FLYHT Aerospace Solutions
Annual Report 2013

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FLYHT AEROSPACE SOLUTIONS LTD. Annual Report 2013 THE FUTURE OF CONNECTIVITY TABLE OF CONTENTS LETTER TO SHAREHOLDERS .........................................................................17 MANAGEMENT DISCUSSION & ANALYSIS .....................................................20 CONSOLIDATED STATEMENT OF FINANCIAL POSITION .................................42 CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (LOSS) ...........43 CONSOLIDATED STATEMENT OF CHANGES IN EQUITY (DEFICIENCY) .........44 CONSOLIDATED STATEMENT OF CASH FLOWS .............................................45 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS ...........................46 CORPORATE INFORMATION ..........................................................................75 Global flights January 1, 2014 COMMONLY USED FINANCIAL TERMS & AVIATION ACRONYMS ACARS: Aircraft Communications Addressing and Reporting System ICE: Iridium Compatible Equipment ADCC: Aircraft Data Communication Corporation IFRS: International Financial Reporting Standards AFIRSTM: Automated Flight Information Reporting System MD&A: Management Discussion and Analysis AVIC: Aviation Industry Corporation of China NCAA: Nigerian Civil Aviation Authority CAAC: Civil Aviation Administration of China OEM: Original Equipment Manufacturer COMAC: Commercial Aircraft Corporation of China, Ltd. R&D: Research and Development EASA: European Aviation Safety Agency SADI: Strategic Aerospace and Defence Initiative FAA: Federal Aviation Administration SFP: Statement of Financial Position FIRST: Fuel Initiative Reporting System Tracker STC: Supplemental Type Certificate GAMA: General Aviation Manufacturers Association TCCA: Transport Canada Civil Aviation GAAP: Generally Accepted Accounting Principles YTD: Year-to-date ICAO: International Civil Aviation Organization THE AVIATION INDUSTRY Today the air transport industry operates a network of some 40,000 routes over which 3.3 billion people and 50 million tonnes of cargo will be carried in 2014. 1 The industry is celebrating a huge milestone in 2014, 100 years of commercial flight. Passenger demand increased 5.2% in 2013. 2 Load factors at 79.5% in 2013. 2 Airbus deliveries increased for the 12th year in a row. 3 There is a positive market outlook for FLYHT with its new product, the DragonTM. “The industry’s positive numbers across all categories fuel cautious optimism as we move into 2014,” GAMA President and CEO Pete Bunce said. “The introduction of new products will be key to strong future growth, which is why GAMA continues to work with authorities across the globe to streamline certification processes.” 4 1 2 3 4 www.iata.org/pressroom/pr/Pages/2014-02-10-01.aspx www.iata.org/pressroom/pr/Pages/2014-02-06-01.aspx www.airbus.com/newsevents/news-events-single/detail/airbus-sets-new-records-in-orders-deliveries-and-backlog/ www.gama.aero/media-center/press-releases/content/gama-releases-2013-year-end-aircraft-shipment-and-billing-number 1 FLYHT AEROSPACE SOLUTIONS LTD. | ANNUAL REPORT | 2013 2 COMPANY PROFILE THE FUTURE OF CONNECTIVITY What was impossible yesterday is an accomplishment today, while tomorrow heralds the unbelievable. Percible Elliot Fansler In 1903 the Wright brothers pioneered the first aircraft and human flight. In 1914 the first commercial flight took place. Over the course of the past century the industry has exploded. With more than 3.3 billion passengers traveling in 2013, it took under a decade for passenger numbers to double; demontstrating just how many people are connected through flight in our global community. Percible Elliot Fansler, the entrepreneur who started the first commercial air flight said, “what was impossible yesterday is an accomplishment today, while tomorrow heralds the unbelievable.” At FLYHT we strive to support the modernization of the aerospace industry by creating innovative solutions that facilitate seamless communication with aircraft. FLYHT is the innovator of a data streaming technology called FLYHTStreamTM. If an airplane encounters an emergency, live flight data will stream from the aircraft in real time. This technology opens new doors for increased safety and data analysis in the aerospace industry. FLYHT Aerospace Solutions Ltd. got its start in 1998 with the technology to collect and interpret data from an aircraft and deliver it directly to the airline. Over the course of the past 14 years FLYHT has become a leader in real-time data communications for the aerospace industry. The technologies FLYHT offers are the Future of ConnectivityTM. FLYHT’s main product and service offering to the industry is the Automated Flight Information Reporting System, or AFIRSTM. The system operates on multiple aircraft types and provides functions such as voice and text messaging, data collection and transmission, and on-demand streaming of black box data. Through its relationship with Iridium Communications Inc., FLYHT offers global satellite coverage that provides service to whoever needs it, whenever they need it, anywhere on the planet. AFIRS sends information to its companion software, UpTimeTM, which stores and transfers the data to the customer in real time. Aircraft operators can use this information to increase safety, improve service, and enhance profitability. In November 2013, FLYHT introduced the Dragon™, a revolutionary, lightweight, portable satellite communications device that blends existing FLYHT technology with that of the iPad. FLYHT developed the new product to meet a growing demand from small aircraft, business jet and helicopter operators for a satellite communications solution similar to AFIRS. FLYHT is headquartered in Calgary, Canada and has clients using its products on every continent. FLYHT has been publicly traded on the Toronto Venture Exchange since March 2003, first under the symbol AMA and now under FLY. 3 FLYHT AEROSPACE SOLUTIONS LTD. | ANNUAL REPORT | 2013 4 INVESTMENT HIGHLIGHTS HIGHLIGHTS OF THE YEAR • An unparalleled technology that saves money, time and drives efficiencies previously unavailable to the airline industry. • Technology installed on over 400 aircraft. • High margin operations – 75-85% gross margin with recurring revenues resulting from multi-year contracts. • Multiple revenue streams to increase monthly average revenue per aircraft. • Historical longevity of technology in the aviation industry means that once a technology has been accepted, it tends to remain for an extended period of time. • FLYHT executed an agreement with Jabil Defense and Aerospace Inc Services (a wholly-owned subsidiary of Jabil Circuit, (NYSE:JBL)) to manufacture the AFIRS 228 product line. • AFIRS 228 was approved on the SITA and ARINC Inc. (“ARINC”) networks to provide ACARS over Iridium messages. Certification expands the market for customers requiring this type of communications system. • AFIRS 228 received the Iridium Compatible Equipment (“ICE”) certification for the commercial use of the AFIRS 228S on the Iridium satellite network. • FLYHT introduced the Dragon as an exciting new member of the FLYHT family of products. The Dragon is a revolutionary lightweight portable satellite communications device that blends existing FLYHT technology with that of the iPad. FLYHT developed the new product to meet a growing demand from small aircraft, business jet and helicopter operators for a satellite communications solution similar to AFIRS. • FLYHT added another commercial Original Equipment Manufacturer (“OEM”) to its customer list with the agreement with Datang Mobile Aviation division in China for the AFIRS 228 to be standard fit on production ARJ21 aircraft. • Shareholders exercised warrants and stock options for an aggregate of $6,144,886. • FLYHT grew revenues by 23.7% over 2012, decreased cash used in operating activities by 36.4% and saw a 16.8% decrease in operating losses. • Continued to secure Supplemental Type Certificates (“STCs”). Received two from TCCA and one from the FAA for the AFIRS 228. Highlights: Total revenue increased 23.7% from $6,469,806 in 2012 to $8,000,364 in 2013. Research and Development (“R&D”) is down $227,510: Note: R&D includes certification engineering which will be an ongoing cost for the company as we secure customers with different aircraft types. Increase in Gross Margin: 59.2% annual (up from 57.2% in 2012). FLY STOCK CHART 2013 2013 Apr Jul Oct 5 FLYHT AEROSPACE SOLUTIONS LTD. | ANNUAL REPORT | 2013 0.50 0.45 0.40 0.35 0.30 0.25 0.20 0.15 0.10 2.00m 1.50m 1.00m 500.0k 0.00 6 2013 FLYHT REVIEW LAST YEAR, WE SET A NUMBER OF OBJECTIVES. HERE’S AN OVERVIEW OF HOW WE DID: Drive a