Holders of the SSF Notes are entitled to certain anti-dilution protections. The Company may prepay the SSF Notes on or after November 28, 2014. The SSF Notes have a maturity date of November 28, 2015, unless the SSF Notes are earlier converted or an event of default or liquidation event occurs.

On February 6, 2013, the Company entered into a Registration Rights Agreement with SSF pursuant to which the Company has agreed to register under the Securities Act of 1933, as amended, the shares of common stock issuable upon conversion of the SSF Notes and SSF Warrants. The Company was required to file such resale registration statement on Form S-1 (or Form S-3 if the Company was eligible to use Form S-3) no later than the earlier of ten days after the Share Increase Effective Date or May 27, 2013 (“Filing Deadline”). Since the registration statement was not filed with the SEC prior to the Filing Deadline, the Company shall pay SSF liquidated damages payments in an amount equal to (i) 3.0% of the aggregate principal amount of the SSF Notes for the first sixty-day period following the Filing Deadline for which no registration statement is filed and (ii) thereafter 1.5% of the aggregate principal amount of the SSF Notes for each thirty-day period following the Filing Deadline for which no registration statement is filed.

The carrying value of the senior secured convertible promissory notes as of March 31, 2013 was as follows (amounts in thousands):

 

Par value of senior secured convertible promissory notes

   $ 8,788   

Discount related to embedded conversion feature 1

     (2,676

Discount related to detachable warrants 2

     (3,247

Accretion of discount on embedded conversion feature 3

     502   
  

 

 

 

Carrying value of senior secured convertible promissory notes

   $ 3,367   
  

 

 

 

 

1  

The Notes contain an embedded conversion feature that the Company has determined is a derivative requiring bifurcation in accordance with the provisions of ASC 815. The embedded conversion feature of the Notes was valued at approximately $0.07 per Note using the Monte Carlo method at March 31, 2013. The fair value of the embedded conversion feature of approximately $2.5 million was recorded as a derivative liability with the offset recorded as a discount on the Notes and included as a component of Senior secured convertible promissory notes in the accompanying consolidated balance sheet as of March 31, 2013.

 

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2  

The Notes contain detachable Warrants that the Company has determined are derivatives requiring bifurcation in accordance with the provisions of ASC 815. The detachable Warrants were valued at approximately $0.09 per warrant using the Monte Carlo method at March 31, 2013. The fair value of the detachable Warrants of approximately $3.1 million was recorded as a derivative liability with the offset recorded as a discount on the Notes and included as a component of Senior secured convertible promissory notes in the accompanying consolidated balance sheet as of March 31, 2013.

 

3  

Accretion of the discount on the embedded conversion feature of $228,611 was recorded to interest expense for the three months ended March 31, 2013 using the effective interest method. Accretion of the discount on the detachable Warrants of $274,450 was recorded to interest expense for the three months ended March 31, 2013 using the effective interest method.

Aircraft Incident

In November 2011, one of the Company’s fractionally-owned aircraft, a 2007 Piaggio P-180, was involved in an incident (“Aircraft Incident”), following which the aircraft was declared a total loss by the Company’s insurer. Only minor injuries were sustained by the passengers and crew. The Company was required to maintain insurance on the aircraft that covered its replacement value, which was estimated to be $4.8 million. During December 2011, the Company received $6.5 million of insurance proceeds which were initially recorded as an accrued liability as of December 31, 2011. The additional insurance proceeds were a result of the Company insuring its aircraft in excess of the replacement value to reimburse the Company for expenses associated with a reduction in available aircraft in its fleet, including, but not limited to, costs incurred for chartered flights, repositioning aircraft to accommodate owner’s requirements, and maintenance costs associated with higher flight hours on the remaining fleet. These proceeds offset similar expenses during the third and fourth quarters of fiscal year 2012 and the first quarter of fiscal year 2013. The fractional ownership documents permit the Company to replace the aircraft on behalf of the fractional owners with another aircraft that is substantially similar and has a market value approximately equal to or greater than the market value of the 2007 Piaggio P-180 involved in the Aircraft Incident. During the third and fourth quarters of fiscal year 2012, the Company purchased the fractional owners’ interest in the aircraft, and simultaneously, the fractional owners of the 2007 Piaggio P-180 entered into new fractional ownership documents for a substantially similar replacement aircraft interest. During the third and fourth quarters of fiscal year 2012, the Company paid a total of approximately $4.8 million and transferred 16.0 fractional shares in connection with this incident. During the first quarter of fiscal year 2013, the Company paid approximately $0.4 million in connection with this incident. As of March 31, 2013, the insurance proceeds liability was zero. In accordance with ASC 225 “Income Statement” (“ASC 225”), there was no gain or loss recognized in connection with the loss of this aircraft.

Employee Termination and Other Costs

During the third quarter of fiscal year 2012, the Company developed and implemented plans to improve sales performance and deliver efficiencies within the finance department. These plans were evaluated and recorded in accordance with ASC 420 “Exit or Disposal Cost Obligations” (“ASC 420”). In connection with the changes in the sales and finance departments, the Company incurred various costs and obligations, including severance payouts to employees and other related charges. The Company expects total costs associated with these activities to be approximately $1.0 million. As of March 31, 2013, the liability attributable to unpaid employee termination and other expense was less than approximately $0.1 million, representing a reduction of approximately $0.1 million from the unpaid employee termination and other expense liability as of June 30, 2012, which was $0.2 million. The reduction in liability represents amounts paid during the nine month period ended March 31, 2013. This liability is included in accrued liabilities in the accompanying consolidated balance sheets.

NOTE 4 – EQUITY TRANSACTIONS

Capital Stock, Redeemable Preferred Stock

As of March 31, 2013, the Company had 40,901,634 shares of its common stock outstanding and 2,699,566 shares of common stock reserved for future issuance under the Company’s 2006 Long-Term Incentive Plan.

As of March 31, 2013, the Company had 152,000 shares of Series A Convertible Preferred Stock (“Series A Preferred Shares”) outstanding. The Company assessed the redemption feature of the Series A Preferred Shares to determine if the instrument should be accounted for as a liability in accordance with ASC Topic 480. The Company has 23,818,303 shares of common stock reserved for issuance upon the conversion of the outstanding Series A Preferred Shares. As a result of the sale of shares consummated on June 30, 2009, September 25, 2009 and October 16, 2009, the conversion price of the Series A Preferred Shares was reduced from $5.15 to $3.57. As a result of the grant of fully-vested restricted stock in July 2012 and September 2012 related to a new capital lease and an amendment of an operating lease, the conversion price of the Series A Preferred Shares was reduced from $3.57 to $3.36. As a result of November 2012 amendments to the July 2012 and September 2012 grants of fully-vested restricted stock related to a new capital lease and an amendment of an operating lease, and new grants of restricted stock in November 2012 related to a reduction in interest on capital lease and floor plan payments, as well as the Notes and Warrants issued pursuant to the Closing as of March 31, 2013, the conversion price of the Series A Preferred Shares was reduced from $3.36 to $0.64.

Based on the number of shares necessary to convert compared to shares authorized and available for issuance along with the other demands on available shares as of March 31, 2013, the Company recognized the embedded conversion feature in the preferred shares as a derivative and bifurcated its value and reconsidered it as a separate liability.

The fair value of the conversion option was determined using a lattice-binomial model. This model requires the input of highly subjective assumptions, including price volatility of the underlying stock. Changes in the subjective input assumptions can materially affect the estimate of fair value of options granted and the Company’s results of operations could be impacted.

The inputs to the model at March 31, 2013 were as follows:

 

The Company’s stock price at March 31, 2013

   $ 0.13   

Conversion price

   $ 0.64   

Dividend yield (per share)

     N/A   

Risk-free interest rate

     0.06

Expected volatility rate

     85

A derivative liability of $1.8 million was recognized with a corresponding charge in the statement of operations in the third quarter ended March 31, 2013.

During the nine months ended March 31, 2013, the Company accrued, but did not pay, dividends on preferred stock of approximately $1.0 million. The Company does not expect to pay dividends on preferred stock for the foreseeable future. As a result of not paying the preferred stock dividend, the dividend rate increased from 9.0% to 9.5% as of March 31, 2013. Continued non-payment of the preferred stock dividends will result in further increases to the dividend rate.

Shares of Reserved Common Stock

As of March 31, 2013, the Company had 75,000,000 shares of its common authorized with 40,901,634 shares issued and outstanding. The Company had 2,699,566 shares of common stock reserved for future issuance under its 2006 Long-Term Stock Incentive Plan. Pursuant to the 2006 Long-Term Incentive Plan, 2.8 million shares of common stock are reserved for issuance under this plan. The Company had unvested restricted stock of 774,174 and 1,619,267 stock options outstanding. The Company entered into Amended and Restated Restricted Stock Agreements with two entities and had reserved on its books 3,526,087 shares of common stock.

As of March 31, 2013, the Company had 152,000 shares of Series A Convertible Preferred Stock outstanding. The Company had 23,818,303 shares of common stock reserved on its books and records for issuance upon the conversion of the outstanding shares of Series A Convertible Preferred Stock.

As of March 31, 2013, the Company had 57,383,865 shares of common stock reserved on its books for issuance upon the conversion of the warrant and 35,152,148 shares of common stock for the issuance upon the conversion of the outstanding convertible secured promissory notes.

Restricted Shares and Stock Options

By recommendation of the Compensation Committee and approval by the Board of Directors, and in accordance with an Employment Agreement executed July 14, 2011, the Company granted equity compensation to Stephen Wagman, President, pursuant to the Company’s Amended and Restated 2006 Long-Term Incentive Plan, as follows:

 

   

30,000 shares of restricted stock granted in July 2011, subject to a three year vesting period, with one-third of the shares vesting upon each of the first three anniversaries of the date of the Employment Agreement, subject to Mr. Wagman’s continued employment with the Company on each vesting date. The fair value at the date of grant was $1.90 per share.

 

   

425,000 stock options granted in July 2011, exercisable at $2.25 per share, subject to a three year vesting period, with one-third of the shares vesting upon each of the first three anniversaries of the date of the Employment Agreement, subject to Mr. Wagman’s continued employment with the Company on each vesting date and the Company achieving certain financial target goals.

 

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In September 2012, by recommendation of the Compensation Committee and approval by the Board of Directors, the Company granted equity compensation to certain employees, pursuant to the Company’s Amended and Restated 2006 Long-Term Incentive Plan, as follows:

 

   

600,000 shares of restricted stock to the Company’s executives and management team, subject to performance-based vesting measures; and

 

   

496,450 stock options to employees of the Company, subject to a three year vesting schedule, with one-third vesting on each successive anniversary date of grant. The fair value of the stock options was $0.42 per share.

In February 2012, the Company granted deferred equity compensation to each of its seven Non-Employee Directors, pursuant to the Amended and Restated 2006 Long-Term Incentive Plan, as follows:

 

   

60,000 shares of restricted stock granted which shall convert into shares of the Company’s common stock on a one-for-one basis upon the earliest of (i) the date of the Non-Employee Director’s cessation of service with the Company, or (ii) the date of a change in control of the Company and 80,000 shares of restricted stock, which shares shall be nontransferable until the earlier of the date of the Non-Employee Director’s cessation of service with the Company or the date of change in control of the Company.

On March 21, 2013, Mr. Wagman resigned as President and terminated his employment with the Company effectively on April 14, 2013, at which time all unvested shares and stock options were forfeited.

Warrants and Notes

The following assumptions were used in valuing the warrants and notes under the Monte Carlo method on their respective dates of issuance. The Monte Carlo method is a theoretical forward-looking valuation model.

