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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
 

 
FORM 8-K/A
(Amendment No. 6)

CURRENT REPORT
Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

Date of Report (Date of earliest event reported): August 13, 2010

THE PAWS PET COMPANY, INC.
    (Exact Name of Registrant as Specified in Charter)

Illinois
333-130446
20-3191557
(State or Other Jurisdiction
(Commission
(IRS Employer
of Incorporation)
File Number)
Identification No.)

2001 Gateway Place, Suite 410
San Jose, CA 95110
(Address of Principal Executive Offices)

(408) 248-6000
Registrant's telephone number, including area code

Pet Airways, Inc.
777 E. Atlantic Avenue, Suite C2-264
Delray Beach, FL 33483
(Former Name or Former Address, if Changed Since Last Report)

Check the appropriate box below if the Form 8-K filing is intended to simultaneously satisfy the filing obligation of the registrant under any of the following provisions:

¨
Written communications pursuant to Rule 425 under the Securities Act (17 CFR 230.425)

¨
Soliciting material pursuant to Rule 14a-12 under the Exchange Act (17 CFR 240.14a-12)

¨
Pre-commencement communications pursuant to Rule 14d-2(b) under the Exchange Act (17 CFR 240.14d-2(b))

¨
Pre-commencement communications pursuant to Rule 13e-4(c) under the Exchange Act (17 CFR 240.13e-4(c))

 
 

 

EXPLANATORY NOTE:

This Amendment No. 6 on Form 8-K/A (“ Amendment No. 6”) amends and restates our Current Report on Form 8-K originally filed with the SEC on August 17, 2010 (the “Original 8-K”) and subsequently amended on August 31, 2010 ("Amendment No. 1”) and on June 20, 2011 (“Amendment No. 2”) and on June 23, 2011 (“Amendment No. 3”) and on August 9, 2011 (“Amendment No. 4”) and on September 19, 2011 (“Amendment No. 5”). We are filing this Amendment No. 6 in response to certain comments received from the staff of the Securities and Exchange Commission.

FORWARD LOOKING STATEMENTS

This report contains forward-looking statements. The forward-looking statements are contained principally in the sections entitled “Description of Business,” “Risk Factors,” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” These statements involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to be materially different from any future results, performances or achievements expressed or implied by the forward-looking statements. In some cases, you can identify forward-looking statements by terms such as “anticipates,” “believes,” “could,” “estimates,” “expects,” “intends,” “may,” “plans,” “potential,” “predicts,” “projects,” “should,” “would” and similar expressions intended to identify forward-looking statements. Forward-looking statements reflect our current views with respect to future events and are based on assumptions and subject to risks and uncertainties. Given these uncertainties, you should not place undue reliance on these forward-looking statements. These forward-looking statements include, among other things, statements relating to:

 
·
our ability to obtain additional capital in future years to fund our plan of operations;

 
·
our history of operating losses and going concern;

 
·
the ability of our suppliers to fulfill their contractual obligations to us in connection with the products and services that we provide to our customers;

 
·
the impact that a downturn or negative changes in the transportation industry could have on our business and profitability;

 
·
the potential size of the market for our services;

 
·
economic, political, regulatory and legal risks associated with our operations; or

 
·
the loss of key members of our senior management and our qualified technical and sales personnel.

Also, forward-looking statements represent our estimates and assumptions only as of the date of this report. You should read this report and the documents that we reference and filed as exhibits to the report completely and with the understanding that our actual future results may be materially different from what we expect. Except as required by law, we assume no obligation to update any forward-looking statements publicly, or to update the reasons actual results could differ materially from those anticipated in any forward-looking statements, even if new information becomes available in the future.

Use of Certain Defined Terms

Except where the context otherwise requires and for the purposes of this report only:

 
·
the “Company,” “we,” “us,” and “our” refer to the combined business of American Antiquities Incorporated and its wholly owned direct and indirect subsidiary Pet Airways, Inc., or “Pet Airways” or “PAWS”, a Florida corporation, as the case may be; and

 
·
“Securities Act” refers to the Securities Act of 1933, as amended.

 
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In this current report we are relying on and we refer to information and statistics regarding the transportation services industry and economy in the US and that we have obtained from, various cited government and institute research publications. This information is publicly available for free and has not been specifically prepared for us for use or incorporation in this current report on Form 8-K or otherwise. We have not independently verified such information, and you should not unduly rely upon it.

ITEM 2.01 COMPLETION OF ACQUISITION OR DISPOSITION OF ASSETS

As previously disclosed in the Company’s Current Report on Form 8-K filed on July 1, 2010, on June 25, 2010, we entered into a share exchange agreement, or the Share Exchange Agreement, with Pet Airways, the shareholders of PAWS, and Joseph A. Merkel, Kevin T. Quinlan, and Bellevue Holdings, Inc., collectively, the majority shareholders of the Registrant (the “AAQS Majority Holders”), which sets forth the terms and conditions of the business combination of the Registrant and PAWS (the “Transaction”) in which all PAWS Shareholders agreed to exchange all of the outstanding and issued capital stock of PAWS for an aggregate of 25,000,000 shares of common A shares (the “Common Stock”), of the Registrant, representing approximately 73% of the outstanding Common Stock after giving effect to the Transaction and the transactions related thereto. The Transaction was approved by the Company’s board of directors and by a majority of its shareholders acting by written consent.

The foregoing description of the terms of the Share Exchange Agreement is qualified in its entirety by reference to the provisions of the agreement filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on July 1, 2010.

On August 13, 2010, we completed an acquisition of Pet Airways pursuant to the Share Exchange Agreement. The acquisition was accounted for as a recapitalization effected by a share exchange, wherein Pet Airways is considered the acquirer for accounting and financial reporting purposes. The assets and liabilities of the acquired entity have been brought forward at their book value, which was determined to be zero and no goodwill has been recognized.

FORM 10 DISCLOSURE

As disclosed elsewhere in this report, on August 13, 2010, we acquired Pet Airways in a reverse acquisition transaction. Please note that the information provided below relates to the combined enterprises after the acquisition of Pet Airways, except that information relating to periods prior to the date of the reverse acquisition only relate to American Antiquities unless otherwise specifically indicated.

DESCRIPTION OF BUSINESS

Business Overview

 
The PAWS Pet Company, Inc., through its wholly-owned subsidiary, Pet Airways, Inc., operates an airline designed specifically for the comfortable and safe transportation of pets by traveling in the main cabin of the aircraft. Pet owners can book their pets on flights online at our website or can book with our agents by phone. Flights can be booked up to three months before the scheduled departure date. Payment for the flights is made with credit card. On the day of the scheduled flight, pet owners drop off their pets at one of our airport facilities located at the departure airport. Our airport facilities function foremost as a staging, inspection, exchange and observation area for our staff and the pets under our care pending there flight departure or scheduled layover. We place the pet passengers into a pet-friendly carrier and then board the carrier into the main cabin of the aircraft. Pet passengers fly in the main cabin of our specially-outfitted aircraft rather than, as is the case for a traditional commercial airline, flying in the cargo bay or flying as carry-on baggage placed under a passenger’s seat. We carry domesticated animals. The number of pets we can carry per flight can vary based on the size of pet, but generally we can carry around 40 pets per flight. We carry mainly dogs and cats. We can carry pets of all sizes from small dogs and cats weighing less than 15 lbs. to dogs that weigh 180 lbs. and have maximum height from the ground to shoulder of 34 inches. After drop off, pet owners can track flight progress through our website. Throughout the flight, we monitor the air quality and temperature of our aircraft ensuring that the pet passengers are safe and comfortable at all times. We have a pet attendant on each flight that is responsible for monitoring the pet passengers during the flight. Upon arrival at the destination airport, we unload the pet passengers from the plane directly into one of our airport facilities for pick up.

We do not own our aircraft. We have a relationship with Suburban Air Freight, Inc. based in Omaha, Nebraska who have two aircraft configured to carry our pets. We have paid for the cost of re-configuring the planes for the transportation of pets at a cost of approximately $500 per plane. We rely on Suburban to provide the aircraft, pilot and ensure the aircraft complies with all appropriate FAA regulations. We do not have a written agreement with Suburban however under the non-written agreement, provides the aircraft, pilot, ensures the aircraft complies with all appropriate FAA regulations and operates the flights according to our schedule. Suburban invoices us on a weekly basis for these services including the cost of the pilot, providing the aircraft, airport fees and fuel costs. Weekly Invoices from suburban are in the range of $36,000 to $40,000 per week on the Los Angeles to New York to Los Angeles route, and $53,000 to $63,000 per week for the Los Angeles to Fort Lauderdale to Los Angeles route.

The maximum weight limit of the Beechcraft 1900 aircraft that we fly is approximately 5,400 lbs. We generally fly one aircraft on our coast-to-coast service.

As of September 30, 2011, we served the following nine markets and airports in the United States and offer a scheduled coast-to-coast service.

 
Market Served
 
Airport
·
Atlanta
 
DeKalb–Peachtree Airport, Atlanta, GA.
·
Baltimore
 
Baltimore/Washington International Airport, Baltimore, MD
·
Chicago
 
Midway Airport, Chicago, IL.
·
Denver
 
Rocky Mountain Metropolitan Airport, Broomfield, CO.
·
Fort Lauderdale
 
Hollywood International Airport, Fort Lauderdale, FL.
·
Los Angeles
 
Hawthorne Executive Airport, Hawthorne, CA.
·
New York
 
Republic Airport, Farmingdale, NY.
·
Omaha
 
Epply Airport, Omaha, NE.
·
Phoenix
 
Falcon Field Airport, Mesa, AZ.

With the exception of Omaha, we are either a tenant or a sub-tenant of the respective airport authority.  At Omaha we have access to office and hanger space at the Suburban Air facility as part of our non-written agreement with Suburban.  Suburban Air is responsible for all flight operations aspects at the airports including air traffic control and landing rights. Any fee associated with use of the airport landing strip and administration is paid by Suburban Air who in turn invoices to us on a weekly basis.

In addition to Pet Airways operations, we evaluate additional pet related products and services that we could add to broaden our product offering. These may include the sale of non-transportation related pet products and services such as pet foods, pet supplements, pet toys, pet clothing and medical services for pets.  However, there can be no assurance that we will add non-transportation related pet products and services to our business or that if we do, we will be successful.
 
 
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We do not currently have sufficient cash on hand to meet our financing needs. As at September 30, 2011 have approximately $50,000 of cash on hand.  At our current monthly cash burn rate of between $20,000 and $35,000, the cash on hand will last us approximately two to three months. For the six months ended June 30, 2011, we generated $911,759 in revenues and recorded a net loss of $(16,040,519).  For the year ended December 31, 2010, we generated $1,348,491 in revenues and recorded a net loss of $(4,055,905). The report of our independent registered accountants issued in connection with the audit of our consolidated financial statements as of and for our year ended December 31, 2010 contained a qualification raising a substantial doubt about our ability to continue as a going concern. In the year ended December 31, 2009, we generated $628,829 in revenues and had a net loss of $(1,218,707). For the six months ended June 30, 2011 and the year ended December 31, 2010, we had accumulated deficits of $(22,105,528) and $(6,065,008), respectively.

On June 3, 2011, we entered into a Securities Purchase Agreement (the “Purchase Agreement”) with the selling security holder, pursuant to which we secured $500,000 of immediate funding through the issuance and sale to selling security holder of 2,253,470 shares of the Company’s common stock (such shares being the “Initial Purchase Shares” and such purchase being the “Initial Purchase”). In connection therewith, (i) we also issued to selling security holder a warrant to purchase up to 20,476,707 shares of our common stock, and (ii) selling security holder agreed to purchase from the Company up to $5.0 million (the “Aggregate Preferred Stock Purchase Price”) of our newly created perpetual and non-convertible Series A Preferred Stock (the “Preferred Stock”), at a price per share of $10,000, in one or more tranches (each a “Preferred Tranche”).  The Preferred Stock participates with the common stock in any dividends or distributions or change of control transactions as further described herein.  In connection with the Purchase Agreement, we also agreed to issue an additional 1,126,735 shares of common stock to selling security holder on the 75 day anniversary of the Initial Purchase as consideration for executing and delivering the Purchase Agreement (the “Commitment Shares”). The Commitment Shares shall not be issued to selling security holder and shall be held in abeyance (and selling security holder shall not have the right to, or be deemed to have, beneficial ownership of such Commitment Shares) to the extent that such issuance would result in selling security holder and its affiliates owning or being deemed the beneficial owner of more than 9.99% of the then issued and outstanding common stock.  The warrant also does not permit issuance of common stock thereunder to the extent that such issuance would result in selling security holder and its affiliates owning or being deemed the beneficial owner of more than 9.99% of the then issued and outstanding common stock.  All of the foregoing was effectuated without registration under the Securities Act, in reliance upon an exemption from registration provided by Section 4(2) under the Securities Act and Rule 506 of Regulation D promulgated thereunder. These securities may not be transferred or sold absent registration under the Securities Act or an applicable exemption therefrom.

Under the terms and subject to the conditions of the Purchase Agreement, from time to time over the two-years following the Initial Purchase, beginning on August 17, 2011, at the Company’s sole discretion, the Company may sell to the selling security holder, and the selling security holder will be obligated to purchase, shares of the Preferred Stock.  In order to effectuate such a sale, the Company will issue to the selling security holder, subject to the terms and conditions of the Purchase Agreement (all of which conditions are outside of the selling security holder’s control) one or more Preferred Tranche notices to purchase a certain dollar amount of such Preferred Stock (each such notice, a “Preferred Notice”).  Upon receipt of a Preferred Notice, the selling security holder will be obligated, subject to the terms and conditions specified in the Purchase Agreement (which conditions are outside of the selling security holder’s control), to purchase the Preferred Stock subject to such Preferred Notice on the 10 th trading day after the date of the Preferred Notice.  Such conditions include, but are not limited to, the following: (i) the Common Stock must be listed for trading or quoted on a trading exchange or market, (ii) the representations and warranties of the Company set forth in the Purchase Agreement must be true and correct as if made on the date of each Preferred Notice (subject, however, to the Company’s ability to update disclosure exceptions to such representations and warranties through the Company’s SEC reports), (iii) the Company must not be in breach or default of the Purchase Agreement or any agreement entered into in connection therewith (the “Transaction Documents”), or any other material agreement of the Company, (iv) there shall have occurred no material adverse effect involving the Company or its business, operations or financial condition since the date of the Initial Purchase, (v) the absence of any law or judicial action prohibiting the transactions contemplated by the Purchase Agreement, or any lawsuit seeking to prohibit or adversely affect such transactions, and (vi) all necessary governmental, regulatory or third party approvals and consents must have been obtained. The maximum amount of each Preferred Tranche is limited to a dollar amount of Preferred Stock equal to the lesser of (a) 20% of the cumulative dollar trading volume of the Common Stock for the 10 trading day-period immediately preceding the applicable Preferred Notice date and (b) $5.0 million less the amount of any previously noticed and funded Preferred Tranches. In addition, each Preferred Notice after the first Preferred Notice may not be given sooner than the trading day after the date on which the closing for the prior Preferred Tranche has occurred.

On June 3, 2011, in connection with our private placement transaction, we issued to the investor a five-year warrant to purchase up to 20,476,707 shares of Common Stock at an initial Exercise Price of $1.02 per share (the “Original Exercise Price”). The maximum number of shares of Common A Stock acquirable upon exercise of such warrants which are being registered pursuant to this registration statement is 7,000,000. The warrant is also exercisable on a cashless basis or through the issuance by the holder of a Secured Promissory Note. Any Secured Promissory Note issued in connection with an exercise of the warrant shall bear interest at 2% per year calculated on a simple interest basis. The entire principal balance and interest thereon shall be due and payable on the fourth anniversary of the date of the Secured Promissory Note. Any such Secured Promissory Note shall be secured by the borrower’s right, title and interest in certain securities held in the portfolio of the borrower with a fair market value equal to the principal amount of the Secured Promissory Note. Additionally, any portion of the warrant may also be exchanged for shares of Common Stock based on a Black-Scholes calculation as more fully set forth in the warrant. The warrant contains certain provisions that protect against dilution in certain events such as stock dividends, stock splits and other similar events. In addition, the warrant has price-based anti-dilution protection in the event the Company issues securities at a value less than the Original Exercise Price, meaning the exercise price of the warrant would be adjusted down to the lowest applicable issuance price following the issuance of the warrant to prevent dilution to the holder.  Pursuant to the warrant, any such anti-dilution adjustments shall be made on a pro-rata basis until such time as the Company has made dilutive issuances which exceed $5.0 million. The warrant shall not be exercisable or exchangeable by the holder (or any future holder) to the extent the holder (or such future holder) or any of its affiliates would beneficially own in excess of 9.9% of the Common Stock as a result of such exercise or exchange.
  
On June 3, 2011,in connection with our private placement transaction, we entered into a Registration Rights Agreement (the “Rights Agreement”) with the investor, pursuant to which we agreed to file one or more Registration Statements on Form S-1 with the Securities and Exchange Commission (“SEC”) covering the resale of the Initial Purchase Shares, the Commitment Shares and the shares of Common Stock underlying the Warrant (the “Registrable Securities”). The initial registration statement was required to be filed within 15 days of the closing and be declared effective by the SEC within 60 days of the closing and was required to cover the resale of an aggregate of 7,000,000 of the Registrable Securities (as adjusted for any stock split, stock dividend, recapitalization, exchange or similar event or otherwise), and upon such registration statement having been utilized for the disposition of 80% of the Registrable Securities initially covered thereby, we are required to prepare and, as soon as practicable, but in no event later than two (2) Business Days thereafter, file an additional registration statement covering the resale of an additional 7,000,000 of the Registrable Securities (as adjusted for any stock split, stock dividend, recapitalization, exchange or similar event or otherwise), and upon such registration statement having been utilized for the disposition of 80% of the Registrable Securities initially covered thereby, we are required to prepare and, as soon as practicable, but in no event later than two (2) Business Days thereafter, file an additional registration statement covering the remaining Registrable Securities. We are required to secure the effectiveness of any such follow-on registration statement when the prior registration statement covers only a remaining 1,050,000 shares. In any event, the parties have agreed that in light of the illiquid nature of the investment into the Company, on each day (each such day, a “Date of Determination”) after the effectiveness of the initial registration statement, we are required to maintain the effectiveness of a registration statement covering that number of shares equal to the lesser of (x) the quotient determined by dividing (A) twenty-five percent (25%) of the cumulative dollar trading volume of the Common Stock for the ten (10) trading day-period immediately prior to such Date of Determination by (B) the closing sale price of the Common Stock for the most recently completed trading day immediately prior to such Date of Determination and (y) the number of shares of Common Stock representing Registrable Securities that remain unsold by the investor.
 
We filed the initial registration statement on June 20, 2011, however, it has yet to be declared effective. We have accrued but not paid penalties of approximately $42,000 through September 24, 2011. We will continue to accrue penalties until such time as the registration statement is declared effective by the SEC. In addition, we may be subject to additional penalties if we fail to maintain the effectiveness of the registration statement.
  
We will not receive any proceeds from the sales of common stock by the selling security holder. However, we will receive the exercise price, if the cashless exercise feature, the full-recourse note exercise feature or the exchange feature is not used, upon exercise of the warrants by the selling security holder. If the cashless exercise feature or the full recourse note feature is used or if the warrant is exchanged, in whole or in part, for shares of common stock, we will not receive any cash proceeds. The maximum amount of proceeds that we may receive from the exercise of the warrant is $20,886,241. There is no guarantee, however, that the selling security holder will exercise for cash. We will require approximately $3,000,000 of additional working capital to continue our operations during the next 12 months and to support our long-term growth strategy, so as to enhance our service offerings and benefit from economies of scale. We expect our working capital requirements and the cash flow provided by future operating activities, if any, to vary greatly from quarter to quarter, depending on the volume of business and competition in the markets we serve. We may seek additional funding through one or more credit facilities, if available, or through the sale of debt or additional equity securities. However, the terms of our June 3, 2011 private placement transaction place restrictions on our ability to consummate any such additional financing without the consent of the investor.  There is no assurance that the investor would consent to such a transaction or if funding of any type would be available to us, or that it would be available at rates and on terms and conditions that would be financially acceptable and viable to us in the long term. If we are unable to raise any necessary additional financing when needed, under the terms of our June 3, 2011 private placement or otherwise, we may be required to suspend operations, sell assets or enter into a merger or other combination with a third party, any of which could adversely affect the value of our common stock, or render it worthless. If we issue additional debt or equity securities, such securities may enjoy rights, privileges and priorities (including but not limited to coupon rates, conversion rights, rights to fixed or preferential dividends, anti-dilution rights or preference as to the distribution of assets upon a liquidation) superior to those enjoyed by holders of our common stock, thereby diluting the value of our common stock.
 
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Organizational History

We were incorporated in the State of Illinois on June 6, 2005 as American Antiquities, Inc. (“AAI”). Historically, we purchased antiques and collectible items for resale, accepted items on consignment, and sold items through various auctions and third party Internet websites.

On August 13, 2010, we completed a reverse acquisition transaction through a share exchange with Pet Airways, Inc. (Florida), which was a successor entity to Panther Air Cargo, LLC (the “Acquisition”), whereby AAI acquired 100% of the issued and outstanding capital stock of Pet Airways, Inc. (Florida) in exchange for 25,000,000 shares of AAI common A shares, which constituted approximately 73% of  AAI issued and outstanding capital stock on a post-acquisition basis as of and immediately after the consummation of the Acquisition.  Following the acquisition, we changed our name to Pet Airways, Inc. and subsequently changed it to The PAWS Pet Company, Inc.

Panther Air Cargo, LLC was formed as a limited liability company in the State of Florida in February 2005. From 2005 through 2009, Panther Air Cargo d/b/a Pet Airways evaluated the market for pet air travel, including reservation systems and processes. It also considered whether it should own its own planes or contract with third parties. It also evaluated the optimal ways to configure the aircraft for safe pet travel and the initial markets to commence flight operations in. Pet Airways began flight operations in July 2009 and from the period July 2009 to March 2010 operated a weekly scheduled service. In March 2010 Pet Airways suspended flight operations to upgrade it’s on line reservation system and to raise additional capital. In June 2010 Pet Airways resumed flight operation after we implemented our new reservation system and raised additional capital by issuing a series of convertible debentures, shares of common stock and warrants. Immediately prior to the Acquisition Panther Air Cargo, LLC was converted to Pet Airways, Inc., a Florida corporation.

As a result of the Acquisition, Pet Airways, Inc. (Florida) became a wholly-owned subsidiary of AAI and the controlling stockholders of Pet Airways, Inc. (Florida) became our controlling stockholders. Also, upon completion of the Acquisition, we changed our name from AAI to Pet Airways, Inc. and adopted the ticker symbol “PAWS” to trade on the OTCQB Market Tier (“OTCQB”). The OTCQB market tier helps investors identify companies that are current in their reporting obligations with the Securities and Exchange Commission (the “SEC”). OTCQB securities are quoted on OTC Markets Group's quotation and trading system.

The share exchange transaction with Pet Airways, Inc. was treated as a reverse acquisition, with Pet Airways, Inc. (Florida) as the acquirer and The PAWS Pet Company, Inc. as the acquired party. Unless the context suggests otherwise, when we refer in this report to business and financial information for periods prior to the consummation of the reverse acquisition, we are referring to the business and financial information of Pet Airways, Inc. and its predecessors. For accounting purposes, the acquisition of Pet Airways, Inc. has been treated as a recapitalization with no adjustment to the historical book and tax basis of the companies’ assets and liabilities.

Upon the closing of the Acquisition on August 13, 2010, Joseph A. Merkel, our former Chief Executive Officer, President and director and Kevin T. Quinlan, our former Chief Financial Officer, Controller and director, resigned. On the same day, our board of directors approved an increase in the size of our board to three board members and appointed Dan Wiesel, Alysa Binder and Andrew Warner to our board of directors at the effective time of the resignation of Messrs. Merkel and Quinlan, to fill the vacancies created by their resignation. In addition, our board of directors appointed Mr. Wiesel as our Chief Executive Officer and Ms. Binder as our Executive Vice President effective immediately at the closing of the Acquisition.

Description of Market

We believe that pet owners who want to travel with their pets are faced with limited, and sometimes dangerous, transportation choices. Pets too big to fit under the seat are relegated to traveling in the airplane’s cargo hold. Our pet passengers fly in the specially equipped main cabin of our aircraft, which is climate-controlled, and supplied with an ample amount of fresh circulating air. Also, the pet attendant constantly monitors our pet passengers for the duration of each flight. Pet Airways offers dedicated routes within the United States with airport facilities that are located away from the main passenger terminals. Our airport facilities tend to be located either in or close to the cargo terminals of the airport.

The number of pets we can carry per flight can vary based on the size of pet, but generally we can carry around 40 pets per flight. We carry mainly dogs and cats. We can carry pets of all sizes from small dogs and cats weighing less than 15 lbs. to dogs that weigh 180 lbs. and have maximum height from the ground to shoulder of 34 inches. 

We do not own our aircraft. We have a relationship with Suburban Air Freight, Inc. based in Omaha, Nebraska who have two aircraft configured to carry our pets. We currently fly one aircraft per week on our coast-to-coast service. We rely on Suburban Air to provide the aircraft, pilot and ensure the aircraft complies with all appropriate FAA regulations. We do not have a written agreement with Suburban however under the non-written agreement, provides the aircraft, pilot, ensures the aircraft complies with all appropriate FAA regulations and operates the flights according to our schedule. Suburban invoices us on a weekly basis for these services including the cost of the pilot, providing the aircraft, airport fees and fuel costs. Invoices from suburban are in the range of $36,000 to $40,000 per week on the Los Angeles to New York to Los Angeles route, and $53,000 to $63,000 per week for the Los Angeles to Fort Lauderdale to Los Angeles route

 
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As of September 30, 2011, we served the following nine markets:

 
Market Served
 
Airport
·
Atlanta
 
DeKalb–Peachtree Airport, Atlanta, GA.
·
Baltimore
 
Baltimore/Washington International Airport, Baltimore, MD
·
Chicago
 
Midway Airport, Chicago, IL.
·
Denver
 
Rocky Mountain Metropolitan Airport, Broomfield, CO.
·
Fort Lauderdale
 
Hollywood International Airport, Fort Lauderdale, FL.
·
Los Angeles
 
Hawthorne Executive Airport, Hawthorne, CA.
·
New York
 
Republic Airport, Farmingdale, NY.
·
Omaha
 
Epply Airport, Omaha, NE.
·
Phoenix
 
Falcon Field Airport, Mesa, AZ.

With the exception of Omaha, we are either a tenant or a sub-tenant of the respective airport authority.  At Omaha, we have access to office and hanger space at the Suburban Air facility as part of our non-written agreement with Suburban.  Suburban Air is responsible for all flight operations aspects at the airports including air traffic control and landing rights. Any fee associated with use of the airport landing strip and administration is paid by Suburban Air, who invoices us on a weekly basis.

We believe most pet owners will be willing to drive up to 2 hours to use our services. Therefore, our long-term goal is to have a network of airport facilities within a 2 hour driving radius of major metropolitan populations. Our ability to meet this goal is dependent on access to additional capital.

In addition to Pet Airways operations, we evaluate additional pet related products and services that we may add to broaden our product offering. These may include the sale of non-transportation related pet products and services such as pet foods, pet supplements, pet toys, pet clothing and medical services for pets.  However, there can be no assurance that we will add any non-transportation related pet products or services to our business or that if we do, we will be successful.

We look for products and services that we believe would appeal to a both pet owners and veterinarians. In particular we look for products and services that have a large potential market that we believe we can enter by leveraging our database of pet owners and veterinarians that we have built up over the past four years.

In August 2011, we announced that Dyson is the exclusive provider of vacuums at our pet fascilities.
 
In August 2011 we announced an exclusive license agreement with Intellicell BioSciences, Inc. under which we can exclusively market and sell IntelliCell’s stromal vascular fraction (SVF) solution in the veterinary market. Under the terms of the agreement we will provide Intellicell with $150,000 towards laboratory equipment and issue up to 6 million shares of common stock subject to achieving certain revenue targets over the next three years. We intend to initially market this new product offering to pet owners and veterinary offices who have signed up to receive our newsletters. We are relying on our ability to  raise additional capital under the terms of the Purchase Agreement with the selling stockholder to be able to fund the cash portion of the investment required. If we are unable to access additional capital pursuant to the terms of the Purchase Agreement, and are unable to secure additional capital from other sources, we will be unable to enter into this market.
 
In September 2011 we announced a strategic relationship with Vet Pets Insurance (VPI), under which we now offer pet owners that visit our site a link to the VPI site to purchase insurance products. We also will have access to market our services to approximately 500,000 VPI policyholders through VPI newsletters, that are sent out to VPI policy holders periodically.

 
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Our Target Market

We believe that our service appeals to a wide market of pet owners, including, among others, vacationers, individuals who own multiple homes, and individuals relocating. Given our sensitivity to pet handling, we also believe that we appeal to breeders, pet rescue services and those traveling with their pets to pet shows.

Our Aircraft

We do not own any of our own aircraft. We have contracted with Suburban Air Freight, Inc. (“Suburban Air”), an air freight operator based in Omaha, Nebraska, to provide Beechcraft 1900 aircraft. We have modified the aircraft to transport our pet passengers safely and comfortably. The current configuration of our aircraft allows for the transport of approximately 40 pet passengers per flight. Based upon our relationship with Suburban Air, we believe that we can add additional planes and flight schedules to enable us to continue to grow our business and increase flight operations to meet the demand for our service. The maximum weight limit of the Beechcraft 1900 aircraft that we fly is approximately 5,400 lbs.
 
Our Airport Facilities

Our airport facilities are located at the airports we service, both departure and arrival. The airport facilities include a check-in desk for the pets, a waiting area for pet owners and a holding area where we keep the pets prior to boarding the aircraft. We also have secure areas where dogs can be exercised. Pet owners generally drop off their pets with us after checking in and then leave the pet in our care.
 
Reservations

Booking Habits

Pet owners tend to book their pets on flights within a 60 day window of the planned travel date. Occasionally, we see booking within seven days. Like a traditional commercial airline, we will fly every week regardless of the level of bookings. Since the inception of our flight operations, many of our flights have been at or near capacity, and we intend to add additional aircraft as demand increases. To the extent we have additional capacity on our flights we expect to fill such capacity by increasing the number of markets that we serve.