substantially higher valuation through accelerated revenue growth and profitability • Successfully increased revenues by 23.7% over the previous year. Major Airbus operator for fleet retrofit 2013 and begin shipping from Airbus factory by late 2013 • SITA and ARINC ACARS over Iridium certification received in July allowed the company to progress with L-3 Communications Corporation, Aviation Recorders Inc. (“L-3”). • Began shipping units in December 2013 and January 2014. Build on strategic relationships to accelerate growth Continued to build relationships around the world and with various organizations: • China: Continued to ship units to airlines in the country. Partnered to provide products to AVIC and COMAC. Agreement established to install AFIRS on the ARJ21 fleet. • NetJets Transportes Aereos SA (“NetJets”): Installations on 10 aircraft complete in Q2 2013 with resulting AFIRS UpTime sales revenue and recurring usage revenue being realized each month. We continue to work with NetJets to advance the program. • Nigeria: Continued flight tracking and safety management system dashboard with newly appointed Nigerian Civil Aviation Authority (“NCAA”) Director General. Signed two new contracts with Nigerian airlines and added AFIRS to three existing customers’ aircraft while supporting current operations and the flight following center. Protect our markets by providing superior technology and service 2014 FLYHT PLAN OBJECTIVES FOR 2014 INLCUDE: • Expanded our STC list with activation STCs for the B767-200/300 from and B737-700/800 from TCCA and on the B777 the FAA. • Launched the Dragon: Responded to an emerging trend in iPad connectivity and coupled it with our core competencies in aircraft communications and reporting to provide a light weight portable product for helicopters and general aviation. Become cash flow positive in 2013 • Closer to cash flow positive by the end of 2013, as the result of revenue growth of 23.7%, an operating loss decrease of 16.8% and a decrease in cash used in operating activities of 36.4%. • Increase installations in China to meet mandate; • Install on two business aircraft OEMs; • Expand service modules to increase revenues; • Pursue additional commercial OEM opportunity; and • Positive cash flow from operations. 7 FLYHT AEROSPACE SOLUTIONS LTD. | ANNUAL REPORT | 2013 8 REVENUE SOURCES REVENUE BASED ON LOCATION 12.7% 8.2% 33.8% 45.3% AFIRS UpTime Sales: 33.8% AFIRS UpTime Usage: 45.3% Services: 12.7% Parts: 8.2% Dollar amounts available on page 25. AFIRS UPTIME USAGE GROWTH $3,853,788 48.1% $549,718 6.9% $1,047,979 13.1% 350000 300000 250000 200000 150000 100000 50000 0 $4,000,000 $3,500,000 $3,000,000 $2,500,000 $2,000,000 $1,500,000 $1,000,000 $500,000 $460,184 5.8% $1,391,446 17.4% 2008 2009 2010 2011 2012 2013 $8,000,364 Flight Hours Recurring Revenue 9 FLYHT AEROSPACE SOLUTIONS LTD. | ANNUAL REPORT | 2013 $697,249 8.7% 10 NORTH AMERICAEUROPEAUSTRALASIAASIACENTRAL & SOUTH AMERICATOTALAFRICA & MIDDLE EAST AFIRS 228 UPDATE THE AFIRS 228 IS FLYHT’S NEXT GENERATION COMMUNICATIONS TECHNOLOGY. HERE’S A SUMMARY OF HOW ITS DEVELOPMENT HAS PROGRESSED OVER THE PAST FEW YEARS. 2011 FLYHT brought AFIRS 228 development in-house First AFIRS 228 demonstration May 2011 in Chester, UK Activation STCs received for AFIRS 228 on Boeing 747-200, ATR 42/72 and Boeing 777 from Transport Canada First European Aviation Safety Agency (“EASA”) activation STC for Hawker 987 series Activation STCs received on Bombardier CRJ 900, Hawker 987 series from TCCA Introduced the next version of the AFIRS 228, the AFIRS 228S to enable ACARS over Iridium 2012 54 AFIRS 228B and six AFIRS 228S units built Contract with L-3 to deliver 228S for installation on Airbus A320 production line Option to install 228B on the factory floor at Bombardier for Chinese customers 2013 An agreement is made with Jabil Defense and Aerospace Services, to manufacture the AFIRS 228 product line Activation STC received for the AFIRS 228 on Boeing 777 from the FAA, and Boeing 767-200/300, 737-700/800 from TCCA AFIRS 228 approved for use on SITA and ARINC which enables it to send ACARS messages through Iridium AFIRS 228S passed ICE certification for the commercial use on the Iridium satellite network FLYHT assessed the current market and responded with a new product... INTRODUCING THE DRAGON In November 2013 FLYHT introduced the Dragon as its latest product. The Dragon is a lightweight portable satellite communications device that is coupled with the iPad to bring existing FLYHT technology to new customers around the globe. FLYHT addressed the current market and responded with a new product, called the Dragon, to meet the demand of the growing small aircraft, business jet and helicopter operators. The Dragon enables a new level of connectivity previously not available to general aviation operators. FEATURES As with FLYHT’s AFIRS product line, the Dragon uses the Iridium satellite network to bring global communications to aircraft operators. That means when they’re flying, they’re not alone. The Dragon enables two-way text messaging through the iPad or iPad Mini so pilots can send messages to dispatch and receive weather and flight-critical information. The device is portable so it allows operators the flexibility of using it where and when they need it. FLYHT does not have to secure STCs, which are costly and take time to obtain, because the device is not installed on an aircraft. It is also an affordable satellite communications device for operators, allowing them greater operational awareness and connectivity, wherever they fly. The Dragon also comes with a satellite phone enabled by the Iridium satellite network for rapid, reliable and private communication channel from the cockpit to the ground. In the event of an emergency, the single-touch emergency button directs the call to a pre-programmed contact on the ground. The Dragon also meets the need of operators required to comply with specific regulations for flight following. With the Dragon, operators will know where their aircraft are and better respond to scheduling and maintenance issues as they arise. The Dragon gives operators information to make key decisions. UpTime, FLYHT’s ground based software, is the interface for operators to track aircraft information and respond accordingly. Collecting and monitoring the time the aircraft are on the ground or on route to a destination is important to determine crew pay, crew duty time and maintenance tracking. The Dragon allows operators to record these times on the iPad and sends the information to the operator. This increases the accuracy and speed of the reporting with far less labour from the staff and crew and eliminates the paper process. MARKET The Dragon has a global market as a product for tens of thousands of general aviation enthusiasts, corporate jet and helicopter operators. It has been tested and approved to meet the ADCC requirements for a satellite communications device on aircraft in China. At a cost of under $10,000 per unit, the Dragon will support operators world-wide while generating recurring revenues for FLYHT. 11 FLYHT AEROSPACE SOLUTIONS LTD. | ANNUAL REPORT | 2013 12 2013 MAJOR ANNOUNCEMENTS CONTRACTS: In 2013 FLYHT signed a total of seven contracts with customers worldwide. Of the aircraft contracted, 26 were for the AFIRS 220, 21 for the AFIRS 228 and five were for the Dragon. JANUARY 2: FLYHT signed a contract with a domestic Nigerian airline for the AFIRS 220 on five Airbus A319 and A320 aircraft. JANUARY 7: FLYHT executed an agreement with Jabil Defense and Aerospace Services, to manufacture the AFIRS 228 product line. Scott Gebicke, President of Jabil Defense & Aerospace Services and VP Global Business Units said: “FLYHT and the AFIRS product represent a disruptive innovation that can transform avionics data management and dissemination. We are proud to help FLYHT deliver the highest quality certified product to its growing customer base and will continue to support them in the development and delivery of their product family.” MAY 3: FLYHT received a purchase order from a major avionics integrator for AFIRS 228 equipment for seven Lockheed C-130 Hercules aircraft owned and operated by a Middle Eastern country’s air force. Bill Tempany, President and CEO of FLYHT stated: “We are excited to continue our success in the global C-130 upgrade programs and look forward to supplying the major global avionic integrators with the many benefits AFIRS 228 provides airlines. This is the second Middle Eastern air force to employ FLYHT’s technology.” MAY 8: FLYHT appointed Mr. Derek Graham as Chief Operating Officer. MAY 15: FLYHT signed a contract with a Maldivian airline to install AFIRS 220 on one Boeing 757 and the AFIRS 228B on two Boeing 767 aircraft. MAY 28: FLYHT announced it closed the final tranche of its previously announced debt offering of non-convertible debentures. FLYHT closed on an aggregate $2.1 million of debentures (pursuant to two tranches) which FLYHT anticipates will be sufficient to meet anticipated liquidity needs. JUNE 26: FLYHT received an activation STC for the AFIRS 228 on the Boeing 777 aircraft from the FAA. Bill Tempany, President and CEO of FLYHT stated: “FLYHT has been diligently working towards securing the Boeing 777 STC from the FAA. This popular aircraft is flown around the world by several of our existing customers as well as several prospects we are pursuing. The receipt of this activation STC is the first from the FAA for the AFIRS 228.” JULY 19: FLYHT reported that the AFIRS 228 has been approved for use on the SITA network as a result of the completion of SITA’s VHF AIRCOM Qualification (“VAQ”) testing in Montreal, Canada. For AFIRS 228 to be qualified and validated to send ACARS and other Datalink messages over the SITA network it was a requirement that the Satcom system pass SITA’s VAQ and compliance procedures. 