 

     Date of Issuance      Underlying
stock value
     Exercise
price
     Term
(years)
     Volatility     Interest
rate
    Number of
simulations
     Fair
Value
of
Warrant
on Date
of
Issuance
 

EarlyBirdCapital Warrants

                     

Third Party Aircraft Purchase Agreement A

     August 3, 2012       $ 0.40       $ 1.00         3.06         75.00     0.32     One million       $ 0.07   

Purchase Agreement B

     November 25, 2012       $ 0.15       $ 0.50         5.00         85.00     0.70     One million       $ 0.10   

LW Air Warrants

                     

Additional LW Warrant C

     November 30, 2012       $ 0.15       $ 0.50         3.00         85.00     0.36     One million       $ 0.08   

Warrant Amendment D

     November 30, 2012       $ 0.15       $ 0.50         2.88         85.00     0.36     One million       $ 0.03   

Hugh Fuller Warrants

                     

HF Warrant E

     November 30, 2012       $ 0.15       $ 0.50         5.00         85.00     0.65     One million       $ 0.04   

HF Overfly Warrant F

     November 30, 2012       $ 0.15       $ 0.50         3.00         85.00     0.36     One million       $ 0.04   

Senior Secured Convertible Promissory Notes

                     

Detachable Warrants G

     November 30, 2012       $ 0.15       $ 0.50         5.00         85.00     0.65     One million       $ 0.10   

Embedded Conversion Feature H

     November 30, 2012       $ 0.15       $ 0.25         3.00         85.00     0.36     One million       $ 0.09   

SSF Investors

                     

Settlement Agreement

     February 6, 2013       $ 0.15       $ 0.50         2.67         85.00     0.60     One million       $ 0.07   

Warrants

     February 6, 2013       $ 0.15       $ 0.50         4.67         85.00     1.20     One million       $ 0.09   

Senior Secured Convertible Promissory Notes

                     

Detachable Warrants G

     February 1, 2013       $ 0.15       $ 0.50         4.67         85.00     1.20     One million       $ 0.09   

Embedded Conversion Feature H

     February 1, 2013       $ 0.15       $ 0.25         2.67         85.00     0.60     One million       $ 0.07   

Detachable Warrants G

     February 28, 2013       $ 0.15       $ 0.50         4.67         85.00     1.20     One million       $ 0.09   

Embedded Conversion Feature H

     February 28, 2013       $ 0.15       $ 0.25         2.67         85.00     0.60     One million       $ 0.07   

Detachable Warrants G

     March 20, 2013       $ 0.15       $ 0.50         4.67         85.00     1.20     One million       $ 0.09   

Embedded Conversion Feature H

     March 20, 2013       $ 0.15       $ 0.25         2.67         85.00     0.60     One million       $ 0.07   

Detachable Warrants G

     March 29, 2013       $ 0.15       $ 0.50         4.67         85.00     1.20     One million       $ 0.09   

Embedded Conversion Feature H

     March 29, 2013       $ 0.15       $ 0.25         2.67         85.00     0.60     One million       $ 0.07   

On August 3, 2012, pursuant to an agreement between EBC and the Company, in consideration for services rendered in connection with an aircraft purchase agreement with a third party, the Company issued to EBC and its affiliates 50,000 warrants to purchase common stock which expire on August 2, 2015. Each warrant permits the holder to purchase one share of the Company’s common stock at an exercise price of $0.60 per share. The fair value of the warrants was estimated at $0.07 per warrant. Due to the immateriality of the amount, the Company immediately expensed the full amount to cost of flight operations during the three months ended September 30, 2012. The Company has the option to redeem warrants at any time at the price of $0.01 per warrant, provided that the volume weighted average price of the Company’s common stock has been at least 200.0% of the exercise price of a warrant for any twenty trading days during any consecutive thirty trading day period ending on the third trading day preceding the date of the notice of redemption. The holder did not exercise any of the warrants nor did the Company redeem any of the warrants on or after August 3, 2012 through March 31, 2013. These warrants were issued without registration under the Securities Act by reason of the exemption from registration afforded by the provisions of Section 4(2) thereof, as a transaction by an issuer not involving any public offering.

B. EarlyBirdCapital, Inc. Purchase Agreement

On November 25, 2012, in consideration for financial consulting and/or investment banking services performed by EBC in connection with the Purchase Agreement, the Company issued warrants to EBC for the purchase of 250,000 shares of the Company’s common stock which expire on November 25, 2017. Each warrant permits the holder to purchase one share of the Company’s common stock at an exercise price of $0.50 per share. The fair value of the warrants was estimated

 

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at $0.10 per warrant using the Monte Carlo method. Due to the immateriality of the amount, the Company immediately expensed the full amount to interest expense during the three months ended December 31, 2012. The holder did not exercise any of the warrants nor did the Company redeem any of the warrants on or after November 25, 2012 through March 31, 2013. These warrants were issued without registration under the Securities Act by reason of the exemption from registration afforded by the provisions of Section 4(2) thereof, as a transaction by an issuer not involving any public offering.

C. Additional LW Warrant

On November 30, 2012, the Company entered into Amendment No. 1 with LW Air. The LW Restricted Stock Agreement provided that the shares issued would be entitled to antidilution protections, which would have required the issuance of additional shares to LW Air in connection with the issuance of the Notes and Warrants. Amendment No. 1 provides for, among other things, revised antidilution rights so the antidilution provisions in the LW Restricted Stock Agreement would not apply in connection with the issuance of the Notes and Warrants; the issuance of 4,000,000 additional shares of fully-vested restricted stock to LW Air and the Additional LW Warrant to purchase an aggregate of 6,000,000 shares of common stock in substantially the same form as the Warrants. The Additional LW Warrant permits the holder to purchase shares of the Company’s common stock at an exercise price of $0.50 per share. The fair value of the Additional LW Warrant was estimated at $0.06 per warrant and approximately $0.5 million will be expensed to cost of flight operations over the three year term. During the three months ended March 31, 2013, the Company expensed less than $0.1 million in cost of flight operations. The warrants underlying the Additional LW Warrant expire on November 28, 2015 and while effective, the warrants are subject to certain anti-dilution rights. The holder did not exercise any of the warrants on or after November 30, 2012 through March 31, 2013. These warrants were issued without registration under the Securities Act by reason of the exemption from registration afforded by the provisions of Section 4(2) thereof, as a transaction by an issuer not involving any public offering.

D. Warrant Amendment

On September 28, 2012, LW Air and the Company amended the management agreements for each aircraft managed by the Company and owned by LW Air so that the Company is not required to pay LW Air additional amounts unless usage of the aircraft exceeds 1,350 hours per year, retroactive to the beginning of each management agreement. Simultaneous with this transaction, the Company issued the LW Warrant to Lorne Weil which replaced the warrant issued to Lorne Weil on September 28, 2012. The LW Warrant was exercisable for the purchase of 2,373,620 shares of the Company’s common stock at an exercise price of $1.00 per share. The fair value of the warrants was estimated at $0.07 per warrant.

On November 30, 2012, the Company entered into the Warrant Amendment with Lorne Weil. The LW Warrant provided certain anti-dilution protections, which would have been triggered in connection with the issuance of the Notes and Warrants. The Warrant Amendment provides for, among other things, revised antidilution rights so the antidilution provisions set forth in the LW Warrant would not apply in connection with the issuance of the Notes and Warrants; a reduction in the exercise price to $0.50 per share; and an increase in the number of shares of common stock issuable upon exercise to 3,560,430 shares of common stock. The fair value of the warrants was estimated at $0.02 per warrant and approximately $0.1 million will be expensed to cost of flight operations over the approximate three year term. During the three months ended March 31, 2013, the Company expensed less than $0.1 million in cost of flight operations, for a cumulative adjustment that was based on the fair value of the recently amended warrants, retroactive to the beginning of the original lease agreement. The remaining balance of the original warrant, LW Warrant and the Warrant Amendment will be recognized ratably over the remaining lease term. The warrants underlying the Warrant Amendment expire on October 19, 2015 and are subject to certain anti-dilution rights. Lorne Weil did not exercise any of the warrants nor did the Company redeem any of the warrants on or after September 28, 2012 through March 31, 2013. These warrants were issued without registration under the Securities Act by reason of the exemption from registration afforded by the provisions of Section 4(2) thereof, as a transaction by an issuer not involving any public offering.

E. HF Warrant

On November 30, 2012, pursuant to the Amended HF Restricted Stock Agreement, Mr. Fuller agreed to a reduction in the interest portion of the lease payments for the Aircraft Leases in the aggregate amount of approximately $1.8 million over fifteen months, with reductions in lease payments in the amount of approximately $0.2 million per month beginning in November 2012 through January 2013, and approximately $0.1 million per month for twelve consecutive months thereafter, ending on January 31, 2014. Pursuant to Amendment No. 1 to the N180HM lease agreement, Mr. Fuller also agreed to extend the term of the lease for an additional sixty (60) months, or until November 30, 2017, on similar terms, except that Mr. Fuller shall have the sole option to terminate the lease agreement and sell the aircraft and the Company agrees that it shall issue to Mr. Fuller a number of units (as defined below) equal to the result of dividing (A) the difference between $1.5 million and the numerical value of the then current payoff amount as outlined in the lease agreement for the aircraft by (B) 0.25. For purposes of this provision, a unit shall consist of one share of the Company’s common stock (the “Issued Stock”) (subject to adjustment as described below) and one warrant to purchase a share of the Company’s common stock at $0.50 (a “Warrant Share”). Mr. Fuller also agreed to extend the term of the Floor Plan Agreement originally entered into in September 2011 for an additional eight (8) months, or until August 30, 2013. In consideration of the foregoing, the Company issued 8,200,000 shares of fully-vested restricted stock to Mr. Fuller, 1,000,000 shares of which related to the $0.3 million reduction in the principal balance of an aircraft to be financed and 7,200,000 shares related to the approximate $1.8 million reduction in the interest portion of the lease payments of the aircraft leases and Amendment No. 1 to the N180HM lease agreement, as well as the HF Warrant to purchase 8,400,000 shares of common stock. The Amended HF Restricted Stock Agreement also contains certain antidilution protections.

The HF Warrant will expire on November 30, 2017, and permits the holder to purchase one share of the Company’s common stock at an exercise price of $0.50 per share. The fair value of the HF Warrants was estimated at $0.03 per warrant and approximately $0.3 million will be expensed to interest expense over the five year term. During the three months ended March 31, 2013, the Company expensed less than $0.1 million in interest expense. The Company has the option to redeem the warrants at any time at the price of $0.01 per warrant, provided that the volume weighted average price of the Company’s common stock has been at least 300.0% of the exercise price of a warrant for any twenty trading days during any consecutive thirty trading day period ending on the third trading day preceding the date of the notice of redemption. Mr. Fuller did not exercise any of the warrants nor did the Company redeem any of the warrants on or after November 30, 2012 through March 31, 2013. These warrants were issued without registration under the Securities Act by reason of the exemption from registration afforded by the provisions of Section 4(2) thereof, as a transaction by an issuer not involving any public offering.

F. HF Overfly Warrant

On November 30, 2012, the Company issued the HF Overfly Warrant to Mr. Fuller, to purchase 645,200 shares of the Company’s common stock. The HF Overfly Warrant was issued in lieu of paying additional amounts owed to Mr. Fuller pursuant to certain Aircraft Leases as a result of the aircraft exceeding certain hourly usage limitations. The warrants expire on November 30, 2015. Each warrant permits the holder to purchase one share of the Company’s common stock at an exercise price of $0.50 per share. The fair value of the warrants was estimated at $0.02 per warrant and approximately less than $0.1 million will be expensed to interest expense over the three year term. During the three months ended March 31, 2013, the Company expensed less than $0.1 million in interest expense. The remaining balance of the warrants, as of March 31, 2013, will be recognized ratably over the remaining lease terms. The Company has the option to redeem warrants at any time at the price of $0.01 per warrant, provided that the volume weighted average price of the Company’s common stock has been at least 300.0% of the exercise price of a warrant for any twenty trading days during any consecutive thirty trading day period ending on the third trading day preceding the date of the notice of redemption. The holder did not exercise any of the warrants nor did the Company redeem any of the warrants on or after November 30, 2012 through March 31, 2013. These warrants were issued without registration under the Securities Act by reason of the exemption from registration afforded by the provisions of Section 4(2) thereof, as a transaction by an issuer not involving any public offering.