Flight Routes

We will fly a coast-to-coast route so as to maximize occupancy in both directions, regardless of any seasonality issues. We are currently flying coast-to-coast and stopping at cities en-route. As demand increases and we enter new markets, we expect to increase the frequency of flights and may eventually use a “hub and spoke” system for flight operations. Under this system, which is used by many of the traditional commercial airlines, we would fly to centralized hubs, based on the west coast and east coast, and fly from the particular hub to destination cities.

We currently have plans to open up operations in the following cities: Orlando, St Louis, Houston, Austin and Dallas. We are currently looking for suitable facilities in these cities. We intended to begin taking reservations for flights in Dallas, Houston, Austin and St. Louis in the Spring of 2011 and begin flights from such cities in the Summer of 2011. Our plans for expansion into these markets has been delayed, however, due to our inability to secure sufficient capital to open such facilities and secure such routes. The cost associated with opening up a new facility can vary. In addition to the monthly lease cost that depends on location and size of facility but can range from approximately $3,000 per month to $9,000 per month, we can expect incur up to $30,000 in capital expenditures per facility.

The timing of opening up a new facility is dependent on a number of other factors including identifying a suitable space, negotiating and executing a lease, completing any tenant improvements, staffing a facility and securing adequate capital to open and operate the facility.

We expect that we can open a new facility within 2-3 months of securing adequate financing for that location. We also expect to be able to we can open up to three facilities concurrently. We need to have sufficient capital available to finance new facilities.

The terms of the private placement transaction also enable us to receive up to $5 million in additional funding from the investor through the issuance of our newly created perpetual and non-convertible Series A Preferred Stock at a price per share of $10,000 in one or more tranches commencing on August 17, 2011 at the earliest and continuing until June 3, 2013 (unless sooner terminated) provided that certain conditions are met, including but not limited to, our continued listing or quotation on a trading market, and the continued accuracy and completeness of our representations and warranties contained in the securities purchase agreement. The maximum amount which we may receive in any tranche is equal to the lesser of (i) 20% of the cumulative dollar trading volume of our common stock for the 10 trading-day period immediately prior to the tranche notice date and (ii) $5,000,000 less the aggregate amount of any previously noticed and funded tranches. We can provide no assurance of what additional funding, if any, that we will ultimately receive under the terms of our June 3, 2011 private placement transaction. We will require additional working capital to continue our operations during the next 12 months and to support our long-term growth strategy, so as to enhance our service offerings and benefit from economies of scale. We expect our working capital requirements and the cash flow provided by future operating activities, if any, to vary greatly from quarter to quarter, depending on the volume of business and competition in the markets we serve. We may seek additional funding through one or more credit facilities, if available, or through the sale of debt or additional equity securities. However, the terms of our June 3, 2011 private placement transaction place restrictions on our ability to consummate any such additional financing without the consent of the investor.  There is no assurance that the investor would consent to such a transaction or if funding of any type would be available to us, or that it would be available at rates and on terms and conditions that would be financially acceptable and viable to us in the long term. If we are unable to raise any necessary additional financing when needed, under the terms of our June 3, 2011 private placement or otherwise or, cannot find an appropriate space we will not be able to open any additional facilities and open up additional flight routes.
 
Seasonality

We expect to experience higher customer volume in the second, third and fourth quarters of the calendar year as compared to the first quarter. The increased volumes in the middle quarters of the year coincide with vacations and holidays.

Our Competition

We believe that we are currently the only airline specifically designed for the comfortable and safe transportation of pets where pets travel in the main cabin and, as such, we do not believe we face any direct competition from other “pet-only” airlines. We do, however, face competition from other transportation providers and pet care services, including traditional commercial airlines, ground transportation services, pet concierge services, boarding facilities, and pet sitters.

Traditional Commercial Airlines

With traditional commercial airlines, small pets may travel with their owners, stowed under the seat, but most airlines will only accept one or two pets per flight. Pets too big to fit under the seat are relegated to traveling in the airplane’s cargo hold.

 
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We believe that cargo is not an appealing way for a pet to travel. We estimate that the air temperature in a plane’s cargo hold can vary from below zero to over one hundred degrees Fahrenheit. The oxygen pressure and ventilation systems in the cargo hold are minimized to suppress potential fire hazards, which can make transport uncomfortable for pets. Our aircrafts are climate controlled, on the ground and in the air, offering ventilation and comfortable temperatures for our pet passengers at all times.

In addition, in traditional commercial airline’s aircraft, pets are classified as baggage and the pilot does not always know that they are carrying pets or live animals.   We believe that these factors contribute to pets being lost and/or injured while in transit in traditional commercial airlines.

Ground Transportation

Pet owners may utilize ground transportation services. While we believe that such services may be problematic for long distances, they may be suitable for a pet owner who is relocating but are not convenient solutions for vacationers. Typically, a coast-to-coast ground service can take between 7 and 10 days to complete.

Pet Concierge Services

Pet concierge services typically are a convenient solution in that they handle the logistics and paperwork associated with pet travel. Unfortunately, we believe that concierge services still use traditional commercial airlines and the pet is relegated to the cargo hold for the duration of the travel.

Pet Boarding and Sitters

Vacationing pet owners can use a boarding service, or leave pets at home with a pet sitter. A pet sitter comes to the owner’s home during his or her time away and gives the animal basic care and interaction. For individuals enjoying an extended vacation or travelling to a second home, this option can be both inconvenient and expensive. According to the San Francisco SPCA web site, most cats are very territorial and are easily stressed if moved to a strange environment, so we do not believe that boarding is a good option for them. Dogs, on the other hand, are very social animals, so being home alone without human companionship for 24 hours can be very upsetting for them, even if you have more than one dog.

Pricing

Our fares are competitively priced with air cargo, pet boarding and ground transport alternatives. Our average fare is $500 per flight, although flights can cost as little as $99 or more than $1,200, depending on the distance travelled and size of pet. We believe that the cost of air cargo ranges from $250 to $1,000 and the cost for a qualified pet to be taken on aircraft as a carry-on range from $150 to $250. Th u s, we believe that our average fare range compares favorably with costs for air cargo or carry-on baggage. Alternatively, we believe ground transport can cost an average of $450 to $1,000 (e.g., pet relocation.com web site offers a minimum of $1,000), depending on distance, and pet boarding services can cost between $350 and $595 per week.

Flight Costs

The cost to us of flying the scheduled service per week depends on the route we travel and the price of fuel, but is in the range of $36,000 to $40,000 per week on the Los Angeles to New York to Los Angeles route, and $53,000 to $63,000 per week for the Los Angeles to Fort Lauderdale to Los Angeles route. These costs are invoiced to us on weekly basis by Suburban Air. We do not track the average flight cost per animal.

Corporate Strategy

Since our first year of operations, we believe that we have demonstrated that there is a strong demand for pet travel. Research data from the Aviation Consumer Protection and Enforcement section of the U.S. Department of Transportation indicates that over two million pets and other live animals travel by air, and most of them, due to size, must travel in the cargo hold of a traditional commercial airline’s aircraft. We believe that transporting pets and animals as cargo presents a clear danger to these pets and animals.

We provide an alternative to cargo transport for pets. Our pet passengers travel in the main cabin of our specially equipped planes where the environment is carefully controlled for maximum comfort. Additionally, all of our flights include an in-flight pet attendant to monitor the cabin environment, and the health and condition of our pet passengers.

  We currently serve nine major cities throughout the United States. To date we have transported over 7,000 pets, which is only a small fraction of the pets that travel by air. Our goal is to expand our flight operations to most major cities throughout the United States so that we are within an easy drive for all pet owners. Over the long term, we may expand our operations to international markets.

 
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Employees

As of September 30, 2011, we had 40 employees, of which 13 were full time. We are not a party to any collective bargaining agreements and we believe that our relationship with our employees is good.

Headquarters and Offices

We lease office space in San Jose, California, which is our corporate headquarters. It is used for corporate administrative functions as well as for representatives, marketing and administrative functions. The San Jose space is leased on a three year term.

Our Airport Facilities

As of September 30, 2011, we operated under an operating lease for the facilities at the airports we service, at both departure and arrival terminals. We lease the space in which all of our airport facilities are located.

Our airport facilities are established at:
 
 
Market Served
 
Airport
·
Atlanta
 
DeKalb–Peachtree Airport, Atlanta, GA.
·
Baltimore
 
Baltimore/Washington International Airport, Baltimore, MD
·
Chicago
 
Midway Airport, Chicago, IL.
·
Denver
 
Rocky Mountain Metropolitan Airport, Broomfield, CO.
·
Fort Lauderdale
 
Hollywood International Airport, Fort Lauderdale, FL.
·
Los Angeles
 
Hawthorne Executive Airport, Hawthorne, CA.
·
New York
 
Republic Airport, Farmingdale, NY.
·
Omaha
 
Epply Airport, Omaha, NE.
·
Phoenix
 
Falcon Field Airport, Mesa, AZ.

  Government Regulation

As an airline we are subject to extensive regulatory and legal compliance requirements. The costs of complying with these regulations are incurred by Suburban Air and built into their charges to us.  If there changes to existing or new regulations that impact Suburban Air, we expect that they will pass on any costs increases to us. We in turn may not be able to offset cost increases with increases in revenue that would result in an increase in our gross margin loss.

 
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RISK FACTORS

This investment has a high degree of risk. Before you invest you should carefully consider the risks and uncertainties described below and the other information in this prospectus. If any of the following risks actually occur, our business, operating results and financial condition could be harmed and the value of our stock could go down. This means you could lose all or a part of your investment.

RISKS RELATED TO OUR BUSINESS

We have experienced a history of losses and have yet to begin generating positive cash flows from operations and, as a result, our auditors have raised substantial doubt about our ability to continue as a going concern.

We do not currently have sufficient cash on hand to meet our financing needs. As at September 30, 2011 have approximately $50,000 of cash on hand.  At our current monthly cash burn rate of between $20,000 and $35,000, the cash on hand will last us approximately two to three months. We have experienced net losses in each calendar quarter since our inception and as of June 30, 2011 and December 31, 2010, had accumulated deficits of $(22,105,528) and $(6,065,008), respectively. We incurred net losses to common stockholders of $(16,040,519) and $(4,055,905) during the six months ended June 30, 2011 and the year ended December 31, 2010, respectively. The report of our independent registered accountants issued in connection with the audit of our consolidated financial statements as of and for our year ended December 31, 2010 contained a qualification raising a substantial doubt about our ability to continue as a going concern. Our quarterly and annual consolidated financial statements do not include any adjustments that may result from the outcome of this uncertainty. If we cannot continue as a viable entity, our stockholders may lose some or all of their investment in us.

We are an early stage company, have limited operating history and anticipate losses and negative cash flow.

We are an early stage company, and have limited operating history upon which prospective investors may base an evaluation as to our likely performance. We have been offering pet transportation services for a limited period of time and a substantial majority of our revenue has occurred within the past two years. We are subject to all the substantial risks inherent in an early stage business enterprise within the airline and pet transportation industry, including increased fuel costs, changes in government regulation, and economic downturns. No assurances can be given that our business will be successful, profitable or that we will ever become profitable. In addition, if we ever do become profitable there can be no assurance that we will remain profitable. Before purchasing our common stock, investors should consider an investment in our common stock in light of the risks, uncertainties and difficulties frequently encountered by early-stage companies in new and rapidly evolving markets such as ours, including those described herein. We may not be able to successfully address any or all of these risks. Failure to adequately address such risks could cause our business to fail which may result in our liquidation.

We may have difficulty managing our growth.

We anticipate that we will continue to grow in the near future. However, there is no guarantee that we will continue to grow in the near future. Our ability to manage growth effectively will depend on our ability to improve and expand our operations, including our financial and management information systems, and to recruit, train and manage additional marketing, operations and administrative personnel. Our management may not be able to manage growth effectively, or may be unable to recruit and retain personnel needed to meet our needs. If we are unable to manage growth or hire necessary personnel, our business could be materially harmed.

We may not be able to maintain our cost structure, thus leading to higher operating costs, which may have a material effect on our financial condition.

Our ability to do business and be profitable is based in part on maintaining the lowest average cost per pet passenger as possible. Any increase in our costs or decrease in the number of pet passengers, both of which may vary considerably for the reasons discussed herein, will significantly increase the average cost per pet passenger and may have a material adverse effect on our business and profitability. Since 2008, we have not been profitable. For the six months ended June 30, 2011 and year ended December 31, 2010, we sustained net losses before income taxes of $(16,040,519) and $(4,055,905), respectively, and our accumulated deficits as of June 30, 2011 and December 31, 2010, were $(22,105,528) and $(6,065,008), respectively. Future losses are likely to occur. We have not generated positive cash flows from operations and have relied almost entirely on funding from a combination of borrowings from and sales of common stock and warrants to third parties.

Sales may fluctuate due to seasonality.

Our business is, in part, seasonal in nature. This seasonality is dependent on numerous factors, including the markets in which we operate, holiday seasons, climate, economic conditions and numerous other factors. A substantial portion of our revenue is derived from travel demand, which can sometimes be difficult to predict. Therefore, our revenue is, to a larger degree, affected by factors that are outside of our control. There can be no assurance that our historic operating patterns will continue in future periods as we cannot influence or forecast many of these factors.

We do not own our own aircraft. We rely upon a third party freight operator for our flights, however we do not currently have a written agreement with such freight operator. In the event that our relationship with such third party materially changes or is terminated, our operations would be materially impacted.
 
We do not own our aircraft. We have a relationship with Suburban Air Freight, Inc. based in Omaha, Nebraska who have two aircraft configured to carry our pets.  The approximate costs to configure an aircraft to carry pets is $500, which cost is covered by us. We rely on Suburban Air to provide the aircraft, pilot and ensure the aircraft complies with all appropriate FAA regulations. We currently fly one aircraft per week on our coast to coast service. There is currently no written contract with Suburban. In the event that Suburban Air alters the terms of the service it provides to us or terminates their relationship with us, we may be forced to temporarily suspend or discontinue our operations if an alternative provider that suits our requirements cannot be identified.
 
 
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Economic downturns may adversely affect our sales .

A further downturn in the economy may affect consumer purchases of discretionary items, which could adversely affect our revenues. Our success depends on the sustained demand for our services. Consumer purchases of discretionary services, such as ours, tend to decline during recessionary periods when disposable income is lower. These downturns have been characterized by diminished services demand and subsequent accelerated erosion of average prices. A general slowdown in the economies in which we sell our services or even an uncertain economic outlook could adversely affect consumer spending on our services and, in turn, our sales and results of operations.

Although we believe that we are the sole “pet only” airline, we indirectly compete with a variety companies that have greater financial and operational resources than us.

We believe that we are the sole “pet only” airline that transports pets in the main cabin of the aircraft that is environmentally controlled. The barrier to competition to establish an operation such as ours requires, in addition to the capital necessary, substantial planning and expertise, purchasing of assets, leasing of space, training of personnel, and licensing from several different governmental agencies in addition to the creation of a strong brand presence in the marketplace. There may, however, be entities that possess the necessary capital and skill to develop a service similar to ours, and thusly there can be no assurance that we will not have direct competitors in the market in the future or that such competition will not have a material adverse effect on our business.

In addition, we currently compete in the same markets with traditional commercial airlines and ground based carriers that, in some cases, have substantially more capital, resources and expertise in the transportation business. While these competitors do not offer the same service that we provide, they do compete with us by providing general pet transportation services. There can no assurances that these competitors or others that may enter the business are not planning to direct substantial cargo capacity and resources at the pet transportation market and, if successful, that it would not have a material adverse effect on our business.

Reliance on Key Personnel.

We are dependent on the expertise, experience and continued services of Daniel Weisel, our Chairman and Chief Executive Officer, Andrew C. Warner, our President and Chief Financial Officer and Alysa Binder, our Executive Vice-President and Chief Development Officer. The loss of Mr. Weisel, Mr. Warner or Ms. Binder could harm our competitive position and financial performance. Our future success depends, to a significant extent, on the continued services of Mr. Weisel, Mr. Warner and Ms. Binder. Competition for personnel throughout the airline and transportation industry is intense and we may be unable to retain our current management and staff or attract, integrate or retain other highly qualified personnel in the future. If we do not succeed in retaining our current management and our staff or in attracting and motivating new personnel, our business could be materially adversely affected.

In order to grow at the pace expected by management, we will require additional capital to support our long-term growth strategies. If we are unable to obtain additional capital in future years, we may be unable to proceed with our plans and we may be forced to curtail our operations.

  We do not presently have adequate cash from operations or financing activities to meet our financing needs. As of September 30, 2011, we had approximately $50,000 in cash on hand compared to $1,511,000 at December 31, 2010 to use in executing our business plan. We estimate that we will be able to satisfy cash requirements for approximately 2-3 months based upon an expected burn rate of approximately $20,000-$35,000 per month absent additional financing. We will require approximately $3,000,000 of additional working capital to continue our operations during the next 12 months and to support our long-term growth strategy, so as to enhance our service offerings and benefit from economies of scale.

On June 3, 2011, we completed a private placement transaction pursuant to which we issued and sold 2,253,470 shares of our common stock and a warrant to purchase 20,476,707 shares of our common stock for gross proceeds of $500,000. We also agreed to issue an additional 1,126,735 shares of our common stock as a commitment fee to the investor on August 17, 2011; provided to the extent the issuance of such shares would result in the investor and its affiliates owning or being deemed the beneficial owner of more than 9.99% of the then issued and outstanding common stock (the “ Investor Ownership Limit ”), then such shares will be held in abeyance (and the investor shall not have the right to, or be deemed to have, beneficial ownership of such shares) until such time, and to the extent, as the investor’s beneficial ownership of such shares would not result in the investor exceeding the Investor Ownership Limit, at which time such shares (and certificates therefor) shall be issued and delivered to the investor and the investor shall then be deemed to have beneficial ownership thereof. The terms of the private placement transaction also enable us to receive up to $5 million in additional funding from the investor through the issuance of our newly created perpetual and non-convertible Series A Preferred Stock at a price per share of $10,000 in one or more tranches commencing on August 17, 2011 at the earliest and continuing until June 3, 2013 (unless sooner terminated) provided that certain conditions are met, including but not limited to, our continued listing or quotation on a trading market, and the continued accuracy and completeness of our representations and warranties contained in the securities purchase agreement. The maximum amount which we may receive in any tranche is equal to the lesser of (i) 20% of the cumulative dollar trading volume of our common stock for the 10 trading-day period immediately prior to the tranche notice date and (ii) $5,000,000 less the aggregate amount of any previously noticed and funded tranches. We can provide no assurance of what additional funding, if any, that we will ultimately receive under the terms of our June 3, 2011 private placement transaction. We will require additional working capital to continue our operations during the next 12 months and to support our long-term growth strategy, so as to enhance our service offerings and benefit from economies of scale. We expect our working capital requirements and the cash flow provided by future operating activities, if any, to vary greatly from quarter to quarter, depending on the volume of business and competition in the markets we serve. We may seek additional funding through one or more credit facilities, if available, or through the sale of debt or additional equity securities. However, the terms of our June 3, 2011 private placement transaction place restrictions on our ability to consummate any such additional financing without the consent of the investor.  There is no assurance that the investor would consent to such a transaction or if funding of any type would be available to us, or that it would be available at rates and on terms and conditions that would be financially acceptable and viable to us in the long term. If we are unable to raise any necessary additional financing when needed, under the terms of our June 3, 2011 private placement or otherwise, we may be required to suspend operations, sell assets or enter into a merger or other combination with a third party, any of which could adversely affect the value of our common stock, or render it worthless. If we issue additional debt or equity securities, such securities may enjoy rights, privileges and priorities (including but not limited to coupon rates, conversion rights, rights to fixed or preferential dividends, anti-dilution rights or preference as to the distribution of assets upon a liquidation) superior to those enjoyed by holders of our common stock, thereby diluting the value of our common stock.

 
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We are increasingly dependent on technology in our operations, and if our technology fails or we are unable to continue to invest in new technology our business may be adversely affected.

We have become increasingly dependent on technology initiatives to enhance customer service in order to compete in the current business environment. The performance and reliability of the technology are critical to our ability to attract and retain customers and our ability to compete effectively. These initiatives will continue to require significant capital investments in our technology infrastructure. If we are unable to make these investments, our business and operations could be negatively affected.

In addition, any internal technology error or failure or large scale external interruption in technology infrastructure we depend on, such as power, telecommunications, or the Internet, may disrupt our technology network. Any individual, sustained or repeated failure of technology could impact our customer service and result in increased costs or lower sales. Our technology systems and related data may be vulnerable to a variety of sources of interruption due to events beyond our control, including natural disasters, terrorist attacks, telecommunications failures, computer viruses, hackers and other security issues. While we have in place, and continue to invest in, technology security initiatives and disaster recovery plans, these measures may not be adequate or implemented properly to prevent a business disruption and its adverse financial consequences to our business.

We rely solely on Suburban Air for our flight operations and compliance with Federal Aviation Administration (“FAA”) regulations.

Our flight operations are entirely managed by Suburban Air although we do not have a formal written agreement with Suburban Air . We are reliant upon Suburban Air to continue to operate and comply with the necessary FAA regulations and be able and willing to fly aircraft on our behalf as required by us . We believe that Suburban Air has additional aircraft that they could make available to us as we expand operations. There can be no assurance that such aircraft will be made available to us when required, that such aircraft will be adequate for transporting pets, or that such aircraft will be made available on economic terms favorable to us. While there are other operators we could engage for flight operations and FAA compliance, there can be no assurance that we will be able engage them on the same, or similar, terms as Suburban Air, and, accordingly, any interruption in our relationship with Suburban Air may have a material adverse effect on our business.

We do not carry business interruption or other insurance, so we have to bear losses ourselves.

We are subject to risk inherent to our business, including equipment failure, theft, natural disasters, industrial accidents, labor disturbances, business interruptions, property damage, product liability, personal injury and death. We do not carry any business interruption insurance or third-party liability insurance or other insurance to cover risks associated with our business. As a result, if we suffer losses, damages or liabilities, including those caused by natural disasters or other events beyond our control and we are unable to make a claim again a third party, we will be required to bear all such losses from our own funds, which could have a material adverse effect on our business, financial condition and results of operations.

 
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Our reputation and financial results could be affected in the event of an accident or incident involving our aircraft.

An accident or incident involving our aircraft could result in additional costs not covered by insurance, such as a decrease in our goodwill and significant litigation and related costs. More importantly, an accident or incident may cause the public to perceive our operation as unsafe or unreliable, particularly if such accident or incident results in harm to our pet passengers. If the public perceives that we are unsafe or unreliable, such perception will have a material adverse impact on our business.

Our quarterly operating results are likely to fluctuate, which may affect our stock price.

Our quarterly revenues, expenses, operating results and gross profit margins will vary from quarter to quarter, and may vary significantly. As a result, our operating results may fall below the expectations of third parties including securities analysts and investors, in some quarters, which could result in a decrease in the market price of our common shares. The reasons our quarterly results may fluctuate include:

variations in profit margins attributable to the utilization of our flights;
changes in the general competitive and economic conditions; and
the introduction of new services by us.

Period-to-period comparisons of our operating results should not be relied on as indications of future performance.
  
 
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RISKS ASSOCIATED WITH THE AIRLINE INDUSTRY

The airline industry tends to experience adverse financial results during general economic downturns, leading to significant trickle down effects for our sub-segment of the airline industry.

Since a substantial portion of airline travel is discretionary, the industry tends to experience a downturn in revenues during general economic downturns. Events beyond our control such as the economic downturn in 2008, can impact travel patterns for a significant amount of time, and thus have a material adverse effect on individual airlines and the industry as a whole.

The 2001 terrorist attacks, seriously harmed the airline industry, and the risk of additional attacks or wars, may harm the industry in the future.

Terrorist attacks and wars both negatively affect the airline industry. The impacts include substantial loss of bookings, increased security compliance costs, increased insurance costs, increased fuel costs and increased airport delays, all of which negatively affect airline revenues. We cannot predict the scope or effects of such incidents in the future as they relate to our success, and such incidents may have a material adverse effect on our operations.

The rapid spread of contagious illnesses can have a material adverse effect on our business and results of operations.

The rapid spread of a contagious illness, such as the H1N1 flu virus or SARS, can have a material adverse effect on the demand for worldwide air travel, and accordingly the demand for pet flight service, and therefore have a material adverse effect on our business and results of operations. Moreover, our operations could be negatively affected if employees are quarantined as of the result of exposure to a contagious illness. Similarly, travel restrictions or operational problems resulting from the rapid spread of contagious illnesses in any market in which we operate may have a material adverse impact on our business and results of operations.

The traditional commercial airline industry is subject to extensive government regulation, and new regulations may increase our operating costs.

Commercial airlines are subject to extensive regulatory and legal compliance requirements that can result in significant costs. For instance, the FAA from time to time issues directives and other regulations relating to the safeguard, maintenance and operation of aircraft that necessitate significant expenditures. Other laws, regulations, taxes and airport rates and charges have also been imposed from time to time that significantly increase the cost of airline operations or reduce revenues. We have a verbal agreement with Suburban Air who operate the aircraft on our behalf and charge us for these operations on a weekly basis. If these changes in regulations impact Suburban Air, we expect that they will pass on any costs associated with the compliance of regulatory changes to us. We in turn may not be able to offset any cost increases with increases in revenue that would result in an increase in our gross margin loss.

 
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Future regulatory action concerning climate change and aircraft emissions could have a significant effect on the airline industry. For example, the European Commission has adopted an emissions trading scheme applicable to all flights operating in the European Union, including flights to and from the United States. Such a system could impose significant costs if we expand our services to Europe. Other laws or regulations such as the European emissions trading scheme or other U.S. or foreign governmental actions may adversely affect our operations and financial results, either through direct costs in our operations or through increases in costs for jet fuel that could result from jet fuel suppliers passing on increased costs that they incur under such a system.

Increased fuel costs or disruptions in fuel supply could have a material adverse effect on our business.

Fuel cost is, and will continue to be, a significant portion of our operating expense. Significant increases could harm our profitability if we are unsuccessful in passing along the increase onto our pet owners , for which the resulting increase in ticket prices may result in a decrease in demand for our services. Historically, fuel costs have fluctuated widely based on geopolitical issues and supply and demand. We cannot assure you that such significant fuel increases can be adequately offset by increasing fares or decreasing other operational costs.

Fuel prices could increase dramatically and supplies could be disrupted as a result of international political and economic circumstances, such as increasing international demand resulting from a global economic recovery, continued conflicts or instability in the Middle East or other oil producing regions and diplomatic tensions between the U.S. and oil producing nations, as well as OPEC production decisions, disruptions of oil imports, environmental concerns, weather, refinery outages or maintenance and other unpredictable events.

Further volatility in jet fuel prices or disruptions in fuel supplies, whether as a result of natural disasters or otherwise, could have a material adverse effect on our results of operations, financial condition and liquidity.

Our operations may be hindered due to inclement weather conditions.

Like all airline traffic, we cannot fly scheduled flights if weather conditions do not permit. One of the principles of our operations is to fly in weather that will not pose any undue risks to our employees or our pet passengers . In the event that the weather does not meet our minimum standards, we will be forced to cancel or delay flights, thus incurring certain additional costs, including, but not limited to, pet boarding costs, pet food costs and fuel costs that may have a material adverse effect on our business.

Our reputation and financial results could be effected in the event of an accident or incident in the airline industry.

An accident or incident in the airline industry may cause the public to perceive airline travel as unsafe. As a result, travel demand could decrease and we may suffer a material adverse effect to our business.

RISK RELATED TO FINANCING OUR OPERATIONS

Without obtaining adequate capital funding, we may not be able to continue as a going concern.

The reports of our independent registered public accounting firms for the years ended December 31, 2010 and 2009 contained an explanatory paragraph to reflect its significant doubt about our ability to continue as a going concern as a result of our history of losses and our liquidity position. If we are unable to obtain adequate capital funding in the future, we may not be able to continue as a going concern, which would have an adverse effect on our business and operations, and the value of your investment in us may materially decline. Our financial statements have been prepared in accordance with accounting principles generally accepted in the United States, which contemplate that we will continue to operate as a going concern. Our financial statements do not contain any adjustments that might result if we are unable to continue as a going concern. Substantial doubt about our ability to continue as a going concern may have created, or may create, negative reactions to the price of the common shares of our stock and we may have a more difficult time obtaining financing.

 
15

 

We have historically incurred losses and we expect these losses will continue in the future.

Since 2008, we have not been profitable. For the six months ended June 30, 2011 and year ended December 31, 2010, we sustained net losses before income taxes of $(16,040,519) and $(4,055,905), respectively, and our accumulated deficits as of June 30, 2011 and December 31, 2010, were $(22,105,528) and $(6,065,008), respectively. Future losses are likely to occur. Accordingly, we may experience significant liquidity and cash flow problems and additional operating losses if we are not able to raise additional capital as needed and on acceptable terms and, in such event, our operations may be reduced or curtailed.

If we are unable to raise additional capital to finance operations, our business operations will be curtailed.

Our operations have relied almost entirely on funding from a combination of borrowings from and sales of common and warrants to third parties. We will need to raise additional capital to fund our anticipated operating expenses and future expansion. Among other things, financing will be required to cover our operating and capital costs. The sale of our stock to raise capital may cause dilution to our existing stockholders. Our inability to obtain adequate financing, whether from current investors or from other third parties, would likely result in the need to reduce or curtail business operations. Any of these events would be materially harmful to our business and may result in a loss of your investment.

The issuance of shares upon conversion of convertible debentures, exercise of outstanding warrants and in lieu of payments of interest on convertible debentures may cause immediate and substantial dilution to our existing stockholders..

If the price per share of our common stock at the time of conversion of our debentures, exercise of any warrants or issuance of shares in lieu of payments of interest on our convertible debentures is in excess of the conversion or exercise prices of these securities, the conversion or exercise of these securities would have a dilutive effect on our common stock. As of September 30, 2011, an aggregate of 24,640,767 shares of our common stock are issuable upon conversion and/or exercise of outstanding convertible debentures and warrants consisting of : (i) outstanding 8% convertible debentures which are convertible into an aggregate of 950,000 shares of our common stock, (ii) outstanding 14% convertible debentures which are convertible into an aggregate of 875,000 shares of common stock, (iii) warrants to purchase an aggregate of 1,000,000 shares of common stock at an exercise price of $1.00 per share expiring August 13, 2015, (iv) warrants to purchase an aggregate of 875,000 shares of common stock at an exercise price of $0.50 per share expiring August 14, 2015, (v) 179,793 shares of common stock issuable in lieu of interest on 8% convertible debentures, (vi) 284,267 shares of common stock issuable in lieu of interest on 14% convertible debentures, (vi) warrants to purchase an aggregate of 20,476,707 shares of common stock at an exercise price of $1.02 per share expiring on June 3, 2016.