13 FLYHT AEROSPACE SOLUTIONS LTD. | ANNUAL REPORT | 2013 14 NOVEMBER 6: FLYHT reported that its Chinese partner Skyblue Technology Development Co. Ltd. issued a press release updating its commitment with FLYHT. Skyblue stated “We are pleased to announce today that we have received commitments from the first seven airlines we have been working on to install the FLYHT AFIRS solution over the next three years and they have placed orders with us for 218 units. Installation of these is anticipated to commence in first quarter 2014 and we plan to add other airlines to this list in the coming months.” NOVEMBER 7: FLYHT received an activation STC for the AFIRS 228 on the Boeing 737- 700/800 series aircraft from TCCA. NOVEMBER 12: FLYHT signed a contract with a South American cargo airline for AFIRS on 12 Boeing 737-400 and 12 ATR- 200 aircraft. The airline is a cargo carrier with plans to be the dominant cargo carrier in the region with an integrated ground and air cargo operation. The company intends to use AFIRS as a key component of its paperless operational strategy, which is designed to reduce total operating costs and increase efficiencies. Bill Tempany, President and CEO of FLYHT stated: “We are excited to be partnering with an operator who has a similar vision to ours and can see the competitive advantage of AFIRS for operational control and cost savings. We are confident that our AFIRS-based solutions will enable our customer’s vision.” NOVEMBER 25: FLYHT introduced the Dragon as an exciting new member of the FLYHT family of products. The Dragon is a revolutionary, lightweight, portable satellite communications device that blends existing FLYHT technology with that of the iPad. FLYHT developed the new product to meet a growing demand from small aircraft, business jet and helicopter operators for a satellite communications solution similar to AFIRS. Bill Tempany, President and CEO of FLYHT stated: “We are very excited to gain access into a new market with the Dragon, previously out of reach for our products. The tens of thousands of general aviation enthusiasts, corporate jet and helicopter operators will now be able to take full advantage of FLYHT’s revolutionary technology. The device has been tested and approved by the ADCC of China for input into their Global Aircraft Management System (“GAMS”). We are looking forward to a rapid adoption of the technology by aviators globally.” DECEMBER 3: FLYHT announced an agreement to provide through Datang Mobile Aviation division, the AFIRS 228 real-time data communications and SATCOM solution complete with FLYHTStream. The system for Satcom voice and all other data services has been successfully installed on the ARJ21 and used during icing tests for the final validation of the Type Certificate for this aircraft. The ARJ21 has been under development by COMAC and certification testing by AVIC for several years and to date, has ordered 415 units from Chinese airlines, customers in Pakistan and various African countries. The first customer deliveries of the aircraft are expected in late 2014. DECEMBER 4: FLYHT announced agreements with three investor relations (“IR”) firms for services into 2014. The lead IR firm will remain The Howard Group Inc. with continued support from Bristol Institutional Relations, a division of Bristol Capital Ltd. and the addition of Kin Communications Inc., who will add a retail presence to the 2014 investor relations strategy. DECEMBER 10: FLYHT announced the sale and shipment of five of its recently released Dragon products to DAC Aviation International Ltee./DAC Aviation (EA) Ltd. (“DAC”) for five Cessna Caravan Aircraft to provide voice and data services in support of their humanitarian missions in Africa. DECEMBER 24: FLYHT announced the exercise of warrants and stock options for an aggregate of $6,087,733 to date in Q4 of 2013. JULY 30: FLYHT reported that the AFIRS 228 has been approved for use on the ARINC network to provide ACARS over Iridium messages. The approval was the result of completion of ARINC’s GLOBALink/Iridium Phase 3 AQP testing in Annapolis, Maryland, which required AFIRS 228 to have the ability to send ACARS and other Datalink messages over the ARINC network through Iridium. Bill Tempany, President and CEO of FLYHT stated: “This is a key milestone for the Company and its customers. To successfully pass the AQP testing on the first attempt is not the industry norm. We are thrilled that the certification program for FLYHT’s products is proceeding as smoothly as planned, which is the result of the highly skilled and dedicated team that FLYHT has assembled. The certification of the AFIRS 228 opens an expanded market to major carriers requiring the AOI capability for FANS or CPDLC compliance for FLYHT. These approvals underpin an aggressive marketing push, which is well underway.” AUGUST 16: FLYHT reported that it received an activation STC for its AFIRS 228 on the Boeing 767-200/300 series aircraft from TCCA. AUGUST 26: FLYHT’s AFIRS 228 received ICE certification from Iridium for the commercial use of the AFIRS 228S on the Iridium satellite network. Bill Tempany, President and CEO of FLYHT stated: “This is a key milestone for the Company and its customers. The ICE certification is another important step in the process of the AFIRS 228 development and allows activation of the units on the Iridium satellite network. We are pleased to continue to complete these tests on schedule and are excited to see shipment of these products occurring on schedule to all of our customers. All of the building blocks are coming into place for a very bright future and the AFIRS 228 product continues to show its strengths through the thorough testing it is being subjected to.” SEPTEMBER 23: FLYHT signed a contract with a Nigerian airline for AFIRS 220 on four Boeing 737 aircraft. NOVEMBER 4: FLYHT signed a contract with an eastern European airline for AFIRS on four Boeing 757. The airline will use AFIRS to provide real-time flight data monitoring. Bill Tempany, President and CEO of FLYHT stated: “We are excited to be catching a great opportunity in a part of the world that is expanding and needing global communications and data tools. We see the growth potential in Russia and the former Soviet countries as a strong growth market for us”. 