 

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G. Detachable Warrants

On November 30, 2012, the Company issued $2.8 million in aggregate principal amount of Notes and Warrants to purchase an aggregate 11,200,000 shares of the Company’s common stock to certain members of the Company’s Board of Directors and their affiliates. On February 1, 2013, February 28, 2013 and March 20, 2013, the Company issued in aggregate principal amount of Notes $2.96 million and Warrants to purchase an aggregate of 11,850,000 shares of the Company’s common stock to eleven accredited investors. At an additional closing on March 29, 2013, the Company issued to an accredited investor $1.97 million in a principal amount Note and Warrant to purchase 7,880,000 shares of the Company’s common stock. The Warrants are exercisable at a price of $0.50 per share. The fair value of the Warrants was estimated at $0.10 and $0.09 per Warrant for November 2012 and March 2013, respectively and approximately $3.2 million will be expensed to interest expense over the five year term. During the nine months ended March 31, 2013, the Company expensed less than $0.3 million in interest expense. The remaining balance of the Warrants, as of March 31, 2013, will be recognized ratably through the exercise date of the Warrant. The purchasers did not exercise any of the Warrants nor did the Company redeem any of the Warrants on or after November 30, 2012 through March 31, 2013. These Warrants were issued pursuant to the exemption from registration afforded by Section 4(2) of the Securities Act of 1933, as amended, and Rule 506 promulgated thereunder.

H. Embedded Conversion Feature

The Notes also contain an embedded conversion feature which the Company has determined is a derivative in accordance with the provisions of ASC 815. Accordingly, the conversion feature was recorded as a derivative liability. The fair value of the conversion feature for the November 2012 issuance was estimated at $0.09 per Note and $0.07 for the Notes issued in the third quarter ending March 31, 2013, respectively. Approximately $2.7 million will be expensed to interest expense over the three year term. During the nine months ended March 31, 2013, the Company expensed less than $0.2 million in interest expense. The remaining balance of the conversion feature, as of March 31, 2013, will be recognized ratably over the remaining term of the Notes. The purchasers did not convert any of the Notes to the Company’s common stock on or after November 30, 2012 through March 31, 2013.

NOTE 5 – FAIR VALUE DISCLOSURE

The following is a summary of our financial assets and liabilities measures at fair value as of March 31, 2013 and June 30, 2012 classified by level in the Valuation Hierarchy (in thousands):

 

     Fair Value at March 31, 2013  
     Level 1      Level 2      Level 3  

Senior secured convertible promissory notes embedded conversion feature

   $ —         $ —         $ 2,519   

Embedded conversion feature preferred stock

     —           —           1,858   

Warrants

     —           —           3,787   
  

 

 

    

 

 

    

 

 

 

Total Derivative liabilities

   $ —         $ —         $ 8,164   
  

 

 

    

 

 

    

 

 

 

 

     Fair Value at June 30, 2012  
     Level 1      Level 2      Level 3  

Senior secured convertible promissory notes embedded conversion feature

   $ —         $ —         $ —     

Warrants

     —           —           —     
  

 

 

    

 

 

    

 

 

 

Total Derivative liabilities

   $ —         $ —         $ —     
  

 

 

    

 

 

    

 

 

 

Financial instruments are assessed on a quarterly basis to determine the appropriate classification within the fair value hierarchy, as defined by ASC 820. Transfers between fair value classifications occur when there are changes in pricing observability levels. Transfers of financial instruments among the levels occur at the end of the reporting period. There were no significant transfers between Level 1, Level 2 and Level 3 classified instruments during 2013 and 2012. During the fiscal year ended June 30, 2012, the Company elected not use fair value option under ASC 820 for any of its financial assets and financial liabilities that are not already recorded at fair value.

The embedded conversion feature of the senior secured convertible promissory notes, embedded conversion feature on preferred stock and warrants are recorded as derivative liabilities using the Monte Carlo method simulation. The model requires management to use eight inputs: underlying stock value, exercise price, vesting, term, volatility, dividend yield, risk-free rate of return and redemption rights feature.

The following is a summary of changes in fair value of our financial assets and financial liabilities that have been categorized within Level 3 of the fair value hierarchy for the three and nine months ended March 31, 2013:

 

     Three Months Ended March 31, 2013  
     Embedded
Conversion
Feature
Warrants
    Embedded
Conversion
Feature on
Preferred
Stock
     Derivative
Liability
Warrants
    Total  

Beginning balance, December 31, 2012

   $ 961      $ —         $ 2,090      $ 3,051   

Additions

     1,716        —           2,106        3,822   

Change in fair value

     (158     1,858         (409     1,291   
  

 

 

   

 

 

    

 

 

   

 

 

 

Ending balance, March 31, 2013

   $ 2,519      $ 1,858       $ 3,787      $ 8,164   
  

 

 

   

 

 

    

 

 

   

 

 

 
     Nine Months Ended March 31, 2013  
     Embedded
Conversion
Feature
Warrants
    Embedded
Conversion
Feature on
Preferred
Stock
     Derivative
Liability
Warrants
    Total  

Beginning balance, June 30, 2012

   $ —        $ —         $ —        $ —     

Additions

     2,677        —           4,256        6,933   

Change in fair value

     (158     1,858         (469     1,231   
  

 

 

   

 

 

    

 

 

   

 

 

 

Ending balance, March 31, 2013

   $ 2,519      $ 1,858       $ 3,787      $ 8,164   
  

 

 

   

 

 

    

 

 

   

 

 

 

Goodwill is measured at fair value on a non-recurring basis. Goodwill is recognized at fair value when it is considered to be impaired.

The following table reflects changes in the fair value of goodwill for the three and nine months ended March 31, 2013:

 

     Three Months Ended March 31, 2013  

Beginning balance, December 31, 2012

   $ 1,141   

Impairment charge

     (1,141
  

 

 

 

Ending balance, March 31, 2013

   $ —     
  

 

 

 
     Nine Months Ended March 31, 2013  

Beginning balance, June 30, 2012

   $ 1,141   

Impairment charge

     (1,141
  

 

 

 

Ending balance, March 31, 2013

   $ —     
  

 

 

 

 

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NOTE 6 – STOCK-BASED COMPENSATION

By recommendation of the Compensation Committee and approval by the Board of Directors, and in accordance with an Employment Agreement executed July 14, 2011, the Company granted equity compensation to Stephen Wagman, President, pursuant to the Company’s Amended and Restated 2006 Long-Term Incentive Plan, as follows:

 

   

30,000 shares of restricted stock granted in July 2011, subject to a three year vesting period, with one-third of the shares vesting upon each of the first three anniversaries of the date of the Employment Agreement, subject to Mr. Wagman’s continued employment with the Company on each vesting date. The fair value at the date of grant was $1.90 per share.

 

   

425,000 stock options granted in July 2011, exercisable at $2.25 per share, subject to a three year vesting period, with one-third of the shares vesting upon each of the first three anniversaries of the date of the Employment Agreement, subject to Mr. Wagman’s continued employment with the Company on each vesting date and the Company achieving certain financial target goals.

In September 2012, by recommendation of the Compensation Committee and approval by the Board of Directors, the Company granted equity compensation to certain employees, pursuant to the Company’s Amended and Restated 2006 Long-Term Incentive Plan, as follows:

 

   

600,000 shares of restricted stock to the Company’s executives and management team, subject to performance-based vesting measures; and

 

   

496,450 stock options to employees of the Company, subject to a three year vesting schedule, with one-third vesting on each successive anniversary date of grant. The fair value of the stock options was $0.42 per share.

In February 2012, the Company granted deferred equity compensation to each of its seven Non-Employee Directors, pursuant to the Amended and Restated 2006 Long-Term Incentive Plan, as follows:

 

   

60,000 shares of restricted stock granted which shall convert into shares of the Company’s common stock on a one-for-one basis upon the earliest of (i) the date of the Non-Employee Director’s cessation of service with the Company, or (ii) the date of a change in control of the Company and 80,000 shares of restricted stock, which shares shall be nontransferable until the earlier of the date of the Non-Employee Director’s cessation of service with the Company or the date of change in control of the Company.

Stock-based compensation expense was as follows for the three months and nine months ended March 31, 2013 and 2012:

 

     Three Months Ended      Nine Months Ended  
     March 31,      March 31,  
     2013      2012      2013      2012  

General and administrative

   $ 157,068       $ 178,876       $ 470,065       $ 533,531   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total stock-based compensation expense

   $ 157,068       $ 178,876       $ 470,065       $ 533,531   
  

 

 

    

 

 

    

 

 

    

 

 

 

The Company estimated the fair value of each option award on the date of grant using the Black-Scholes option pricing model. The volatility assumption is based on a calculation of the volatility of the Company’s five year historical stock price ranging from 60.68% to 67.49% with a weighted average of 63.37%. The risk-free interest rate assumption is based upon observed interest rates appropriate for the expected term of the Company’s employee stock options ranging from 1.51 % to 4.67% with a weighted average of 2.80%. The dividends yield assumption is based on the Company’s intent not to issue a dividend under its dividend policy. The expected term is based on the simplified method in accordance with ASC 820 or 6 years. The fair values range from $1.09 to $3.23 with a weighted average of $1.59.

 

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NOTE 7 – LOSS PER SHARE

The following securities were not included in the diluted net income loss per share calculation because their effect was antidilutive for the periods ended March 31, 2013 and 2012:

 

     Three Months Ended      Nine Months Ended  
     March 31,      March 31,  
     2013      2012      2013      2012  

Common stock options

     1,619,267         1,376,100         1,619,267         1,376,100   

Common stock convertible notes

     35,152,148         —           35,152,148         —     

Common stock warrants

     54,057,778         2,811,507         54,057,778         2,811,507   

Unvested restricted stock

     774,174         241,426         774,174         241,426   

Series A Convertible Preferred Stock

     23,818,303         4,251,857         23,818,303         4,251,857   
  

 

 

    

 

 

    

 

 

    

 

 

 

Excluded potentially dilutive securities

     115,421,670         8,680,890         115,421,670         8,680,890   
  

 

 

    

 

 

    

 

 

    

 

 

 

NOTE 8 – SUBSEQUENT EVENTS

Effective April 19, 2013, Bret Holmes was appointed Chief Financial Officer of the Company. Mr. Holmes was previously the Chief Financial Officer at Eleets Transportation Co., Inc. and related entities from June 2009 through December 2012. Mr. Holmes also served as Chief Financial Officer for Aslan Development from March 2006 to June 2009 and Chief Financial Officer at Watson Custom Home Builders from October 2004 to March 2006.