Following the conversion of our outstanding convertible debentures and exercise of outstanding warrants, our issued and outstanding common stock would increase to 66,695,728 shares, which represents an increase of approximately 51% over our current issued and outstanding shares of 44,054,961.

We may be subject to penalties if the registration statement of which this prospectus is a part s not declared effective in a timely manner, if we fail to maintain the effectiveness of the registration statement of which this prospectus is a part, or if we fail to file with the SEC any required reports under Section 13 of 15(d) of the Exchange Act of 1934, as amended.

The registration rights agreement contains certain payment requirements if the registration statement is not filed on or before June 20, 2011 or declared effective by the SEC by August 2, 2011. The registration statement was filed before the June 20, 2011 deadline however, it has yet to be declared effective. We have accrued but not paid penalties of approximately $42,000 through September 24, 2011. Additional payments will apply if we fail to maintain the effectiveness of the registration statement. In addition, we will also be liable for certain payments if a registration statement is not properly available for use for any reason and we fail to file with the SEC any required reports under Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended. Upon the occurrence of any of the aforementioned events, we will be obligated to pay to each holder of registrable securities an amount equal to 2% of the fair market value of the registrable securities on the date of occurrence of each such failure and every 30 days thereafter until such failure is cured.
 
We are not permitted to include any securities other than those issued or issuable to the investor in our June 2011 private placement until such time as all of the securities issued or issuable to the selling security holder are covered by one or more effective registration statements. This may significantly limit our ability to raise capital through future equity offerings.

The registration rights agreement prohibits us from including any securities other than those issued or issuable to the investor in our June 2011 private placement on any registration statement without the prior written consent of the accredited investor until such time   as all of the securities issued or issuable to the accredited investor are covered by one or more effective registration statements. Pursuant to the terms of the registration rights agreement, we are required to file three registration statements on behalf of the accredited investors. Once the registration statement, of which this prospectus forms a part, has been utilized for the disposition of 80% of the securities covered thereby, we are required to prepare and file a registration statement covering the sale of an additional 7,000,000 shares on behalf of the accredited investors. Once that registration statement has been utilized for the disposition of 80% of the securities covered by such registration statement, we are required to prepare and file a registration statement covering the remaining shares then held or issuable to the accredited investor. This may significantly limit our ability to raise capital through future equity financings as we will not be able to offer registration rights to other potential investors until we have satisfied our obligations under the registration rights agreement or unless the accredited investor waives its rights under the registration rights agreement.

RISKS RELATED TO THE MARKET FOR OUR STOCK GENERALLY

Our common stock is quoted on the OTCQB, which may have an unfavorable impact on our stock price and liquidity.

Our common stock is currently quoted on the OTCQB. The OTCQB market tier helps investors identify companies that are current in their reporting obligations with the Securities and Exchange Commission (the “SEC”). OTCQB securities are quoted on OTC Markets Group's quotation and trading system. The OTCQB is a significantly more limited market than established trading markets such as the New York Stock Exchange or NASDAQ. The quotation of our shares on the OTCQB may result in a less liquid market available for existing and potential stockholders to trade shares of our common stock, could depress the trading price of our common stock and could have a long-term adverse impact on our ability to raise capital in the future. We plan to list our common stock with NASDAQ or New York Stock Exchange or other exchanges as soon as practicable. However, we cannot assure you that we will be able to meet the initial listing standards of any stock exchange, or that we will be able to maintain any such listing.

We may be subject to penny stock regulations and restrictions and you may have difficulty selling shares of our common stock.

The SEC has adopted regulations which generally define so-called “penny stocks” to be an equity security that has a market price less than $5.00 per share or an exercise price of less than $5.00 per share, subject to certain exemptions. Our common stock is considered to be a “penny stock” and is subject to Rule 15g-9 under the Exchange Act, or the Penny Stock Rule. This rule imposes additional sales practice requirements on broker-dealers that sell such securities to persons other than established customers and “accredited investors”, as such term is defined in the Securities Act. For transactions covered by Penny Stock Rule, a broker-dealer must make a special suitability determination for the purchaser and have received the purchaser's written consent to the transaction prior to sale. As a result, this rule may affect the ability of broker-dealers to sell our securities and may affect the ability of purchasers to sell any of our securities in the secondary market, thus possibly making it more difficult for us to raise additional capital.

 
16

 

For any transaction involving a penny stock, unless exempt, the rules require delivery, prior to any transaction in penny stock, of a disclosure schedule required by the SEC relating to the penny stock market. Disclosure is also required to be made about sales commissions payable to both the broker-dealer and the registered representative and current quotations for the securities. Finally, monthly statements are required to be sent disclosing recent price information for the penny stock held in the account and information on the limited market in penny stock.

There can be no assurance that our common stock will qualify for exemption from the Penny Stock Rule. In any event, even if our common stock were exempt from the Penny Stock Rule, we would remain subject to Section 15(b)(6) of the Exchange Act, which gives the SEC the authority to restrict any person from participating in a distribution of penny stock, if the SEC finds that such a restriction would be in the public interest.

Our Series A Preferred Stock has a liquidation preference of $10,000 per share of Series A Preferred Stock, plus any accrued but unpaid dividends with respect to such shares of Series A Preferred Stock.

Upon any liquidation, dissolution or winding up of our Company after payment or provision for payment of our debts and other liabilities and any liquidation preferences of senior securities, before any distribution or payment may be made to the holders of any junior securities, including our common stock, the holders of our Series A Preferred Stock shall be entitled to a liquidation preference in the amount of $10,000 per share of Series A Preferred Stock plus any accrued but unpaid dividends. Dividends on our Series A Preferred Stock accrue at a rate of 10% per annum from the date of issuance and are payable upon redemption of the Series A Preferred Stock. If we were liquidated, the ability of our common stockholders to receive any distribution of payment would be significantly limited if there were then a significant amount of shares of Series A Preferred Stock outstanding.

We have never paid dividends on our common stock and we do not anticipate paying dividends in the foreseeable future.

We have never paid cash dividends on our common stock. So long as any shares of our Series A Preferred Stock are outstanding, no dividends or other distributions may be paid, declared or set apart with respect to any junior securities, including our common stock, other than dividends or other distributions payable on our common stock solely in the form of additional shares of common stock. Accordingly, investors must be prepared to rely on sales of their common stock after price appreciation to earn an investment return, which may never occur. Investors seeking cash dividends should not purchase our common stock.

Our controlling stockholders hold a significant percentage of our outstanding voting securities, which could hinder our ability to engage in significant corporate transactions without their approval.

Mr. Dan Wiesel and Ms. Alysa Binder are the beneficial owners of approximately 41% of our outstanding voting securities as of September 30, 2011. As a result, they possess significant influence, giving them the ability, among other things, to elect members of our board of directors and to authorize or prevent proposed significant corporate transactions. Their ownership and control may also have the effect of delaying or preventing a future change in control, impeding a merger, consolidation, takeover or other business combination or discourage a potential acquirer from making a tender offer. The interests of these two stockholders may not always coincide with the interests of other stockholders, and they may act in a manner that advances their best interests and not necessarily those of other stockholders, which may affect the market price for our securities.

 
17

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

Some of the information in this filing contains forward-looking statements that involve substantial risks and uncertainties. You can identify these statements by forward-looking words such as “may,” “will,” “expect,” “anticipate,” “believe,” “estimate” and “continue,” or similar words. You should read statements that contain these words carefully because they:
 
 
·
discuss our future expectations;

 
·
contain projections of our future results of operations or of our financial condition; and

 
·
state other “forward-looking” information.

We believe it is important to communicate our expectations. However, there may be events in the future that we are not able to accurately predict or over which we have no control. Our actual results and the timing of certain events could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth under “Risk Factors,” “Business” and elsewhere in this prospectus.

Overview

We are an airline designed specifically for the comfortable and safe transportation of pets. Pet owners can book their pets on flights online at our website or can book flights with our agents by phone. Flights can be booked up to three months before the scheduled departure date. Payment for the flights is made with credit card. On the day of the scheduled flight, pet owners drop off their pets at one of our airport facilities located at the departure airport. We place our pet passengers into a pet friendly carrier and then board the carrier into the main cabin of the airplane. Our pet passengers fly in the main cabin of our specially-outfitted aircraft rather than, as is the case for a traditional commercial airline, flying in the cargo bay or flying as carry-on baggage placed under a passenger’s seat. After drop off, pet owners can track flight progress through our website. Throughout the flight, we monitor the air quality and temperature of our aircraft ensuring that our pet passengers are safe and comfortable at all times. We have a pet attendant on each flight that is responsible for monitoring our pet passengers during the flight. Upon arrival at the destination airport, we unload our pet passengers from the plane directly into one of our airport facilities for pick up. As of June 30, 2011, we served nine markets in the U.S. and offer scheduled coast-to-coast service.

We do not own our aircraft. We have a relationship with Suburban Air based in Omaha, Nebraska who have two aircraft configured to carry our pets.  We rely on Suburban to provide the aircraft, pilot and ensure the aircraft complies with all appropriate FAA regulations. We currently fly one aircraft per week on our coast to coast service. There is no written contract with Suburban.

We believe that our service appeals to a wide market of pet owners, including, among others, vacationers, individuals who own multiple homes, and individuals relocating. Given our sensitivity to pet handling, we also believe that we appeal to breeders, pet rescue services and those traveling with their pets to pet shows.

Operational Metrics

The key operational metrics that we regularly monitor include approved credit card transactions, bookings of our pet passengers on our flights on a daily basis. By tracking the bookings, we can implement pricing strategies in order to maximize our flight revenues.

•           Our reservations employees track the number of incoming phone calls to both assist pet owners with reservations and answer any questions they may have. On a weekly basis we track flight bookings and expected revenues.
•           We have a weekly cash flow report that is used to review cash receipts against expenses along with projected cash inflows and outflows.
•           On a monthly basis, we review the income statement, balance sheet and cash flow against our operational plan highlighting any significant variances from plan.

 
18

 

Outlook

We believe that the market for our pet transportation service is large and continues to grow. The cost of aircraft operation, including pilot use and jet fuel, and the cost of airport facilities space, along with certain external conditions such as weather and government regulations, are all conditions which may affect our ability to execute our business plan. We believe that we are currently the only airline specifically designed for the comfortable, efficient transportation of pets and, as such, we do not believe we face any direct competition from other pet-only airlines. We do, however, face competition from other transportation providers and pet care services, including traditional commercial airlines, ground transportation services, pet concierge services, boarding facilities, and pet sitters. Some of these competitors have substantially greater market share and financial resources than us. We have found that certain potential customers view our small size and limited financial resources as a negative even if they prefer our services to those of our larger competitors. Based on our current revenues and the size of the pet transportation market, we believe we have a market share of less than 1 percent.

Our primary strategic objective is to strengthen our position in the market for pet travel and generate a substantial increase in revenue over the next 12 months. We plan to achieve this objective by continuing to enhance the value of our brand, increasing the number of cities that we service and the number of aircraft that we operate, and developing new services in our airport facilities. We believe that our near-term success will depend particularly on our ability to increase customer adoption of our pet transportation services. Since we have limited capital resources, we will need to closely manage our expenses and conserve our cash by continually monitoring any increase in expenses and reducing or eliminating unnecessary expenditures. We believe that key risks include overall economic conditions and the overall level of travel spending, economic and business conditions within our target customer sector, our ability to expand our services, both to additional cities and within the cities we already service, competitive factors in our industry, and our ability to raise the capital necessary to grow our business. Our prospects must be considered in light of the risks, expenses and difficulties encountered by companies at an early stage of development, particularly given that we operate in a niche market, that we have limited financial resources, and continue to face an uncertain economic environment. Accordingly, we may not be successful in addressing such risks and difficulties.

Critical Accounting Policies

The discussion and analysis of financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We continuously evaluate our estimates and judgments, including those related to revenue recognition, bad debts, impairment of intangible assets, income taxes, contingencies and litigation. Our estimates are based on historical experience and assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
 
Our Board of Directors has reviewed our related disclosures in our Form 10-K for the period ended December 31, 2010 and Form 10-Q for the period ended June 30, 2011 filed the SEC. We believe the following critical accounting policies, among others, affect our more significant judgments and estimates used in the preparation of our consolidated financial statements:
 
Revenue Recognition
 
We recognize revenue when the earning process is completed. In our business, the earning process is complete when the scheduled flight service, or a replacement flight service, purchased by the buyer has been delivered.  Revenue from tickets sold prior to schedule flights is initially recorded as unearned revenue, net of any discounts, and is recognized as revenue in the period when the scheduled service has been provided or offered to the buyer as agreed. In the ordinary course of our business, a portion of the tickets sold are sometimes not used by the buyer on the agreed date of the flight. In such cases, for a nominal change fee, we will issue to holders of unused tickets a “voucher” which stated value can be applied toward the purchase of a flight for up to one year. Accordingly, the change fee is earned when the voucher is issued and the stated voucher value remains unearned until recorded as revenue upon the earlier of the vouchers expiration date or delivery of the flight service that it was applied to. Tickets purchased for scheduled flights that are cancelled by the Company may be refunded or applied towards another flight at the buyer's request. Refunds processed are removed from unearned revenue.  Any inconvenience cost incurred by the Company for the benefit of the buyer is charged to cost of revenue when incurred.  Cancelled scheduled flights requiring refunds or additional costs to accommodate the buyer’s revised travel plans have not been a significant issue since resumption of flights in June 2010. Unearned revenue consists of tickets and vouchers for future scheduled flights that have not been completed or provided as agreed.
 
Derivative Liabilities
 
We have utilized convertible debentures with warrants to purchase shares of common stock to settle certain liabilities and fund operations resulting in the recording of a derivative liability. Current guidance for valuing and classifying transactions of this type include ASC 470-20 “Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement”),    “EITF No. 98-5, Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios" and EITF No. 00-27, “Application of Issue No. 98-5 to Certain Convertible Instruments.” Accordingly, we have used the Black-Scholes option-pricing model as our method of determining the fair value of the convertible debenture issued with a warrant.  The resulting calculation of the beneficial conversion feature (BCF) and warrant equity component are recorded to APIC with an offset discount to the principal value of the convertible debenture. We have used the effective yield interest method for amortizing the discount to interest expense over the maturity term of the convertible debenture. We record to interest expense the unamortized discount value associated with a debenture converted in a period.
 
Accruals for Contingent Liabilities
 
We make estimates of liabilities that arise from various contingencies for which values are not fully known at the date of the accrual or during the periodic financial planning and analysis cycle. These contingencies may include, but are not limited, to accruals for reserves for costs and awards involving legal settlements, cost associated with planned changes in workforce or operating levels, costs associated with reduced flight services from Suburban, the building out of leased premises, vacating leased premises or abandoning leased equipment, and costs involved with the discontinuance of a segment of a business. Events may occur that are resolved over a period of time or on a specific future date. Management makes estimates using the facts available of the probability of the outcomes and range of cost, if measureable, of these occurrences and charges them to expense in the appropriate periods. If the ultimate resolution of any event is different than management’s estimate caused by a change in facts or material operating assumptions, compensating entries to earnings may be required.
 
 
19

 

Equity-Based Compensation

We are using the Black-Scholes option-pricing model as our method of valuation for share-based awards (e.g., warrant to purchase shares of common stock) used to settle certain liabilities to non-employees. Our determination of fair value of share-based payment awards on the date of grant using the option-pricing model is affected by our equity price as well as assumptions regarding our expected equity price volatility over the term of the awards, the selection of a risk free interest rate, the ultimate disposition of the award and the impact of the award on earnings per share.  For example, in calculating the expected equity price volatility, we may consider using our historical experience only, our experience plus that of a publicly trade index volatility experience, or a blended volatility experience for public peer companies.  We also evaluate carefully the expected life term of an award though the vesting of awards to date have been immediate.  Finally, we attempt to use a risk free rate that is widely quoted and pertinent across a broad range of transactions.
 
20

 

Results of Operations

Three Months Ended June 30, 2011 compared to Three Months Ended June 30, 2010

   
For the Three Months Ended June 30,
   
2011 over 2010 Change
 
   
2011
   
2010
   
$
   
%
 
   
(Unaudited)
             
Revenue
  $ 519273       100 %   $ 252,933       100 %   $ 226,340       105 %
Cost of revenue
    566,525       109 %     283,016       112 %     283,509       100 %
Gross loss
    (47,252 )     -9 %     (30,083 )     -12 %     (17,169 )     57 %
                                                 
Operating expenses:
                                               
Sales, general and administration
    889,405       171 %     221,582       88 %     667,823       301 %
                                                 
Loss from operations
    (936,657 )     -180 %     (251,665 )     -99 %     (684,992 )     272 %
                                                 
Other income (expense):
                                               
Interest income
    2       0 %     4       0 %     (2 )     -50 %
Interest expense
    (77,625 )     -15 %     (5,752 )     -2 %     (71,873 )     *  
Loss on extinguishment of debt
    (571,122 )     -110 %     -       *       (571,122 )     *  
Warrant liability expense
    (12,839,860 )     *       -       *       (12,839,860 )     *  
Other income (expense), net
    (13,488,605 )     *       (5,748 )     -2 %     (13,482,857 )     *  
                                                 
Loss before income taxes
    (14,425,262 )     *       (257,413 )     -102 %     (14,167,849 )     *  
(Provision) benefit for income taxes
    -       -       -       -       -       -  
                                                 
Net loss
  $ (14,425,262 )     *     $ (257,413 )     -102 %   $ (14,167,849 )     *  
 

 
* Percentage change is not meaningful.

Revenue

Revenue increased $266,340 or 105%, to $519,273   for the three months ended June 30, 2011 compared to $252,933 for the three months ended June 30, 2010. The increase is due to higher ticket sales and the number of pets being flown aboard our aircraft driven by approximately 12 weeks of flying in the 2011 period compared to five weeks of flying in the 2010 period which included the temporary suspension of flight operations starting March 2010 and ending June 2010 to rebuild the reservation system and raise additional capital.

Cost of Revenue

Cost of revenue increased $283,509, or 100%, to $566,525 for the three months ended June 30, 2011 compared to $283,016 for the three months ended June 30, 2010. The increase is primarily the result of approximately 13 weeks of flight operations in the 2011 period compared to five weeks of flying in the 2010 period which included the temporary suspension of flight operations starting March 2010 and ending June 2010 to rebuild the reservation system and raise additional capital.

Gross Loss

Gross loss for the three months ended June 30, 2011 was $(47,252), an increase loss of $(17,169) over the same period in 2010. The gross loss increase is due to operating 7 more flights in the 2011 period compared to reduced flights in the 2010 period caused by the temporary suspension of flight operations starting March 2010 and ending in June 2010.

 
Operating Expenses
 
Operating expenses increased $667,823 or 301%, to $889, 405 for the three months ended June 30, 2011 compared to $221,582 for the three months ended June 30, 2010. The operating expense increase is primarily due to higher compensation costs from increased staffing levels, occupancy expenses for airport facilities and administrative offices, ongoing professional, legal and accounting costs for financing and reporting and, to a lesser extent, aggregate spending associated with information systems, customer acquisition and related marketing expenses. In March 2010, business operations were suspended until June 2010 pending the receipt of additional financing. During this period, operating expenses were curtailed by reductions in staffing, compensation and related expenses and restriction on spending for all but essential discretionary items.
 
Other Income (Expense)
 
Other income (expense), net increased by $(13.5 million) to $(13.5 million) for the three months ended June 30, 2011 due to a derivative warrant valuation expense of $(12.8 million) and $(571,122) on the loss on the extinguishment of the $250,000 debenture, amortization of $(47,443) in debt discount to interest expense resulting from convertible debentures and interest payable on the outstanding debentures settled in shares of common stock in lieu of cash.
 
(Provision)Benefit for Income Taxes
 
We have provided a full valuation allowance on our net deferred tax asset as net operating losses are anticipated for the year ended December 31, 2011.
 
Net Loss
 
Net loss for the three months ended June 30, 2011 was $(14.4 million) or $(14.2 million) higher than the net loss of $(257,413) for the three months ended June 30, 2010. The increase in net loss is primarily due to an increase in gross loss, operating expenses, a derivative warrant valuation expense of $(12.8 million), the $(571,122) net loss on the extinguishment of the $250,000 debenture in the period, the amortization of $(47,443) of debt discount to interest expense and interest payable on the outstanding convertible debentures settled in shares of common stock in lieu of cash.
 
 
22

 
 
Six Months Ended June 30, 2011 compared to Six Months Ended June 30, 2010

   
For the Six Months Ended June 30,
   
2011 over 2011 Change
 
   
2011
   
2010
   
$
   
%
 
Revenue
  $ 911,759       100 %   $ 516,537       100 %   $ 395,222       77 %
Cost of revenue
    1,166,453       128 %     573,606       111 %     592,847       103 %
Gross loss
    (254,694 )     -28 %     (57,069 )     -11 %     (197,625 )     346 %
                                                 
Operating expenses:
                                               
Sales, general and administration
    1,887,870       207 %     412,165       80 %     1,475,705       358 %
                                                 
Loss from operations
    (2,142,564 )     -235 %     (469,234 )     -91 %     (1,673,330 )     357 %
                                                 
Other income (expense):
                                               
Interest income
    4       0 %     179       0 %     (175 )     -98 %
Interest expense
    (486,977 )     -53 %     (6,767 )     -1 %     (480,210 )     *  
Loss on extinguishment of   debt
    (571,122 )     -63 %     -       *       (571,122 )     *  
Warrant liability expense
    (12,839,860 )     *       -       *       (12,839,860 )     *  
Other income (expense), net
    (13,897,955 )     *       (6,588 )     -1 %     (13,891,367 )     *  
                                                 
Loss before income taxes
    (16,040,519 )     *       (475,822 )     -92 %     (15,564,697 )     *  
(Provision) benefit for income taxes
    -       *       -       *       -       *  
                                                 
Net loss
  $ (16,040,519 )     *     $ (475,822 )     -92 %   $ (15,564,697 )     *  

*
Percent change is not meaningful.

Revenue

Revenue increased $395,222 or 77%, to $911,759 for the six months ended June 30, 2011 compared to   $516,537 for the six months ended June 30, 2010. The increase is due primarily to increased ticket sales and the number of pets flown aboard our aircraft driven largely by flying for approximately 25 weeks during the 2011 period compared to 13 weeks during the 2010 period, which included the temporary suspension of flight operations starting March 2010 and ending June 2010 to rebuild the reservation system and raise additional capital.

Cost of Revenue

Cost of revenue increased $592,847, or 103%, to $1,166,453 for the six months ended June 30, 2011 compared to $573,606 for the six months ended June 30, 2010. The increase is primarily the result of approximately 25 weeks of flight operations for the 2011 period, compared to seven weeks of flight operations for the 2010 period which included the temporary suspension of flight operations starting March 2010 and ending June 2010 to rebuild the reservation system and raise additional capital.

Gross Loss

Gross loss for the six months ended June 30, 2011 was $(254,694) compared to a loss of $(57,069) from the same period in 2010. The gross loss increase is due to operating 12 more flights in the 2011 period compared to reduced flights in the 2010 period caused by the temporary suspension of flight operations starting March 2010 and ending in June 2010.
Operating Expenses

Operating expenses increased $1,475, 705 or 358%, to $1,887, 870 for the six months ended June 30, 2011 compared to $412,165 for the six months ended June 30, 2010. This increase is primarily due to higher compensation costs from increased staffing levels to support operations, occupancy costs, professional expenses for financing activities, public company reporting and, to a lesser extent, aggregate spending associated with marketing activities, travel and information systems support. In March 2010, flight operations were suspended until early June 2010 pending the receipt of financing. During this period, operating expenses were curtailed by reductions in staffing, compensation and related expenses and restriction on spending for all but essential discretionary items.

Other Income (Expense)

Other income (expense), net increased by $(13.9 million) to $(13.9 million) for the six months ended June 30, 2011 due to a derivative warrant valuation expense of $(12.8 million), $(571,122) on the loss on the extinguishment of the $250,000 debenture, debt discount amortization of $(80,913) and accelerated amortization of $(325,399) debt discount to interest expense resulting from the conversion of aggregate $525,000 principal amount convertible debentures and interest payable on the outstanding convertible debentures settled in shares of common stock in lieu of cash.

 
23

 

(Provision)Benefit for Income Taxes

We have provided a full valuation allowance on our net deferred tax asset as net operating losses are anticipated for the year ended December 31, 2011.

Net Loss

Net loss for the six months ended June 30, 2011 was $(16.0 million) or $(15.6 million) higher than the net loss of $(475,822) for the six months ended June 30, 2010. The increase in net loss is primarily due to higher gross loss, operating expenses, a derivative warrant valuation expense of $(12.8 million), the $(571,122) loss on the extinguishment of the $250,000 debenture in the period, the amortization and accelerated amortization of $(406,312) of debt discount to interest expense and interest payable on the outstanding convertible debentures settled in shares of common stock in lieu of cash.

Liquidity and Capital Resources

At June 30, 2011, we had $102,436 in cash and cash equivalents as compared to $1,511,057 in cash and cash equivalents at December 31, 2010.

Net cash used in operating activities was $1,820,968 and $258,301 for the six months ended June 30, 2011 and 2010, respectively. The cash use for the 2011 period is due primarily to net loss resulting from flight operations for the 2011 period and the reduction of payable balances offset by the non-cash charges from the loss on the extinguishment of the $250,000 debentures, amortization and write off of the derivative liability debt discount and settlement of liabilities with equity to non-employees.

Net cash used in investing activities was $87,653 and $13,000 during the six months ended June 30, 2011 and 2010, respectively. The cash used for the 2011 period is due primarily to upgrades to the reservation system enhancements and additions to office furnishings and the build out for the San Jose administrative offices and airport facilities, respectively.

Net cash provided by financing activities was $500,000 and $750,000 during the six months ended June 30, 2011 and 2010, respectively. The cash provided for the 2011 period is due to proceeds of the issuance of 2,253,470 shares of common stock for $500,000 from the Socius CG II, Ltd. financing (See Socius CG II, Ltd. Agreement below).

We did not have any material non-cancelable purchase commitments for capital expenditures or contingencies out of the ordinary course of business accrued at June 30, 2011.

 
24

 
 
Socius CG II, Ltd. Agreement

On June 3, 2011, we entered into a Securities Purchase Agreement (the “Purchase Agreement”) with an accredited investor, pursuant to which we secured $500,000 of immediate funding through the issuance and sale to accredited investor of 2,253,470 shares of the Company’s common stock (such shares being the “Initial Purchase Shares” and such purchase being the “Initial Purchase”). In connection therewith, (i) we also issued to accredited investor a warrant to purchase up to 20,476,707 shares of our common stock, and (ii) accredited investor agreed to purchase from the Company up to $5.0 million (the “Aggregate Preferred Stock Purchase Price”) of our newly created perpetual and non-convertible Series A Preferred Stock (the “Preferred Stock”), at a price per share of $10,000, in one or more tranches (each a “Preferred Tranche”).  The Preferred Stock participates with the common stock in any dividends or distributions or change of control transactions as further described herein.  In connection with the Purchase Agreement, we also agreed to issue an additional 1,126,735 shares of common stock to accredited investor on the 75 day anniversary of the Initial Purchase as consideration for executing and delivering the Purchase Agreement (the “Commitment Shares”). The Commitment Shares shall not be issued to accredited investor and shall be held in abeyance (and accredited investor shall not have the right to, or be deemed to have, beneficial ownership of such Commitment Shares) to the extent that such issuance would result in accredited investor and its affiliates owning or being deemed the beneficial owner of more than 9.99% of the then issued and outstanding common stock.  The warrant also does not permit issuance of common stock thereunder to the extent that such issuance would result in accredited investor and its affiliates owning or being deemed the beneficial owner of more than 9.99% of the then issued and outstanding common stock.  All of the foregoing was effectuated without registration under the Securities Act, in reliance upon an exemption from registration provided by Section 4(2) under the Securities Act and Rule 506 of Regulation D promulgated thereunder. These securities may not be transferred or sold absent registration under the Securities Act or an applicable exemption therefrom.

Under the terms and subject to the conditions of the Purchase Agreement, from time to time over the two-years following the Initial Purchase, beginning on August 17, 2011, at the Company’s sole discretion, the Company may sell to the accredited investor, and the accredited investor will be obligated to purchase, shares of the Preferred Stock.  In order to effectuate such a sale, the Company will issue to the accredited investor, subject to the terms and conditions of the Purchase Agreement (all of which conditions are outside of the accredited investor’s control) one or more Preferred Tranche notices to purchase a certain dollar amount of such Preferred Stock (each such notice, a “Preferred Notice”).  Upon receipt of a Preferred Notice, the accredited investor will be obligated, subject to the terms and conditions specified in the Purchase Agreement (which conditions are outside of the accredited investor’s control), to purchase the Preferred Stock subject to such Preferred Notice on the 10 th trading day after the date of the Preferred Notice.  Such conditions include, but are not limited to, the following: (i) the Common Stock must be listed for trading or quoted on a trading exchange or market, (ii) the representations and warranties of the Company set forth in the Purchase Agreement must be true and correct as if made on the date of each Preferred Notice (subject, however, to the Company’s ability to update disclosure exceptions to such representations and warranties through the Company’s SEC reports), (iii) the Company must not be in breach or default of the Purchase Agreement or any agreement entered into in connection therewith (the “Transaction Documents”), or any other material agreement of the Company, (iv) there shall have occurred no material adverse effect involving the Company or its business, operations or financial condition since the date of the Initial Purchase, (v) the absence of any law or judicial action prohibiting the transactions contemplated by the Purchase Agreement, or any lawsuit seeking to prohibit or adversely affect such transactions, and (vi) all necessary governmental, regulatory or third party approvals and consents must have been obtained. The maximum amount of each Preferred Tranche is limited to a dollar amount of Preferred Stock equal to the lesser of (a) 20% of the cumulative dollar trading volume of the Common Stock for the 10 trading day-period immediately preceding the applicable Preferred Notice date and (b) $5.0 million less the amount of any previously noticed and funded Preferred Tranches. In addition, each Preferred Notice after the first Preferred Notice may not be given sooner than the trading day after the date on which the closing for the prior Preferred Tranche has occurred.