15 FLYHT AEROSPACE SOLUTIONS LTD. | ANNUAL REPORT | 2013 16 TO OUR SHAREHOLDERS A YEAR OF BUILDING STRENGTH To our shareholders and loyal supporters; 2013 saw the culmination of many efforts that have consumed our company for several years. The final certification and delivery of an AFIRS 228S, the commercialization of the AFIRS 228B, the announcement and shipment of the Dragon and the completion of the program with L-3 for factory installation of AFIRS on the Airbus A320 are all major accomplishments for our company. As we continue to progress in 2014 here’s a review of what we achieved from our 2013 objectives. Major Airbus operator for fleet retrofit 2013 and begin shipping from Airbus factory by late 2013 Important milestones during the year included the receipt of certification for the AFIRS 228S from SITA and ARINC in July 2013 to send ACARS messages over Iridium. The ACARS aviation protocol has been a mainstay of communicating air traffic messages for over 50 years. SITA and ARINC are the only two organizations approved to route those messages on the ground and from the ground to airborne equipment. In 2011 Iridium was approved to carry those messages by satellite instead of traditional VHF radio. With the certifications received from SITA and ARINC as well as the ICE certification in August of last year, AFIRS 228S can provide safety services voice and data communications between pilots and air traffic controllers. This capability was an original goal in the initiation of the AFIRS 228 project. Continued development and receipt of certifications led to the first factory install shipment of AFIRS 228S in December of 2013 to a major European operator of Airbus A320 aircraft. The initial shipments achieved a small royalty payment in 2013. The initial deployment of these units will not generate recurring revenue for us as the ACARS over Iridium revenues go to the two ACARS providers, though we are working to secure the voice and Electronic Flight Bag (“EFB”) data revenues for FLYHT and will expand services to those customers over time as we gain a foothold with major carriers from having our hardware on their fleets. In 2014, FLYHT will continue to participate in working groups of the Airlines Electronic Engineering Committee (“AEEC”) and the Radio Technical Commission for Aeronautics (“RTCA”) that set industry standards, influence regulations and create value for airlines and the aviation industry. FLYHT’s involvement enables a voice among industry participants, gains insight into customer needs and allows the company to better prepare AFIRS for industry requirements. Priority to drive a substantially higher valuation through accelerated revenue growth and profitability While we did not become cash flow positive in 2013 as we had hoped, we moved closer as the result of revenue growth of 23.7%. We will continue to strive to be cash flow positive throughout 2014. The increase in revenues is an outstanding achievement in our view because we did not finish many of the major products until the fourth quarter of the year. These project completions put us in good stead going forward to achieve even stronger growth in revenues, become a self-sustaining cash flow positive organization and start to show returns for the loyal shareholders who have been with us for many years. We continued to reduce our cash burn, seen in the decrease in cash used in operating activities of 36.4% and the decrease of 16.8% in our operating losses. It is important to note that the engineering work associated with STC development is shown as R&D and therefore will always be an expense due to our continued expansion of STCs on different aircraft types. One of the most exciting developments in 2013 was the exercise of warrants at the end of the year by shareholders. We were very pleased when all but 1.2 million of the 16.5 million $0.40 warrants expiring in December 2013 were exercised contributing to 2013’s total of $6,144,886. The cash brought in from those warrants will be used to pay off our debts and we plan to have the convertible debenture converted this year or we will be repaying it in December. Even with the move of the principal payment of the $3,159,000, for that debenture into current liabilities, we have positive modified working capital and that is the measure we will be watching closely to make sure it continues to grow throughout the coming year. Build on our strategic relationships to accelerate growth We built on our strategic relationships in China to secure a partner to provide our products to AVIC and COMAC and see our continued strength in the China market as being a strong part of our core competencies acknowledged by shareholders. China continued to expand with the installation of over 30 units now in place, an order in hand for another 218 units and the agreement to put AFIRS on as standard fit on the ARJ21 fleet (a twin engine airliner under development by COMAC). We are confident we have strengthened our position in China and that 2014 and beyond will be very good years for us in that market. NetJets has used our system for eight months and have indicated they are very pleased with the results. We are currently working with them to identify a NetJets internal sponsor to move the program forward. As with everything in the aviation industry, it will take time but we are confident the end result will be very positive. We continue to expand our presence with our three partners doing C-130 upgrades and as these time-tried aircraft come up for renewal, we plan to be an important part of their communications infrastructure. Protect our markets by providing superior technology and service As for protecting our markets with superior technology, we took an immerging trend, iPad connectivity, and coupled it with our core competencies in UpTime with Iridium to provide a lightweight portable product for helicopters and general aviation aircraft, the Dragon. We will continue to expand and protect our markets by providing innovative products to the industry. 17 FLYHT AEROSPACE SOLUTIONS LTD. | ANNUAL REPORT | 2013 18 Our team at FLYHT has been working hard to achieve our desired results and objectives. It is always a pat on the back when we receive customer feedback on the quality of our work. Here is some recent recognition we received. MANAGEMENT DISCUSSION & ANALYSIS “I have worked Tech Pubs for over 30 years and worked from various source data. I have seen many levels of quality. Working from your ICA and STC for the B767 AFIRS 220 data, I must say it is the most pristine documentation I have ever seen! Your content stands out head and shoulders above the rest.” “FIRST [Fuel Initiative Reporting System Tracker] is a key element to any fuel conservation initiative, it is the big “M” within the PEMC framework – Plan, Execute, Measure, Correct. And the system does it accurately and timely, always.“ “FLYHT knowledge and flexibility to accommodate specific requirements is remarkable and makes the AFIRS and FIRST solutions a “must have” solution for the aviation companies engaged to be the most efficient as possible in terms of fuel usage.” 2014 OBJECTIVES As with last year, we have published a list of objectives that management will aim for in 2014. The objectives are: • Increase China installs to meet mandate • Install on two business aircraft OEMs • Expand service modules to increase revenues • Pursue additional commercial OEM opportunity • Positive cash flow from operations Already in 2014 we have seen some positive news when in February we were recognized as a top ten performer in the Technology & Life Sciences Category of the 2014 TSX Venture 50®. The list is a ranking of strong performing companies trading on the TSX Venture Exchange. This marks our third appearance on the list, previously in 2008 and 2010, and we plan to continue to grow in the coming year. We trust that 2014 is going to be a memorable year for FLYHT and want to thank our shareholders, our staff, our suppliers and customers who have been with us through thick and thin and assure everyone we are working toward a bright and positive future. Bill Tempany, Chief Executive Officer This management discussion and analysis (“MD&A”) is as of April 14, 2014 and should be read in conjunction with the audited annual consolidated financial statements of FLYHT Aerospace Solutions Ltd. (“FLYHT” or the “Company”) as at and for the years ended December 31, 2013 and 2012 and the accompanying notes. Additional information with respect to FLYHT can be found on SEDAR at www.sedar.com. The Company has prepared its December 31, 2013 consolidated financial statements in accordance with International Financial Reporting Standards (“IFRS”), as issued by the International Accounting Standards Board (“IASB”). The Company’s accounting policies are provided in note 3 to the consolidated financial statements. NON-GAAP FINANCIAL MEASURES The Company reports its financial results in accordance with IFRS or Generally Accepted Accounting Principles (”GAAP”). It also occasionally uses certain non-GAAP financial measures, such as working capital, modified working capital, and loss before research and development (“R&D”). FLYHT defines working capital as current assets less current liabilities. The Company defines modified working capital as current assets less current liabilities not including customer deposits or the current portion of unearned revenue. A clearer picture of short-term net cash requirements can be drawn by excluding these two items because those customer deposits and unearned revenue are nonrefundable. Loss before R&D is defined as the net loss before the direct costs associated with R&D. These non-GAAP financial measures are always clearly indicated. The Company believes that these non-GAAP financial measures provide investors and analysts with useful information so they can better understand the financial results and perform a