On June 6, 2013, the Company commenced visual inspections and records review of the time controlled parts on its aircraft by voluntarily ceasing flying each aircraft during the period until the inspection with respect to such aircraft is completed in order to ensure the highest degree of compliance and safety. An audit of the time controlled parts was already underway during scheduled maintenance checks as part of its new safety system; however, the Company was notified of an anonymous call received questioning the adequacy of the system for monitoring time controlled parts. As such, it is the Company’s policy to fully investigate such claims. The Company anticipates that it will begin release of aircraft back into service on a continual basis this week following the completion of these inspections.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Overview

Avantair, Inc. is a Delaware corporation and was organized in 2004. Avantair, Inc. and its subsidiaries (the “Company” or “Avantair”) are in the business of providing private aviation services through three primary flight service programs:

 

  (i) the sale of fractional ownership interests through the Fractional Ownership program;

 

  (ii) the lease of fractional interests through the Axis Lease program; and

 

  (iii) the sale of flight hour cards through the Edge Card program.

Collectively, participants in each of these programs are referred to herein as “program participants”. These services are provided to program participants on the Company’s managed aircraft fleet for business and personal use. The Company’s core strategic focus is providing its program participants with the highest level of safety, service and satisfaction. In addition to providing private aviation services, the Company provides limited fixed based operation (“FBO”) services in Clearwater, Florida. In January 2013, the Company ceased its FBO operations at its Camarillo, CA facility and entered into a sublease agreement with an unrelated third party. The Company will retain a portion of one hangar which may be used for maintenance of the Company’s aircraft. The sublease agreement transferred all FBO operations to the unrelated third party and established a base rent schedule that reflects the reduced occupancy of the facility. Effective December 2011, the Company closed its limited FBO services in Caldwell, New Jersey. The Company also leases a facility in Dallas, Texas, which is used to perform maintenance on the Company’s aircraft.

As of March 31, 2013, the Company operated 56 aircraft within its fleet, which is comprised of 43 fractionally-owned aircraft, 6 company-owned core aircraft and 7 leased and company-managed aircraft.

The Company generates revenue primarily through the sale and lease of fractional ownership interests in aircraft, by providing management and maintenance services related to those aircraft and through the sale of flight hour cards providing either 15, 25 or 50 hours of flight time per year. The Company markets fractional ownership interests to individuals and businesses, generally with a minimum share size of a one-sixteenth ownership interest, which the Company refers to as the Fractional Ownership program. Under management and maintenance agreements with fractional owners and lessees, the Company provides pilots, maintenance, fuel and hangar space for the aircraft in exchange for a fixed monthly fee.

In response to market conditions and to provide further alternatives for private air travel, the Company initiated the Axis Lease program effective February 2011. The Axis Lease program, which offers various lease terms up to ten years and a minimum of 50 hours per year, offers many of the same benefits as the Fractional Ownership program. The Axis Lease program requires monthly lease payments, together with a management and maintenance agreement similar to that of the Fractional Ownership program.

The Company’s Edge Card program, offers access to blocks of flight hours ranging from 15, 25 or 50 hours of flight time. Once the card holder has exhausted the hours purchased, neither the card holder nor the Company has any further obligations to each other.

The Company’s Axis Club Membership program, which was replaced by the Axis Lease program effective March 2011, offered access to blocks of flight hours for a three year membership fee of $75,000. The program required Axis Club members to purchase a minimum of three 25 hour flight hour cards over a three year period. This program also allowed for club membership fees to be applied towards the purchase of a fractional ownership interest.

The Company presently sources all of its aircraft from a single manufacturer, Piaggio America, Inc. (“Piaggio”). As of March 31, 2013, the Company had contractual commitments to purchase 48 additional Piaggio Avanti II aircraft through 2013 with a mutual understanding that the aircraft delivery dates and any related payments can be extended. The total commitment if exercised during the period, including a proposed price escalation, is valued at approximately $305.1 million, net of deposits paid on future aircraft deliveries of $6.4 million. The Company believes that the pricing structure afforded by utilizing the Piaggio Avanti aircraft allows the Company to attract a program participant desiring quality at a lower price point than its competitors. Offering the cabin cross section of a mid-size aircraft and the fuel efficiency of a turboprop, along with no hourly fees, allows the Company to lower the cost of private air travel for a broader range of individuals and businesses.

The Company’s primary sources of operating funds are the collection of the following:

 

   

management and maintenance fees from fractional owners and lessees;

 

   

lease fees;

 

   

sale of fractional ownership shares; and

 

   

sale of flight hour cards

Revenue for sales by product category can be found in the accompanying consolidated statements of operations for the three and nine months ended March 31, 2013 and 2012, respectively. Sales units by product category are as follows:

 

    Unit Sales for the Three Months Ended     Unit Sales for the Nine Months Ended  
    March 31, 2013     March 31, 2012     March 31, 2013     March 31, 2012  

New Fractional Ownership program shares sold

    10        6.5        10        8.5   

Axis Lease program shares leased

    —          11.5        25        54   

Axis Club Memberships (1)

    —          —          —          1   

Flight hour cards

    74        81        198        271   

 

(1)  

Replaced by Axis Lease program in March 2011

 

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On October 25, 2012, the Company made an announcement regarding the voluntary stand down of its operations in order to complete a comprehensive review of records and supporting maintenance documentation and an inspection of its aircraft fleet. This voluntary action was taken in coordination with the Federal Aviation Administration. During the stand down, which lasted approximately three weeks, the Company furloughed a portion of its employees. Beginning November 8, 2012, the Company started recalling its employees and commenced operating some of its aircraft on November 11, 2012 with a return to service of a majority of its fleet by November 19, 2012. The effect of the operational stand down negatively impacted the Company’s cash receipts, liquidity and retention of program participants. Separate of charter and costs associated with retention of program participants, the Company incurred approximately $1.2 million for consulting, Federal Aviation Administration (“FAA”), furlough, legal, communication and other costs.

During the first quarter of fiscal year 2012, the Company began the implementation of a series of cost saving initiatives to reduce fixed costs. These initiatives will continue to have no impact to the safety of flight operations, which is the Company’s highest priority. These initiatives continued throughout fiscal year 2012 and included:

 

   

a reduction in force involving approximately 25 employees, primarily in the Company’s FBO operations;

 

   

elimination of the Company’s satellite marketing office and related expenses;

 

   

renegotiation of the Company’s Clearwater, FL lease;

 

   

closure of the Company’s limited FBO operations in New Jersey;

 

   

organization and personnel changes within the sales and finance departments; and

 

   

other negotiations with key vendors designed to drive operating and performance efficiencies.

Since July 2012, the Company expanded its cost saving initiatives toward its goal of positive earnings and improved cash flows. These initiatives will continue to have no impact to the safety of flight operations, which is the Company’s highest priority. Recent cost saving initiatives include:

 

   

improving financing terms and reducing debt service obligations related to any new, and many of the existing aircraft financing obligations;

 

   

reducing compensation expense for Senior Management, as well as applying measures more broadly throughout the Company;

 

   

reducing compensation to non-employee directors of the Company’s Board of Directors;

 

   

implementing plans designed to reduce fuel expense by dissemination of process guidelines and real-time tracking of fuel usage on all flights together with renegotiation of fuel purchase contracts with key vendors;

 

   

lower maintenance costs resulting from strategically planning scheduled maintenance checks at our facilities, which in turn will reduce third party vendor costs, and optimizing parts inventory to reduce downtime and improve efficiency;

 

   

terminating its FBO operations at the Camarillo facility and entering into a sublease agreement with an unrelated third party which will reduce personnel costs, facility lease payments and other operating expenses; and

 

   

continuing a series of broader efforts throughout the Company, including examination of back office functions to further reduce costs associated with shipping, supplies, travel expense and consulting fees.

In addition to the cost savings initiatives discussed above, in the third fiscal quarter of 2013, the Company continues its plans to strategically eliminate more costly aircraft from its fleet and, as a result, expects to see a corresponding decrease in its cost of flight operations, which includes maintenance costs. The Company also anticipates lower maintenance costs as a result of driving increased efficiencies through the use of third party aircraft maintenance operators to provide increased levels of maintenance contract services for its fleet.

Employee Termination and Other Costs

During the third quarter of fiscal year 2012, the Company developed and implemented plans to improve sales performance and deliver efficiencies within the finance department. These plans were evaluated and recorded in accordance with Accounting Standards Codification (“ASC”) ASC 420 “Exit or Disposal Cost Obligations” (“ASC 420”). In connection with the changes in the sales and finance departments, the Company incurred various costs and obligations, including severance payouts to employees and other related charges. The Company expects total costs associated with these activities to be approximately $1.0 million. As of March 31, 2013, the liability attributable to unpaid employee termination and other expense was less than $0.1 million, representing a reduction of approximately $0.1 million from the unpaid employee termination and other expense liability as of June 30, 2012, which was $0.2 million. The reduction in liability represents amounts paid during the nine month period ended March 31, 2013. This liability is included in accrued liabilities in the accompanying consolidated balance sheet.

 

Aircraft Incident

In November 2011, one of the Company’s fractionally-owned aircraft, a 2007 Piaggio P-180, was involved in an incident (“Aircraft Incident”), following which the aircraft was declared a total loss by the Company’s insurer. Only minor injuries were sustained by the passengers and crew. The Company was required to maintain insurance on the aircraft that covered its replacement value, which was estimated to be $4.8 million. During December 2011, the Company received $6.5 million of insurance proceeds which were initially recorded as an accrued liability as of December 31, 2011. The additional insurance proceeds were a result of the Company insuring its aircraft in excess of the replacement value to reimburse the Company for expenses associated with a reduction in available aircraft in its fleet, including, but not limited to, costs incurred for chartered flights, repositioning aircraft to accommodate owner’s requirements, and maintenance costs associated with higher flight hours on the remaining fleet. These proceeds offset similar expenses during the third and fourth quarters of fiscal year 2012 and the first quarter of fiscal year 2013. The fractional ownership documents permit the Company to replace the aircraft on behalf of the fractional owners with another aircraft that is substantially similar and has a market value approximately equal to or greater than the market value of the 2007 Piaggio P-180 involved in the Aircraft Incident. During the third and fourth quarters of fiscal year 2012, the Company purchased the fractional owners’ interest in the aircraft and, simultaneously, the fractional owners of the 2007 Piaggio P-180 entered into new fractional ownership documents for a substantially similar replacement aircraft interest. During the third and fourth quarters of fiscal year 2012, the Company paid a total of approximately $4.8 million and transferred 16.0 fractional shares in connection with this incident. During the first quarter of fiscal year 2013, the Company paid approximately $0.4 million in connection with this incident. As of March 31, 2013, the insurance proceeds liability was zero. In accordance with ASC 225 “Income Statement” (“ASC 225”), there was no gain or loss recognized in connection with the loss of this aircraft.

 

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Results of Operations

The following table sets forth key information about our financial results for the three months ended March 31, 2013 and 2012:

 

     Three Months Ended        
     March 31,     Change  
     2013     2012     $     %  

Revenue

        

Fractional aircraft shares sold

   $ 2,076      $ 8,126      $ (6,050     -74

Lease revenue

     1,065        729        336        46

Management and maintenance fees

     21,123        21,355        (232     -1

Flight hour card and club membership revenue

     6,236        7,758        (1,522     -20

Flight activity and other ancillary billing

     3,662        5,406        (1,744     -32

Other revenue

     498        2,222        (1,724     -77
  

 

 

   

 

 

   

 

 

   

Total revenue

     34,660        45,596        (10,936  

Operating expenses

        

Cost of fractional aircraft shares sold

     1,691        7,771        (6,080     -78

Cost of flight operations

     21,815        20,371        1,444        -7

Cost of fuel

     8,399        9,469        (1,070     -11

General and administrative expenses

     5,088        5,374        (286     -5

Selling expenses

     708        1,433        (725     -51

Depreciation and amortization

     1,090        1,094        (4     0

Employee termination and other costs

     —           883        (883     -100

Impairment goodwill expense

     1,141        —          1,141        100

Gain on receipt of used share

     (74     (624     550        -88

Gain on sale of asset

     (37     —           (37     -100
  

 

 

   

 

 

   

 

 

   

Total operating expenses

     39,821        45,771        (5,950  
  

 

 

   

 

 

   

 

 

   

Other income (expense)

        

Interest and other income

     42        33        9        27

Interest expense

     (1,560     (1,080     (480     44

Change in fair value of derivative liabilities

     (1,291     —           (1,291     100
  

 

 

   

 

 

   

 

 

   

Total other expense

     (2,809     (1,047     (1,762  
  

 

 

   

 

 

   

 

 

   

Net loss

   $ (7,970   $ (1,222   $ (6,748     552
  

 

 

   

 

 

   

 

 

   

Three months ended March 31, 2013 compared to the three months ended March 31, 2012

Total revenue decreased by approximately $11 million or 24%, primarily as a result of:

 

   

a $6.1 million decrease in fractional aircraft shares sold which was due primarily to the following:

 

   

$3.5 million of lower revenue recognized on fractional shares sold before July 1, 2010, fully amortized prior to March 31, 2013, under ASC 605-25; and

 

   

$2.6 million of lower revenue recognized on fractional shares sold with no residual guarantee during the three months ended March 31, 2013 as there were no fractional shares sold with a residual guarantee during the three months ended March 31, 2012.