On June 3, 2011, in connection with our private placement transaction, we issued to the investor a five-year warrant to purchase up to 20,476,707 shares of Common Stock at an initial Exercise Price of $1.02 per share (the “Original Exercise Price”). The warrant is also exercisable on a cashless basis or through the issuance by the holder of a secured promissory note. Any secured promissory note issued in connection with an exercise of the warrant shall bear interest at 2% per year calculated on a simple interest basis. The entire principal balance and interest thereon shall be due and payable on the fourth anniversary of the date of the secured promissory note. Any such secured promissory note shall be secured by the borrower’s right, title and interest in certain securities held in the portfolio of the borrower with a fair market value equal to the principal amount of the secured promissory note. Additionally, any portion of the warrant may also be exchanged for shares of common stock based on a Black-Scholes calculation as more fully set forth in the warrant. The warrant contains certain provisions that protect against dilution in certain events such as stock dividends, stock splits and other similar events. In addition, the warrant has price-based anti-dilution protection in the event the Company issues securities at a value less than the Original Exercise Price, meaning the exercise price of the warrant would be adjusted down to the lowest applicable issuance price following the issuance of the warrant to prevent dilution to the holder.  Pursuant to the warrant, any such anti-dilution adjustments shall be made on a pro-rata basis until such time as the Company has made dilutive issuances which exceed $5.0 million. The warrant shall not be exercisable or exchangeable by the holder (or any future holder) to the extent the holder (or such future holder) or any of its affiliates would beneficially own in excess of 9.9% of the Common Stock as a result of such exercise or exchange.

In connection with the above transaction, the Company recorded a net charge to operations of $12,839,860, which represents $13,863,695, the value of the warrants on June 3, 2011, less an adjustment of $1,023,835 to reflect the value of the derivative warrant liability on June 30, 2011.

 
25

 

Non-Cash Expense Items

During the three and six months ended June 30, 2011, we continued to minimize cash usage and seek out additional equity financings for working capital purposes while using equity for the settlement of services rendered in lieu of cash and general corporate purposes. We also issued shares of common stock in lieu of cash for interest payments on debentures. A significant portion of the equity issuances resulted in non-cash settlements of liabilities that are included in the net loss for the three and six months ended June 30, 2011. Additionally, other transactions and events occurred in which significant non-cash expense arose due to the nature of those occurrences.

The following table summarizes the non-cash expense items, total amount and percentage of our net loss for the three and six months ended June 30, 2011 and 2010:

   
Three Months Ended June 30,
   
Six Months Ended June 30,
 
Cash and non-cash items in Net loss:
 
2011
   
%
   
2010
   
%
   
2011
   
%
   
2010
   
%
 
Cash
  $ (847,327 )     5.9 %   $ (44,733 )     17.4 %   $ (1,953,375 )     12.2 %   $ (245,402 )     51.6 %
Non-cash
    (13,577,935 )     94.1 %     (212,680 )     82.6 %     (14,087,144 )     87.8 %     (230,420 )     48.4 %
Net loss
  $ (14,425,262 )     100.0 %   $ (257,413 )     100.0 %   $ (16,040,519 )     100.0 %   $ (475,822 )     100.0 %
                                                                 
Summary of non-cash items:
    2011               2010               2011               2010          
Derivative warrant valuation expense, net
  $ (12,839,860 )           $ -             $ (12,839,860 )           $ -          
Loss on extinguishment of 14% debenture
    (571,122 )             -               (571,122 )             -          
Accelerated amortization of debt discount from conversion of debenture
    -               -               (325,399 )             -          
Warrants issued for services rendered by non-employees
    (30,000 )             -               (169,062 )             -          
Amortization of debt discount
    (47,443 )             -               (80,913 )             -          
Common shares issued for interest payable in lieu of cash
    (73,442 )             -               (73,442 )             -          
Depreciation and amortization
    (16,068 )             -               (27,346 )             (3,923 )        
Common shares issued for services rendered by non-employees
    -               (96,580 )             -               (97,431 )        
Common shares issued in lieu of cash to employees
    -               (116,100 )             -               (129,066 )        
Total non-cash
  $ (13,577,935 )           $ (212,680 )           $ (14,087,144 )           $ (230,420 )        
                                                                 
Non-cash dilutive per share amount
  $ (0.33 )           $ (0.01 )           $ (0.35 )           $ (0.01 )        
 
 
26

 

Year Ended December 31, 2010 compared to Year Ended December 31, 2009

The following table sets forth, certain statement of operations data relating to the business for the periods indicated.
 
   
For the Years Ended December 31,
   
2010 over 2009
 
   
2010
   
2009
   
$
   
%
 
                               
Revenue
  $ 1,348,491       100 %   $ 628,829       100 %   $ 719,662       114 %
Cost of revenue
    1,588,693       118 %     890,005       142 %     698,688       79 %
Gross loss
    (240,202 )     -18 %     (261,176 )     -42 %     20,974       -8 %
                                                 
Operating expenses:
                                               
Sales, general and administration
    3,560,555       264 %     959,504       153 %     2,601,051       271 %
                                                 
Loss from operations
    (3,800,757 )     -282 %     (1,220,680 )     -194 %     (2,580,077 )     211 %
                                                 
Other income (expense):
                                               
Interest income
    185       0 %     1,973       0 %     (1,788 )     -91 %
Interest expense
    (255,333 )     -19 %     -       -       (255,333 )     *  
Other income (expense), net
    (255,148 )     -19 %     1,973       0 %     (257,121 )     *  
                                                 
Loss before income taxes
    (4,055,905 )     -301 %     (1,218,707 )     -194 %     (2,837,198 )     233 %
(Provision) benefit for income taxes
    -       -       -       -       -       -  
                                                 
Net loss
  $ (4,055,905 )     -301 %   $ (1,218,707 )     -194 %   $ (2,837,198 )     233 %
  

 
* Percentage change is not meaningful.

Revenue. Revenue for the year ended December 31, 2010 was $1,348,491 compared to $628,829 for the year ended December 31, 2009, or an increase of 114%. The increase is due to a significant increase in the number of our pet passengers flown as well as a higher average ticket price in 2010 compared to 2009. We commenced flight operations in June 2009 and continued flight operations until February 2010. From March 2010 to early June 2010, we ceased flight operations to allow us to rebuild our web site reservation system and raise additional capital. We resumed full flight operations at the end of June 2010 and continued uninterrupted scheduled flights through the remainder of the year.

Cost of revenue. Cost of revenue increased 79% to $1,588,693 (118% of revenue) for the year ended December 31, 2010 compared to $890,005 (142% of revenue) for the year ended December 31, 2009. Cost of revenue includes the costs of the aircraft and pilot contracted from Suburban Air, the cost of fuel, credit card charges and pet handling costs. The increase is primarily due to the increase in the number of flights in 2010 resulting in greater aircraft usage and pilot contract cost, higher prices for aircraft fuel and fuel consumption and the increase in credit card processing fees for tickets purchased on our web-site.

Gross loss. Our cost of revenue has been consistently greater than our revenue, resulting in a gross loss, for the years ended December 31, 2010 and 2009. Gross loss for the year ended December 31, 2010, decreased $20,974 to $(240,202). This improvement in gross loss is due primarily to the higher levels of revenue resulting from improved increase number of our pet passengers and flights in 2010. Although we have seen an improvement in our gross margins we have significant fixed cost made up of the cost of the aircraft, pilot and fuel costs we pay to Suburban Air. It will be difficult to cover these fixed costs unless we can expand the number of cities and increase the number of destinations available to our customers. As a commercial airline, we have a policy of flying the scheduled routes regardless of the utilization which means some flights will fail to cover the fixed cost base.

Operating expenses. Operating expenses for the year ended December 31, 2010 consisted mainly of payroll costs, lounge rental costs, non-cash equity-based compensation, professional fees, and outside services. The operating expenses for the year 2010 were $3,560,555 compared to $959,504 for 2009. The increase is due to higher payroll costs, an increase in non-cash equity-based compensation expenses and costs associated with external services during the year.

 
27

 

Other income (expense), net. The other income (expense) represents the interest income earned on excess cash invested in money market and interest earning deposit accounts at a FDIC insured financial institution, interest expense payable in cash or shares of common stock recorded on the outstanding $250,000 face amount, 14% convertible debenture and $1,000,000 aggregate face amount, 8% convertible debentures (“debentures”) at year end and amortization expense of the derivative liability discount. Interest income decreased to $185 in 2010 from $1,973 in 2009 due to a lower weighted average cash and cash equivalent balance during the year. Interest expense increased to $(255,333) in 2010 primarily due to the accrued interest of $(157,062) on the debentures issued in 2010 and $(94,324) of derivative liability discount amortization.

  Non-Cash Expense Items

During 2010, we have entered into a number of equity financings for working capital purposes, the settlement of services rendered in lieu of cash and general corporate purposes. We also issued unsecured, convertible debentures (“debentures”) with interest payable in shares of common stock. A significant portion of the issuances resulted in non-cash settlements of liabilities that are included in the net loss for the year at December 31, 2010 ($1,550,211 or 38% of net loss). Additionally, other transactions and events occurred in which significant non-cash expense arose due to the nature of those occurrences.

The following tables summarize the non-cash expense items, total amount and percentage of our net loss for the years ended December 31, 2010 and 2009:
 
     
For the Years Ended December 31,
 
   
2010
   
%
   
2009
   
%
 
Cash and non-cash expenses in Net loss:
                       
Cash expense
  $ (2,505,694 )     62 %   $ (1,209,500 )     99 %
Non-cash expense
    (1,550,211 )     38 %     (9,207 )     1 %
Net loss
  $ (4,055,905 )     100 %   $ (1,218,707 )     100 %

   
For the Years Ended December 31,
 
   
2010
   
2009
 
Summary of non-cash expense items:
           
Warrants issued for services rendered by non-employees
  $ (885,000 )   $ -  
Common shares issued for services rendered by non-employees
    (247,432 )     -  
Common shares issued in lieu of cash compensation to employees
    (129,065 )     -  
Common shares to be issued for accrued interest due on debentures
    (157,062 )     -  
Derivative liability discount amortization
    (94,324 )     -  
Loss on write off of intangibles
    (11,600 )     -  
Depreciation and amortization on property and equipment
    (25,728 )     (9,207 )
Total non-cash expense
  $ (1,550,211 )   $ (9,207 )
 
 
28

 

Liquidity and Capital Resources
 
   
For the Years Ended December 31,
 
   
2010
   
2009
 
Net cash used by operating activities:
  $ (2,082,243 )   $ (1,045,309 )
                 
Net cash used by investing activities:
  $ (97,956 )   $ (61,166 )
                 
Net cash provided by investing activities:
  $ 3,520,000     $ 1,185,500  

For the years ended December 31, 2010 and 2009, we incurred losses from operations of $(3,800,757) and $(1,220,680), respectively. Since inception, we have financed our operations and capital expenditures through private sales of equity securities, existing cash balances and cash generated from operations. We had $1,511,057 of cash and cash equivalents on hand at December 31, 2010.

Net cash used in operating activities for the year ended December 31, 2010 was $(2,082,243) compared to $(1,045,309) for the year ended December 31, 2009. Cash used in 2010 operations consisted primarily of funding scheduled flight operations, administration expenses, public company costs and a portion of the net loss for 2010. Cash used in 2009 operations consisted primarily of funding the ramp up of flight operations, administration cost and a portion of the net loss for 2009.

Net cash used in investing activities for the year ended December 31, 2010 was $(97,956) compared to $(61,166) for the year ended December 31, 2009. The use of cash in investing activities for both years was primarily for purchases of property and equipment, web site and on-line reservation system development and the further build-out of our airport facilities.
 
Net cash provided by financing activities for the year ended December 31, 2010 was $3,520,000 compared to $1,185,500 for the year ended December 31, 2009. The cash provided in 2010 was from completing a $1,250,000 unsecured, convertible debenture financing with a group of investors and proceeds from the private placement sale of $2,270,000 in common stock. The cash provided in 2009 was primarily from the sale of $1,195,500 in membership units (converted into no par value common stock shares, and paid-in capital as a result of the Acquisition).

Financings

During the months of June and August 2010, we entered into convertible debenture financing agreements for a $250,000 face amount, 14% convertible debenture due in June 2011 and $1,000,000 aggregate face amount, 8% convertible debentures due August 2013, with a carrying value of $304,193 net of the unamortized derivative discount of $695,807, respectively. The debentures are convertible at various conversion rates into shares of our common stock. The interest accrued is payable in cash or common stock at our option. The amount of accrued interest based on electing the payment in common stock option was $157,062 at December 31, 2010.

During the quarter ended September 30, 2010, we sold an aggregate of 1,184,831 shares of common stock to investors for total proceeds of $270,000 at an average price of approximately $0.23 per share.

During the quarter ended December 31, 2010, we sold an aggregate of 4,000,000 shares of our common stock at a price of $0.50 per share for gross cash proceeds of $2,000,000 to the Daniel T. Zagorin Trust. The closing market price on the stock on November 3, 2010 was $2.25. The foregoing securities were sold pursuant to Section 4(2) and Regulation D under the Securities Act of 1933, as amended, and have not been registered in the United States under the Securities Act or in any other jurisdiction and may not be offered or sold in the United States absent registration or an applicable exemption from the registration requirements.

 
29

 

While we have been able to manage our working capital and capital expenditure needs with the current cash and equity or debt financings, additional financing is required in order to meet our current and projected cash flow requirements from operations. Based on our current cash position, projected cash receipts, expenditures and level of operations, we believe we need to raise additional funds or renegotiate existing financing facilities in order to support our operations for the next twelve months. The amount of funding required will be determined by many factors, some of which are beyond our control, and we may require funding sooner than currently anticipated or to cover unforeseen expenses. We anticipate securing any additional funding through the issuance of debt or equity securities or through renegotiation of existing financing facilities. The sale of additional common stock, preferred stock or convertible equity or debt will result in dilution to our stockholders. We have no commitment for any additional financing and we can provide no assurance that such financing will be available in an amount or on terms acceptable to us, if at all. If we are unable to obtain additional funds when they are needed or if such funds cannot be obtained on terms favorable to us or if we are unable to renegotiate existing financing facilities, we may be required to delay or scale back our operations, which could delay development and adversely affect our ability to generate future revenues.

We cannot guarantee that we will be able to obtain such financing from available sources or on acceptable terms. Financing transactions may include the issuance of equity or debt securities, obtaining credit facilities, or other financing mechanisms. However, the trading price of our common stock and any further downturn in the U.S. stock and debt markets could make it more difficult to obtain financing through the issuance of equity or debt securities. Even if we are able to raise the funds required, it is possible that we could incur unexpected costs and expenses, fail to collect significant amounts owed to us, or experience unexpected cash requirements that would force us to seek alternative financing. Further, if we issue additional equity or debt securities, stockholders may experience additional dilution or the new equity securities may have rights, preferences or privileges senior to those of existing holders of our common stock.

Our registered independent certified public accountants have stated in their report dated March 24, 2011 that we have incurred operating losses in the last two years, and that we are dependent upon management’s ability to develop profitable operations. These factors among others may raise substantial doubt about our ability to continue as a going concern.

Off-Balance Sheet Arrangements

As of June 30, 2011 and December 31, 2010, we did not have any relationships with unconsolidated entities or financial partners, such as entities often referred to as structured finance or special purpose entities that had been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As such, we are not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships.

Inflation

In the opinion of management, inflation will not have a material impact on our financial condition and results of our operations.

 Related Party Transactions

Fees totaled $204,483, $380,000 and $240,839, for the six months ended June 30, 2011 and years ended December 31, 2010 and 2009, respectively, paid to Mr. Daniel Wiesel, our Chairman and Chief Executive Officer and Ms. Alysa Binder, our Executive Vice President and Director, for consulting, development and strategic advisory services.

In November 2010, we issued to the Daniel T. Zagorin Trust 4,000,000 shares of common stock at a price of $0.50 per share for gross proceeds of $2,000,000. The shares were issued pursuant to the exemption from registration provided by Section 4(2) of the Securities Act of 1933, as amended.

 Contractual Obligations and Commitments

The Company did not have any non-cancellable purchase obligations or commitments at June 30, 2011.

Operating Lease Commitments

The Company had one lease agreement with a term in excess of one year at June 30, 2011. Future minimum lease payments under non-cancelable operating leases with initial or remaining terms in excess of one year at June 30, 2011, were:
 
Period Ended June 30,
 
Operating Leases
 
2011
  $ 60,000  
2012
    60,000  
2013
    25,000  
2014
    -  
2015
    -  
Thereafter
    -  
Total minimum lease payments
  $ 145,000  

Employment Agreements

The Company had no employment agreements at June 30, 2011.

 
30

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

The following table sets forth information regarding beneficial ownership of our common stock as of September 30, 2011 (i) by each person who is known by us to beneficially own more than 5% of our common stock; (ii) by each of our officers and directors; and (iii) by all of our officers and directors as a group. Unless otherwise specified, the address of each of the persons set forth below is in care of The PAWS Pet Company, Inc., 2001 Gateway Place, Suite 410, San Jose, CA 95110.
 
   
Amount and
       
   
Nature of
   
Percent
 
   
Beneficial
   
of
 
Name Beneficial Owner
 
Ownership (1)
   
Class (2)
 
Officers and Directors
           
Daniel Wiesel and Alysa Binder (3)
    17,123,273       38.87 %
Andrew C. Warner
    21,675       0.05 %
All officers and directors as a group (3 persons)
    17,144,948       38.92 %
                 
5% Security Holders
               
The Daniel T. Zagorin Trust (4)
    7,444,078       16.90 %
 
(1)
Beneficial Ownership is determined in accordance with the rules of the SEC and generally includes voting or investment power with respect to securities. Each of the beneficial owners listed above has direct ownership of and sole voting power and investment power with respect to the shares of our common stock.

(2)
A total of 44,054,961 shares of our common stock are considered to be outstanding pursuant to SEC Rule 13d-3(d) (1) as of September 30, 2011. For each beneficial owner above, any options exercisable within 60 days are included in the denominator.

(3)
Dan Wiesel and Alysa Binder are husband and wife and own their shares jointly with right of survivorship.

(3)
Daniel T. Zagorin has voting and dispositive control over the shares held by the Daniel T. Zagorin Trust.
 


 
31

 

MANAGEMENT

The following table sets forth the name, age and position of each of the Company's executive officers and directors were as follows:

Name
 
Age
 
Position
Dan Wiesel,
 
55
 
Chairman, Chief Executive Officer and Director
         
Andrew C. Warner,
 
48
 
President and Chief Financial Officer and Director
         
Alysa Binder,
 
47
 
Executive Vice President and Chief Development Officer and Director
         
Charles A. Lynch,
  
83
  
Director

Business Experience

Dan Wiesel co- founded Pet Airways in 2005 and has served as our Chairman of the Board and Chief Executive Officer since August 2009. Mr. Wiesel also served as President and Chief Financial Officer until January 2011.  From 1983 to 1985, Mr. Wiesel served as Vice President of Acquisitions for a national real estate investment company, where Mr. Wiesel was responsible for the negotiation and purchase of over $300 million in commercial real estate. Subsequently, in 1985 Mr. Wiesel founded The Wendemere Group, a real estate development firm, which built custom homes with a total value of more than $20 million. In 1990, Mr. Wiesel founded StitchIt Corporation, a manufacturer of women’s swimwear. In 1995, as principal of Interlink Recruiting, Mr. Wiesel was responsible for the creation of this boutique executive recruiting firm. Mr. Wiesel holds an MBA in Entrepreneurship from the University of Southern California and holds a private pilot’s license.  As a result of these and other professional experiences, Mr. Wiesel possesses particular knowledge and experience in business development, sales strategy and management that strengthen the board’s collective qualifications, skills, and experience.

Andrew C. Warner joined our Board of Directors in August 2010 and was appointed our President and Chief Financial Officer in January 2011. From 2009 to 2010, Mr. Warner served as Chief Financial Officer of EnergyConnect Group Inc.  Prior to that date, Mr. Warner was an independent consultant to emerging technology companies. From 2005 to 2007, Mr. Warner served as Chief Financial Officer of SmartDisk Corporation, a leading provider of storage solutions, which was sold to Verbatim in 2007. From 2003 to 2005, Mr. Warner was co-founder and Chief Executive Officer of Zio Corporation, a digital consumer electronics’ company sold to SmartDisk Corporation in 2005. From 1999 to 2003, Mr. Warner served as   Chief Financial Officer of SCM Microsystems, a publically held company in the security and consumer products market. Mr. Warner also served as Executive Vice President of the Consumer Products division as well as President of SCM Microsystems' North American operations. Prior to that, Mr. Warner held senior finance positions at Dazzle Inc. and Madge Networks N.V.  Mr. Warner is an Associate Member of the Chartered Institute of Management Accounts (UK) and holds a BA with honors from Humberside University. Mr. Warner possesses particular knowledge and experience in business development, sales strategy and management that strengthen the board’s collective qualifications, skills, and experience.

Alysa Binder is a co-founder of Pet Airways and has served as our Executive Vice President and Chief Development Officer since August 2009.  Ms. Binder began her career in the premium incentive industry, responsible for marketing and sales to large corporate customers. Ms. Binder later founded a retail jewelry operation, expanding the business to include custom creations for high-profile clients. In 1995, Ms. Binder founded Interlink Recruiting. Ms. Binder is Dan Wiesel’s wife. In 2005, Ms. Binder joined Dan in founding Pet Airways. As a result of these and other professional experiences, Ms. Binder possesses particular knowledge and experience in business development, strategic planning and marketing that strengthen the board’s collective qualifications, skills, and experience.

Charles A. Lynch has served as a member of our board of directors since March 2011.  Since 1989, Mr. Lynch has served as Chairman of Market Value Partners. Prior to joining the Company’s board of directors, from 2006 to 2009, Mr. Lynch served as Chairman of Corazonas Foods Inc.  Prior to that, from 2004 to 2008, Mr. Lynch was Chairman and Chief Executive Officer of nSpired Natural Foods.  Mr. Lynch graduated from Yale University with a Bachelors of Science in industrial administration and later received an honorary doctor of laws from Golden Gate University. Mr. Lynch is the former Chairman of The California Business Roundtable, the Palo Alto Medical Foundation, and the United Way of the Bay Area. As a result of these and other professional experiences, Mr. Lynch possesses particular knowledge and experience in board practices; international business and strategic planning that strengthen the board’s collective qualifications, skills, and experience.

 
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Directors serve at the discretion of the board of directors. Executive officers are elected by and serve at the discretion of the board of directors.

Family Relationships

Mr. Wiesel, our Chief Executive Officer and Chairman of our board of directors, and Ms. Binder, our Executive Vice President and a director, are currently married.

Audit Committee

Due to the size of our operation, members of the board of director’s serve collectively as the Audit Committee and have primary responsibility for monitoring the quality of internal financial controls and ensuring that the financial performance of our Company is properly measured and reported on. It receives and reviews reports from management and auditors relating to the annual, periodic and interim accounts and the accounting and internal control systems in use throughout our company.

Our Audit Committee also consults with our independent registered public accounting firm prior to the presentation of financial statements to stockholders and, as appropriate, initiates’ inquiries into aspects of our financial affairs. Our Audit Committee is responsible for establishing procedures for the receipt, retention and treatment of complaints regarding accounting, internal accounting controls or auditing matters, and for the confidential, anonymous submission by our employees of concerns regarding questionable accounting or auditing matters. The Audit Committee meets not less than quarterly and has unrestricted access to our auditors.

Audit Committee member, Andrew Warner, will qualify as an “audit committee financial expert” as that term is defined in the rules and regulations of the SEC. The designation of Mr. Warner as an “audit committee financial expert” will not impose on him any duties, obligations or liability that are greater than those that are generally imposed on him as a member of our Audit Committee and our Board of Directors, and his designation as an “audit committee financial expert” pursuant to this SEC requirement will not affect the duties, obligations or liability of any other member of our Audit Committee or Board of Directors.

 
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EXECUTIVE COMPENSATION

Summary Compensation Table

The following Summary Compensation Table shows the compensation for years 2010 and 2009 awarded to or earned by our Chairman and Chief Executive Officer and Executive Vice President and Chief Development Officer as of December 31, 2010.  There were no other highly compensated executive officers serving in such capacities as of December 31, 2010. The persons listed in the following Summary Compensation Table are referred to herein as the “Named Executive Officers or NEOs.”
 
                   
Stock
   
All Other
       
       
Salary
   
Bonus
   
Awards
   
Compensation
   
Total
 
Name and Principal Position
 
Year
 
($)
   
($)
   
($)(2)
   
($)(1)
   
($)
 
Dan Wiesel
 
2010
  $ -     $ -     $ 50,000     $ 230,000     $ 280,000  
Chairman of the Board and Chief Executive Officer
 
2009
  $ -     $ -     $ -     $ 90,000     $ 90,000  
                                             
Alysa Binder
 
2010
  $ -     $ -     $ 50,000     $ 150,000     $ 200,000  
Executive Vice President and Chief Development Officer
 
2009
  $ -     $ -     $ -     $ 150,839     $ 150,839  
                                             
Joseph A. Merkel
 
2010
    -       -       -       -       -  
Former Chief Executive Officer and President (3)
 
2009
    40,000       -       -       -       40,000  
                                             
Kevin T. Quinlan
 
2010
    -       -       -       -       -  
Former Chief Financial Officer and Controller (4)
 
2009
    -       -       -       -       -  
Joseph A. Merkel
 
2010
    -       -       -       -       -  
  

 
(1)
Represents payments of $230,000 and $150,000 to Mr. Wiesel and Ms. Binder, respectively, made for consulting, development and strategic advisory services in 2010. Represents payments of $90,000 and $150,839 to Mr. Wiesel and Ms. Binder, respectively, made by the predecessor company in 2009.
 
 
(2)
In May 2010, we granted to each of Mr. Wiesel and Ms. Binder 1,481,038 shares of restricted stock, all of which were fully vested upon grant.  We recorded a grant date $50,000 fair value of the awards Mr. Wiesel and Ms. Binder each received, calculated in accordance with FASB Accounting Standard Codification 718, “Compensation — Stock Compensation,” or ASC 718, as disclosed in Notes 2 and 7 to the Company’s consolidated financial statements included in its Annual Report on Form 10-K for the years ended December 31, 2010 and 2009. We have not entered into any employment agreements with our named executive officers.
 
  
(3)
Mr. Merkel resigned as our Chief Executive Officer, President and as a member of our Board of Directors effective August 13, 2010.

(4)
Mr. Quinlan resigned as our Chief Financial Officer, Controller and as a member of our Board of Directors effective August 13, 2010.

We have not entered into any employment agreements with our named executive officers.  All of the 2010 compensation provided to our named executive officers in 2010 consisted of payments for consulting, management and advisory services.

DIRECTOR COMPENSATION

During 2010, we did not provide any compensation to our directors in connection with their services as directors. Effective March 2011, we pay each non-employee director a fee of $1,500 for each “in-person” board or committee meeting and $500 for every telephonic board or committee meeting.  All directors are reimbursed for all reasonable expenses incurred in connection with the performance of their respective duties as a director.  Our board of directors has determined that Mr. Charles Lynch is “independent” as that term is defined in Rule 4200(a) of the NASDAQ listing standards.
Related Party Transactions
 
Fees totaled $ 222,500, $380,000 and $240,839, for the six months ended June 30, 2011 and years ended December 31, 2010 and 2009, respectively. For the six months ended June 30, 2011, we paid to Mr. Wiesel, our Chairman and Chief Executive Officer and Ms. Binder, our Executive Vice President and Director, the aggregate amounts of $122,500 and $100,000, respectively, for consulting, development and strategic advisory services. For the years ended December 31, 2010, we paid to Mr. Wiesel, our Chairman and Chief Executive Officer and Ms. Binder, our Executive Vice President and Director, the aggregate amounts of $230,000 and $150,000, respectively, for consulting, development and strategic advisory services.

In November 2010, we issued to the Daniel T. Zagorin Trust, who was at that time and remains a holder in excess of 5% of our issued and outstanding shares of common stock, 4,000,000 shares of common stock at a price of $0.50 per share for gross proceeds of $2,000,000. The shares were issued pursuant to the exemption from registration provided by Section 4(2) of the Securities Act of 1933, as amended.

 
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Legal Proceedings

From time to time, we are involved in legal proceedings, claims, and litigation that occur in connection with our business. We routinely assess our liabilities and contingencies in connection with these matters based upon the latest available information and, when necessary, we seek input from our third-party advisors when making these assessments. Consistent with SEC rules and requirements, we describe below material pending legal proceedings (other than ordinary routine litigation incidental to our business), material proceedings known to be contemplated by governmental authorities, other proceedings arising under federal, state, or local environmental laws and regulations (including governmental proceedings involving potential fines, penalties, or other monetary sanctions in excess of $10,000) and such other pending matters that we may determine to be appropriate.

On June 23, 2011, we filed a complaint in the Superior Court of The State of California, County of Santa Clara against Evan Bines and Alpine Capital Partners, Inc., for (a) breach of oral contract and (b) negligent misrepresentation from the breach of a contract to provide at least $2 million in financing for the Company conditional upon the Company completing a reverse merger with a public entity. We are asking the court in a jury trial for judgment against Evan Bines and Alpine Capital Partners, Inc. for (1) compensatory damages in an amount proven at trial, (2) the return of all unearned shares in the merged entity (now known as The PAWS Pet Company, Inc.) as compensation for the merger transaction, (3) consequential damages in an amount proven at trial, (4) interest commencing from the date of breach, (5) punitive and exemplary damage, (6) recoverable attorneys’ fees and (7) any other relief.

Except as noted above, there are no other proceedings in which any of our directors, officers or affiliates, or any registered or beneficial shareholder, is an adverse party or has a material interest adverse to our interest.

As of September 30, 2011, there were no other claims, actions, pending or threatened lawsuits that could reasonably be expected to have a material effect on the results of our operations.

 
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MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Our stock is currently quoted on the OTCQB for trading. Our stock trades now under the symbol “PAWS” and previously traded under AAQS. The following table sets forth, for the calendar quarters indicated, the high and low bid prices of our common stock as reported by the OTCQB. These quotations reflect inter-dealer prices, without markup, mark-down or commission, and may not represent actual transactions.