better analysis of the Company’s growth and profitability potential. Since non-GAAP financial measures do not have a standardized definition, they may differ from the non-GAAP financial measures used by other companies. The Company strongly encourages investors to review its financial statements and other publicly filed reports in their entirety and not rely on a single non-GAAP measure. FORWARD-LOOKING STATEMENTS This discussion includes certain statements that may be deemed “forward-looking statements” that are subject to risks and uncertainty. All statements, other than statements of historical facts included in this discussion, including, without limitation, those regarding the Company’s financial position, business strategy, projected costs, future plans, projected revenues, objectives of management for future operations, the Company’s ability to meet any repayment obligations, the use of non-GAAP financial measures, trends in the airline industry, the global financial outlook, expanding markets, R&D of next generation products and any government assistance in financing such developments, foreign exchange rate outlooks, new revenue streams and sales projections, cost increases as related to marketing, R&D (including AFIRS 228), administration expenses, and litigation matters, may be or include forward-looking statements. Although the Company believes the expectations expressed in such forward-looking statements are based on a number of reasonable assumptions regarding the Canadian, U.S., and global economic environments, local and foreign government policies/regulations and actions, and assumptions made based upon discussions to date with the Company’s customers and advisers, such statements are not guarantees of future performance and actual results or developments may differ materially from those in the forward-looking statements. Factors that could cause actual results to differ materially from those in the forward-looking statements include but are not limited to production rates, timing for product deliveries and installations, Canadian, U.S., and foreign government activities, volatility of the aviation market for FLYHT’s products and services, factors that result in significant and prolonged disruption of air travel worldwide, U.S. military activity, market prices, foreign exchange rates, continued availability of capital and financing, and general economic, market, or business conditions in the aviation industry, worldwide political stability or any effect those may have on the Company’s customer base. Investors are cautioned that any such statements are not guarantees of future performance, and that actual results or developments may differ materially from those projected in the forward-looking statements. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, there can be no assurance that such expectations will prove to have been correct. The Company cannot assure investors that actual results will be consistent with any forward-looking statements; accordingly, readers should not place undue reliance on forwardlooking statements. The forward-looking statements contained herein are current only as of the date of this document. The Company disclaims any intentions or obligation to update or revise any forward-looking statements or comments as a result of any new information, future event or otherwise, unless such disclosure is required by law. OVERVIEW FLYHT is a designer, developer and service provider of innovative solutions to the global aerospace industry. The Company’s solutions are designed to improve the productivity and profitability of its customers and enable communication between pilots and ground support. FLYHT’s tools deliver data from the aircraft to operations groups on the ground, on demand. The Company’s products are available for commercial, business and military aircraft. FLYHT’s emergency data streaming program, FLYHTStreamTM, can stream position reports and data from an aircraft in flight to ground support in real time. FLYHT’s products and services, featured below, are marketed globally by a team of employees and agents based in Canada, the United States, China, the United Kingdom, Singapore, Ireland, Abu Dhabi, and Argentina. 19 FLYHT AEROSPACE SOLUTIONS LTD. | ANNUAL REPORT | 2013 20 AFIRS™ UPTIME™ FLYHT FUEL MANAGEMENT SYSTEM UNDERFLOOR STOWAGE UNIT FLYHT’s Automated Flight Information Reporting System (“AFIRS”) is a device installed on aircraft and monitors hundreds of essential functions from the plane and the black box. AFIRS sends the information to the UpTime server on the ground, which stores and relays the data to the airline in real time. Airlines use this information to increase passenger safety, improve productivity, maximize efficiency and enhance profitability. In addition to its data monitoring functions, AFIRS provides voice and text messaging capabilities that give pilots the ability to communicate with ground support. FLYHT also builds value added applications for operators such as FLYHTStream and the FLYHT Fuel Management System that run on the AFIRS hardware and its UpTime servers. FLYHT offers global satellite coverage, providing service to whoever needs it, when they need it, anywhere on the planet. The AFIRS 220 has been FLYHT’s signature product since 2004. The unit has received regulatory certification for installation in approximately 30 widely used commercial aircraft brands and models. FLYHT’s AFIRS 228 device continues to demonstrate its value in the marketplace. In 2013, it achieved new certification requirements for Supplemental Type Certificates (“STCs”) and safety services messaging. FLYHT sold another 21 AFIRS 228 units during the year. The unit has received regulatory certification for installation on approximately eight widely used commercial aircraft brands and models. The 228 incorporates improvements over the 220 in several important areas: processing capacity, data transmission characteristics and programmability. The 228’s features cater to the evolving needs of airlines by providing a flexible product that is programmed for the information they need. AFIRS 228 is an addition to FLYHT’s product line, not a replacement for the 220. The Company will continue to sell its AFIRS 220. FLYHTSTREAM™ On July 12, 2012 the BEA - the French Civil Aviation Safety Investigation Authority - published their final report on the June 1st 2009 accident of Air France flight AF 447 from Rio de Janeiro to Paris. In the report the BEA recommends “…that EASA and ICAO make mandatory as quickly as possible, for airplanes making public transport flights with passengers over maritime or remote areas, triggering of data transmission to facilitate localisation as soon as an emergency situation is detected on board”. FLYHT is the only aerospace company that has demonstrated the ability to fulfill the BEA’s recommendation. FLYHT’s patent-pending technology FLYHTStream is a revolutionary new technology that performs real-time triggered alerting and black-box data streaming in the event of an emergency on the aircraft. FLYHTStream uses AFIRS’ onboard logic and processing capabilities on the aircraft in combination with UpTime’s ground-based servers to interpret and route alerts and messages from the aircraft in trouble to parties on the ground that need to know such as the airline, operation centers and regulators. The FLYHT Fuel Management System is a powerful way to focus attention on areas of greatest savings potential automatically, and to provide the information necessary to make decisions about the operation. Most airlines currently rely on a system of reports, manually generated and analyzed to make fuel savings decisions within the operation. This is time-consuming and relies on the user to calculate areas of potential by cross-referencing a great number of queries. The FLYHT Fuel Management System is not just a report-generation tool; it is a dynamic, interactive application that answers key questions by generating alerts and providing the user with the ability to quickly identify trends. FLYHT designed this unique application that highlights exceptions to best practices, provides quick drill downs to spot the root cause of issues, and identifies trends. It is an intuitive tool that enables fuel managers to act on information instead of compiling and analyzing data. FIRST The Fuel Initiative Reporting System Tracker (“FIRST”) is a component of the FLYHT Fuel Management System (FIRST can also be purchased as a stand-alone module) that eliminates uncertainty about the effectiveness of an airline’s fuel savings initiatives. The system allows operators to customize and choose settings that are important to their operation. It