 

   

a $1.5 million decrease in flight hour card and club membership revenue due to club memberships expiring through 2013; and a 10% decrease in the number of card hours flown in 2013;

 

   

a $1.7 million decrease in flight activity and other ancillary billing due to a 13% decrease in revenue-generating flight hours flown in the third quarter of fiscal year 2013 compared to the third quarter of fiscal year 2012 as a result of the voluntary stand down of operations in the second quarter of fiscal year 2013; and

 

   

a $1.7 million decrease in other revenue due to a decrease in demonstration flight revenue, remarketing fees on pre-owned share sales, FBO fuel, and rent revenue.

 

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These decreases were offset by:

 

   

a $0.3 million increase in Axis Lease program lease revenue, which resulted from additional sales of Axis Lease program leases.

Operating expenses decreased by $6.0 million or 13% primarily as a result of:

 

   

a $6.1 million decrease in the cost of fractional aircraft shares sold due primarily to the following:

 

   

$2.9 million of lower cost recognized on fractional shares sold before July 1, 2010, fully amortized prior to March 31, 2013, under ASC 605-25; and

 

   

$2.5 million of lower cost recognized on fractional shares sold with no residual guarantee during the three months ended March 31, 2013 as there were no shares sold with a residual guarantee during the three months ended March 31, 2012.

 

   

a $1 million decrease in the cost of fuel due to a 10% reduction in revenue hours flown in the third quarter of fiscal year 2013;

 

   

a $0.7 million decrease in selling expenses is primarily due to decreased marketing expenses and the Company’s previously discussed cost savings initiatives, which were implemented subsequent to the first quarter of fiscal year 2012; and

 

   

a $0.3 million decrease in general and administrative expenses is primarily due to reduction in bonus expense, stock and deferred compensation expense along with hanger rent; offset by an increase of $0.5 million in bad debt expense and legal cost.

These decreases were offset by:

 

   

a $1.4 million increase in the cost of flight operations primarily due to the following:

 

   

a $3.5 million increase in charter expense due to demand for aircraft during peak travel periods in conjunction with reduced core and fractional aircraft availability, offset by a decreased payroll expense, and reduction in flight fees and a reduction in maintenance costs.

Other income (expense) increased $1.8 million as a result of:

 

   

a $0.6 million decrease in change in fair value of derivative liabilities for the valuation of warrants during the three months ended March 31, 2013 offset by an increase in change in fair value of derivative liabilities for the valuation of the embedded conversion feature of the preferred stock of $1.8 million and by an increase of $0.5 million in interest expense relating to debt modifications and convertible debt for the three months ended March 31, 2013.

The following table sets forth key information about our financial results for the nine months ended March 31, 2013 and 2012:

 

     Nine Months Ended        
     March 31,     Change  
     2013     2012     $     %  

Revenue

        

Fractional aircraft shares sold

   $ 8,900      $ 21,742      $ (12,842     -59

Lease revenue

     3,046        1,681        1,365        81

Management and maintenance fees

     64,820        62,622        2,198        4

Flight hour card and club membership revenue

     20,088        25,520        (5,432     -21

Flight activity and other ancillary billing

     13,129        14,841        (1,712     -12

Other revenue

     3,040        5,111        (2,071     -40
  

 

 

   

 

 

   

 

 

   

Total revenue

     113,023        131,517        (18,494  
  

 

 

   

 

 

   

 

 

   

Operating expenses

        

Cost of fractional aircraft shares sold

     7,533        20,185        (12,652     -63

Cost of flight operations

     62,458        58,822        3,636        6

Cost of fuel

     24,417        28,469        (4,052     -14

General and administrative expenses

     17,223        17,093        130        1

Selling expenses

     2,318        5,010        (2,692     -54

Depreciation and amortization

     3,679        3,173        506        16

Employee termination and other costs

     69        883        (814     -92

Impaired goodwill expense

     1,141        —          1,141        100

Gain on receipt of used share

     (254     —           (254     -100

(Gain) loss on sale of asset

     417        (624     1,041        -167
  

 

 

   

 

 

   

 

 

   

Total operating expenses

     119,001        133,011        (14,010  
  

 

 

   

 

 

   

 

 

   

Other income (expense)

        

Interest and other income

     73        113        (40     -36

Interest expense

     (3,367     (3,376     9        0

Change in fair value of derivative liabilities

     (1,232     —           (1,232     100

Gain on debt extinguishment

     —           439        (439     -100
  

 

 

   

 

 

   

 

 

   

Total other expense

     (4,526     (2,824     (1,702     -60
  

 

 

   

 

 

   

 

 

   

Net loss

   $ (10,504   $ (4,318   $ (6,186     143
  

 

 

   

 

 

   

 

 

   

 

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Nine months ended March 31, 2013 compared to the nine months ended March 31, 2012

Total revenue decreased by approximately $18 million or 14%, primarily as a result of:

 

   

a $12.8 million decrease in fractional aircraft shares sold was due primarily to the following:

 

   

$10 million of lower revenue recognized on fractional shares sold before July 1, 2010, fully amortized prior to March 31, 2013, under ASC 605-25; and

 

   

$3 million of lower revenue recognized for fractional shares sold with no residual guarantee during the nine months ended March 31, 2013 as there were no shares sold with a residual guarantee during the nine months ended March 31, 2013.

 

   

a $5.4 million decrease in flight hour card and club membership revenue due to club memberships expiring through 2013 and a 19% decrease in card hours flown in the third quarter of fiscal year 2013;

 

   

a $2 million decrease in other revenue due to a decrease in demonstration flight revenue, remarketing fees on pre-owned share sales and FBO fuel and rent revenue; and

 

   

a $1.7 million decrease in flight activity and other ancillary billing due to $2.3 million of FAA airworthiness directive billings offset by a $3.9 million decrease in flight activity as a result of a 16% decrease in revenue-generating flight hours resulting from the voluntary stand down of operations in the second quarter of fiscal year 2013.

These decreases were offset by:

 

   

a $2.2 million increase in management and maintenance fees due to a greater number of lessees paying management and maintenance fees as a result of additional sales of the Axis Lease program leases, together with an increase in the average monthly management fee per share; and

 

   

a $1.4 million increase due to a greater number of lessees paying lease fees as a result of additional sales of the Axis Lease program leases.

Operating expenses decreased by approximately $14 million or 11% primarily as a result of:

 

   

a $12.7 million decrease in the cost of fractional aircraft shares sold primarily due to the following:

 

   

$9 million decrease in the cost of fractional shares sold before July 1, 2010, fully amortized prior to March 31, 2013, under ASC 605-25; and

 

   

$2.9 million decrease in the cost of fractional shares sold with no residual guarantee during the nine months ended March 31, 2013 as there were no shares sold with a residual guarantee during the nine months ended March 31, 2012.

 

   

a $4 million decrease in the cost of fuel due to a 14% decrease in total flight hours as a result of the voluntary stand down of operations during the second quarter of fiscal year 2013;

 

   

a $2.7 million decrease in selling expenses is primarily due to decreased marketing expenses and the Company’s previously discussed cost savings initiatives, which were implemented subsequent to the first quarter of fiscal year 2012; and

 

   

a $0.2 million gain on a non-cash, non-reciprocal used share acquisition during the nine months ended March 31, 2013, and no such transaction during the nine months ended March 31, 2012.

These decreases were offset by:

 

   

a $3.6 million increase in the cost of flight operations primarily due to the following:

 

   

a $9 million increase in charter expense due to demand for aircraft during peak travel periods in conjunction with reduced core and fractional aircraft availability, offset by insurance proceeds received for insurance claims on one of the Company’s fractional aircraft that received hail damage while parked on the tarmac during a severe thunderstorm in Colorado, and reduced flight fees and payroll expenses due to the voluntary stand down of operations and commencement of maintenance outsourcing efforts.

 

   

a $0.5 million increase in depreciation and amortization due primarily to accelerated depreciation of a repurchased share previously held under a lease arrangement, in July 2012; and

 

   

a $1.0 million increase in loss on sale of asset related to a sale-leaseback transaction in the first quarter of fiscal year 2013, which was evaluated in accordance with ASC 840-40 “Sale-Leaseback Transactions” (“ASC 840-40”); There were no such transactions resulting in a loss on sale of asset for the nine months ended March 31, 2012.

Other income (expense) increased by $1.7 million for the nine month period ending March 31, 2013 as a result of:

 

   

a $1.8 million increase in change in fair value of derivative liabilities for valuation of the embedded conversion feature of the preferred stock, offset by a decrease $0.6 million in change in fair value of derivative liabilities for valuation of warrants for the nine months ended March 31, 2013. There were no such transactions requiring valuation for the nine months ended March 31, 2012.

Liquidity and Capital Resources

The Company’s primary sources of liquidity have been cash provided by operations, cash raised from its equity offering as Ardent Acquisition Corp., cash provided from its debt facilities, cash raised from the preferred and common stock offerings, cash

 

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raised from its senior secured convertible promissory notes offering and other asset-based borrowing. The Company uses its cash primarily to fund losses from operations and to fund the purchase and leasing of aircraft. Cash generated from operations has not been sufficient to provide all working capital needed to meet the Company’s requirements. At March 31, 2013 and June 30, 2012, the Company had a working capital deficit of approximately $71.6 million and $75.8 million, respectively, and a stockholders’ deficit of approximately $61.7 million and $53.3 million, respectively. In addition to the cost of acquiring aircraft, the Company’s primary expenses are related to fuel, aircraft repositioning (i.e., moving an aircraft from one location to another to accommodate program participants’ requirements), flight operations and pilot expenses, maintenance, charters, insurance and selling, general and administrative expenses. At March 31, 2013 and June 30, 2012, the Company had assets of approximately $78.3 million and $91.3 million, respectively. For the three and nine months ended March 31, 2013, the Company had revenue of approximately $34.7 million and $113 million, respectively, and net losses of approximately $8.0 million and $10.5 million, respectively. The Company has incurred losses since inception and may not be able to generate sufficient revenue from its business in the future to achieve or sustain profitability and positive cash flows. As of March 31, 2013, cash and cash equivalents were approximately $2.4 million, a decrease of $2.9 million from June 30, 2012. A net decrease in the components of working capital led to approximately $6.5 million of net cash used in operating activities. Capital expenditures for parts, software, computer equipment and office equipment resulted in approximately $1.6 million of cash used in investing activities. Principal payments on short and long-term debt, offset by proceeds received from the senior secured convertible promissory note issuance resulted in approximately $5.3 million of cash provided by financing activities.