Year Ending December 31, 2011
 
     
High
   
Low
 
1st  Quarter Ended March 31, 2011
  $ 1.75     $ 0.65  
2nd Quarter Ended June 30, 2011
  $ 1.12     $ 0.40  
3rd  Quarter Ending September 30, 2011 (through September 26, 2011)
  $ 0.60       0.15  

Year Ended December 31, 2010
 
   
High
   
Low
 
1st  Quarter Ended March 31, 2010
  $ 0.50     $ 0.13  
2nd Quarter Ended June 30, 2010
  $ 0.50     $ 0.50  
3rd  Quarter Ended September 30, 2010
  $ 3.00     $ 0.50  
4th  Quarter Ended December 31, 2010
  $ 2.95     $ 1.49  

Year Ended December 31, 2009
 
   
High
   
Low
 
1st  Quarter Ended March 31, 2009
  $ 0.27     $ 0.13  
2nd Quarter Ended June 30, 2009
  $ 0.25     $ 0.24  
3rd  Quarter Ended September 30, 2009
  $ 0.25     $ 0.25  
4th  Quarter Ended December 31, 2009
  $ 0.25     $ 0.20  

We have not paid any dividends on our common or preferred stock and do not anticipate paying any cash dividends in the foreseeable future. We intend to retain any earnings to finance operations and the growth of the business.

We cannot assure you that we will ever pay cash dividends. Whether we pay any cash dividends in the future will depend on the financial condition, results of operations and other factors that the Board of Directors will consider.

 
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Holders

As of September 30, 2011, we had 113 record holders of our common stock. The number of record holders was determined from the records of our transfer agent and does not include beneficial owners of common stock whose shares are held in the names of various security brokers, dealers, and registered clearing agencies.

Securities Authorized for Issuance Under Equity Compensation Plans

The following is certain information about our equity compensation plans as of June 30, 2011:
 
   
(a)
   
(b)
   
(c)
 
Plan Category
 
Number of
securities
to be issued
upon exercise
of outstanding
options,
warrants
and rights
   
Weighted–average
exercise price
of outstanding
options, warrants
and rights
   
Number of
securities
remaining available
for future issuance
under equity
compensation
plans (excluding
securities reflected
in column (a)
 
Equity Compensation Plans approved by security holders
                 
Equity Compensation Plans not approved by security holders
                4,000,000  

Stock Incentive Plan

In 2010, we adopted our Stock Incentive Plan (the "Plan"). Under the Plan, at September 30, 2011 we had 4,000,000 shares approved and reserved and at December 31, 2010 and 2009 we had 4,000,000 shares reserved and zero shares, respectively, for the issuance of stock options to employees, officers, directors and outside advisors. Under the Plan, the options may be granted to purchase shares of our common stock at fair market value at the date of grant.

As of September 30, 2011, the Company granted 1,072,000 options to purchase shares of our common stock to officers and employees with an exercise price of $0.17 per option, the fair market value of the stock at the date of grant. The options vest from zero to three years.  The option compensation value will be expensed to operations over the option’s vesting schedule.  Using the Black-Scholes option-pricing model and an estimated forfeiture rate, the fair value of options granted is approximately $188,000.

RECENT SALES OF UNREGISTERED SECURITIES.

On June 3, 2011, we entered into a Securities Purchase Agreement (the “Purchase Agreement”) with an accredited investor, pursuant to which we secured $500,000 of immediate funding through the issuance and sale to the accredited investor of 2,253,470 shares of the Company’s common stock (such shares being the “Initial Purchase Shares” and such purchase being the “Initial Purchase”). In connection therewith, (i) we also issued to the accredited investor a warrant to purchase up to 20,476,707 shares of our common stock, and (ii) the accredited investor agreed to purchase from the Company up to $5.0 million (the “Aggregate Preferred Stock Purchase Price”) of our newly created perpetual and non-convertible Series A Preferred Stock (the “Preferred Stock”), at a price per share of $10,000, in one or more tranches (each a “Preferred Tranche”).  The Preferred Stock participates with the common stock in any dividends or distributions or change of control transactions as further described herein.  In connection with the Purchase Agreement, we also agreed to issue an additional 1,126,735 shares of common stock to the accredited investor on the 75 day anniversary of the Initial Purchase as consideration for executing and delivering the Purchase Agreement (the “Commitment Shares”). The Commitment Shares shall not be issued to the accredited investor and shall be held in abeyance (and the accredited investor shall not have the right to, or be deemed to have, beneficial ownership of such Commitment Shares) to the extent that such issuance would result in the accredited investor and its affiliates owning or being deemed the beneficial owner of more than 9.99% of the then issued and outstanding common stock.  The warrant also do not permit issuance of common stock thereunder to the extent that such issuance would result in the accredited investor and its affiliates owning or being deemed the beneficial owner of more than 9.99% of the then issued and outstanding common stock.  All of the foregoing was effectuated without registration under the Securities Act, in reliance upon an exemption from registration provided by Section 4(2) under the Securities Act and Rule 506 of Regulation D promulgated thereunder. These securities may not be transferred or sold absent registration under the Securities Act or an applicable exemption therefrom.

In June 2011, we issued an aggregate of 40,884 shares of common stock in lieu of interest payable. The securities were issued in transactions that were exempt from the registration requirements of the Securities Act pursuant to Section 4(2) of the Securities Act, which exempts transactions by an issuer not involving a public offering.

In addition, in June 2011, we exchanged a 14% convertible debenture of our wholly-owned subsidiary, Pet Airways, Inc., with a principal balance of $250,000, convertible at a rate of $0.40 per share and a due date of June 18, 2011 for a 14% convertible debenture of ours with a principal balance of $350,000, convertible at a rate of $0.40 per share with a due date of August 14, 2013. In connection with the exchange of the convertible debenture, we issued a warrant to purchase an aggregate of 875,000 shares of our common stock with an exercise price of $0.50 per share expiring on August 14, 2015. The securities were issued in transactions that were exempt from the registration requirements of the Securities Act pursuant to Section 4(2) of the Securities Act, which exempts transactions by an issuer not involving a public offering.

During the six months ended June 30, 2011, we issued 197,484 shares of its common stock for services rendered by non-employees, 189,392 shares of its common stock in lieu interest payable in cash or stock, 1,300,000 shares of its common stock from the conversion of aggregate $525,000 principal amount of 8% convertible debentures and warrants valued at $169,061 for the aggregate purchase of 116,575 shares of common stock for services rendered by non-employees. The securities were issued in transactions that were exempt from the registration requirements of the Securities Act pursuant to Section 4(2) of the Securities Act, which exempts transactions by an issuer not involving a public offering.

During the three months ended December 31, 2010, we sold an aggregate of 4,000,000 shares of our common stock at a price of $0.50 per share for gross cash proceeds of $2,000,000 to the Daniel T. Zagorin Trust. The closing market price of the stock on November 3, 2010 was $2.25. The foregoing securities were sold pursuant to Section 4(2) and Regulation D under the Securities Act of 1933, as amended, and have not been registered in the United States under the Securities Act or in any other jurisdiction and may not be offered or sold in the United States absent registration or an applicable exemption from the registration requirements.

 
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In June 2010, the Company issued a $250,000 face amount unsecured, convertible debenture, with an interest rate of 14% per annum and a maturity date of June 18, 2011. The debenture is convertible into shares of the Company’s stock at conversion prices of $0.40 per share.  Interest on the above debentures is payable quarterly starting January 1, 2011. At the Company’s option, interest due may be settled in cash or shares of Company common stock.
In August, 2010, in a series of transactions, the Company issued five unsecured, convertible debentures, aggregating $500,000, with interest rates of 8% per annum and a maturity date of August 2013. The debentures are convertible into shares of the Company’s stock at conversion prices of $0.50 per share.
 
Also, in August 2010, the Company issued a $500,000 face amount unsecured, convertible debenture with an interest rate of 8% and a maturity date of August 2013. The debentures are convertible into shares of the Company’s stock at conversion prices of $0.40 per share.  Interest on the above debenture is payable quarterly starting January 1, 2011. At the Company’s option, interest due may be settled in cash or shares of Company common stock.
 
The $250,000 face amount, 14% convertible debenture with a maturity date of June 18, 2011, which at the option of the debenture holder had the option of being converted into a $250,000 face amount, 8% convertible debenture with a maturity date of August 2013, was to be issued warrants to purchase 625,000 shares of common stock upon its conversion into the 8% convertible debenture.
 
Except as expressly set forth above, the individuals and entities to which we issued securities as indicated in this section of the registration statement are unaffiliated with us.

 
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DESCRIPTION OF SECURITIES
 
COMMON STOCK
 
We are authorized to issue up to 100,000,000 shares of common stock, no par value. As of September 30, 2011, there were 44,054,961 shares of common stock outstanding. Holders of the common stock are entitled to one vote per share on all matters to be voted upon by the stockholders. Holders of common stock are entitled to receive ratably such dividends, if any, as may be declared by the Board of Directors out of funds legally available therefor. Upon the liquidation, dissolution, or winding up of our company, the holders of common stock are entitled to share ratably in all of our assets which are legally available for distribution after payment of all debts and other liabilities and liquidation preference of any outstanding common stock. Holders of common stock have no preemptive, subscription, redemption or conversion rights.
 
PREFERRED STOCK

We are authorized to issue up to 10,000,000 shares of Preferred Stock, no par value. On May 27, 2011, the Company filed an amended and restated Certificate of Designations of Preferences, Rights and Limitations of Series A Preferred Stock (the “Certificate of Designations”) with the Secretary of State of the State of Illinois. A summary of the Certificate of Designations is set forth below:

Ranking and Voting. The Preferred Stock ranks, with respect to rights upon liquidation, winding-up or dissolution, (i) senior to the Common Stock, and any other classes of stock or series of preferred stock of the Company other than a class or series of preferred stock intended to be listed for trading and (ii) junior to and all existing and future indebtedness of the Company.

No right of Conversion. The Preferred Stock is not convertible into Common Stock.

Dividends and Other Distributions. Commencing on the date of issuance of any such shares of Preferred Stock, holders of Preferred Stock shall be entitled to receive dividends on each outstanding share of Preferred Stock, which shall accrue at a rate equal to 10% per annum from the date of issuance. Accrued dividends shall be payable upon redemption of the Preferred Stock. So long as any shares of Preferred Stock are outstanding, no dividends or other distributions may be paid, declared or set apart with respect to any junior securities other than dividends or other distributions payable on the Common Stock solely in the form of additional shares of Common Stock. After payment of dividends at the annual rates set forth above, any additional dividends declared shall be distributed ratably among all holders of Preferred Stock and Common Stock in proportion to the number of shares of Common Stock that would be held by each such holder of Preferred Stock as if the Preferred Stock were converted into Common Stock by taking the Series A Liquidation Value (as defined below) divided by the market price of one share of Common Stock on the date of distribution.

Liquidation. Upon any liquidation, dissolution or winding up of the Company after payment or provision for payment of debts and other liabilities of the Company and any liquidation preferences to the senior securities, before any distribution or payment is made to the holders of any junior securities, the holders of Preferred Stock shall first be entitled to be paid out of the assets of the Company available for distribution to its stockholders an amount with respect to the Series A Liquidation Value, after which any remaining assets of the Company shall be distributed ratably among the holders of the Preferred Stock and the holders of junior securities, as if the Preferred Stock were converted into Common Stock by taking the Series A Liquidation Value divided by the market price of one share of Common Stock on the date of distribution.

Redemption. The Company may redeem, for cash or by an offset against any outstanding note payable from the holder to the Company that was issued by the holder, any or all of the Preferred Stock at any time at a redemption price per share equal to $10,000 per share of Preferred Stock, plus any accrued but unpaid dividends with respect to such share of Preferred Stock (the “Series A Liquidation Value”).
 
The Preferred Stock has not been and will not be registered under the Securities Act and may not be transferred or sold absent registration under the Securities Act or an applicable exemption therefrom.

 
39

 

On June 3, 2011, we entered into a Securities Purchase Agreement (the “Purchase Agreement”) with an accredited investor, pursuant to which the accredited investor agreed to purchase from the Company up to $5.0 million (the “Aggregate Preferred Stock Purchase Price”) of our newly created perpetual and non-convertible Series A Preferred Stock (the “Preferred Stock”), at a price per share of $10,000, in one or more tranches (each a “Preferred Tranche”).  The Preferred Stock participates with the common stock in any dividends or distributions or change of control transactions as further described herein. 

Under the terms and subject to the conditions of the Purchase Agreement, from time to time over the two-years following the initial purchase, beginning on August 17, 2011, at the Company’s sole discretion, the Company may sell to the accredited investor, and the accredited investor will be obligated to purchase, shares of the Preferred Stock.  In order to effectuate such a sale, the Company will issue to the accredited investor, subject to the terms and conditions of the Purchase Agreement (all of which conditions are outside of the accredited investor’s control) one or more Preferred Tranche notices to purchase a certain dollar amount of such Preferred Stock (each such notice, a “Preferred Notice”).  Upon receipt of a Preferred Notice, the accredited investor will be obligated, subject to the terms and conditions specified in the Purchase Agreement (which conditions are outside of the accredited investor’s control), to purchase the Preferred Stock subject to such Preferred Notice on the 10 the trading day after the date of the Preferred Notice.  Such conditions include, but are not limited to, the following: (i) the Common Stock must be listed for trading or quoted on a trading exchange or market, (ii) the representations and warranties of the Company set forth in the Purchase Agreement must be true and correct as if made on the date of each Preferred Notice (subject, however, to the Company’s ability to update disclosure exceptions to such representations and warranties through the Company’s SEC reports), (iii) the Company must not be in breach or default of the Purchase Agreement or any agreement entered into in connection therewith (the “ Transaction Documents ”), or any other material agreement of the Company, (iv) there shall have occurred no material adverse effect involving the Company or its business, operations or financial condition since the date of the Initial Purchase, (v) the absence of any law or judicial action prohibiting the transactions contemplated by the Purchase Agreement, or any lawsuit seeking to prohibit or adversely affect such transactions, and (vi) all necessary governmental, regulatory or third party approvals and consents must have been obtained. The maximum amount of each Preferred Tranche is limited to a dollar amount of Preferred Stock equal to the lesser of (a) 20% of the cumulative dollar trading volume of the Common Stock for the 10 trading day-period immediately preceding the applicable Preferred Notice date and (b) $5.0 million less the amount of any previously noticed and funded Preferred Tranches. In addition, each Preferred Notice after the first Preferred Notice may not be given sooner than the trading day after the date on which the closing for the prior Preferred Tranche has occurred.
 
WARRANTS
 
In connection with the issuance of our 8% convertible debentures, we issued warrants to purchase an aggregate of 1,000,000 shares of common stock with an exercise price of $1.00 per share expiring on August 13, 2015. The warrants contain certain provisions that protect against dilution in certain events such as stock dividends, stock splits and other similar events. In connection with the issuance of our 14% convertible debentures, we issued warrants to purchase 875,000 shares of common stock at an exercise price of $0.50 per share expiring on August 14, 2015. The warrants contain certain provisions that protect against dilution in certain events such as stock dividends, stock splits and other similar events.

On June 3, 2011, in connection with our private placement transaction, we issued to the investor a five-year warrant to purchase up to 20,476,707 shares of Common Stock at an initial Exercise Price of $1.02 per share (the “Original Exercise Price”). The warrant is also exercisable on a cashless basis or through the issuance by the holder of a full-recourse secured promissory note in an initial principal amount equal to the aggregate exercise price (the “Secured Promissory Note”). Any Secured Promissory Note issued in connection with an exercise of the warrant shall bear interest at 2% per year calculated on a simple interest basis. The entire principal balance and interest thereon shall be due and payable on the fourth anniversary of the date of the Secured Promissory Note. Any such Secured Promissory Note shall be secured by the borrower’s right, title and interest in certain securities held in the portfolio of the borrower with a fair market value equal to the principal amount of the Secured Promissory Note. Additionally, any portion of the warrant may also be exchanged for shares of Common Stock based on a Black-Scholes calculation as more fully set forth in the warrant.

The warrant contains certain provisions that protect against dilution in certain events such as stock dividends, stock splits and other similar events. In addition, the warrant has price-based anti-dilution protection in the event the Company issues securities at a value less than the Original Exercise Price, meaning the exercise price of the warrant would be adjusted down to the lowest applicable issuance price following the issuance of the warrant to prevent dilution to the holder.   Pursuant to the warrant, any such anti-dilution adjustments shall be made on a pro-rata basis until such time as the Company has made dilutive issuances which exceed $5.0 million.

The warrant shall not be exercisable or exchangeable by the holder (or any future holder) to the extent the holder (or such future holder) or any of its affiliates would beneficially own in excess of 9.9% of the Common Stock as a result of such exercise or exchange.
 
REGISTRATION RIGHTS

On June 3, 2011, we entered into a Registration Rights Agreement (the “Rights Agreement”) with the investor, pursuant to which we agreed to file registration statements on Form S-1 with the Securities and Exchange Commission (“SEC”) covering the resale of the shares issued in the private placement and the shares of common stock underlying the warrant (the “Registrable Securities”). The initial registration statement, of which this prospectus is a part, must be declared effective by the SEC within 60 days of the closing and covers the resale of an aggregate of 7,000,000 of the Registrable Securities (as adjusted for any stock split, stock dividend, recapitalization, exchange or similar event or otherwise), and upon such registration statement having been utilized for the disposition of 80% of the Registrable Securities initially covered thereby, we shall prepare and, as soon as practicable, but in no event later than two (2) business days thereafter, file an additional registration statement covering the resale of an additional 7,000,000 of the Registrable Securities (as adjusted for any stock split, stock dividend, recapitalization, exchange or similar event or otherwise), and upon such registration statement having been utilized for the disposition of 80% of the Registrable Securities initially covered thereby, we shall prepare and, as soon as practicable, but in no event later than two (2) business days thereafter, file an additional registration statement covering the remaining Registrable Securities. The Company shall be required to secure the effectiveness of any such follow-on registration statement when the prior registration statement covers only a remaining 1,050,000 shares.  In any event, the parties have agreed that in light of the illiquid nature of the investment into the Company, on each day (each such day, a “Date of Determination”) after the effectiveness of this registration statement, we are required to maintain the effectiveness of a registration statement covering that number of shares equal to the lesser of (x) the quotient determined by dividing (A) twenty-five percent (25%) of the cumulative dollar trading volume of the common stock for the ten (10) trading day-period immediately prior to such Date of Determination by (B) the closing sale price of the common stock for the most recently completed trading day immediately prior to such Date of Determination and (y) the number of shares of Common Stock representing Registrable Securities that remain unsold by the investor.

 
40

 

 The Rights Agreement contains certain payment requirements if the a registration statement is not filed on or before the applicable filing deadline ( a “Filing Failure”) or declared effective by the SEC by the applicable effectiveness deadline (an “Effectiveness Failure”). Additional payments will apply if a registration statement is not maintained effective with the SEC (a “Maintenance Failure”). In addition, the Company shall also be liable for certain payments if a registration statement is not properly available for use for any reason and the Company fails to file with the SEC any required reports under Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended (“Current Public Information Failure”). Upon the occurrence of a Filing Failure, Effectiveness Failure, Maintenance Failure or Current Public Information Failure (collectively, a “Registration Rights Failure”), the Company shall be obligated to pay to each holder of Registrable Securities an amount equal to 2% of the fair market value of the Registrable Securities on the date of occurrence of each Registration Rights Failure and every 30 days thereafter until such Registration Rights Failure is cured.
 
TRANSFER AGENT
 
Our transfer agent for our common stock is Corporate Stock Transfer, Inc. 3200 Cherry Creek Dr. South Suite 430, Denver, CO, 80209.
 
INDEMNIFICATION FOR SECURITIES ACT LIABILITIES
 
Our Articles of Incorporation, as amended, provide to the fullest extent permitted by Illinois law, our directors or officers shall not be personally liable to us or our shareholders for damages for breach of such director’s or officer’s fiduciary duty. The effect of this provision of our Articles of Incorporation, as amended, is to eliminate our rights and our shareholders (through shareholders’ derivative suits on behalf of our company) to recover damages against a director or officer for breach of the fiduciary duty of care as a director or officer (including breaches resulting from negligent or grossly negligent behavior), except under certain situations defined by statute. We believe that the indemnification provisions in our Articles of Incorporation, as amended, are necessary to attract and retain qualified persons as directors and officers. In addition, we have entered into indemnification agreements with our officers and directors.
 
Insofar as indemnification for liabilities arising under the Securities Act of 1933 (the “Act” or “Securities Act”) may be permitted to directors, officers or persons controlling us pursuant to the foregoing provisions, or otherwise, we have been advised that in the opinion of the Securities and Exchange Commission, such indemnification is against public policy as expressed in the Act and is, therefore, unenforceable.

ITEM 2.03 Creation of a Direct Financial Obligation

On June 25, 2010, we entered into the Share Exchange Agreement, which transaction closed on August 13, 2010, as described in Item 2.01 of this report. In connection with the closing of the Share Exchange Agreement, the Company issued (a) the holder of the PAWS 14% convertible Debenture in principal amount of $250,000 issued in June 2010 (the “PAWS 14% Debenture”) an 8% Debenture in principal amount of $250,000 convertible into shares of AAQS at $.40 per share and a warrant to acquire shares of AAQS stock at $1.00 per share and (b) the holders of the PAWS 8% convertible Debenture in principal amount of $900,000 (the “PAWS 8% Debenture”) a 8% Debentures in the aggregate principal amount of $900,000 convertible into shares of AAQS at $.40 per share and a warrant to acquire shares of AAQS stock at $1.00 per share.

In addition to the 8% Debentures issued in exchange for the PAWS 14% Debenture and the PAWS 8% Debentures, on August 13, 2010, the Company closed an offering of $400,000 aggregate principal amount of its 8% Debentures convertible into shares of AAQS at $.50 per share and warrants to acquire shares of AAQS stock at $1.00 per share. All of the 8% Debentures are due August 13, 2013 and interest is payable, at the company’s option, in cash or shares of its common stock. Pursuant to a subscription agreement, the Company agreed to register the shares of Common A shares into which the 8% Debentures are convertible under the Securities Act of 1933 (the “Securities Act”).

The 8% Debentures were sold pursuant to Section 4(2), Section 4(6), and Regulation D under the Securities Act of 1933, as amended and have not been registered in the United States under the Securities Act or in any other jurisdiction and may not be offered or sold in the United States absent registration or an applicable exemption from the registration requirements.

The net proceeds from the offering will be used for general corporate purposes.
 
Immediately following closing of the financing, the Company issued to a former consultant a warrant to acquire 150,000 shares of Common A shares exercisable at $.50 per share.

 
41

 

ITEM 3.02 UNREGISTERED SALES OF EQUITY SECURITIES

On August 13, 2010, we issued 25,000,000 shares of our common A shares to the shareholders of Pet Airways. The total consideration for the 25,000,000 shares of our common A shares was 11,534,010 ordinary shares of Pet Airways, which is all the issued and outstanding capital stock of Pet Airways. The number of our shares issued to the shareholders of Pet Airways was determined based on an arms-length negotiation. The issuance of our shares to these shareholders was made in reliance on the exemption provided by Section 4(2) of the Securities Act for the offer and sale of securities not involving a public offering and Regulation D promulgated thereunder.

We issued securities in reliance upon Rule 506 of Regulation D of the Securities Act. These shareholders who received the securities in such instances made representations that (a) the shareholder is acquiring the securities for his, her or its own account for investment and not for the account of any other person and not with a view to or for distribution, assignment or resale in connection with any distribution within the meaning of the Securities Act, (b) the shareholder agrees not to sell or otherwise transfer the purchased shares unless they are registered under the Securities Act and any applicable state securities laws, or an exemption or exemptions from such registration are available, (c) the shareholder has knowledge and experience in financial and business matters such that he, she or it is capable of evaluating the merits and risks of an investment in us, (d) the shareholder had access to all of our documents, records, and books pertaining to the investment and was provided the opportunity ask questions and receive answers and to obtain any additional information which we possessed or were able to acquire without unreasonable effort and expense, and (e) the shareholder has no need for the liquidity in its investment in us and could afford the complete loss of such investment. Management made the determination that the investors in instances where we relied on Regulation D are accredited investors (as defined in Regulation D) based upon management’s inquiry into their sophistication and net worth. In addition, there was no general solicitation or advertising for securities issued in reliance upon Regulation D.

In instances described above where we indicate that we relied upon Section 4(2) of the Securities Act in issuing securities, our reliance was based upon the following factors: (a) the issuance of the securities was an isolated private transaction by us which did not involve a public offering; (b) there were only a limited number of offerees; (c) there were no subsequent or contemporaneous public offerings of the securities by us; (d) the securities were not broken down into smaller denominations; and (e) the negotiations for the sale of the stock took place directly between the offeree and us.

ITEM 4.01 CHANGES IN REGISTRANT’S CERTIFYING ACCOUNTANT

Pursuant to a recommendation from our board of directors, on August 13, 2010, we dismissed Cordovano and Honeck LLP, the independent registered principal accountants of our company.

During the company's two most recent fiscal years and subsequent interim period preceding the termination of Cordovano and Honeck LLP, there were no disagreements with Cordovano and Honeck LLP, which were not resolved on any matter concerning accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements, if not resolved to the satisfaction of Cordovano and Honeck LLP, would have caused to make reference to the subject matter of the disagreements in connection with its reports. Cordovano and Honeck LLP, as our principal independent accountant, did not provide an adverse opinion or disclaimer of opinion to our financial statements, nor modify its opinion as to uncertainty, audit scope or accounting principles, except that the reports of Cordovano and Honeck LLP, for the fiscal years ended October 31, 2009, and 2008 indicated conditions which raised substantial doubt about our ability to continue as a going concern.

We provided Cordovano and Honeck LLP, with a copy of this disclosure before its filing with the SEC. We requested that Cordovano and Honeck LLP provide us with a letter addressed to the SEC stating whether or not it agrees with the above statements. A copy of this letter is attached as exhibit 16.1 to this current report.

On August 13, 2010 our board of directors approved and authorized the engagement of KBL LLP as our independent public accountants.

Prior to engaging KBL LLP on August 13, 2010, KBL LLP did not provide our company with either written or oral advice that was an important factor considered by our company in reaching a decision to change our independent registered public accounting firm from Cordovano and Honeck LLP, to KBL LLP.

 
42

 

ITEM 5.01 CHANGES IN CONTROL OF REGISTRANT

Reference is made to the disclosure set forth under Item 2.01 of this report, which disclosure is incorporated herein by reference.

As a result of the closing of the reverse acquisition with Pet Airways, the former shareholders of Pet Airways now own approximately 73% of the total outstanding shares of our capital stock and approximately 73% total voting power of all our outstanding voting securities.

ITEM 5.02. DEPARTURE OF DIRECTORS OR CERTAIN OFFICERS; ELECTION OF DIRECTORS; APPOINTMENT OF CERTAIN OFFICERS; COMPENSATORY ARRANGEMENTS OF CERTAIN OFFICERS

Upon the closing of the Share Exchange Agreement, on August 13, 2010, Mr. Joseph A. Merkel, our former President, Chief Executive Officer, and director, and Mr. Kevin T. Quinlan, our former President, Chief Executive Officer, and director, submitted resignation letters pursuant to which each resigned from all offices of the Company that he held and from his position as our director effective immediately. Neither Mr. Merkel’s nor Mr. Quinlan’s resignation was not in connection with any known disagreement with us on any matter.

On the same day, our board of directors increased the size of our board of directors to 3 members and appointed Messrs. Wiesel, Binder and Warner to our board of directors at the effective time of the resignation of Messrs. Merkel and Quinlan to fill the vacancies created by Messrs. Merkel and Quinlan’s resignation and the increase in board size.

In addition, our board of directors appointed Mr. Dan Wiesel as our Chief Executive Officer, effective immediately at the closing of the Share Exchange Agreement.

For certain biographical and other information regarding the newly appointed officers and directors, see the disclosure under Item 2.01 of this report, which disclosure is incorporated herein by reference.

ITEM 5.03. AMENDMENT TO ARTICLES OF INCORPORATION; CHANGE IN FISCAL YEAR

In connection with the closing of the share exchange, on August 13, 2010 we changed our fiscal year end to December 31. The Share Exchange is deemed to be a reverse merger for accounting purposes, with Pet Airways, the acquirer operating entity. Starting with the periodic report for the quarter in which the Share Exchange was completed, we will file annual and quarterly reports based on the December 31 fiscal year end of Pet Airways.

In reliance on Section III F of the SEC's Division of Corporate Finance: Frequently Requested Accounting and Financial Reporting Interpretations and Guidance dated March 31, 2001, we do not intend to file a transition report to reflect the change in fiscal year end.

ITEM 5.06. CHANGE IN SHELL COMPANY STATUS.

As a result of the consummation of the Transaction described in Item 2.01 of this Current Report on Form 8-K, we believe that we are no longer a shell corporation as that term is defined in Rule 405 of the Securities Act and Rule 12b-2 of the Exchange Act .

ITEM 9.01 FINANCIAL STATEMENTS AND EXHIBITS
 
Financial Statements for the interim periods ended June 30, 2010 and 2009

Filed herewith are the following:
 
1. 
Unaudited condensed consolidated financial statements of Pet Airways, Inc. for the three and six months ended June 30, 2011 and 2010.

2. 
Audited consolidated financial statements of The PAWS Pet Company, Inc. for the years ended December 31, 2010 and 2009.
 
Financial Statements of Business Acquired

Filed herewith are the following:
 
(a)
Unaudited condensed consolidated financial statements of Pet Airways, Inc. for the three and six months ended June 30, 2011 and 2010.

(b)
Audited consolidated financial statements of Pet Airways, Inc. for the years ended December 31, 2010 and 2009.