uses real-time flight data acquired from the aircraft’s onboard systems, and presents the data to operations personnel in an easy to read dashboard. The dashboard compares how pilots are operating the aircraft to how they could be flying in order to maximize efficiency and fuel savings. Where compliance has not been met, associated costs, in a dollar amount, are shown. The tool is de-identified to meet pilot union requirements, but can be filtered to display performance by pilot if desired. is a revolutionary, THE DRAGON™ lightweight, portable satellite The Dragon communications device that blends existing FLYHT technology with that of the iPad. FLYHT developed the new product to meet a growing demand from small aircraft, business jet and helicopter operators for a satellite communications solution similar to AFIRS. The device is portable, allowing operators the flexibility to use it where and when they need it. Because the Dragon is not installed on the aircraft, there is no need for STCs. The Dragon allows real-time voice and data communications enabled by the Iridium satellite network connected through the cockpit and the pilot’s headset, though does not have data analysis or the safety services capabilities of other AFIRS products. An iPad application acts as an interface for the user in the cockpit to send and receive messages, such as weather updates, from the ground. Another key feature is flight following, so operators always know where their assets are in the sky. The Underfloor Stowage Unit offers the flight crew additional stowage space in the cockpit. With this addition, manuals are always within reach of the seated crew and are kept safe, dry and clean inside the stowage unit. In addition, safety equipment and other items required by the flight crew can be accessed any time throughout the flight without leaving the cockpit. The stowage unit is certified to be installed in Bombardier CRJ series, Challenger and DHC-8s and can also be installed in other aircraft types. SYSTEM APPROVALS A Supplemental Type Certificate (“STC”) is an airworthiness certification required to modify an aircraft from its original design and is issued by an aviation regulator. FLYHT’s AFIRS equipment is an addition to an aircraft and therefore an STC is required prior to installation. FLYHT has received or applied for AFIRS product approvals from Transport Canada Civil Aviation (“TCCA”), the Federal Aviation Administration (“FAA”) in the United States, the European Aviation Safety Agency (“EASA”) in Europe, and the General Administration of Civil Aviation of China (“CAAC”) for various aircraft models, depending on customer requirements. FLYHT’s expertise in airworthiness certification enabled it to join a select group of Canadian companies in October 2008 who are approved by TCCA as a Design Approval Organization (“DAO”). Very few organizations achieve DAO status because of the time and expertise required to meet TCCA standards. FLYHT’s DAO status, along with the delegations it has received, allows the Company to obtain and revise its own STCs with minimal TCCA oversight. This speeds up the process by lessening waiting time, cost and reliance on contractors. In addition to its DAO status, the Company also has two engineers on staff with delegated authority, allowing them to approve electrical and structural design aspects of an airworthiness certification. If an issue is encountered during the STC process, the delegated staff member(s) have the authority to approve necessary changes and continue the process without the involvement of an external party. The process to receive a STC takes some time to complete, but always starts with an application for the STC through any one of TCCA, FAA or EASA. Generally, FLYHT starts the process with TCCA by opening an application with the regulator, after which an STC data package is created. The data package consists of the engineering documents that outline how the AFIRS equipment will be installed on the aircraft. Once the data package and first stage of approvals are granted by the regulator, ground and flight tests takes place. To fulfill the flight test requirement, FLYHT must have access to the appropriate type and model of aircraft. This is done in cooperation with an existing or potential customer. Once these tests are completed, FLYHT submits an activation data package to TCCA that enables the AFIRS unit to be integrated with the aircraft systems. If TCCA approves the submission, an STC is issued. To obtain an STC from another regulator, FLYHT prepares an application, which is sent through TCCA to the regulator such as FAA, EASA or CAAC along with the STC package previously approved by TCCA. The regulator reviews the package and issues the STC. The time required for the approval process through TCCA varies depending on the aircraft and workloads. A general rule of thumb is about three months, with a minimum of another three months if an STC is required from another regulator such as FAA, EASA or CAAC. FLYHT has received STC approvals for AFIRS 220 on the following aircraft: • Airbus A319, A320, A321 • Airbus A330 • Boeing B737-200, 300, 400, 500 • Boeing B737-600, 700, 800 • Boeing B757-200 • Boeing B767-200, 300 • Bombardier DHC-8-100, 200, 300, 400 • Bombardier CRJ100, 200, 440 • DC-10 • Fokker F100 • Hawker Beech 750, 800XP, 850XP, 900XP • Viking Air DHC-7 (LSTC) FLYHT has received STC approvals for AFIRS 228 on the following aircraft: • Airbus A319, 320, 321 • ATR 42, 72 • Boeing B737–700, 800 • Boeing 747-200 • Boeing B767-200, 300 • Boeing B777 • Bombardier CRJ-700, 900 • Hawker Beech 750, 800XP, 850XP, 900XP FLYHT has received provisions-only STC approvals for AFIRS 228 on the following aircraft and expects full STCs in 2014: • McDonnell Douglas MD-81, 82, 83, 87, 88 FLYHT has STC applications in process for AFIRS 220, expected to be submitted, depending on market requirements, for the following aircraft: • Embraer Legacy 600 FLYHT has STC applications in process for AFIRS 228, expected to be submitted, depending on market requirements, for the following aircraft: • Boeing B737-200, 300, 400, 500 • Boeing B747-400 • Boeing B757-200 • Bombardier DHC-8-400 • Dassault Falcon 2000 21 FLYHT AEROSPACE SOLUTIONS LTD. | ANNUAL REPORT | 2013 22 In addition, the Company will be filing the necessary documents to obtain approval for the AFIRS 228 for a majority of currently approved 220 STCs, depending on market requirements over the next several years. Portions of those costs, including salaries and salary burden, will be covered by funding committed by Industry Canada in February 2011 under the Strategic Aerospace and Defence Initiative (“SADI”) program. TRENDS AND ECONOMIC FACTORS FLYHT examines the results of growth and measurements made by leading aviation groups in order to determine the health of the industry. AFIRS is a technology that can be installed on commercial, business or military aircraft while the Company’s latest product, the Dragon, is available to the General Aviation market. The airline industry saw a 5.2% increase in passenger demand in 2013 compared to the previous year. Load factors, meaning how close to capacity the flights were for the year, were near record levels at 79.5%, up 0.4 percentage points over 2012. Demand in international markets expanded at a faster rate (5.4%) than domestic travel (4.9%)1. Global freight traffic measured in Freight Tonne Kilometers (“FTK”) was very slow at the beginning of 2013 and only grew by 1.4% over the whole year. 2014 is expected to be slow year for the cargo market.2 RPK and FTK measure passenger and freight contributions to airline revenue. These are significant measures to determine the health of the industry because the larger the increase, the more people are flying, suggesting growth in the industry. Large commercial aircraft manufacturers recorded solid numbers for deliveries and new orders in 2013. Airbus delivered 626 commercial aircraft, including 1619 gross orders beating the previous record set in 2011 by 11 aircraft3. Boeing delivered 648 aircraft in 2013, an 8% increase from the previous year. The OEM also had record revenue for the year, a 6% increase from 20124. Embraer delivered 90 commercial jets in 2013, a decrease from the previous year though they made up for it with an increase of the difference in deliveries of business jets5. Bombardier delivered 238 aircraft, compared to 233 for the previous year. During this same period, Bombardier received 81 firm orders for commercial aircraft6. The General Aviation Manufacturers Association (“GAMA”) reported that numbers in worldwide general aviation airplane shipments rose 4.3% to 2,256 shipments in 2013 from 2,164 in 