The Company’s primary operating strategy is to achieve positive cash flows by continuing the Company’s cost savings initiatives, flight operations cost reductions associated with strategically eliminating more costly aircraft from its fleet and lowering maintenance costs as a result of driving increased efficiencies through the use of third-party aircraft maintenance operators to provide increased levels of maintenance contract services for its fleet. During the first quarter of fiscal year 2012, the Company began the implementation of a series of cost saving initiatives, discussed above in “Overview”, to reduce fixed costs and since July 2012, the Company has expanded its cost saving initiatives toward its goal of positive earnings and improved cash flows. These initiatives will continue to have no impact to the safety of flight operations, which is the Company’s highest priority.

For the next twelve months, we anticipate significant cash and capital needs to finance our business and cover our ongoing working capital needs in order to continue operations. We are currently in the arrears on various lease and vendor payments. We are funding monthly operations with cash receipts and incremental equity on an as needed basis. In order to cover our daily cash needs, we are considering raising additional funds in the form of equity capital, senior loans through private placements, loan applications or any other alternative approach. Our ability to obtain needed financing may be impaired by factors such as the capital markets, and the fact we are not profitable, which could impact the availability or cost of future financings. If we do not secure these funds, we may be forced to suspend or terminate operations.

On June 6, 2013, the Company commenced visual inspections and records review of the time controlled parts on its aircraft by voluntarily ceasing flying each aircraft during the period until the inspection with respect to such aircraft is completed in order to ensure the highest degree of compliance and safety. An audit of the time controlled parts was already underway during scheduled maintenance checks as part of its new safety system; however, the Company was notified of an anonymous call received questioning the adequacy of the system for monitoring time controlled parts. As such, it is the Company’s policy to fully investigate such claims. The Company anticipates that it will begin release of aircraft back into service on a continual basis this week following the completion of these inspections. The Company believes that the effect of the aircraft inspections may negatively impact its cash receipts, its liquidity and retention of program participants in the upcoming two to three month period.

Beginning in the second quarter of fiscal year 2013, the Company initiated steps to raise additional capital through multiple offerings of securities. On November 30, 2012, the Company entered into a Note and Warrant Purchase Agreement (the “Purchase Agreement”) providing for the issuance of an aggregate of up to $10.0 million in principal amount of senior secured convertible promissory notes (the “Notes”) and warrants to purchase up to an aggregate of 40,000,000 shares of common stock (the “Warrants”) The securities offered will not be and have not been registered under the Securities Act of 1933, as amended, and may not be offered or sold in the United States absent registration or an applicable exemption from the registration requirements. At the initial closing, which occurred on November 30, 2012, the Company issued to certain members of the Company’s Board of Directors and their affiliates Notes in an aggregate principal amount of $2.8 million and Warrants to purchase an aggregate of 11,200,000 shares (the “Initial Closing”). During the third quarter ended March 31, 2013, the Company issued to eleven accredited investors, that are also participants in the fractional ownership program, Notes in an aggregate principal amount of approximately $5.0 million and Warrants to purchase an aggregate of 19,730,000 shares of common stock. Additionally, on February 6, 2013, the Company entered into a Settlement Agreement (the “Settlement Agreement”) with the SSF Investors to resolve the matter and issued to the SSF Investors senior secured convertible promissory notes having an aggregate principal amount of approximately $1.1 million (the “SSF Notes”) and warrants to purchase an aggregate of 4,222,148 shares of common stock (the “SSF Warrants). In addition, on January 17, 2013, the Company, the holders of the Notes and Warrants and Barry Gordon, as collateral agent, entered into the Amendment to Note and Warrant Purchase Agreement, Senior Secured Convertible Promissory Notes, Warrants, Security Agreement and Registration Rights
Agreement (the “Note Financing Amendment”). The purpose of the Note Financing Amendment was to include Special Situations Fund III QP, L.P., Special Situations Cayman Fund, L.P., Special Situations Private Equity Fund, L.P. and David Greenhouse (collectively, the “SSF Investors”) in the financing transaction and to amend the terms by which the documents may be amended, terminated or waived. The Notes bore interest at an initial rate of 2.0% per annum, which increased to 12.0% per annum since the Company was unsuccessful in obtaining stockholder approval by March 31, 2013 to increase the Company’s authorized shares of common stock so that a sufficient number of shares are reserved for the conversion of the Notes. Holders of the Notes may, at their option, elect to convert all outstanding principal and accrued but unpaid interest on the Notes into shares of common stock at a conversion price of $0.25 per share but may convert only a portion of such Notes if an inadequate number of authorized shares of common stock is available to effect such optional conversion. Holders of the Notes are entitled to certain anti-dilution protections. The Company may prepay the Notes on or after November 28, 2014. The Notes have a maturity date of November 28, 2015, unless the Notes are earlier converted or an event of default or liquidation event occurs. The Warrants are exercisable at an exercise price of $0.50 per share, which exercise price is subject to certain anti-dilution protections, but the Warrants may not be exercised unless a sufficient number of authorized shares of common stock are available for exercise of the Warrants. The Warrants expire on November 30, 2017. If the Company is unable to raise additional capital or the amount raised is not adequate, there can be no assurance that the Company can continue operations or meet its ongoing obligations and commitments. In addition, the Company is working with its vendors, lessors and lenders, to extend payment terms as the Company seeks to raise additional capital.

Refer to Note 3 to the accompanying consolidated financial statements for a summary of the Company’s financing arrangements.

Off-Balance Sheet Arrangements

At March 31, 2013, the Company did not have any material commercial commitments (except for those noted in Note 3 “Commitments and Contingencies – Purchase Commitments” in the accompanying consolidated financial statements), including guarantees or standby repurchase obligations, or any relationships with unconsolidated entities or financial partnerships, including entities often referred to as structured finance or special purpose entities or variable interest entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

Critical Accounting Policies and Estimates

As discussed in our Form 10-K for the fiscal year ended June 30, 2012, the discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in conformity with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses reported in those financial statements. These judgments can be subjective and complex, and consequently, actual results could differ from those estimates. The Company believes that of its significant accounting policies, the following may involve a higher degree of judgment and estimation. The judgments, or the methodology on which the judgments are made, are reviewed with the Audit Committee.

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk.

The information called for by this Item is omitted in reliance upon Item 305(e) of Regulation S-K.

 

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Item 4. Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

As of March 31, 2013, under the direction of the Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of March 31, 2013, our disclosure controls and procedures were ineffective and we have identified a material weakness in the effectiveness of internal control over financial reporting related to a shortage of resources in the accounting department which lead to the inability to file its periodic reports in a timely manner.

The Chief Executive Officer and Chief Financial Officer believe that the material information required to be disclosed in the Company’s periodic report filings with SEC has been effectively recorded, processed, summarized and reported, albeit not in a timely manner.

Changes to Internal Control over Financial Reporting

As of June 30, 2012, the Company’s management assessed the effectiveness of the Company’s internal controls using the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on management’s assessment, as of June 30, 2012, management believes the Company’s internal controls over financial reporting were not effective based on those criteria. As a result, management identified the following material weakness in the Company’s internal control over financial reporting:

 

   

the Company did not have a control in place for quarterly balance sheet reconciliation reviews with senior financial leadership;

 

   

the Company’s detective control requiring review of journal entries for completeness and accuracy was not operating effectively; and

 

   

the Company’s detective control requiring a monthly review of the consolidated statement of operations was not operating effectively.

The above control deficiencies, together with the span of time for which the control deficiencies occurred and the misstatements that were identified in the Company’s June 30, 2011 fiscal year-end and fiscal year 2012 and 2011 interim financial statements, led management to conclude that the control deficiencies that existed during the June 30, 2012 and 2011 fiscal years and the quarters within those fiscal years, meet the criteria of a material weakness.

The Company commenced a remediation plan and completed the following actions during the three months ended September 30, 2012:

 

   

The finance team in place discovered and reported the errors of the previous financial leadership;

 

   

The finance team examined every balance sheet account and improved every balance sheet account reconciliation;

 

   

Reports were developed and procedures improved to properly account for fuel, un-vouchered receipts and capitalization of core aircraft costs; and

 

   

A formal quarterly balance sheet review process was implemented to address the missing control identified above.

During the quarter ended March 31, 2013, the Company identified an additional material weakness related to the shortage of resources in the accounting department which resulted in the Company’s inability to file its periodic reports in a timely manner.

There were no changes in our internal control over financial reporting, identified in connection with the evaluation of such internal control that occurred during the period ended March 31, 2013, other than the items identified above, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II – OTHER INFORMATION

 

Item 1. Legal Proceedings.

From time to time, the Company is party to various legal proceedings in the normal course of business. It is expected that these claims would be covered by insurance subject to customary deductibles. Those claims, even if lacking merit, could result in the expenditure of significant financial and managerial resources. As of March 31, 2013, there were no legal proceedings which the Company would anticipate having a material adverse effect on its financial position, results of operations or cash flows.

 

Item 1A. Risk Factors.

Information regarding risk factors appears in Item 1A of our Annual Report on Form 10-K for the fiscal year ended June 30, 2012, which was filed with the SEC on September 28, 2012, and in Item 1A of our Quarterly Report on Form 10-Q for the quarterly period ended December 31, 2012, which was filed with the SEC on February 14, 2013. There have been no material changes from the risk factors previously disclosed in that Annual Report on Form 10-K and Quarterly Report on Form 10-Q except:

Risks Related to Our Business

The Company may face challenges as it seeks to maintain sufficient liquidity, reduce its operating and other expenditures and raise additional funds. The Company may not be able to raise those funds or reduce its operating and other expenditures to expected levels.

The Company has experienced negative cash flow since its inception. The Company’s net cash used in operations for the nine months ended March 31, 2013 was approximately $6.5 million and as of March 31, 2013, the Company had cash and cash equivalents of $2.4 million. As of March 31, 2013, the Company had incurred an aggregate of approximately $27.1 million in short and long-term indebtedness to third party lenders, including $8.8 million in senior secured convertible promissory notes. Much of this indebtedness is secured by certain of the Company’s assets. The Company’s business may not generate sufficient cash flow from operations or from other sources sufficient to enable it to repay its indebtedness and to fund its other liquidity needs, which could have a material adverse effect on its business, results of operations and financial condition.

In order to fund the Company’s operations, the Company will need to incur borrowings or raise capital through the sale of debt or equity securities including through the issuance of senior secured convertible promissory notes, or Notes, and warrants, or Warrants, described in Part I, Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources.” The Company’s ability to borrow or access the capital markets for future offerings, including the senior secured convertible promissory note and warrant financing, may be limited by its financial condition as well as by adverse market conditions resulting from, among other things, general economic conditions and contingencies and uncertainties that are beyond its control. The Company’s ability to obtain future financing is subject to the value of its unencumbered assets, the value of which is limited. In addition, the Company may seek to raise additional capital in additional closings of senior secured convertible promissory notes and warrants or in subsequent offerings. The terms of these proposed offerings may vary from the terms of the senior secured convertible promissory notes and warrants issued by the Company in November 2012, February 2013 and March 2013. There can be no assurance that the Company will be successful in obtaining stockholder approval for any necessary increases in the authorized shares of common stock related to these offerings. If the Company is unable to complete one or more of such offerings or if the amount raised is not adequate, there can be no assurance that the Company can continue operations or meet its ongoing obligations and commitments. The Company’s failure to obtain the funds necessary for the operation of the business could have a material adverse effect on its business, results of operations and financial condition.