 
43

 

(d) Exhibits

3.1
Amended and Restated Articles of Incorporation (incorporated by reference to Exhibit 3.1 to the registration statement Form SB-2, File No. 333-130446, initially filed with the SEC on December 19, 2005, as amended)
   
3.2
Amended and Restated Bylaws (incorporated by reference to Exhibit 3.2 to registration statement Form SB-2, File No. 333-130446, initially filed with the SEC on December 19, 2005, as amended)
   
3.3
Amendment to Articles of Incorporation (incorporated by reference to Exhibit 3.1 to the current report on Form 8-K filed with the SEC on October 25, 2010)
   
3.4
Articles of Amendment dated July 27, 2011 (incorporated by reference to Exhibit 3.1 to the current report on Form 8-K filed with the SEC on August 4, 2011)
   
10.1
Form of Share Exchange Agreement, dated as of June 25, 2010, among the Registrant, Pet Airways, Inc., a Florida corporation (“PAWS”), the stockholders of PAWS, and Joseph A. Merkel, Kevin T. Quinlan, and Bellevue Holdings, Inc. (incorporated by reference to Exhibit 10.1 to the current report on Form 8-K filed with the SEC on July 1, 2010)
   
10.2
Form of 8% Convertible Debenture (incorporated by reference to Exhibit 10.1 to the current report on Form 8-K filed with the SEC on August 17, 2010)
   
10.3
Form of Subscription Agreement for 8% Convertible Debentures and Share Purchase Warrants (incorporated by reference to Exhibit 10.2 to the current report on Form 8-K filed with the SEC on August 17, 2010)
   
10.4
Form of Common Stock Subscription Agreement (incorporated by reference to Exhibit 10.1 to the current report on Form 8-K filed with the SEC on November 9, 2010)
   
10.5
Securities Purchase Agreement, dated as of June 3, 2011 (incorporated by reference to Exhibit 10.1 to the current report on Form 8-K filed with the SEC on June 6, 2011)
   
10.6
Warrant to Purchase Common A Stock (incorporated by reference to Exhibit 10.2 to the current report on Form 8-K filed with the SEC on June 6, 2011)
   
10.7
Amended and Restated Certificate of Designation of Series A Preferred Stock (incorporated by reference to Exhibit 10.3 to the current report on Form 8-K filed with the SEC on June 6, 2011)
   
10.8
Registration Rights Agreement dated June 3, 2011 (incorporated by reference to Exhibit 10.4 to the current report on Form 8-K filed with the SEC on June 6, 2011)
   
10.9
Form of Lock-Up Agreement (incorporated by reference to Exhibit 10.5 to the current report on Form 8-K filed with the SEC on June 6, 2011)
   
10.10
Form of 14% Convertible Debenture (incorporated by reference to Exhibit 10.10 to the registration statement on Form S-1 filed with the SEC on June 20, 2011)
   
10.11
Laboratory Services License Agreement dated August 26, 2011  (incorporated by reference to Exhibit 10.11 to the current report on Form 8-K filed with the SEC on September 1, 2011)
   
16.1
Letter from Cordovano and Honeck LLP, dated August 30, 2010 (incorporated by reference to Exhibit 16.1 to the current report on Form 8-K/A filed with the SEC on August 31, 2010)
   
21.1
Subsidiaries of the Registrant (incorporated by reference to Exhibit 21.1 to the annual report on Form 10-K filed with the SEC on March 28, 2011)

 
44

 

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.
 
   
THE PAWS PET COMPANY , INC.
 
       
Dated:  October 13, 2011
By:
/s/ Andrew C. Warner
 
   
Andrew C. Warner
 
   
Chief Financial Officer
 

 
45

 

The PAWS Pet Company, Inc. and Subsidiary
Index to Consolidated Financial Statements
 
Condensed Consolidated Balance Sheets as of June 30, 2011 and December 31, 2010
 
F-2
Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2011 and 2010
 
F-3
Condensed Consolidated Statements of Cash Flows for six  months ended June 30, 2011 and 2010
 
F-4
Notes to Condensed Consolidated Financial Statements
 
F-5
     
Report of Independent Registered Public Accounting Firm
 
F-16
Consolidated Balance Sheets — December 31, 2010 and 2009
 
F-17
Consolidated Statements of Operations — Years ended December 31, 2010 and 2009
 
F-18
Consolidated Statement of Stockholders’ Equity— Years ended December 31, 2010 and 2009
 
F-19
Consolidated Statements of Cash Flows — Years ended December 31, 2010 and 2009
 
F-20
Notes to Consolidated Financial Statements
 
F-21

 
F-1

 

THE PAWS PET COMPANY, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
   
June 30, 2011
   
December 31,
2010
 
 
 
(Unaudited)
   
(Audited)
 
ASSETS
           
Current assets:
           
Cash and cash equivalents
  $ 102,436     $ 1,511,057  
Receivable due from credit card clearing house
    50,000       123,134  
Prepaid expenses
    15,393       119,354  
Deferred financing fees
    843,957       -  
Total current assets
    1,011,786       1,753,545  
                 
Property and equipment, at cost
    256,199       168,546  
Less: accumulated depreciation and amortization
    (65,933 )     (38,587 )
Property and equipment, net
    190,266       129,959  
                 
Security deposits and other
    35,313       30,787  
Total assets
  $ 1,237,365     $ 1,914,291  
                 
LIABILITIES AND STOCKHOLDERS' (DEFICIT) EQUITY
               
Current liabilities:
               
14% debenture
  $ -     $ 250,000  
Accounts payable
    145,530       550,216  
Accrued expenses
    1,032,326       342,159  
Unearned revenue
    207,930       125,603  
Derivative warrant liability
    13,309,860       -  
Total current liabilities
    14,695,646       1,267,978  
                 
Convertible debentures, face amount of $825,000 and $1,000,000, net of debt discount of $632,127 and $695,807 at June 30, 2011 and December 31, 2010, respectively
    192,873       304,193  
                 
Commitments and contingencies
    -       -  
                 
Stockholders' (deficit) equity:
               
Series A preferred stock, 1,200,000 shares authorized, none issued and outstanding at June 30, 2011 and December 31, 2010, respectively.
    -       -  
Common stock, no par value, 100,000,000 shares authorized, 44,054,961 and 34,314,615 issued and outstanding at June 30, 2011 and December 31, 2010, respectively.
    -       -  
Additional paid-in capital
    8,454,374       6,407,128  
Accumulated deficit
    (22,105,528 )     (6,065,008 )
Total stockholders' (deficit) equity
    (13,651,154 )     342,120  
Total liabilities and stockholders' (deficit) equity
  $ 1,237,365     $ 1,914,291  

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

 
F-2

 

THE PAWS PET COMPANY, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)

   
Three months ended June 30,
   
Six months ended June 30,
 
   
2011
   
2010
   
2011
   
2010
 
   
(Unaudited)
   
(Unaudited)
 
Revenue
 
$
519,273
   
$
252,933
   
$
911,759
   
$
516,537
 
Cost of revenue
   
566,525
     
283,016
     
1,166,453
     
573,606
 
Gross loss
   
(47,252
)
   
(30,083
)
   
(254,694
)
   
(57,069
)
                                 
Operating expense:
                               
Sales, general and administration
   
889,405
     
221,582
     
1,887,870
     
412,165
 
                                 
Loss from operations
   
(936,657
)
   
(251,665
)
   
(2,142,564
)
   
(469,234
)
                                 
Other income (expense):
                               
Interest income
   
2
     
4
     
4
     
179
 
Interest expense
   
(77,625
)
   
(5,752
)
   
(486,977
)
   
(6,767
)
Loss on extinguishment of debt
   
(571,122
)
   
-
     
(571,122
)
   
-
 
Derivative warrant valuation expense, net
   
(12,839,860
)
   
-
     
(12,839,860
)
   
-
 
Other income (expense), net
   
(13,488,605
)
   
(5,748
)
   
(13,897,955
)
   
(6,588
)
                                 
Loss before income taxes
   
(14,425,262
)
   
(257,413
)
   
(16,040,519
)
   
(475,822
)
Provision (benefit) for income taxes
   
-
     
-
     
-
     
-
 
                                 
Net loss
 
$
(14,425,262
)
 
$
(257,413
)
 
$
(16,040,519
)
 
$
(475,822
)
                                 
Net loss per share, basic and diluted
 
$
(0.35
)
 
$
(0.01
)
 
$
(0.40
)
 
$
(0.02
)
                                 
Weighted average shares used in calculation of basic and diluted net loss per share
   
41,175,742
     
30,548,060
     
40,397,966
     
29,114,911
 

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

 
F-3

 

THE PAWS PET COMPANY, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

   
Six months ended June 30,
 
   
2011
   
2010
 
         
(Unaudited)
 
CASH FLOWS FROM OPERATING ACTIVITIES:
           
Net loss
 
$
(16,040,519
)
 
$
(475,822
)
Adjustments to reconcile net loss to net cash used in operating activities:
         
Depreciation and amortization
   
27,346
     
3,923
 
Derivative warrant valuation expense, net
   
12,839,860
     
-
 
Loss on extinguishment of 14% debenture
   
571,122
     
-
 
Accelerated amortization of debt discount from conversion of debenture
   
325,399
     
-
 
Amortization of debt discount
   
80,913
     
-
 
Warrants issued in lieu of cash for services rendered by non-employees
   
169,062
     
-
 
Common shares issued in lieu of cash for services rendered by non-employees
   
-
     
97,431
 
Common shares issued in lieu of cash compensation to employees
   
-
     
129,066
 
Changes in certain assets and liabilities:
               
Receivable due from credit card clearing house
   
73,134
     
-
 
Prepaid expenses
   
103,961
     
-
 
Security deposits and other
   
(4,526
)
   
(12,166
)
Accounts payable
   
(404,686
)
   
(55,806
)
Accrued expenses
   
355,639
     
149,689
 
Unearned revenue
   
82,327
     
(94,616
)
Net cash used in operating activities
   
(1,820,968
)
   
(258,301
)
                 
CASH FLOWS FROM INVESTING ACTIVITIES:
               
Purchases of property and equipment
   
(87,653
)
   
(13,000
)
Net cash used in investing activities
   
(87,653
)
   
(13,000
)
                 
CASH FLOWS FROM FINANCING ACTIVITIES:
               
Proceeds from issuance of common stock
   
500,000
     
-
 
Proceeds from issuance of debt
   
-
     
750,000
 
Net cash provided by financing activities
   
500,000
     
750,000
 
Net change in cash and cash equivalents
   
(1,408,621
)
   
478,699
 
Cash and cash equivalents at beginning of period
   
1,511,057
     
171,257
 
Cash and cash equivalents at end of period
 
$
102,436
   
$
649,956
 
                 
Supplementary disclosure of cash flow information
               
Cash paid during the year for:
               
Income taxes
 
$
800
   
$
-
 
Interest expense
 
$
-
   
$
1,794
 
Non-cash transactions:
               
Deferred financing fees
 
$
843,957
   
$
-
 
Conversion of 8% convertible debentures to 1.3 million shares of common stock
 
$
525,000
   
$
-
 
Derivative warrant valuation APIC component
 
$
470,000
   
$
-
 
Issuance of 14% convertible debenture with warrants in exchange for 14% debenture
 
$
350,000
   
$
-
 
Derivative liability discount from issuance of 14% convertible debenture with warrants
 
$
342,632
   
$
-
 
Extinguishment of 14% debenture exchanged for 14% convertible debenture
 
$
250,000
   
$
-
 
Common shares issued in 2011 for services rendered in 2010 by non-employees
 
$
298,824
   
$
-
 
Common shares issued in 2011 in lieu of cash for 2010 interest due
 
$
157,062
   
$
-
 
Common shares issued in 2011 in lieu of cash for 2011 interest due
 
$
73,442
   
$
-
 

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

 
F-4

 

THE PAWS PET COMPANY, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1. Summary of Significant Accounting Policies

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements of The PAWS Pet Company, Inc. (“The PAWS Pet Company, Inc. or Company”), and its wholly owned subsidiary Pet Airways, Inc., have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and the rules and regulations of the Securities and Exchange Commission for interim financial information. In the opinion of the Company’s management, the accompany condensed consolidation financial statements reflect all adjustments, consisting of normal, recurring adjustments, considered necessary for a fair presentation of the results for the interim periods ended June 30, 2011 and 2010. Although management believes that the disclosures in these unaudited condensed consolidated financial statements are adequate to make the information presented not misleading, certain information and footnote disclosures normally included in financial statements that have been prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to the rules and regulations of the Securities Exchange Commission. Financial results for The PAWS Pet Company, Inc. and airlines in general, can be seasonal in nature. In recent years, The PAWS Pet Company, Inc. revenues, as well as its overall financial performance, have been better in its second and third quarters than in its first and fourth quarters. Air travel is also significantly impacted by, but not limited to general economic conditions, the amount of disposable income available to consumers and unemployment levels. The results for the six and three months ended June 30, 2011 are not necessarily indicative of the results to be expected for the year ending December 31, 2011. These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and footnotes thereto included in the Annual Report on Form 10-K for the year ended December 31, 2010.

Certain prior period amounts have been reclassified to conform to the current presentation.  These reclassifications had no impact on the consolidated financial position, results of operations and net cash flows from operations.

Going Concern Matters

The accompanying unaudited condensed consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business.  The Company does not presently have adequate cash from operations or financing activities to meet its long-term financing needs.  For the periods ended June 30, 2011 and December 31, 2010, the Company had $102,436 and $1,511,057, respectively, in cash and cash equivalents to use in executing its business plan.  For the six months ended June 30, 2011, the Company generated $911,759 in revenues and recorded a net loss of $(16,040,519) including non-cash charges of $(12,839,860) in derivative warrant valuation expense from the issuance of a warrant and $(571,122) in loss on extinguishment of debt.  For the year ended December 31, 2010, the Company generated $1,348,491 in revenues and recorded a net loss of $(4,055,905). As a result of these and other factors, the Company’s independent registered accountants have included an explanatory paragraph in their audited consolidated financial statements and footnotes in the Annual Report on Form 10-K for the year ended December 31, 2010 as to the substantial doubt about the Company’s ability to continue as a going concern.  As further described in Footnote 2 “Equity” to the unaudited condensed consolidated financial statements, on June 3, 2011 the Company issued 2,253,470 common shares and a warrant to purchase 20,476,707 common shares at a price of $1.02 per share to Socius CG II, Ltd. (“Socius”) for cash of $500,000 and secured an equity line of credit for up to $5 million subject to the Company meeting certain conditions.  If the Company does not meet the conditions permitting drawdowns against the equity line, it will require up to $3 million in additional working capital to continue its operations during the next 12 months and to support its long-term growth strategies, so as to enhance its service offerings and benefit from economies of scale. The Company’s working capital requirements and the cash flow provided by future operating activities, if any, will vary greatly from quarter to quarter, depending on the volume of business and competition in the markets it serves. The Company, provided Socius gives its consent, may seek any necessary funding through one or more sources and credit facilities, if available, or through the sale of debt or issuance of additional equity securities. However, there is no assurance that funding of any type would be available to the Company, or that it would be available at rates and on terms and conditions that would be financially acceptable and viable to the Company or Socius in the long term. If the Company is unable to raise any necessary additional financing when needed, the Company may be required to suspend operations, sell assets or enter into a merger or other combination with a third party, any of which could adversely affect the value of its no par value, common stock (“common stock”), or render it worthless. If the Company issues additional debt or equity securities, such securities may enjoy rights, privileges and priorities (including but not limited to coupon rates, conversion rights, rights to fixed or preferential dividends, anti-dilution rights or preference as to the distribution of assets upon a liquidation) superior to those enjoyed by holders of the Company’s common stock, thereby diluting the value of the Company’s common stock.

The Company’s prospects must be considered in light of the risks, expenses and difficulties encountered by companies at an early stage of development, particularly given that the Company has limited financial resources. The Company may not be successful in addressing such risks and difficulties.
Our prospects must be considered in light of the risks, expenses and difficulties encountered by companies at an early stage of development, particularly given that we have limited financial resources. We may not be successful in addressing such risks and difficulties.

Business Overview

The PAWS Pet Company, Inc., through its wholly owned subsidiary, Pet Airways, Inc., is an airline designed specifically for the comfortable and safe transportation of pets by traveling in the main cabin of the aircraft. Pet owners can book their pets on flights online at our website or can book with our agents by phone. Flights can be booked up to three months before the scheduled departure date. Payment for the flights is made with credit card. On the day of the scheduled flight, the pet owner drops off their pets at one of our airport facilities located at the departure airport. We place the pet passengers into a pet-friendly carrier and then board the carrier into the main cabin of the aircraft. Pet passengers fly in the main cabin of our specially-outfitted aircraft rather than, as is the case for a traditional commercial airline, flying in the cargo bay or flying as carry-on baggage placed under a passenger’s seat. The number of pet passengers we can carry per flight can vary based on the size of pet passengers, but generally we can carry around 40 pet passengers per flight. We carry mainly dogs and cats. We can carry pet passengers of all sizes from small dogs and cats weighing less than 15 lbs. to dogs that weigh 180 lbs. and have maximum height from the ground to shoulder of 34 inches. After drop off, pet owners can track flight progress through our website. Throughout the flight, we monitor the air quality and temperature of our aircraft ensuring that the pet passengers are safe and comfortable at all times. We have a pet attendant on each flight that is responsible for monitoring the pet passengers during the flight. Upon arrival at the destination airport, we unload the pet passengers from the plane directly into one of our airport facilities for pick up.

 
F-5

 

We were incorporated in the State of Illinois on June 6, 2005 as American Antiquities, Inc. (“AAI”). In June 2010, we formed Pet Airways, Inc., a Florida corporation, (“Pet Airways, Inc. (Florida)”) by the conversion of Panther Air Cargo, LLC (“Panther Air”) a limited liability company. Effective the date of the conversion, Panther Air began operating as Pet Airways, Inc. (Florida).

On August 13, 2010, we completed a reverse acquisition transaction through a share exchange with Pet Airways, Inc. (Florida) (the “Acquisition”), whereby AAI acquired 100% of the issued and outstanding capital stock of Pet Airways, Inc. (Florida) in exchange for 25,000,000 shares of AAI common shares, which constituted approximately 73% of our issued and outstanding capital stock on a post-acquisition basis as of and immediately after the consummation of the Acquisition. As a result of the Acquisition, Pet Airways, Inc. (Florida) became a wholly-owned subsidiary of AAI and the controlling stockholders of Pet Airways, Inc. (Florida) became our controlling stockholders. Also, upon completion of the Acquisition, we changed our name from AAI to Pet Airways, Inc. and commenced trading under the ticker symbol “PAWS” on the OTCQB Market Tier (“OTCQB”).  The OTCQB market tier of the OTC market helps investors easily identify companies that are current in their reporting obligations with the Securities and Exchange Commission (the “SEC”). OTCQB securities are quoted on OTC Markets Group's quotation and trading system. On July 27, 2011, we filed Articles of Amendment to our Articles of Incorporation to change our name to The PAWS Pet Company, Inc.

The share exchange transaction with The PAWS Pet Company, Inc. was treated as a reverse acquisition, with Pet Airways, Inc. (Florida) as the acquirer and Pet Airways, Inc. as the acquired party. Unless the context suggests otherwise, when we refer in this report to business and financial information for periods prior to the consummation of the reverse acquisition, we are referring to the business and financial information of Pet Airways, Inc. and its predecessors. For accounting purposes, the acquisition of Pet Airways, Inc. has been treated as a recapitalization with no adjustment to the historical book and tax basis of the companies’ assets and liabilities.

Pet Airways, Inc. suspended flight operations in March 2010 to upgrade its reservation system and raise additional capital.  Pet Airways, Inc. raised additional capital by issuing a series of convertible debentures, shares of common stock and warrants and resumed flight operations in June 2010.

Critical Accounting Policies and Estimates

The preparation of the Company’s unaudited condensed consolidated financial statements requires the Company to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. The Company based these estimates and assumptions on historical experience and evaluates them on an on-going basis to ensure they remain reasonable under current conditions. Actual results could differ from those estimates. Critical accounting policies and estimates are summarized below.

Revenue Recognition

We recognize revenue when the earning process is completed. In our business, the earning process is complete when the scheduled flight service, or a replacement flight service, purchased by the buyer has been delivered. Revenue from tickets sold prior to schedule flights is initially recorded as unearned revenue, net of any discounts, and is recognized as revenue in the period when the scheduled service has been provided or offered to the buyer as agreed. In the ordinary course of our business, a portion of the tickets sold are sometimes not used by the buyer on the agreed date of the flight. In such cases, for a nominal change fee, we will issue to holders of unused tickets a “voucher” which stated value can be applied toward the purchase of a flight for up to one year. Accordingly, the change fee is earned when the voucher is issued and the stated voucher value remains unearned until recorded as revenue upon the earlier of the vouchers expiration date or delivery of the flight service that it was applied to. Tickets purchased for scheduled flights that are cancelled by the Company may be refunded or applied towards another flight at the buyer's request. Refunds processed are removed from unearned revenue. Any inconvenience cost incurred by the Company for the benefit of the buyer is charged to cost of revenue when incurred. Cancelled scheduled flights requiring refunds or additional costs to accommodate the buyer’s revised travel plans have not been a significant issue since resumption of flights in June 2010. Unearned revenue consists of tickets and vouchers for future scheduled flights that have not been completed or provided as agreed.

Fees charged by the credit card processors for handling the ticket sales are recorded to cost of sales at the time the tickets are sold due to the relatively short period of time between the sale of a ticket and providing the scheduled transportation service.

 
F-6

 

Derivative Liabilities
  
We have utilized convertible debentures with warrants to purchase shares of common stock to settle certain liabilities and fund operations resulting in the recording of a derivative liability. Current guidance for valuing and classifying transactions of this type included ASC 470-20 "Debt with Conversion and Other Options".  Accordingly, we have used the Black-Scholes option-pricing model as our method of determining the fair value of the convertible debenture issued with a warrant. The resulting calculation of the beneficial conversion feature (BCF) and warrant equity component are recorded to additional paid in capital (“APIC”) with an offset discount to the principal value of the convertible debenture. We have used the effective yield interest method for amortizing the discount to interest expense over the maturity term of the convertible debenture. We record to interest expense the unamortized discount value associated with a debenture converted in a period.
 
The Company accounts for certain its Warrants (see Note 2, Equity, Socius CG II, Ltd. Financing) as derivatives under the guidance of ASC 815-10, Accounting for Derivative Instruments and Hedging Activities, and ASC 815-40, Contracts in an Entity’s Own Stock.

Contingent Liabilities
 
We make estimates of liabilities that arise from various contingencies for which values are not fully known at the date of the accrual or during the periodic financial planning and analysis cycle. These contingencies may include, but are not limited, to accruals for reserves for costs and awards involving legal settlements, cost associated with planned changes in workforce or operating levels, costs associated with reduced flight services from Suburban, the building out of leased premises, vacating leased premises or abandoning leased equipment, and costs involved with the discontinuance of a segment of a business. Events may occur that are resolved over a period of time or on a specific future date. Management makes estimates using the facts available of the probability of the outcomes and range of cost, if measureable, of these occurrences and charges them to expense in the appropriate periods. If the ultimate resolution of any event is different than management’s estimate caused by a change in facts or material operating assumptions, compensating entries to earnings may be required.

Stock Based Compensation

The Company applies ASC 718-10 Stock Compensation and ASC 505-50 Equity Based Payments to Non-Employees in accounting for stock options issued to employees and non-employees, respectively. For stock options and warrants issued to non-employees, the Company applies the same standard, which requires the recognition of compensation cost based upon the fair value of stock options and warrant at the grant date using the Black-Scholes option pricing model. Our determination of fair value of share-based payment awards on the date of grant using the option-pricing model is affected by our equity price as well as assumptions regarding our expected equity price volatility over the term of the awards, the selection of a risk free interest rate, the ultimate disposition of the award and the impact of the award on earnings per share. For example, in calculating the expected equity price volatility, we may consider using our historical experience only, our experience plus that of a publicly trade index volatility experience, or a blended volatility experience for public peer companies. We also evaluate carefully the expected life term of an award though the vesting of awards to date have been immediate. Finally, we attempt to use a risk free rate that is widely quoted and pertinent across a broad range of transactions.

Cash and Cash Equivalents

The Company considers all highly liquid debt instruments and other short-term investments with maturity of three months or less, when purchased, to be cash equivalents.  The Company maintains cash and cash equivalent balances at a financial institution that is insured by the Federal Deposit Insurance Corporation.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.

Reservation System Development Costs

The Company accounts for reservation system (“website”) development costs in accordance with Accounting Standards Codification (“ASC”) 350-50 “Website Development Costs.” All costs incurred in the planning stage are expensed as incurred. Costs incurred in the website application and infrastructure development stage are accounted for in accordance with ASC 350-50, which requires the capitalization of certain costs that meet specific criteria. Costs incurred in the day to day operation of the website are expensed as incurred.

 
F-7

 

Fair Value Measurements

The Company has adopted a single definition of fair value, a framework for measuring fair value, and expanded disclosures concerning fair value. In this valuation, the exchange price is the price in an orderly transaction between market participants to sell an asset or transfer a liability at the measurement date and fair value is a market-based measurement and not an entity-specific measurement.

The Company utilizes the following hierarchy in fair value measurements:

 
·
Level 1 – Inputs use quoted prices in active markets for identical assets or liabilities that the Company has the ability to access.

 
·
Level 2 – Inputs use other inputs that are observable, either directly or indirectly. These inputs include quoted prices for similar assets and liabilities in active markets as well as other inputs such as interest rates and yield curves that are observable at commonly quoted intervals.

 
·
Level 3 – Inputs are unobservable inputs, including inputs that are available in situations where there is little, if any, market activity for the related asset or liability.

Depreciation, amortization and capitalization

The Company records depreciation and amortization, when appropriate, using the straight-line method over the estimated useful life of the assets (three to five years).  Expenditures for maintenance and repairs are charged to expense as incurred.  Additions, major renewals and replacements that increase the property's useful life are capitalized.  Property sold or retired, together with the related accumulated depreciation is removed from the appropriate accounts and the resultant gain or loss is included in operating income or loss.

Long-lived assets

The Company periodically evaluates whether events and circumstances have occurred that may warrant revision of the estimated useful life of its trademark costs.  If and when such factors, events or circumstances indicate possible impairment to its trademark costs, the Company would make an estimate of undiscounted cash flows over the remaining lives of the respective assets in measuring recoverability from future operations.  The Company incurred no impairment losses during the periods presented.

 
F-8

 

Income Taxes

The Company follows FASB Accounting Standards Codification No 740, Income Taxes. Deferred tax assets or liabilities are recorded to reflect the future tax consequences of temporary differences between the financial reporting basis of assets and liabilities and their tax basis at each year-end. These amounts are adjusted, as appropriate, to reflect enacted changes in tax rates expected to be in effect when the temporary differences reverse.

The Company records deferred tax assets and liabilities based on the differences between the financial statement and tax bases of assets and liabilities and on operating loss carry forwards using enacted tax rates in effect for the year in which the differences are expected to reverse. A valuation allowance is provided when it is more likely than not that some portion or all of a deferred tax asset will not be realized.

Recent Accounting Pronouncements

In January 2010, the FASB issued ASC Update No. 2010-06, Improving Disclosure about Fair Value Measurements (ASU 2010-06).  ASU 2010-06 requires additional disclosures regarding fair value measurements, amends disclosures about post-retirement benefit plan assets and provides clarification regarding the level of disaggregation of fair value disclosures by investment class.  ASU 2010-06 is effective for interim and annual reporting periods beginning after December 15, 2009, except for certain Level 3 activity disclosure requirements that will be effective for reporting periods beginning after December 15, 2010.  The adoption of this standard did not have an impact on our consolidated financial position or results of operations.

In December 2010, the FASB issued ASC Update No. 2010-29, Business Combination (ASU 2010-29). ASU 2010-29 specify that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. ASU 2010-29 also expand the supplemental pro forma disclosures under Topic 805 to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. ASU 2010-29 clarify the acquisition date that should be used for reporting the pro forma financial information disclosures in Topic 805 when comparative financial statements are presented. ASU 2010-29 also improve the usefulness of the pro forma revenue and earnings disclosures by requiring a description of the nature and amount of material, nonrecurring pro forma adjustments that are directly attributable to the business combination(s). ASU 2010-29 is effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. Early adoption is permitted. The adoption of this standard will not have a material impact on our consolidated financial position or results of operations.

In May 2011, the FASB issued ASC Update No. 2011-04, Fair Value Measurement (ASU 2011-04). ASU 2011-04 will result in common fair value measurement and disclosure requirements in U.S. GAAP and IFRSs. Consequently, the amendments change the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements. For many of the requirements, the Board does not intend for ASU No. 2011-04 to result in a change in the application of the requirements in Topic 820. Some of ASU 2011-04 clarifies the Board’s intent about the application of existing fair value measurement requirements. Other amendments change a particular principle or requirement for measuring fair value or for disclosing information about fair value measurements. ASU 2011-04 is to be applied prospectively. For public entities, ASU 2011-04 is effective during interim and annual periods beginning after December 15, 2011. Early application by public entities is not permitted. The adoption of this standard will not have a material impact on our consolidated financial position or results of operations.

In June 2011, the FASB issued ASC Update No. 2011-05, Comprehensive Income (ASU 2011-05). ASU 2011-05 provides that an entity has the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. In a single continuous statement, the entity is required to present the components of net income and total net income, the components of other comprehensive income and a total for other comprehensive income, along with the total of comprehensive income in that statement. In the two-statement approach, an entity is required to present components of net income and total net income in the statement of net income. The statement of other comprehensive income should immediately follow the statement of net income and include the components of other comprehensive income and a total for other comprehensive income, along with a total for comprehensive income. Regardless of whether an entity chooses to present comprehensive income in a single continuous statement or in two separate but consecutive statements, the entity is required to present on the principal of the financial statements reclassification adjustments for items that are reclassified from other comprehensive income to net income in the statement(s) where the components of net income and the components of other comprehensive income are presented. ASU 2011-05 should be applied retrospectively. For public entities, ASU 2011-05 is effective for fiscal years, and interim periods within those years beginning after December 15, 2011. Early adoption is permitted, because compliance with ASU 2011-05 is already permitted. ASU 2011-05 does not require any transition disclosures. The adoption of this standard will not have a material impact on our consolidated financial position or results of operations.

 
F-9

 

Management does not believe that any recently issued, but not yet effective, accounting standards if currently adopted would have a material effect on the accompanying condensed consolidated financial statements.

2. Equity

Preferred Stock Authorized

On May 27, 2011, the Company filed an amended and restated Certificate of Designations of Preferences, Rights and Limitations of Series A Preferred Stock (the “Certificate of Designations”) with the Secretary of State of the State of Illinois. A summary of the Certificate of Designations is set forth below:

Ranking and Voting. The Preferred Stock ranks, with respect to rights upon liquidation, winding-up or dissolution, (i) senior to the Common Stock, and any other classes of stock or series of preferred stock of the Company other than a class or series of preferred stock intended to be listed for trading and (ii) junior to and all existing and future indebtedness of the Company.

No right of Conversion. The Preferred Stock is not convertible into Common Stock.

Dividends and Other Distributions. Commencing on the date of issuance of any such shares of Preferred Stock, holders of Preferred Stock shall be entitled to receive dividends on each outstanding share of Preferred Stock, which shall accrue at a rate equal to 10% per annum from the date of issuance. Accrued dividends shall be payable upon redemption of the Preferred Stock. So long as any shares of Preferred Stock are outstanding, no dividends or other distributions may be paid, declared or set apart with respect to any junior securities other than dividends or other distributions payable on the Common Stock solely in the form of additional shares of Common Stock. After payment of dividends at the annual rates set forth above, any additional dividends declared shall be distributed ratably among all holders of Preferred Stock and Common Stock in proportion to the number of shares of Common Stock that would be held by each such holder of Preferred Stock as if the Preferred Stock were converted into Common Stock by taking the Series A Liquidation Value (as defined below) divided by the market price of one share of Common Stock on the date of distribution.