2012. Total shipments of helicopters also increased 7% in the year.7 FLYHT continues to meet the needs of the aviation industry through the introduction of value-added information products and specialty services that build customer value and FLYHT revenues from existing and new installations. Key achievements in 2013 were the certification of the AFIRS 228S in order to send Aircraft Communications Addressing and Reporting System (“ACARS”) messages over Iridium; as well, as the Iridium Compatible Environment (“ICE”) certification to send voice and data safety services messaging on the Iridium satellite network. The Company will continue to participate in industry working groups in 2014 to advance engineering and technical requirements and prepare for future development of the AFIRS product line to meet industry needs. On the economic side of industry trends, the weakening of the Canadian dollar relative to the U.S. dollar during the fourth quarter of 2013 versus the same quarter of 2012 had a positive impact on the Company’s revenue and income compared to the same quarter of 2012. As a result of these movements, the Company’s revenues, which are substantially all denominated in U.S. dollars, were higher than they would have been had the foreign exchange rates not changed. It is the standard of the aviation industry to conduct business in U.S. dollars. While the majority of the Company’s costs are denominated in Canadian dollars, a significant portion of the cost of sales, marketing and component costs are U.S. dollar denominated, and therefore create a natural hedge against fluctuations of the Canadian dollar. 1. http://www.iata.org/pressroom/pr/Pages/2014-02-06-01.aspx 2. http://www.iata.org/pressroom/pr/Pages/2014-02-05-01.aspx 3. http://www.airbus.com/newsevents/news-events-single/detail/airbus- sets-new-records-in-orders-deliveries-and-backlog/ 4. http://boeing.mediaroom.com/2014-01-29-Boeing-Reports-Record-2013- Revenue-EPS-and-Backlog-and-Provides-2014-Guidance 5. http://www.embraer.com.br/Documents/noticias/008-Results%204Q13- Ins-VPF-I-14.pdf 6. http://www.bombardier.com/en/media-centre/newsList/details. bombardier-inc-q4c2013financialresults20140213.html? 7. http://www.gama.aero/media-center/press-releases/content/gama- releases-2013-year-end-aircraft-shipment-and-billing-number CONTRACTS AND ACHIEVEMENTS OF FISCAL 2013 Contracts FLYHT Aerospace Solutions Ltd. signed a total of a total of seven contracts on 52 aircraft with customers worldwide. 26 were for the AFIRS 220, 21 for the AFIRS 228 and five were for the Dragon. In January, FLYHT signed a contract with a domestic Nigerian airline for the AFIRS 220 on five Airbus A319 and A320 Aircraft. In May, FLYHT received a purchase order from a major avionics integrator for AFIRS 228 equipment for seven Lockheed C-130 Hercules aircraft owned and operated by a Middle Eastern country’s air force. Achievements • AFIRS 228 was approved on the SITA and ARINC networks to provide ACARS over Iridium messages. • AFIRS 228 received the ICE certification for the commercial use of the AFIRS 228S on the Iridium satellite network. • FLYHT introduced the Dragon as an exciting new member of the FLYHT family of products. The Dragon is a revolutionary, lightweight, portable satellite communications device that blends existing FLYHT technology with that of the iPad. FLYHT developed the new product to meet a growing demand from small aircraft, business jet and helicopter operators for a satellite communications solution similar to AFIRS. Also in May, FLYHT signed a contract with a schedule Maldivian airline to install AFIRS 220 on one Boeing 757 and the AFIRS 228B on two Boeing 767 aircraft. • FLYHT added another commercial OEM to its customer list with the agreement with Datang Mobile Aviation division in China for the AFIRS 228 to be standard fit on production ARJ21 aircraft. In September, FLYHT signed a contract with a Nigerian airline for AFIRS 220 on four Boeing 737 aircraft. • Shareholders exercised warrants and stock options for an aggregate of $6,144,886. In November, FLYHT signed a contract with an eastern European airline for AFIRS on four Boeing 757. • FLYHT received an activation STC in June for the AFIRS 228 on the Boeing 777 aircraft from the FAA. Also in November, FLYHT signed a contract with a South American cargo airline for AFIRS on 12 Boeing 737-400 and 12 ATR-200 aircraft. The airline is a cargo carrier with plans to be the dominant cargo carrier in the region with an integrated ground and air cargo operation. In December, FLYHT announced the sale and shipment of five of its recently released Dragon products to DAC Aviation International Ltee./DAC Aviation (EA) Ltd. (“DAC”) for five Cessna Caravan Aircraft to provide voice and data services in support of their humanitarian missions in Africa. • FLYHT received an activation STC in August for its AFIRS 228 on the Boeing 767-200/300 series aircraft from TCCA. • In September, FLYHT received an activation STC for the AFIRS 228 on the Boeing 737- 700/800 series aircraft from TCCA. 23 FLYHT AEROSPACE SOLUTIONS LTD. | ANNUAL REPORT | 2013 24 RESULTS OF OPERATIONS YEAR ENDED DECEMBER 31, 2013 AND 2012 Loss per share (basic & fully diluted) 0.01 0.00 0.01 Quarterly Results AFIRS UpTime sales AFIRS UpTime usage Parts Services Revenue Loss Loss before R&D AFIRS UpTime sales AFIRS UpTime usage Parts Services Revenue Loss Loss before R&D Loss per share (basic & fully diluted) Selected Annual Information Q4 2013 $ 592,483 1,080,503 79,716 184,055 Q3 2013 $ Q2 2013 $ 583,742 1,009,837 881,903 307,588 409,804 846,438 61,586 245,573 Q1 2013 $ 521,777 815,874 206,672 172,813 1,936,757 2,183,037 2,163,434 1,717,136 1,438,795 615,950 1,038,283 745,444 174,987 680,936 Q4 2012 $ 1,063,933 774,657 85,138 296,673 Q3 2012 $ 555,413 799,872 48,591 145,885 Q2 2012 $ 581,290 756,705 19,168 227,312 2,220,401 1,549,761 1,584,475 1,115,169 621,446 40,436 0.00 133,102 1,954,303 2,174,901 290,563 1,183,274 961,742 0.00 0.02 0.02 970,136 281,570 0.01 Q1 2012 $ 264,148 760,392 49,523 41,106 Liquidity and Capital Resource The Company’s cash at December 31, 2013 increased to $5,184,803 from $676,246 at December 31, 2012. The Company has an available operating line of $250,000 that was undrawn as at December 31, 2013. The operating line bears an interest rate of Canadian chartered bank prime plus 1.5%, and is secured by assignment of cash collateral and a general security agreement. At December 31, 2013, the Company had negative working capital of $894,887 compared to negative $2,772,247 as of December 31, 2012, an improvement of $1,877,360. Neither customer deposits, nor the current portion of unearned revenue are refundable, and if those two items are not included in the working capital calculation, the resulting modified working capital at December 31, 2013 would be positive $760,174 compared to positive $742,068 at December 31, 2012. The Company funded 2013 operations primarily through cash received from sales, the proceeds of private placements, and funding received through the SADI grant program. If the costs associated with R&D were factored out, there would have been an increase in cash of $6,703,863. It is expected that R&D expenses will continue to decrease as the AFIRS 228 project moves into the next phase of enhancements and the finished product continues to generate revenues. The resulting increase in cash inflows from sales will reduce the requirement for further funding. The Company believes that if funding is required to meet cash flow requirements in 2014, it will be able to do so either through debt or equity instruments. Cash and cash equivalents Restricted cash Trade and other receivables Deposits and prepaid expenses Inventory December 31, 2013 December 31, 2012 $ 5,184,803 250,000 784,426 145,554 $ 676,246 250,000 1,209,497 99,464 1,308,243 1,663,918 Trade payables and accrued liabilities (3,704,496) (3,658,254) Variance $ 4,508,557 - (425,071) 46,090 (355,675) (46,242) 1,613,411 Unearned revenue Loans and borrowings Finance lease obligations Current tax liabilities Working capital Unearned revenue Customer deposits Modified working capital (1,103,834) (2,717,245) (3,745,513) (271,832) (3,473,681) (13,175) (19,963) (895) (4,078) 6,788 3,183 (894,887) (2,772,247) 1,877,360 1,103,834 2,717,245 (1,613,411) 551,227 760,174 797,070 742,068 (245,843) 18,106 Assets Non-current financial liabilities Revenue Comprehensive loss Comprehensive loss per share – basic & fully diluted 2013 $ 8,435,962 1,992,028 8,000,364 4,063,164 0.03 2012 $ 4,968,972 3,118,142 6,469,806 4,883,752 0.04 2011 $ 5,509,709 2,519,337 5,467,199 6,543,049 0.06 25 FLYHT AEROSPACE SOLUTIONS LTD. | ANNUAL REPORT | 2013 26 As