In addition, since early fiscal year 2012, the Company has engaged in cost saving initiatives. There can be no assurance that continued implementation of these cost savings initiatives will be successful or sufficient. The Company’s inability to continue to engage in cost savings initiatives will have a material adverse effect on its business, results of operations and financial condition.

If Avantair is unable to fund its operations and capital expenditures Avantair may not be able to continue to acquire additional aircraft, which would have a material adverse effect its business.

Avantair has experienced significant negative cash flow since its inception. In order to fund Avantair’s operations and capital expenditures, Avantair may be required to incur borrowings or raise capital through the sale of debt or equity securities. The Company’s ability to borrow or access the capital markets for future offerings may be limited by its financial condition at the time of contingencies and uncertainties that are beyond our control. Avantair’s failure to obtain the funds for necessary future capital expenditures could limit its ability to acquire additional inventory of aircraft and could have material adverse effect on our business results of operations and financial conditions.

Our Financial Statements have been prepared assuming that our Company will continue as a going concern.

The factors described herein raise substantial doubt about our ability to continue as a going concern. Our financial statements do not include any adjustments that might result from this uncertainty. If we cannot generate the required revenues and gross margin to achieve profitability or obtain additional capital on acceptable terms, we will need to substantially revise our business plan in order to continue operations and an investor could suffer the loss of a significant portion or all of his investment in our Company.

Avantair recently experienced a voluntary stand down of its operations to complete reviews of its aircraft maintenance records and inspection of its aircraft in coordination with the Federal Aviation Administration (FAA) which could have an adverse impact on the Company’s ability to operate its aircraft and cause Avantair to incur substantial additional costs to continue flight operations.

On October 25, 2012, the Company made an announcement regarding the voluntary stand down of its operations in order to complete a comprehensive review of records and supporting maintenance documentation and an inspection of its aircraft fleet. This voluntary action was taken in coordination with the FAA. During the stand down, which lasted approximately three weeks, the Company furloughed a portion of its employees. Beginning November 8, 2012, the Company started recalling its employees and commenced operating some of its aircraft on November 11, 2012 with a return to service of a majority of its fleet by November 19, 2012. The effect of the operational stand down negatively impacted the Company’s cash receipts, liquidity and retention of program participants. Separate of charter and costs associated with retention of program participants, the Company incurred approximately $1.2 million for consulting, FAA, furlough, legal, communication and other costs. There can be no assurance that the Company will not incur additional costs in connection with the stand down, which may have a material adverse effect on the Company’s business, results of operations and financial condition.

The successful unionization of the Company’s pilots could disrupt our operations and harm our business.

On February 14, 2013, the National Mediation Board (the “Board”) conducted an election to determine whether a group of pilots (“Pilots”) employed by Avantair, Inc. should be represented by the International Association of Sheet Metal, Air, Rail and Transportation Workers (“SMART”) for purposes of the Railway Labor Act (“RLA”). Prior to this election, the Pilots were not represented by any labor union, employee association, organization with bargaining rights, or similar organization. Following the election, the Board concluded that a sufficient number of Pilots had voted in favor of certifying SMART as their representative under the RLA and, as such, SMART has been duly designated and authorized to represent the Pilots for purposes of the RLA. While the Company respects its employees’ right to unionize or not to unionize. It could result in increased labor costs or reduced operating efficiency for the Company, which could have a material adverse effect on the Company’s business, financial condition and results of operations.

Risks Related to Our Common Stock

There will be a substantial number of shares of the Company’s common stock available for sale in the future that will be substantially dilutive to its current stockholders and may cause a decrease in the market price of its common stock.

 

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As of March 31, 2013, the Company had 40,901,634 shares of common stock outstanding, 2,699,566 shares of common stock available for future issuance under its Amended and Restated 2006 Long-Term Stock Incentive Plan (“2006 Long-Term Stock Incentive Plan”) and warrants to purchase 30,105,630 shares outstanding. In addition, as of March 31, 2013, the Company has 152,000 shares of Series A Convertible Preferred Stock outstanding. As of March 31, 2013, the Company has 23,818,303 shares of common stock reserved for issuance upon the conversion of the outstanding shares of Series A Convertible Preferred Stock. Beginning in the second quarter of fiscal year 2013, the Company initiated steps to raise additional capital through multiple offerings of securities. The securities offered will not be and have not been registered under the Securities Act of 1933, as amended, and may not be offered or sold in the United States absent registration or an applicable exemption from the registration requirements. At the Initial Closing, which occurred on November 30, 2012, the Company issued $2.8 million in aggregate principal amount of Notes and Warrants to purchase 11,200,000 shares of the Company’s common stock. At additional closings, which occurred during the third quarter ended March 31, 2013, the Company issued to eleven accredited investors, that are also participants in the fractional ownership program, Notes in an aggregate principal amount of approximately $5.0 million and Warrants to purchase an aggregate of 19,730,000 shares. The Company may seek to raise additional capital in additional closings of the Notes and Warrants or subsequent offerings. The terms of these proposed offerings may vary from the terms of the Notes and Warrants. If one or more of these closings or offerings is consummated, the issuance of some or all of these securities will further substantially dilute the Company’s existing stockholders as will additional issuances that will be triggered under anti-dilution and similar provisions of the Company’s outstanding securities. Any dilution of the common stock may cause a decrease in the market price of the common stock.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

LW Warrant and Warrant Amendment

On September 28, 2012, LW Air, which is controlled by Lorne Weil who is a director of the Company, and the Company amended the management agreements for each aircraft managed by the Company and owned by LW Air so that the Company is not required to pay LW Air additional amounts unless usage of the aircraft exceeds 1,350 hours per year, retroactive to the beginning of each management agreement. Simultaneous with this transaction, the Company issued an Amended and Restated Warrant (the “LW Warrant”) with Lorne Weil for the purchase of 2,373,620 shares of the Company’s common stock at an exercise price of $1.00 per share. The LW Warrant replaced the original warrant dated October 19, 2009 that was issued to Lorne Weil for the purchase of 2,373,620 shares of the Company’s common stock. The LW Warrant expires on October 19, 2015 and is subject to certain anti-dilution rights. On November 30, 2012, the Company amended the LW Warrant (the “Warrant Amendment”) which increased the number of shares for which the LW Warrant is exercisable from 2,373,620 shares to 3,560,430 shares of common stock and reduced the exercise price of the LW Warrant from $1.00 per share to $0.50 per share. The Warrant Amendment also amended the antidilution rights so the antidilution provisions of the LW Warrant set forth in the warrant would not apply in connection with the Notes and Warrants. The LW Warrant and Warrant Amendment were issued without registration under the Securities Act by reason of the exemption from registration afforded by the provisions of Section 4(2) thereof, as a transaction by an issuer not involving any public offering.

LW Restricted Stock Agreement and Additional LW Warrant

Effective September 28, 2012, the terms of the Company’s management agreements with LW Air were amended to irrevocably reduce LW Air’s monthly proceeds pursuant to each of the aircraft management agreements by $25,000 per month for a period of twelve consecutive months beginning in August 2012, or $0.3 million per aircraft, the aggregate reduction of LW Air’s monthly proceeds totaling $1.5 million, with respect to all five of the aircraft owned by LW Air. Simultaneous with this transaction, the Company entered into a Restricted Stock Agreement (the “LW Restricted Stock Agreement”), dated as of September 28, 2012, pursuant to which the Company issued to LW Air 2,000,000 shares of fully-vested restricted stock at a price of $0.75 per share, subject to certain antidilution rights, for an aggregate value of $1.5 million.

On November 30, 2012, the Company entered into Amendment No. 1 to the LW Restricted Stock Agreement with LW Air. The LW Restricted Stock Agreement provided that the shares issued would be entitled to antidilution protections, which would have required the issuance of additional shares to LW Air in connection with the issuance of the Notes and Warrants. Amendment No. 1 provides for, among other things, revised antidilution rights so the antidilution provisions in the LW Restricted Stock Agreement would not apply in connection with the issuance of the Notes and Warrants; the issuance of 4,000,000 additional shares of fully-vested restricted stock to LW Air on November 30, 2012 and warrants to purchase an aggregate of 6,000,000 shares of common stock (the “Additional LW Warrant”) on November 30, 2012, in substantially the same form as the Warrants. These warrants were issued without registration under the Securities Act by reason of the exemption from registration afforded by the provisions of Section 4(2) thereof, as a transaction by an issuer not involving any public offering.

Amended and HF Restricted Stock Agreement and HF Warrant

In July 2012, the Company entered into a ten year lease agreement with Midsouth for $4.6 million, related to one used Piaggio Avanti II (“July Aircraft Lease and issued 200,000 shares of fully-vested restricted stock, with a par value of $0.0001, at a price of $1.50 per share to reduce the principal balance to be financed by $300,000 pursuant to a restricted stock agreement dated August 16, 2012 with Mr. Fuller (the “Original HF Restricted Stock Agreement”). Following the expiration of the lease agreement, the Company has the option to purchase the aircraft at the then fair market value. The obligation outstanding at September 30, 2012 totaled approximately $4.4 million. The Company paid no fees or commissions in connection with the issuance of these shares.

The Company is currently a party to various lease agreements with Midsouth, Mr. Fuller, or other entities controlled by Mr. Fuller for the lease of seven aircraft (“Aircraft Leases”). On November 30, 2012, the Company entered into an Amended and Restated Restricted Stock Agreement with Mr. Fuller (the “Amended HF Restricted Stock Agreement”), which amended and restated the Original HF Restricted Stock Agreement. Under the Amended HF Restricted Stock Agreement, Mr. Fuller agreed to a reduction in the interest portion of the lease payments under the Aircraft Leases in the aggregate amount of approximately $1.8 million over fifteen months, with a reduction in lease payments in the amount of approximately $0.2 million per month beginning in November 2012 through January 2013, and approximately $0.1 million per month for twelve consecutive months thereafter, ending on January 31, 2014. Pursuant to Amendment No. 1 to the N180HM lease agreement, Mr. Fuller also agreed to extend the term of the lease for an additional sixty (60) months, or until November 30, 2017, on similar terms, except that Mr. Fuller shall have the sole option to terminate the lease agreement and sell the aircraft and the Company agrees that it shall issue to Mr. Fuller a number of units (as defined below) equal to the result of dividing (A) the difference between $1.5 million and the numerical value of the then current payoff amount as outlined in the lease agreement for the aircraft by (B) 0.25. For purposes of this provision, a unit shall consist of one share of the Company’s common stock (the “Issued Stock”) (subject to adjustment as described below) and one warrant to purchase a share of the Company’s common stock at $0.50 (a “Warrant Share”). Mr. Fuller also agreed to extend the term of the Floor Plan Financing Agreement originally entered into in September 2011 for an additional eight (8) months, or until August 30, 2013. In consideration of the foregoing, the Company issued 8,200,000 shares of fully-vested restricted stock to Mr. Fuller, 1,000,000 shares of which related to the $0.3 million reduction in the principal balance of an aircraft to be financed and 7,200,000 shares related to the approximate $1.8 million reduction in the interest portion of the lease payments of the aircraft leases and Amendment No. 1 to the N180HM lease agreement, as well as a warrant (the “HF Warrant”) to purchase 8,400,000 shares of common stock in substantially the same form as the Warrants. The Amended HF Restricted Stock Agreement also contains certain antidilution protections. These securities were issued without registration under the Securities Act by reason of the exemption from registration afforded by the provisions of Section 4(2) thereof, as a transaction by an issuer not involving any public offering.

 

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HF Overfly Warrant

On November 30, 2012, the Company issued a Warrant (the “HF Overfly Warrant”) to Mr. Fuller, to purchase 645,200 shares of common stock at an exercise price of $0.50 per share. The HF Overfly Warrant was issued in lieu of paying additional amounts owed to Mr. Fuller pursuant to certain Aircraft Leases as a result of the aircraft exceeding certain hourly usage limitations. These warrants were issued without registration under the Securities Act by reason of the exemption from registration afforded by the provisions of Section 4(2) thereof, as a transaction by an issuer not involving any public offering.