Liquidation. Upon any liquidation, dissolution or winding up of the Company after payment or provision for payment of debts and other liabilities of the Company and any liquidation preferences to the senior securities, before any distribution or payment is made to the holders of any junior securities, the holders of Preferred Stock shall first be entitled to be paid out of the assets of the Company available for distribution to its stockholders an amount with respect to the Series A Liquidation Value, after which any remaining assets of the Company shall be distributed ratably among the holders of the Preferred Stock and the holders of junior securities, as if the Preferred Stock were converted into Common Stock by taking the Series A Liquidation Value divided by the market price of one share of Common Stock on the date of distribution.

Redemption. The Company may redeem, for cash or by an offset against any outstanding note payable from Socius to the Company that was issued by Socius, any or all of the Preferred Stock at any time at a redemption price per share equal to $10,000 per share of Preferred Stock, plus any accrued but unpaid dividends with respect to such share of Preferred Stock (the “Series A Liquidation Value”).

During the three months ended June 30, 2011, the Company issued 197,484 shares of its common stock for services rendered by non-employees, 104,708 shares of its common stock in lieu of interest payable in cash or stock, 1,300,000 shares of its common stock from the conversion of $525,000 face amount of unsecured, 8% convertible debentures and warrants for the aggregate purchase of 116,575 shares of common stock for services rendered by non-employees.

Socius CG II, Ltd. Financing

On June 3, 2011, the Company entered into a securities purchase agreement with Socius CG II, Ltd. (“Socius”), pursuant to which we secured $500,000 of immediate funding through the issuance and sale of 2,253,470 shares of common stock and a warrant to purchase up to 20,476,707 shares of common stock at an initial exercise price of $1.02 (subject to anti-dilution adjustment).  In addition, Socius agreed to purchase up to an additional $5 million in non-convertible Series A Preferred Stock (“Preferred Stock”) from the Company over the next two years, subject to the Company meeting certain conditions.

Subject to the terms and conditions of the securities purchase agreement, beginning 75 days after the closing of the initial purchase, at the Company’s sole discretion, the Company may submit to Socius a tranche notice to purchase a certain dollar amount of the Company’s Preferred Stock at $10,000 per share. The maximum amount that may be funded under any tranche cannot exceed 20% of the cumulative trading volume of the common stock for the 10 trading day-period prior to the applicable tranche notice date.

In connection with the securities purchase agreement, the Company agreed to issue on the 75 day anniversary of the initial purchase by Socius, 1,126,735 shares of common stock to Socius as consideration for executing the securities purchase agreement. The fair value of the consideration was estimated at $788,708 using the June 3, 2011 common stock closing price of $0.70 per share and was recorded as accrued expense and realized as financing cost charged to additional paid in capital (“APIC”).

 
F-10

 

In addition, with the closing of the Socius financing, the Company approved the issuance of an aggregate of 1,800,000 shares of common stock as contingent consideration valued at $1,260,000 using the June 3, 2011 common stock closing price of $0.70 per share to two non-employee consultants. The share issuance was recorded as APIC and as financing cost charged to APIC.
 
In connection with the issuance of the warrant to purchase up to 20,476,707 shares of common stock at an initial exercise price of $1.02 (subject to anti-dilution adjustment), using the Black-Scholes option-pricing model that valued the warrants at $0.70 and $0.65 per share at June 3 and June 30, 2011 respectively, the Company recorded a charge to operations of $12,839,860 and to additional paid in capital of $470,000.  The value of the derivative warrant liability is $13,309,860 at June 30, 2011.  In connection with this transaction the Company recorded deferred financing fees of $843,957.

Common Stock Issued

In January 2011, the Company issued an aggregate of 188,939 shares of common stock valued, using the closing stock price, at $288,143 as compensation for services rendered by non-employees and 1,300,000 shares of common stock pursuant to the conversion of aggregate $525,000 principal amount of the 8% convertible debentures.

On February 14, 2011, the Company elected to issue 104,708 shares of common stock valued, using the closing stock price, at $157,062 in lieu of cash to satisfy the interest payable at January 1, 2011 to the convertible debentures holders.

On February 15, 2011, the Company issued 8,545 shares of common stock valued, using the Black Scholes pricing option model, of $10,681 as compensation for services rendered by non-employees.

On June 3, 2011, the Company issued 2,253,470 shares of common stock to Socius for cash consideration of $500,000 and 1,800,000 shares of common stock valued, using the closing stock price, at $1,260,000 for financing fees paid to non-employees.

On June 6, 2011, the Company elected to issue 40,884 shares of common stock valued, using the closing stock price, at $44,973 in lieu of cash to satisfy the interest payable at April 1, 2011 to the convertible debentures holders.

On June 30, 2011, the Company elected to issue 43,800 shares of common stock valued, using the closing stock price, at $28,469 in lieu of cash to satisfy the interest payable at July 1, 2011.

Warrants

On January 4, 2011, the Company issued a warrant with an exercise price of $1.00 for the purchase of 100,000 shares of common stock valued at $1.50 per share using the Black-Scholes option-pricing model, or $150,000, as settlement of services rendered by non-employee in 2010.

On February 4, 2011, the Company issued a warrant with an exercise price of $1.00 purchase of 16,575 shares of common stock valued at $1.15 per share using the Black-Scholes option-pricing model, or $19,061, as settlement of services rendered by non-employee in 2010.

The aggregate intrinsic value of the warrants for purchase of common stock related to Socius, non-employees and the convertible debentures outstanding of 23,168,282 and 1,700,000 shares is $981,250 and $850,000 at June 30, 2011 and December 31, 2010, respectively.

Stock Incentive Plan

In 2010, we adopted our Stock Incentive Plan (the "Plan"). Under the Plan, at June 30, 2011 we had 4,000,000 shares approved and reserved and at December 31, 2010 we had 4,000,000 shares reserved for the issuance of stock options to employees, officers, directors and outside advisors. Under the Plan, the options may be granted to purchase shares of our common stock at fair market value at the date of grant.

We have not issued any options under the Stock Incentive Plan as of June 30, 2011. (See footnote 6 “Subsequent Events”).

3. Debt Obligations

Current 14% Debenture

Extinguishment of 14% Debenture

In June 2010, Pet Airways, Inc. (Florida) issued a $250,000 principal amount unsecured debenture, with an interest rate of 14% per annum and a maturity date of June 18, 2011 (“14% debenture”). Interest on the 14% debenture is payable quarterly starting January 1, 2011. At the Company’s option, interest due may be settled in cash or shares of Company common stock.

 
F-11

 

On June 3, 2011, The PAWS Pet Company, Inc. (Illinois) extinguished the $250,000 principal amount 14% debenture in exchange for a $350,000 principal amount convertible debenture with a coupon interest rate of 14% per annum, a conversion price of $0.50 per share of common stock and a maturity date of August 14, 2013 (“14% convertible debenture”) and a detached warrant for the purchase of 875,000 shares of common stock at an exercise price of $0.50 per share with an expiration date of June 3, 2016. The extinguishment of the $250,000 principal amount 14% debenture resulted in a total loss on the extinguishment of debt of $571,122 including $10,128 of accrued interest payable.

The 14% convertible debenture and detached warrant issued above is subject to derivative liability accounting. Using the Black-Scholes option pricing model, a fair value of the debenture’s beneficial conversion feature and warrant component derivative was determined to be $342,632 and has been recorded as APIC and debt discount. Using the Black-Scholes option pricing model, a fair value of the detached warrant was determined to be $481,250 and has been recorded as APIC and element of the total loss on the extinguishment of debt.

Convertible Debentures

In August 2010, in a series of transactions, the Company issued five unsecured, convertible debentures, with an aggregate principal balance of $500,000, with interest rates of 8% per annum and a maturity date of August 2013. The debentures are convertible into shares of the Company’s stock at a conversion price of $0.50 per share. Also, in August 2010, the Company issued an unsecured, convertible debenture in the principal amount of $500,000 with an interest rate of 8% and a maturity date of August 2013. The debenture is convertible into shares of the Company’s stock at a conversion price of $0.40 per share. Interest on the above debentures is payable quarterly. At the Company’s option, interest due may be settled in cash or shares of Company common stock.

In January 2011, the debenture holders of aggregate $525,000 principal amount of 8% convertible debentures elected to convert their debentures into 1,300,000 shares of common stock.

At June 30, 2011, an aggregate of $475,000 and $350,000 principal amount 8% and 14% convertible debentures, respectively, were outstanding.

At June 30, 2011 and December 31, 2010, the aggregate $825,000 and $1,000,000 convertible debentures if-converted shares of common stock issuable at conversion rates ranging from $0.40 to $0.50 per share resulted in 1,825,000 and 2,250,000 shares and have a fair market value of $1,186,250 and $3,375,000 using the common stock closing prices of $0.65 and $1.50 per share, that exceeds the aggregate principal amount of the convertible debentures by $361,250 and $2,375,000, respectively.
 
Debt Discount

On January 17, 2011, the Company amortized to interest expense $325,399 of the debt discount related to the conversion of aggregate $525,000 principal amount unsecured 8% convertible debentures into 1,300,000 shares of common stock.

On June 3, 2011, the Company issued a 14% convertible debenture and detached warrant that was subject to derivative liability accounting. Using the Black-Scholes option pricing model, a fair value of the debenture’s beneficial conversion feature and warrant component derivative was determined to be $342,632 and has been recorded as debt discount and APIC.

For period ended June 30, 2011, the Company amortized to interest expense using the effective interest method $68,460 and $12,453 or $80,913 of the debt discount related to the outstanding $475,000 principal amount and $350,000 principal amount convertible debentures, respectively.

At June 30, 2011 and December 31, 2010, the aggregate unamortized debt discount was $632,127 and $695,807, respectively. The unamortized debt discount at June 30, 2011 is being amortized to interest expense using the effective interest method through the earlier of the conversion date or the maturity dates of the convertible debentures. The total effective interest rate on the liability component was 14 percent for the period ended June 30, 2011.

 
F-12

 

The following table summarizes the principal, unamortized debt discount and equity components of our convertible debentures derivative liability net carrying amount:
 
   
June 30,
2011
   
December 31,
2010
 
Principal amount 8% convertible debenture
 
$
475,000
   
$
1,000,000
 
Principal amount 14% convertible debenture
   
350,000
     
-
 
Unamortized debt discount
   
(632,127
)
   
(695,807
)
Net carrying amount
 
$
192,873
   
$
304,193
 
                 
Equity component (recognized in Additional paid-in capital)
 
$
1,614,013
   
$
790,131
 

 
F-13

 

4. Commitments and Contingencies

The Company may from time to time subject to various legal proceedings and claims arising in the ordinary course of business, including, but not limited to, ongoing examinations by the Internal Revenue Service (IRS). Consistent with SEC rules and requirements, we describe below material pending legal proceedings (other than ordinary routine litigation incidental to our business), material proceedings known to be contemplated by governmental authorities, other proceedings arising under federal, state, or local environmental laws and regulations (including governmental proceedings involving potential fines, penalties, or other monetary sanctions in excess of $10,000) and such other pending matters that we may determine to be appropriate.

On June 23, 2011, we filed a complaint in the Superior Court of The State of California, County of Santa Clara against Evan Bines and Alpine Capital Partners, Inc., for (a) breach of oral contract and (b) negligent misrepresentation from the breach of a contract to provide at least $2 million in financing for the Company conditional upon the Company completing a reverse merger with a public entity. We are asking the court in a jury trial for judgment against Evan Bines and Alpine Capital Partners, Inc. for (1) compensatory damages in an amount proven at trial, (2) the return of all unearned shares in the merged entity (now known as The PAWS Pet Company, Inc.) as compensation for the merger transaction, (3)consequential damages in an amount proven at trial, (4) interest commencing from the date of breach, (5) punitive and exemplary damage, (6) recoverable attorneys’ fees and (7) any other relief.

Except as noted above, the Company's management has not been made aware of or party to legal proceedings, IRS examinations or asserted claims the outcome of which, individually or collectively, will have a material adverse effect on the Company's financial condition, results of operations, or cash flow. The Company offers flight insurance to its customers at different levels of coverage. The Company is self-insured and has not accrued a reserve against potential loss.

 
F-14

 

5. Net loss per share

The Company computes net loss per share in accordance with U.S. generally accepted accounting principles. Basic net loss per share is computed by dividing net loss attributable to common stockholders (numerator) by the weighted average number of common shares outstanding (denominator) during the period. Diluted net loss per share gives effect to all dilutive potential common shares outstanding during the period including stock options, warrants, and convertible debentures using the treasury stock method.

The following is a reconciliation of the weighted average number of common shares used to calculate basic net loss per share to the weighted average common and potential common shares used to calculate diluted net loss per share for the three and six months ended June 30, 2011 and 2010:
 
   
Three months ended June 30,
   
Six months ended June 30,
 
   
2011
     
2010
*
   
2011
     
2010
*
   
(Unaudited)
   
(Unaudited)
 
 Numerator:
                             
Net loss, basic
 
$
(14,425,262
)
 
$
(257,413
)
 
$
(16,040,519
)
 
$
(475,822
)
Effect of interest expense and debt discount amortization
   
-
     
-
     
-
     
-
 
Net loss, dilutive
   
(14,425,262
)
   
(257,413
)
   
(16,040,519
)
   
(475,822
)
Denominator:
                               
Weighted shares outstanding, basic
   
41,175,742
     
30,548,060
     
40,397,966
     
29,114,911
 
Effect of dilutive securities:
                               
Convertible debentures and warrants (1)
   
-
     
-
     
-
     
-
 
Weighted shares outstanding, dilutive
   
41,175,742
     
30,548,060
     
40,397,966
     
29,114,911
 
                                 
Net loss per share, basic and dilutive
 
$
(0.35
)
 
$
(0.01
)
 
$
(0.40
)
 
$
(0.02
)
  

 
(1)
At June 30, 2011, excludes 24,618,282 shares for the three and six month periods, respectively, issuable upon conversion of outstanding debentures and exercise of warrants as the net effect is antidilutive.
 
*
For comparability during this reportable period, the shares in the denominator for the three and six month periods ended June 30, 2010 are present on a post-acquisition and post-share exchanged pro-forma basis.

 
F-15

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors
The PAWS Pet Company, Inc.

We have audited the accompanying consolidated balance sheets of The PAWS Pet Company, Inc. and its Subsidiary as of December 31, 2010 and 2009, and the related consolidated statements of operations, stockholders’ equity and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company’s management.

Our responsibility is to express an opinion on these consolidated financial statements based on our audits.  We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting.

Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion the consolidated financial statements referred to above present fairly, in all material respects, the financial position of The PAWS Pet Company , Inc. and its Subsidiary as of December 31, 2010 and 2009, and the results of their operations and their cash flows for the years then ended in conformity with U.S. generally accepted accounting principles.

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 13 to the consolidated financial statements, the Company had accumulated losses of $(6,065,008) as of December 31, 2010, which raises substantial doubt about its ability to continue as a going concern. Management’s plans concerning these matters are also described in Note 13. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

/s/ KBL, LLP
New York, NY
March 24, 2011

 
F-16

 

THE PAWS PET COMPANY, INC.
CONSOLIDATED BALANCE SHEETS

   
For the Year Ended December
31,
 
   
2010
   
2009
 
ASSETS
           
Current assets:
           
Cash and cash equivalents
 
$
1,511,057
   
$
171,256
 
Receivable due from credit card clearing house
   
123,134
     
-
 
Prepaid expenses
   
119,354
     
-
 
Total current assets
   
1,753,545
     
171,256
 
                 
Property and equipment, at cost
   
168,546
     
70,590
 
Less: accumulated depreciation and amortization
   
(38,587
)
   
(12,859
)
Property and equipment, net
   
129,959
     
57,731
 
                 
Non-current assets
               
Intangible assets, net
   
-
     
11,600
 
Security deposits
   
30,787
     
19,600
 
Total non-current assets
   
30,787
     
31,200
 
Total assets
 
$
1,914,291
   
$
260,187
 
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
               
Current liabilities:
               
14% convertible debenture
 
$
250,000
   
$
-
 
Accounts payable
   
550,216
     
67,584
 
Accrued expenses
   
342,159
     
21,591
 
Unearned revenue
   
125,603
     
94,616
 
Total current liabilities
   
1,267,978
     
183,791
 
                 
Non-current liabilities:
               
8% convertible debentures, face amount $1,000,000, net of discount of $695,807
   
304,193
     
-
 
                 
Commitments and contingencies:
   
-
     
-
 
                 
Stockholders' equity:
               
Preferred stock, no par, 10,000,000 shares authorized, none issued and outstanding at December 31, 2010 and 2009.
   
-
     
-
 
Common stock, no par value, 100,000,000 shares authorized, 38,314,615 and 26,911,942 issued and outstanding at December 31, 2010 and 2009, respectively.
   
-
     
-
 
Additional paid-in capital
   
6,407,128
     
2,085,500
 
Accumulated deficit
   
(6,065,008
)
   
(2,009,104
)
Total stockholders' equity
   
342,120
     
76,396
 
Total liabilities and stockholders' equity
 
$
1,914,291
   
$
260,187
 

The accompanying notes are an integral part of these consolidated financial statements

 
F-17

 

THE PAWS PET COMPANY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS

   
For the Years Ended December
31,
 
   
2010
   
2009
 
Revenue
 
$
1,348,491
   
$
628,829
 
Cost of revenue
   
1,588,693
     
890,005
 
Gross loss
   
(240,202
)
   
(261,176
)
                 
Operating expense:
               
Sales, general and administrative
   
3,560,555
     
959,504
 
                 
Loss from operations
   
(3,800,757
)
   
(1,220,680
)
                 
Other income (expense):
               
Interest income
   
185
     
1,973
 
Interest expense
   
(255,333
)
   
-
 
Other income (expense), net
   
(255,148
)
   
1,973
 
                 
Loss before income taxes
   
(4,055,905
)
   
(1,218,707
)
(Provision) benefit for income taxes
   
-
     
-
 
                 
Net loss
 
$
(4,055,905
)
 
$
(1,218,707
)
                 
Net loss per share
 
$
(0.13
)
 
$
(0.05
)
                 
Weighted average shares used in calculation of net loss per share
   
32,365,036
     
24,770,195
 

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

 
F-18

 

THE PAWS PET COMPANY, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

   
Years Ended December 31, 2010 and 2009
 
   
Common
Stock
                   
   
No Par
   
Additional
         
Total
 
   
Value
   
Paid-In
   
Accumulated
   
Stockholders’
 
   
Shares
   
Capital
   
(Deficit)
   
Equity
 
Balance, December 31, 2008 (1)
   
23,370,780
   
$
890,000
   
$
(790,397
)
 
$
99,603
 
                                 
Common stock issued for cash
   
3,541,162
     
1,195,500
     
-
     
1,195,500
 
                                 
Net loss
   
-
     
-
     
(1,218,706
)
   
(1,218,706
)
                                 
Balance, December 31, 2009 (1)
   
26,911,942
     
2,085,500
     
(2,009,103
)
   
76,397
 
                                 
Common shares issued for cash
   
5,184,831
     
2,270,000
     
-
     
2,270,000
 
                                 
Common shares issued for services rendered by non-employees
   
2,881,434
     
247,432
     
-
     
247,432
 
                                 
Common shares issued in lieu of cash compensation to employees
   
3,336,408
     
129,065
     
-
     
129,065
 
                                 
Warrants issued for services rendered by non-employees
   
-
     
885,000
     
-
     
885,000
 
                                 
Fair value of warrants to purchase 1,400,000 shares of common stock, issued with $1,000,000 face value amount, 8% convertible debentures
   
-
     
790,131
     
-
     
790,131
 
                                 
Net loss
   
-
     
-
     
(4,055,905
)
   
(4,055,905
)
                                 
Balance, December 31, 2010
   
38,314,615
   
$
6,407,128
   
$
(6,065,008
)
 
$
342,120
 
 
The accompanying notes are an integral part of these consolidated financial statements.

 
F-19

 

THE PAWS PET COMPANY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS

   
For the Years Ended December
31,
 
   
2010
   
2009
 
             
CASH FLOWS FROM OPERATING ACTIVITIES:
       
Net loss
 
$
(4,055,905
)
 
$
(1,218,707
)
Adjustments to reconcile net loss to net cash used in operating activities:
               
Depreciation and amortization
   
25,728
     
9,207
 
Derivative liability discount amortization
   
94,324
     
-
 
Loss on write down of intangible assets
   
11,600
     
-
 
Common shares issued for services rendered by non-employees
   
247,432
     
-
 
Common shares issued in lieu of cash compensation to employees
   
129,065
     
-
 
Warrants issued for services rendered by non-employees
   
885,000
     
-
 
Changes in operating assets and liabilities:
               
Receivable due from credit card clearing house
   
(123,134
)
   
-
 
Prepaid expenses
   
(119,354
)
   
-
 
Security deposits
   
(11,187
)
   
(19,600
)
Accounts payable
   
482,633
     
67,584
 
Accrued expenses
   
320,568
     
21,591
 
Unearned revenue
   
30,987
     
94,616
 
Net cash used in operating activities
   
(2,082,243
)
   
(1,045,309
)
                 
CASH FLOWS FROM OPERATING ACTIVITIES:
               
Purchases of property and equipment
   
(97,956
)
   
(61,166
)
Net cash used in investing activities
   
(97,956
)
   
(61,166
)
                 
CASH FLOWS FROM FINANCING ACTIVITIES:
               
Proceeds from issuance of convertible debentures
   
1,250,000
     
-
 
Proceeds from issuance of common stock
   
2,270,000
     
-
 
Proceeds from issuance of LLC membership units
   
-
     
1,195,500
 
Other
   
-
     
(10,000
)
Net cash provided by financing activities
   
3,520,000
     
1,185,500
 
Net change in cash and cash equivalents
   
1,339,801
     
79,025
 
Cash and cash equivalents at beginning of year
   
171,256
     
92,231
 
Cash and cash equivalents at end of year
 
$
1,511,057
   
$
171,256
 
                 
Supplementary disclosure of cash flow information
               
Cash paid during the year for:
               
Income taxes
 
$
-
   
$
-
 
Interest expense
 
$
3,947
   
$
8,644
 
Non-cash transactions:
               
Surrender of LLC membership units for common stock shares
 
$
(1,195,000
)
 
$
-
 
Issuance of  common stock shares for LLC membership units
 
$
1,195,000
   
$
-
 
Fair value of warrants to purchase 1,400,000 shares of common stock, issued with the $1,000,000 aggregate face amount, 8% convertible debentures
 
$
790,131
   
$
-
 

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

 
F-20

 

THE PAWS PET COMPANY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010

1.  Description of the Business

The PAWS Pet Company, Inc., through its wholly-owned subsidiary, Pet Airways, Inc. operates the only airline designed specifically for the comfortable and safe transportation of pets where pets travel in the main cabin of the aircraft.  Pet owners book their pets on flights at our website (“www.petairways.com”) or can book with our agents by phone. Flights may be booked up to three months before the scheduled departure date. Payment for the flights is made with a credit card. On the day of the scheduled flight, the pet passengers are then dropped off at one of our facilities located at the airport, placed into a pet friendly carrier and then boarded on the aircraft. Pet passengers fly in the main cabin of our specially outfitted aircraft rather than flying in the cargo hole or flying as carry-on baggage under the seat, as required of a traditional commercial airline. We monitor the air quality and temperature of our aircraft ensuring that the pet passengers are safe and comfortable at all times throughout the flight and have an attendant on the flights who is responsible for checking the pet passengers during the flight. Upon arrival at the destination, the pet passenger is unloaded from the plane and can be picked up by the pet owner at one of our airport facilities. We currently serve nine cities in the United States in a coast to coast service.

The PAWS Pet Company, Inc. (formerly American Antiquities, Inc. or AAI) was originally incorporated in the State of Illinois on June 6, 2005. In August 2010, The PAWS Pet Company, Inc. completed an acquisition of Pet Airways, Inc. (Florida), a Florida corporation formed by the conversion of Panther Air Cargo, LLC, a limited liability company, pursuant to a Share Exchange Agreement (the “Acquisition”).  The Acquisition was accounted for as a recapitalization effected by a share exchange, wherein Pet Airways, Inc.  (Florida) is considered the acquirer for accounting and financial reporting purposes.  The assets and liabilities of the acquired entity have been brought forward at their book values, which were determined to be zero, goodwill was not recognized and the share exchange impact has been reflected in the opening balances of stockholders’ equity.

Following the Acquisition, we changed our name to Pet Airways, Inc. and moved our corporate headquarters from the state of Illinois to Florida. On July 27, 2011, we filed Articles of Amendment to our Articles of Incorporation to change our name to The PAWS Pet Company, Inc. and moved our corporate headquarters from the state of Florida to California.

Continuation of Company As A Going Concern

The Company has experienced net losses in each calendar quarter since our inception and, as of the year ended December 31, 2010, had an accumulated deficit of $(6,065,008). The Company incurred a net loss to common stockholders of $(4,055,905) during the year ended December 31, 2010. As a result of these conditions, the report of our independent registered accountants issued in connection with the audit of our consolidated financial statements as of and for our year ended December 31, 2010 contained a qualification raising a substantial doubt about our ability to continue as a going concern. Our consolidated financial statements do not include any adjustments that may result from the outcome of this uncertainty. If we cannot continue as a viable entity, our stockholders may lose some or all of their investment in us.

2.  Summary of Significant Accounting Policies

Fiscal Year

The Company’s fiscal year is the twelve month period ending on December 31.

Principles of Consolidation

The consolidated financial statements presented above include the accounts of Pet Airways, Inc. and its subsidiary.  All significant inter-company balances and transactions have been eliminated.

Use of Estimates

The preparation of consolidated financial statements and related footnote disclosures in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. The Company evaluates, on an on-going basis, its estimates and judgments, including those related to revenue recognition, bad debts, impairment of goodwill and intangible assets, income taxes, contingencies and litigation. Its estimates are based on historical experience and assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

 
F-21

 

Cash and Cash Equivalents

The Company considers all highly liquid investments with an original maturity or remaining maturity of three months or less at the date of purchase to be classified as cash and cash equivalents consisting of checking and money market accounts.  Cash and cash equivalents are stated at cost, which approximates market value, and are primarily maintained at two financial institutions.

Advertising Costs

Advertising and marketing costs of $84,403 and $2,134 were expensed as incurred in each of the years ended December 31, 2010 and 2009, respectively.

Other Receivables

Other receivables are carried at cost. They consist of amounts due from credit card companies associated with the sales of tickets for future travel.

Property and equipment

Property and equipment are stated at cost.  Depreciation of computer equipment and software is computed using the straight line method over the estimated useful lives of the assets.  Estimated useful lives of three to five years are used for computer equipment and software.  The Company constructed a number of airport based facilities during 2010 and 2009 and recorded the cost as leasehold improvements as a part of the build out of these spaces.  These leasehold improvements are recorded at cost and are being amortized over the shorter of the estimated useful lives of three years or the accompanying lease term. Property and equipment sold, retired or disposed of, together with related accumulated depreciation is removed from the appropriate accounts and the resultant gain or loss is included in income or loss.  The interest expense amount subject to capitalization during the construction period of the airport facilities was immaterial as of December 31, 2010 and 2009.

Long-lived assets

The Company reviews long-lived assets for impairment when circumstances indicate the carrying amount of an asset may not be recoverable based on the undiscounted future cash flows of the asset. Determination of recoverability is based on an estimate of undiscounted future cash flows resulting from the use of the asset, and its eventual disposition. Measurement of an impairment loss for intangible and long-lived assets that management expects to hold and use is based on the fair value of the asset as estimated using a discounted cash flow model. No long-lived assets were impaired as of December 31, 2010 and 2009.

Concentrations

Payment collected is invested in money market and interest earning deposit accounts at a FDIC insured financial institution at times at levels that may exceed the $250,000 insurance limit afford each account holder.  We have contracted with Suburban Air Freight, Inc. (“Suburban Air”), an air freight operator based in Omaha, Nebraska, to provide Beech 1900 aircraft for all our flights. As the Company collects payment by major credit cards from customers before or concurrent with their pet travel or services, the Company has no credit concentration risk.

Revenue Recognition

The Company recognizes revenue when it is earned. Tickets sold are initially deferred and pet passengers’ revenue is recognized when the transportation is provided. Tickets sold but not used on the date of the flight can typically be re-used towards another flight for up to one year from the initial flight date. Tickets issues for flights that are cancelled can be refunded or can be used towards another flight. Unearned revenue is made up of tickets purchased for future flights and processed credit card transactions for ticket for future flights that have not taken place for the years ended December 31, 2010 and 2009.

 
F-22

 

Income Taxes

The Company accounts for income taxes using the asset and liability approach in accordance with ASC 740, “Accounting for Income Taxes”.  The asset and liability approach requires the recognition of deferred tax liabilities and assets for the expected future tax consequences of temporary differences between the carrying amounts and the tax basis of assets and liabilities.  The effect on deferred taxes of a change in tax rates is recognized in operations in the period that includes the enactment date.  Due to recurring net operating losses, there has been no provision for income taxes in the periods presented. In June 2006, the Financial Accounting Standards Board (“FASB”) issued FASB ASC 740-10-25 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. ASC 740-10-25 also provides guidance on recognition, classification, treatment of interest and penalties, and disclosure of such positions. Effective January 1, 2009, the Company adopted the provisions of ASC 740-10-25, as required. As a result of implementing ASC 740-10-25, there has been no adjustment to the Company’s consolidated financial statements and the adoption of ASC 740-10-25 did not have a material effect on the Company’s consolidated financial statements for the years ended December 31, 2010 and 2009.

Computation of Earnings per Share

In accordance with FASB ASC 260, “Earnings per Share”, the basic loss per common share is computed by dividing net loss available to common stockholders by the weighted average number of common shares outstanding.  Diluted loss per common share is computed in a manner similar to basic loss per common share except that the denominator is increased to include the number of additional common shares that would have been outstanding if the potential common shares had been issued and if the additional common shares were dilutive. At December 31, 2010 and 2009, the Company stock equivalents were anti-dilutive and excluded in the diluted loss per share computation.

Equity Based Award Compensation

The Company accounts for equity-based compensation under the provisions of ASC 718-10 and ASC 505-50 “Stock Compensation and Equity Based Payments to Non-Employees”. ASC 718 requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in our Statement of Operations.

The Company uses the Black-Scholes option-pricing model as its method of valuation for share-based awards.  Our determination of fair value of share-based payment awards on the date of grant using an option-pricing model is affected by our stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to our expected stock price volatility over the term of the awards, and certain other market variables such as the risk free interest rate. Equity-based compensation expense for awards to employees and non-employees recognized was $1,261,497 and $0 for the years ended December 31, 2010 and 2009, respectively.

Comprehensive Loss

The Company had no items of other comprehensive income or expense for the years ended December 31, 2010 and 2009, respectively.  Accordingly, the Company’s comprehensive loss and net loss are the same for all periods presented.

Segment Information

ASC 280, “Disclosures about Segments of an Enterprise and Related Information”, establishes standards for reporting information regarding operating segments in annual consolidated financial statements and requires selected information for those segments to be presented in interim financial reports issued to stockholders. It also establishes standards for related disclosures about products and services and geographic areas. Operating segments are identified as components of an enterprise about which separate discrete financial information is available for evaluation by the chief operating decision maker, or decision-making group, in making decisions how to allocate resources and assess performance. The Company operates in a single segment, internally reports the results of operations for that segment and the information disclosed herein materially represents all of the financial information related to the single operating segment.
 
Reclassification

The Company has made certain reclassifications to conform to prior periods’ data to the current presentation. These reclassifications had no effect on reported losses, operating ratios or ROI measurements.

Reverse Acquisition Accounting

On August 13, 2010, the Company completed a reverse acquisition transaction through a share exchange with Pet Airways, Inc. (Florida) (the “Acquisition”), whereby the Company acquired 100% of the issued and outstanding capital stock of Pet Airways, Inc. (Florida) in exchange for 25,000,000 shares of the Company’s common shares, which constituted approximately 73% of the Company’s issued and outstanding capital stock on a post-acquisition basis as of and immediately after the consummation of the Acquisition.

 
F-23

 

The share exchange transaction with the Company was treated as a reverse acquisition, with Pet Airways, Inc. (Florida) as the acquirer and the Company as the acquired party. Unless the context suggests otherwise, when the Company refer in this report to business and financial information for periods prior to the consummation of the reverse acquisition, the Company is referring to the business and financial information of Pet Airways, Inc. and its predecessors. Under GAAP guidance ASC 805-40, “Business Combinations – Reverse Acquisitions”, the Acquisition has been treated as a reverse acquisition with no adjustment to the historical book and tax basis of the companies’ assets and liabilities.

Accordingly, the effect of the Acquisition on the stockholders’ equity opening balances for common shares and additional paid-in capital has been retroactively adjusted as shown below:

   
Year Ended December 31, 2009 and 2008
 
  
 
Common Stock
No Par Value
Shares
   
Additional
Paid-In
Capital
 
Balance, December 31, 2008, pre-reverse acquisition
    7,890,000     $ 890,000  
Share exchange adjustment
    15,480,780       -  
Balance, December 31, 2008, post-reverse acquisition
    23,370,780     $ 890,000  
                 
Balance, December 31, 2009, pre-reverse acquisition
    9,085,500     $ 2,085,500  
Share exchange adjustment
    14,285,280       -  
Common stock sales, post-reverse acquisition
    3,541,162       1,195,500  
Balance, December 31, 2009, post-reverse acquisition
    26,911,942     $ 2,058,588  
 
The effect of the Acquisition on the calculation net loss per share for the year ended December 31, 2010 was not material.

Fair Value Measurement

The Company adopted the provisions of ASC 820 “Fair Value Measurements and Disclosures” on January 1, 2009, the beginning of our 2009 fiscal year. ASC 820 clarifies the principle that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. Under the standard, fair value measurements are separately disclosed by level within the fair value hierarchy. As originally issued, it was effective for fiscal years beginning after November 15, 2007, with early adoption permitted. It does not require any new fair value measurements. It only applies to accounting pronouncements that already require or permit fair value measures, except for standards that relate to share-based payments.

On February 12, 2008, the FASB allowed deferral of the effective date of ASC 820 for one year, as it relates to nonfinancial assets and liabilities. Accordingly, our adoption related only to financial assets and liabilities. Upon adoption ASC 820, there was no cumulative effect adjustment to beginning retained earnings and no impact on the consolidated financial statements as of December 31, 2010 and 2009, respectively.

Valuation techniques considered under ASC 820 techniques are based on observable and unobservable inputs. The ASC classifies these inputs into the following hierarchy:

Level 1 inputs are observable inputs and use quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date and are deemed to be most reliable measure of fair value.
 
Level 2 inputs are observable inputs and reflect assumptions that market participants would use in pricing the asset or liability developed based on market data obtained from sources independent of the reporting entity. Level 2 inputs includes 1) quoted prices for similar assets or liabilities in active markets, 2) quoted prices for identical or similar assets or liabilities in markets that are not active, 3) observable inputs such as interest rates and yield curves observable at commonly quoted intervals, volatilities, prepayment speeds, credits risks, default rates, and 4) market-corroborated inputs.
 
Level 3 inputs are unobservable inputs and reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability based on the best information available under the circumstances.

 
F-24

 

In October 2008, the FASB clarified the application of ASC 820 in determining the fair value of a financial asset when the market for that financial asset is not active.
 
The Company adopted the provisions of ASC 825, “The Fair Value Option for Financial Assets and Liabilities”, on January 1, 2009, the beginning of our 2009 fiscal year. ASC 825 permits us to choose to measure certain financial assets and liabilities at fair value that are not currently required to be measured at fair value (the “Fair Value Option”). Election of the Fair Value Option is made on an instrument-by-instrument basis and is irrevocable. At the adoption date, unrealized gains and losses on financial assets and liabilities for which the Fair Value Option has been elected are reported as a cumulative adjustment to beginning retained earnings.

Our current and non-current debentures payable obligations are valued using Level 3 inputs. The fair values of the obligations exceed their carrying cost and are fairly presented throughout our consolidated financial statements at December 31, 2010.

Accounting Standards Codification

In September 2009, FASB issued ASC 105, formerly FASB Statement No. 168, the FASB Accounting Standards Codification (“Codification”) and the Hierarchy of Generally Accepted Accounting Principles (“GAAP”), a replacement of FASB Statement No. 162 (“SFAS 168”). SFAS 168 establishes the Codification as the single source of authoritative GAAP in the United States, other than rules and interpretive releases issued by the SEC. The Codification is a reorganization of current GAAP into a topical format that eliminates the current GAAP hierarchy and establishes instead two levels of guidance authoritative and non-authoritative. All non-grandfathered, non-SEC accounting literature that is not included in the Codification will become non-authoritative. The FASB’s primary goal in developing the Codification is to simplify user access to all authoritative GAAP by providing all the authoritative literature related to a particular accounting topic in one place. The Codification was effective for interim and annual periods ending after September 15, 2009. As the Codification was not intended to change or alter existing GAAP, it did not have a material impact on the Company’s consolidated financial statements.
 
Recent Accounting Pronouncements

In February 2010, the FASB issued FASB ASU 2010-09, Subsequent Events, and Amendments to Certain Recognition and Disclosure Requirements, which clarifies certain existing evaluation and disclosure requirements in ASC 855 related to subsequent events. FASB ASU 2010-09 requires SEC filers to evaluate subsequent events through the date in which the consolidated financial statements are issued and is effectively immediately. The new guidance does not have an effect on its consolidated results of operations and financial condition.
 
In January 2010, the FASB issued FASB ASU 2010-06, “ Improving Disclosures about Fair Value Measurements ”, which clarifies certain existing disclosure requirements in ASC 820 as well as requires disclosures related to significant transfers between each level and additional information about Level 3 activity. FASB ASU 2010-06 begins phasing in the first fiscal period after December 15, 2009. The Company did not make nor anticipates a significant transfer between each level as of December 31. 2010.  As such, the Company does not believe this ASU will have any material impact on its consolidated financial position, results of operations or cash flows.
 
In January 2010, the FASB issued Update No. 2010-05 “Compensation—Stock Compensation—Escrowed Share Arrangements and Presumption of Compensation” (“2010-05”). 2010-05 re-asserts that the Staff of the Securities Exchange Commission (the “SEC Staff”) has stated the presumption that for certain stockholders escrowed share represent a compensatory arrangement. 2010-05 further clarifies the criteria required to be met to establish a position different from the SEC Staff’s position. The Company does not have any escrowed shares held at this time. The adoption of this update by the Company did not have any material impact on its consolidated financial position, results of operations or cash flows.

In January 2010, the FASB issued Update No. 2010-04 “Accounting for Various Topics—Technical Corrections to SEC Paragraphs” (“2010-04”). 2010-04 represents technical corrections to SEC paragraphs within various sections of the Codification. Management is currently evaluating whether these changes will have any material impact on its consolidated financial position, results of operations or cash flows.
 
In January 2010, the FASB issued Update No. 2010-02 “Accounting and Reporting for Decreases in Ownership of a Subsidiary—a Scope Clarification” (“2010-02”) an update of ASC 810 “Consolidation.” 2010-02 clarifies the scope of ASC 810 with respect to decreases in ownership in a subsidiary to those of a: subsidiary or group of assets that are a business or nonprofit, a subsidiary that is transferred to an equity method investee or joint venture, and an exchange of a group of assets that constitutes a business or nonprofit activity to a non-controlling interest including an equity method investee or a joint venture. Management does not expect adoption of this update to have any material impact on its consolidated financial position, results of operations or operating cash flows. Management does not intend to decrease its ownership in its wholly-owned subsidiary.

 
F-25

 

In January 2010, the FASB issued Update No. 2010-01 “Accounting for Distributions to Stockholders with Components of Stock and Cash—a consensus of the FASB Emerging Issues Task Force” (“2010-03”) an update of ASC 505 “Equity.” 2010-03 clarifies the treatment of stock distributions as dividends to stockholders and their effect on the computation of earnings per shares. The Company has not and does not intend to declare dividends for preferred or common stock holders. Management does not expect adoption of this update to have any material impact on its reportable earnings per share and consolidated financial position.

Management does not believe that any recently issued, but not yet effective, accounting standards if currently adopted would have a material effect on the accompanying consolidated financial statements.

3.  Property and Equipment

Property and equipment consist of the following at:
 
   
For the Year Ended December 31,
 
  
 
2010
   
2009
 
Equipment and furniture
  $ 39,526     $ 25,190  
Leasehold improvements
    22,638       20,335  
Lounge equipment
    18,626       13,250  
Website development
    87,756       11,815  
      168,546       70,590  
Less: accumulated depreciation and amortization
    (38,587 )     (12,859 )
Property and equipment, net
  $ 129,959     $ 57,731  
 
Depreciation and amortization expense was $25,728 and $9,207 for the years ended December 31, 2010 and 2009, respectively.
 
4.  Capital  

Common Stock
 
The Company is authorized to issue up to 100,000,000 shares of common stock, no par value. There were 38,314,615 and 26,911,942 shares of common outstanding as of December 31, 2010 and 2009, respectively. Holders of the common stock are entitled to one vote per share on all matters to be voted upon by the stockholders. Holders of common stock are entitled to receive ratably such dividends, if any, as may be declared by the Board of Directors out of funds legally available therefore. Upon the liquidation, dissolution, or winding up of our Company, the holders of common stock are entitled to share ratably in all of our assets which are legally available for distribution after payment of all debts and other liabilities and liquidation preference of any outstanding common stock. Holders of common stock have no preemptive, subscription, redemption or conversion rights. The outstanding shares of common stock are validly issued, fully paid and non-assessable.

During the year ended December 31, 2010, the Company issued an aggregate of 3,766,434 shares of common stock and warrants exercisable into common stock to consultants for services valued at $1,132,432.

During the year ended December 31, 2010, the Company issued an aggregate of 3,336,408 shares of common stock to employees for services valued at $129,065.

In 2009, the Company did not issue shares of common stock to employees or consultants for services.

Pursuant to the terms of the 8% and 14% convertible debentures (“debentures”), the Company has elected to issue shares of common stock to satisfy the accrued interest due to the debenture holders on January 1, 2011.  The accrued interest at December 31, 2010 is convertible into 104,708 common stock shares at conversion rates ranging from $0.40 to $0.50 per share.  The Company’s closing stock price was $1.50 on December 31, 2010. The resulting $157,062 common stock share value has been recognized as interest expense and accrued interest at December 31, 2010. (See Note 7 - Debt Obligations).
 
There were no stock warrants or stock options exercised for the years ended December 31, 2010 and 2009.

Preferred Stock
 
The Company is authorized to issue up to 10,000,000 shares of preferred stock, no par value. The 10,000,000 shares of preferred stock authorized are undesignated as to preferences, privileges and restrictions. As the shares are issued, the Board of Directors must establish a “series” of the shares to be issued and designate the preferences, privileges and restrictions applicable to that series. As of December 31, 2010 and 2009, there were no shares of any series of preferred stock outstanding.

 
F-26

 

5.  Private Placements

Common Stock Sale
 
During the calendar quarters ended March 31 and June 30, 2010, the Company sold an aggregate of 1,036,727 and 148,104, respectively, shares of common stock for cash proceeds of $270,000.
 
In the calendar quarters ended December 31, 2010, the Company sold 4,000,000 shares of common stock at a price of $0.50 per share for gross cash proceeds of $2,000,000 to Daniel T. Zagorin Trust.  The closing market price on November 3, 2010 was $2.25. The foregoing securities were sold in a private placement transaction pursuant to Section 4(2), Section 4(6), and Regulation D under the Securities Act of 1933, as amended and have not been registered in the United States under the Securities Act or in any other jurisdiction and may not be offered or sold in the United States absent a registration or an applicable exemption from the registration requirements.

6.  Stock Options Plan

Stock Incentive Plan
 
The Company has a Stock Incentive Plan (the "Plan").  Under the Plan, at December 31, 2010 and 2009, the Company had 4,000,000 and zero shares, respectively, reserved for the issuance of stock options to employees, officers, directors and outside advisors.  Under the Plan, the options may be granted to purchase shares of the Company's common equity at fair market value, as determined by the Company's Board of Directors, at the date of grant.  

The Company has not issued options under the Stock Incentive Plan as of December 31, 2010 and 2009.
 
7.   Debt Obligations

Current 14% Convertible Debenture
 
In June 2010, the Company issued a $250,000 face amount unsecured, convertible debenture, with an interest rate of 14% per annum and a maturity date of June 18, 2011. The debenture is convertible into shares of the Company’s stock at conversion prices of $0.40 per share.  Interest on the above debentures is payable quarterly starting January 1, 2011. At the Company’s option, interest due may be settled in cash or shares of Company common stock.
 
Non-current 8% Convertible Debentures
 
In August, 2010, in a series of transactions, the Company issued five unsecured, convertible debentures, aggregating $500,000, with interest rates of 8% per annum and a maturity date of August 2013. The debentures are convertible into shares of the Company’s stock at conversion prices of $0.50 per share.
 
Also, in August 2010, the Company issued a $500,000 face amount unsecured, convertible debenture with an interest rate of 8% and a maturity date of August 2013. The debentures are convertible into shares of the Company’s stock at conversion prices of $0.40 per share.  Interest on the above debenture is payable quarterly starting January 1, 2011. At the Company’s option, interest due may be settled in cash or shares of Company common stock.
 
The $250,000 face amount, 14% convertible debenture with a maturity date of June 18, 2011, which at the option of the debenture holder had the option of being converted into a $250,000 face amount, 8% convertible debenture with a maturity date of August 2013, was to be issued warrants to purchase 625,000 shares of common stock upon its conversion into the 8% convertible debenture. At December 31, 2010, the conversion contingency had not been satisfied and accordingly, no fair market value for the warrants was recorded at December 31, 2010.
 
Pursuant to the terms of the debentures, the Company has elected to issue common stock shares to satisfy the accrued interest due to the debenture holders on January 1, 2011.  The accrued interest at December 31, 2010 is convertible into 104,708 common stock shares at conversion rates ranging from $0.40 to $0.50 per share.  The Company’s closing stock price was $1.50 on December 31, 2010. The resulting $157,062 common stock share value has been recognized as interest expense and accrued interest at December 31, 2010. (See Note 14 - Subsequent Events)
 
Warrants
 
The Company granted common stock warrants to non-employee individuals and unrelated entities to purchase 300,000 and 1,400,000 shares of common stock in May and August 2010, respectively. At the date of grant, the warrants each had a life of 5 years and were valued at $885,000 and $4,130,000, respectively, using a Black-Scholes option-pricing model with the following assumptions:
 
Stock Price
  $ 2.95  
Expected Term
 
5 years
 
Expected Volatility
    706 %
Dividend Yield
    0 %
Risk-Free Interest Rate
    1.61 %

 
F-27

 

A summary of the warrant activity for the year ended December 31, 2010 is as follows:
 
   
Number 
of 
Warrants
  
  
Weighted 
Average 
Exercise
 Price
  
  
Weighted Average
Remaining 
Contracted
Term (Years)
  
  
Aggregate
Intrinsic 
Value
  
Outstanding at December 31, 2009
   
-
   
$
-
     
-
   
$
-
 
Granted
   
1,700,000
   
$
1.00
     
4.62
   
$
850,000
 
Exercised
   
-
   
$
-
     
-
   
$
-
 
Expired/Cancelled
   
-
   
$
-
     
-
   
$
-
 
Outstanding at December 31, 2010
   
1,700,000
   
$
1.00
     
4.62
   
$
850,000
 
Exercisable at December 31, 2010
   
1,700,000
   
$
1.00
     
4.62
   
$
850,000
 
Weighted Average Grant Date Fair Value
         
$
1.30
                 
 
The fair market value of the 300,000 warrants issued for non-employee services at grant date is $885,000 and was expensed as share-based compensation non-employee for year ended December 31, 2010.
 
We determined that this transaction is subject to accounting under ASC 470-20 “Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement”).   The fair market value of the 1,400,000 warrants issued in connection with the August 2010 issuance of $1,000,000 principal amount unsecured, 8% convertible debentures at grant date is $790,131. Accordingly, the derivative liability discount warrant value of $790,131 has been recorded as additional paid-in capital and a contra account to the $1,000,000 principal amount of the convertible debentures.  

The debenture’s contractual coupon accrued interest at December 31, 2010 is $58,233.  In accordance with the terms of the debentures, the Company has elected to issue shares of common stock to satisfy the accrued interest due to the debenture holders on January 1, 2011.  The accrued interest is convertible into 104,708 shares of common stock at conversion rates ranging from $0.40 to $0.50 per share.  The Company’s closing stock price was $1.50 on December 31, 2010. The resulting $157,062 common stock value has been recognized as interest expense and accrued interest at December 31, 2010.

At December 31, 2010, the unamortized debt discount was $695,807. During the year ended December 31, 2010, the Company recognized a total of $94,324 of interest expense from the amortization of the discount on the derivative liability component. The discount on the derivative liability component will be amortized using the effective interest method through August 13, 2013.  The total effective interest rate on the liability component was 14 percent. At December 31, 2009, the Company did not have convertible debentures with warrants issued and outstanding.
 
The following table summarizes the principal, debt discount and equity components of our convertible debentures derivative liability carrying amount:
 
   
December 31,
2010
 
Principal
 
$
1,000,000
 
Unamortized debt discount
   
(695,807
)
Net carrying amount
 
$
304,193
 
Equity component (recognized in Additional paid-in capital)
 
$
790,131
 
 
At December 31, 2010, the convertible debentures if-converted shares of common stock of 2,250,000, at rates ranging from $0.40 to $0.50 per share, have a value of $3,375,000 that exceeds the principal amount of the convertible debentures by $2,375,000 using the common stock closing price of $1.50 per share.
 
8.  Segment Information
 
At December 31, 2010 and 2009, the Company operated in a single segment. Internally management reports the results of operations for that segment and the information disclosed herein materially represents all of the financial information related to the single operating segment.

 
F-28

 

9.  Income Taxes
 
The provision (benefit) for income taxes for the year ended December 31, 2010 differs from the amount which would be expected as a result of applying the statutory tax rates to the income (losses) before income taxes due primarily to changes in the valuation allowance to fully reserve net deferred tax assets and also due to the fact that the Company was taxed as a partnership during January to July of 2010, resulting in no tax benefit or deferred tax asset during this period.
 
From August to the year ended December 31, 2010, the Company had deferred tax assets primarily consisting of its net operating loss carryforwards and capitalized start-up costs for tax purposes.  However, because of cumulative losses in several consecutive years, the Company has recorded a full valuation allowance such that its net deferred tax asset is zero.  

With respect to tax years prior to the year ended December 31, 2010, the Company was taxed as a partnership.  Accordingly, all of the losses of the Company flow through to the members of the partnership and the Company has no deferred tax assets or loss carryforwards from this period.
 
Deferred tax assets are comprised of the following components:

   
Years Ended December 31,
  
  
  
2010
   
2009
 
Current:
           
Deferred state taxes
 
$
(775
)
 
$
-
 
Accruals and reserves
   
14,382
     
-
 
     
13,607
     
-
 
                 
Non-current:
               
Property, equipment and capitalized start-up costs
   
120,379
     
-
 
Net operating loss carryforwards
   
782,724
     
-
 
Deferred state taxes
   
(48,691
)
   
-
 
     
854,412
     
-
 
                 
Total deferred tax asset
   
868,019
     
-
 
                 
Deferred tax asset valuation allowance
   
(868,019
)
   
-
 
Net deferred tax asset
 
$
-
   
$
-
 

We must also make judgments whether the deferred tax assets will be recovered from future taxable income. To the extent that we believe that recovery is not likely, we must establish a valuation allowance. A valuation allowance has been established for deferred tax assets which we do not believe meet the “more likely than not” criteria. Our judgments regarding future taxable income may change due to changes in market conditions, changes in tax laws, tax planning strategies or other factors. If our assumptions and consequently our estimates change in the future, the valuation allowances we have established may be increased or decreased, resulting in a respective increase or decrease in income tax expense. 
 
On July 13, 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes, effective for fiscal years beginning after Dec. 15, 2006 ("FIN 48").  FIN 48 is intended to clarify the accounting for uncertainty in income taxes recognized in an enterprise's consolidated financial statements, in accordance with FASB Statement No. 109 (FASB ASC 740), Accounting for Income Taxes, by prescribing a more-likely-than-not (i.e., greater than 50% likelihood of receiving a benefit) threshold to recognize any benefit of a tax position taken or expected to be taken in a tax return. Tax positions that meet the recognition threshold are reported in the consolidated financial statements. The guidance further provides the benefit to be realized assuming a review by tax authorities having all relevant information and applying current conventions. The interpretation also clarifies the consolidated financial statements classification of tax related penalties and interest and set forth new disclosures regarding unrecognized tax benefits. The adoption of ASC 740-10 did not have a material impact on our consolidated financial results.
 
At December 31, 2010, the Company had available net operating loss carryforwards of approximately $1,937,000 for federal income tax purposes.  Such carryforwards may be used to reduce consolidated taxable income, if any, in future years through their expiration in 2030 subject to limitations of Section 382 of the Internal Revenue Code, as amended.  Utilization of net operating loss carryforwards may be limited due to the ownership changes and the Company’s acquisitions.

 
F-29

 

The effective tax rate on income (loss) before income taxes differ from the federal income tax statutory rate for the following reasons:  
 
   
For the Years Ended December 31,
 
Tax rate reconciliation:
 
2010
   
2009
 
Tax at statutory U.S. tax rates
 
$
(1,401,218
)
   
34.00
%
   
414,360
     
-34.00
%
State income tax, net of federal benefit
   
(83,468
)
   
2.03
%
   
-
         
Stock compensation
   
303,129
     
-7.36
%
   
-
         
Loss reported on Panther partnership
   
348,103
     
-8.45
%
   
(414,360
)
   
34.00
%
Non-deductible expenses
   
78,925
     
-1.92
%
   
-
         
Valuation allowance
   
754,529
     
-18.30
%
   
-
         
Total income tax provision
 
$
-
     
0.00
%
 
$
-
     
0.00
%
 
10.   Net Loss per Share
 
Net loss per share is computed based on the weighted average number of shares of common stock and potentially dilutive securities assumed to be outstanding during the period using the treasury stock method. Potentially dilutive securities consist of our convertible debt securities, stock options and warrants to purchase common stock.

11.   Commitments and Contingencies

Operating lease commitments

Rent expense charged to operations were $254,897 and $105,330 for the years ended December 31, 2010 and 2009, respectively. The Company had one lease agreement with a term in excess of one year at December 31, 2010. Future minimum lease payments under non-cancelable operating leases with initial or remaining terms in excess of one year at December 31, 2010, were:
 
Year End December 31,
 
Operating Leases
 
2011
 
$
60,000
 
2012
   
60,000
 
2013
   
55,000
 
2014
   
-
 
2015
   
-
 
Thereafter
   
-
 
Total minimum lease payments
 
$
175,000
 

Employment Agreements
 
The Company had no employment agreements at December 31, 2010.

12.   Legal Proceedings
 
There were no ongoing legal proceedings nor is the Company aware of any material un-asserted claims for the year ended December 31, 2010.  From time to time, we may become involved in various lawsuits and legal proceedings which arise in the ordinary course of business. However, litigation is subject to inherent uncertainties, and an adverse result in these or other matters may arise from time to time that may harm our business. The Company is currently not aware of any such legal proceedings or claims other than those mentioned above that it believes will have, individually or in the aggregate, a material adverse effect on its business, financial condition or operating results.
 
13.  Going Concern Matters
 
The accompanying audited consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business.  We do not presently have adequate cash from operations or financing activities to meet our long-term financing needs.  As of December 31, 2010, we had $1,511,057 in cash on hand to use in executing our business plan.  We will require additional working capital to continue our operations during the next 12 months and to support our long-term growth strategies, so as to enhance our service offerings and benefit from economies of scale. Our working capital requirements and the cash flow provided by future operating activities, if any, will vary greatly from quarter to quarter, depending on the volume of business and competition in the markets we serve. We may seek any necessary funding through one or more credit facilities, if available, or through the sale of debt or additional equity securities. However, there is no assurance that funding of any type would be available to us, or that it would be available at rates and on terms and conditions that would be financially acceptable and viable to us in the long term. If we are unable to raise any necessary additional financing when needed, we may be required to suspend operations, sell assets or enter into a merger or other combination with a third party, any of which could adversely affect the value of our common stock, or render it worthless. If we issue additional debt or equity securities, such securities may enjoy rights, privileges and priorities (including but not limited to coupon rates, conversion rights, rights to fixed or preferential dividends, anti-dilution rights or preference as to the distribution of assets upon a liquidation) superior to those enjoyed by holders of our common stock, thereby diluting the value of our common stock.

 
F-30

 

14.  Subsequent Events
 
On January 4, 2011, the Company issued 25,474 shares of common stock to Suburban Air to satisfy $43,306 due from the Company for services in 2010.   The reduction to accounts payables and an increase in paid-in capital will be recorded in the first quarter of 2011.
 
On January 4, 2011, the Company settled with Keith M. McGruder, a consultant to the Company, to pay $15,000 in fees and to issue 100,000 warrants with an exercise price of $1.00.  The $15,000 fee was recorded to accrue expense and consulting expense as of December 31, 2010.  The warrants were valued at $150,000 or $1.50 per warrant using a Black-Scholes option-pricing model with the following assumptions:
 
Stock Price
 
$
1.50
 
Expected Term
 
3 years
 
Expected Volatility
   
717.9
%
Dividend Yield
   
0
%
Risk Free Interest Rate
   
1.26
%
 
The $150,000 value of the 100,000 warrants will be recorded as non-employee share-based compensation expense and increase in paid-in capital will be recorded in the first quarter of 2011.
 
On January 4, 2011, the Company issued 162,563 shares of common stock to James D. Dodrill, a consultant to the Company.  The shares are valued at the then $1.50 quoted trading price of the Company’s common stock or $243,845.  The $243,845 is recognized as stock-based compensation expense non-employee and an accrued liability as of December 31, 2010. The reduction to accrued liability and an increase in paid-in capital will be recorded in the first quarter of 2011.
 
On January 7, 2011, Peter Orr elected to convert $25,000 of his $100,000 convertible debenture with the Company (see Note 9 - Debt Obligations). The Company issued 50,000 shares of common stock.  The per share exercise price of conversion was $0.50 per share or $25,000.  The $25,000 share value will be recognized as an increase in paid-in capital in the first quarter of 2011.
 
On January 17, 2011, The Daniel T. Zagorin Trust elected to convert its $500,000 convertible note with the Company (see Note 9 - Debt Obligations).  The Company issued 1,276,575 shares of common stock.  At the time of the conversion, the per share exercise price of conversion was $0.40 per share or $500,000.  The $500,000 share value will be recognized as an increase in paid-in capital in the first quarter of 2011.
 
On January 18, 2011, Pam Seitz, a non-employee, was issued 902 shares of common stock to satisfy $992 liability due from the Company.  The price per share was based on the Company’s closing stock price of $1.10 on January 18, 2011. The $992 is recognized as stock-based compensation expense non-employee and an accrued liability as of December 31, 2010. The reduction to accrued liability and an increase in paid-in capital will be recorded in the first quarter of 2011.
 
On February 4, 2011, David Leadbetter, a consultant to the Company, was issued 16,575 warrants for common stock in exchange for services.  The warrants have an exercise price of $1.00.  The warrants were valued at $19,061 or $1.15 per warrant using a Black-Scholes option-pricing model with the following assumptions:
 
Stock Price
 
$
1.15
 
Expected Term
 
3 years
 
Expected Volatility
   
717.9
%
Dividend Yield
   
0
%
Risk Free Interest Rate
   
1.31
%

The fair market value of the warrants at grant date was recorded as share-based compensation expense non-employee and an increase in paid-in capital in the first quarter of 2011.
 
On February 14, 2011, the Company issued the unsecured, convertible debentures holders 104,708 shares of common stock to satisfy the accrued but unpaid interest expense of $157,062 due on January 1, 2011.  The $157,062 share value will be recognized as an increase in paid-in capital in the first quarter of 2011 (see Note 6 - Common Stock).
 
On February 15, 2011, the Company issued 8,545 shares of common stock to Kim Thornton, a consultant that provided services to the Company during 2010.  The shares are valued using a price of $1.25 the closing quoted trading price of the Company’s common stock or $10,681.  The $10,681 share value will be recognized as stock-based compensation expense non-employee and an accrued liability as of the year ended December 31, 2010.  Upon issuance of the shares, a reduction to accrued liability and an increase in paid-in capital will be recorded in the first quarter of 2011.

 
F-31