Notes and Warrants

On November 30, 2012, the Company entered into a Note and Warrant Purchase Agreement (the “Purchase Agreement”) providing for the issuance of an aggregate of up to $10.0 million in principal amount of senior secured convertible promissory notes (the “Notes”) and warrants to purchase up to an aggregate of 40,000,000 shares of common stock (the “Warrants”) at an initial and additional closings (the “Financing”). The securities offered will not be and have not been registered under the Securities Act of 1933, as amended, and may not be offered or sold in the United States absent registration or an applicable exemption from the registration requirements. At the Initial Closing, which occurred on November 30, 2012, the Company issued to certain members of the Company’s Board of Directors and their affiliates Notes in an aggregate principal amount of $2.8 million and Warrants to purchase an aggregate of 11,200,000 shares. On February 1, 2013 and February 28, 2013 and March 20, 2013 the Company issued to a total of eleven accredited investors Notes in an aggregate principal amount of $2,962,500 and Warrants to purchase an aggregate of 11,850,000 common shares. At an additional closing on March 29, 2013, the Company issue to an accredited investor Notes in an aggregate amount $1,970,000 and Warrants to purchase an aggregate of 7,880,000 shares of common stock (the “Additional Closing”). On February 6, 2013, the Company entered into a Settlement Agreement (the “Settlement Agreement”) with the SSF Investors to resolve the matter and issued to the SSF Investors senior secured convertible promissory notes having an aggregate principal amount of $1,055,537 (the “SSF Notes”) and warrants to purchase an aggregate of 4,222,148 shares of common stock (the “SSF Warrants). In addition, on January 17, 2013, the Company, the holders of the Notes and Warrants and Barry Gordon, as collateral agent, entered into the Amendment to Note and Warrant Purchase Agreement, Senior Secured Convertible Promissory Notes, Warrants, Security Agreement and Registration Rights Agreement (the “Note Financing Amendment”). The purpose of the Note Financing Amendment was to include Special Situations Fund III QP, L.P., Special Situations Cayman Fund, L.P., Special Situations Private Equity Fund, L.P. and David Greenhouse (collectively, the “SSF Investors”) in the financing transaction and to amend the terms by which the documents may be amended, terminated or waived. The Notes bore interest at an initial rate of 2.0% per annum, which increased to 12.0% per annum since the Company was unsuccessful in obtaining stockholder approval by March 31, 2013 to increase the Company’s authorized shares of common stock so that a sufficient number of shares are reserved for the conversion of the Notes. Holders of the Notes may, at their option, elect to convert all outstanding principal and accrued but unpaid interest on the Notes into shares of common stock at a conversion price of $0.25 per share, but may convert only a portion of such Notes if an inadequate number of authorized shares of common stock is available to effect such optional conversion. Holders of the Notes are entitled to certain anti-dilution protections. The Company may prepay the Notes on or after the November 28, 2014. The Notes have a maturity date of November 28, 2015, unless the Notes are earlier converted or an event of default or liquidation event occurs. An “event of default” occurs, in certain cases following a cure period or declaration by the holders of the Notes, if: the Company’s fails to pay any principal or interest when due under the Note; the Company materially breaches any covenant, representation or warranty under the Financing documents; certain bankruptcy related events occur; the Company admits in writing that it is generally unable to pay its debts as they become due; or the Company ceases the operation of its business without the consent of holders of the Notes. Upon an event of default, in such case following any applicable cure period or applicable declaration by the holders, or liquidation event, the Notes will become due and payable. The Warrants are exercisable at an exercise price of $0.50 per share, which exercise price is subject to certain anti-dilution protections, but the Warrants may not be exercised unless a sufficient number of authorized shares of common stock are available for the exercise of the Warrants. The Warrants expire on November 30, 2017. The securities were issued pursuant to the exemption from registration afforded by Section 4(2) of the Securities Act of 1933, as amended, and Rule 506 promulgated thereunder.

EarlyBirdCapital, Inc. Warrants

The EarlyBirdCapital, Inc. warrants (“Warrants”) to purchase common stock are initially exercisable at an exercise price of $0.50 per share, which exercise price is subject to certain anti-dilution protections for issuances of certain securities of the Company at a price less than 75% of the then current exercise price. The Warrants are not exercisable, however, unless a sufficient number of authorized shares of common stock are available for the exercise of the Warrants. The Company has agreed to use best efforts to obtain stockholder approval to increase the number of authorized shares so that a sufficient number will be reserved for issuance upon exercise of the Warrants. Each Warrant expires on the date that is five years following the date the Warrant is issued, or November 30, 2017. The securities were issued pursuant to the exemption from registration afforded by Section 4(2) of the Securities Act of 1933, as amended, and Rule 506 promulgated thereunder.

 

Item 3. Defaults Upon Senior Securities.

None.

 

Item 4. Mine Safety Disclosures.

Not applicable.

 

Item 5. Other Information.

None.

 

Item 6. Exhibits.

See Exhibit Index.

PART III — NARRATIVE

None.

 

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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.

June 13, 2013

 

AVANTAIR, INC.
By:   /s/ Steven Santo
  Steven Santo
  Chief Executive Officer
By:   /s/ Bret A. Holmes
  Bret A. Holmes
  Chief Financial Officer


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EXHIBIT INDEX

 

Exhibit

Number

  

Exhibit Description

  

Filed

with

this

Report

  

Incorporated by

Reference herein

from Form or

Schedule

  

Filing

Date

  

SEC File/

Reg.

Number

  3.1    Fourth Amended and Restated Certificate of Incorporation.      

Form 8-K

(Exhibit 3.1)

   1/25/13    000-51115
10.1    Note and Warrant Purchase Agreement, dated as of November 30, 2012, by and among the Company and certain investors.      

Form 8-K

(Exhibit 10.1)

   12/6/12    000-51115
10.2    Form of Senior Secured Convertible Promissory Note      

Form 8-K

(Exhibit 10.2)

   12/6/12    000-51115
10.3    Form of Warrant issued by the Company to certain investors.      

Form 8-K

(Exhibit 10.3)

   12/6/12    000-51115
10.4    Security Agreement, dated as of November 30, 2012, by and among the Company and Barry Gordon as Collateral Agent.      

Form 8-K

(Exhibit 10.4)

   12/6/12    000-51115
10.5    Registration Rights Agreement, dated as of November 30, 2012, by and among the Company and the investors party thereto.      

Form 8-K

(Exhibit 10.5)

   12/6/12    000-51115
10.6    Amendment No. 1 to Restricted Stock Agreement, dated as of November 30, 2012, issued by the Company to LW Air.      

Form 8-K

(Exhibit 10.6)

   12/6/12    000-51115
10.7    Warrant issued by the Company to LW Air on November 30, 2012.      

Form 8-K

(Exhibit 10.7)

   12/6/12    000-51115
10.8    Amendment No. 1 to Amended and Restated Warrant, dated as of November 30, 2012, issued by the Company to Lorne Weil.      

Form 8-K

(Exhibit 10.8)

   12/6/12    000-51115
10.9    Amended and Restated Restricted Stock Agreement, dated as of November 30, 2012, issued by the Company to Hugh Fuller.      

Form 8-K

(Exhibit 10.9)

   12/6/12    000-51115
10.10    Warrant issued by the Company to Hugh Fuller on November 30, 2012.      

Form 8-K

(Exhibit 10.10)

   12/6/12    000-51115
10.11    Warrant issued by the Company to Hugh Fuller on November 30, 2012.      

Form 8-K

(Exhibit 10.11)

   12/6/12    000-51115
10.12    Amendment No. 1 to the N180HM Aircraft Lease Agreement, dated as of November 30, 2012, by and among the Company and Clear Aircraft, Inc.      

Form 8-K

(Exhibit 10.12)

   12/6/12    000-51115
10.13    Warrant issued by the Company to EarlyBirdCapital, Inc. on November 30, 2012            
10.14    Settlement Agreement, dated as of February 6, 2013, by and among the Company, Special Situations Fund III QP, L.P., Special Situations Cayman Fund, L.P., Special Situations Private Equity Fund, L.P. and David Greenhouse.      

Form 8-K

(Exhibit 10.1)

   2/8/13    000-51115
10.15    Form of Senior Secured Convertible Promissory Note issued by the Company      

Form 8-K

(Exhibit 10.2)

   2/8/13    000-51115
10.16    Form of Warrant issued by the Company      

Form 8-K

(Exhibit 10.3)

   2/8/13    000-51115
10.17    Registration Rights Agreement, dated as of February 6, 2013, by and among the Company, Special Situations Fund III QP, L.P., Special Situations Cayman Fund, L.P., Special Situations Private Equity Fund, L.P. and David Greenhouse.      

Form 8-K

(Exhibit 10.4)

   2/8/13    000-51115
31.1    Chief Executive Officer Certification pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934            
31.2    Chief Financial Officer Certification pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934            
32    Certification of the Chief Executive Officer and Chief Financial Officer under Section 906 of the Sarbanes-Oxley Act of 2002            


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101   *    The following materials from Avantair, Inc.’s Quarterly Report on Form 10-Q for the quarter ended March 31,2013, formatted in XBRL (eXtensible Business Reporting Language): (i) the Consolidated Balance Sheets as of March 31, 2013 (unaudited) and June 30, 2012 (Note 2), (ii) the Consolidated Statements of Operations for the three and nine months ended March 31, 2013 and 2012 (unaudited), (iii) the Consolidated Statements of Cash Flows for the nine months ended March 31, 2013 and 2012 (unaudited), and (v) Notes to Consolidated Financial Statements (unaudited).
    
    
    
    
    
    
    
* Pursuant to Rule 406T of Regulation S-T, the Interactive Data Files on Exhibit 101 hereto are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.

Exhibit 31.1

CERTIFICATIONS

I, Steven Santo, certify that:

 

  1. I have reviewed this quarterly report on Form 10-Q of Avantair, 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 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 report;

 

  4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

 

  (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared;

 

  (b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 

  (c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

  (d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

 

  5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, 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 and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 

  (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: June 13, 2013

 

/s/ Steven Santo

Name:   Steven Santo
Title:  

Chief Executive Officer

(Principal Executive Officer)

Exhibit 31.2

CERTIFICATIONS

I, Bret A. Holmes, certify that:

 

  1. I have reviewed this quarterly report on Form 10-Q of Avantair, 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 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 report;

 

  4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

 

  (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared;

 

  (b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 

  (c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

  (d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

 

  5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, 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 and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 

  (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: June 13, 2013

 

/s/ Bret A. Holmes

Name:   Bret A. Holmes
Title:  

Chief Financial Officer

(Principal Financial Officer)

Exhibit 32

CERTIFICATIONS UNDER SECTION 906

Pursuant to section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a) and (b) of section 1350, chapter 63 of title 18, United States Code), each of the undersigned officers of Avantair, Inc., a Delaware corporation (the “Company”), does hereby certify, to such officer’s knowledge, that:

The Quarterly Report for the quarter ended March 31, 2013 (the “Form 10-Q”) of the Company fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, and the information contained in the Form 10-Q fairly presents, in all material respects, the financial condition and results of operations of the Company.

 

Dated: June 13, 2013

   
   

/s/ Steven Santo

    Steven Santo
    Chief Executive Officer
    (Principal Executive Officer)

Dated: June 13, 2013

   
   

/s/ Bret A. Holmes

    Bret Al. Homes
    Chief Financial Officer
    (Principal Financial Officer)