of December 31, 2013, the Canadian equivalent of the Company’s outstanding accounts payable to Sierra Nevada Corporation (“SNC”) was $1,921,384 (December 31, 2012: $1,790,571) relating to their involvement with the development of the AFIRS 228. The outstanding amount in USD remained unchanged from 2012 to 2013. If this amount was removed from the working capital it would be positive $1,026,497 at December 31, 2013 and negative $981,676 at December 31, 2012. As well, the modified working capital would be a positive $2,681,558 at December 31, 2013 and positive $2,532,639 at December 31, 2012. As reported in the 2010 Annual Report the development effort for the AFIRS 228 program was split into four general modules: (1) hardware, (2) board support software (both developed by a Calgary contractor), (3) Embedded Logic Applications (“ELA”) (developed by FLYHT staff in Calgary), and (4) core software (the responsibility of SNC). Late in 2010, it was recognized by management that progress on the AFIRS 228 program was on track for year end delivery for the hardware, board support software and ELA. However, time estimates to complete the core software continued to slip and costs had escalated. In the third quarter of 2011, management of FLYHT reviewed the state of the core software development with SNC in order to develop a plan and prepare for the transition from a SNC deliverable to FLYHT maintained software. It was determined by management that the best course of action to successfully complete the 228 in a timely fashion was to repatriate the core software development to Calgary and build a team around the existing resources of FLYHT’s Calgary based contractors and staff. The transition occurred in February 2011, and as anticipated, the first customer test flight was completed before the end of 2011. Full certification has begun to meet the timelines required by our current customers and prospects. The current accounts payable amount outstanding of $1,921,384 is presently under dispute in the courts. See the Contingency section on page 39 for further clarification. In two tranches on April 18 and May 28, 2013, the Company issued an aggregate $2,110,000 of debentures in a debt offering. The debentures mature on June 30, 2016 and bear interest at a rate of 12% per annum on the contributed amounts, which shall be accrued and paid annually in arrears commencing December 1, 2013. Purchasers of debentures received a capital discount premium of 10% on the financing, meaning that for every $1.00 debenture acquired, FLYHT shall owe, on the maturity date, principal equal to $1.10 to the debenture holder. The purchasers of the debentures were also issued one common share of the Corporation for every $1.00 principal amount of debentures acquired pursuant to the offering. A total of 2,110,000 common shares were issued under these tranches. All of the securities issued thereunder were subject to a 4-month hold period. The debentures are not listed on any stock exchange and are not convertible into common shares. The debentures are secured against all personal property of FLYHT, including FLYHT’s intellectual property and are subordinated in right of payment to all existing and future secured bank and/or governmental indebtedness of FLYHT and any existing security already registered against FLYHT’s assets. The fair value of the debenture was determined at the time of issue as the difference between the principal value of the debentures and the discounted cash flows assuming an 18% rate. In 2013 a total of 16,007,102 warrants were exercised, each exercisable into one common share for total proceeds of $6,051,986: (a) 1,071,522 warrants were exercised with an exercise price of $0.20 per share for proceeds of $214,304 (b) 1,365,500 warrants were exercised with an exercise price of $0.30 per share for proceeds of $409,650, and (c) 13,570,080 warrants were exercised with an exercise price of $0.40 per share for proceeds of $5,428,032 Also in 2013, a total of 314,000 stock options were exercised for total proceeds of $92,900, with each stock option exercised into one common share: (a) 224,000 stock options were exercised with an exercise price of $0.25 for proceeds of $56,000, and (b) 90,000 stock options were exercised with an exercise price of $0.41 per share for proceeds of $36,900 As at April 14, 2014, FLYHT’s issued and outstanding share capital was 163,045,548. The achievement of positive earnings before interest and amortization is necessary before the Company can improve liquidity. The Company has continued to expand its cash flow potential through its continued marketing drive to clients around the world. Management believes that the Company’s installation momentum, conversion of installations to recurring revenue, new revenue streams, and ongoing sales will be sufficient to meet standard liquidity requirements going forward. To continue as a going concern, the Company will need to attain profitability and/or obtain additional financing to fund ongoing operations. If general economic conditions or the financial condition of a major customer deteriorates, then the Company may have to scale back operations to create positive cash flow from existing revenue and/or raise the necessary financing in the capital markets. It is the Company’s intention to continue to fund operations by adding revenue and its resulting cash flow as well as continue to manage outgoing cash flows. If the need arises due to market opportunities, the Company may meet those needs via the capital markets. These material uncertainties may cast significant doubt upon the Company’s ability to continue as a going concern. Risks and Uncertainties FLYHT operates in the aviation industry and part of the business involves risks and uncertainties. The Company takes steps to manage these risks, though it is important to identify risks that could have a material effect on business or results of operations. Such risks are listed below. The areas defined are not inclusive. Installations at c-checks The Company’s product, AFIRS 220, can take approximately 200 person-hours or more to install on an aircraft, depending on the aircraft type and crew. Since the box needs a longer period to be installed, the installation is usually scheduled when the aircraft is undergoing its routine c-check or scheduled maintenance. The timing of c-checks depends on how many segments the aircraft has flown and is based on the manufacturer’s guidelines, though it can take as long as two or three years before an aircraft is out of service for an extended period. Waiting for a c-check for AFIRS installation is a risk to the Company because it results in a delay in initial revenue from the sale of the box and the Company does not receive recurring revenue connected with the monthly service offerings until the device is installed and running. The Company takes steps to mitigate this risk by encouraging customers to install AFIRS at their aircraft’s earliest availability and works with them to provide the box at the right time for installation, preferably while the aircraft is down for normal service. The goal is to reduce aircraft downtime and save the customer as much money as possible. Another risk mitigation tool used by the Company is to offer special discounts to airlines that pay for all units up front. This discount decreases FLYHT’s gross margin slightly, but allows the Company to bring in cash immediately after signing an agreement. As well, the terms of the Company’s standard agreement states that payment is due a minimum of 45 days prior to the shipment of kits. Foreign currency fluctuations The Company does a majority of its business in U.S. dollars so there is a risk of currency fluctuation. The majority of the Company’s costs are denominated in Canadian dollars, though a significant portion of costs of goods sold and distribution costs are U.S. dollar denominated, and therefore create a natural hedge against fluctuations of the Canadian dollar. General economic and financial market conditions In an industry, such as the aviation industry, finances are tied to global trends and patterns. Since the economic recession in 2008, all sectors including the commercial sector have slowed down. As an airline’s spending is tied to their income, they may be unwilling or unable to spend money, particularly on a value-added product such as AFIRS. In order to address this risk, the sales team has developed a number of strategies. One strategy the Company has achieved is a global sales presence. FLYHT has established sales agents on every continent. While some economies of the world may be in a bit of a slump or downturn, there is a place for FLYHT in growing markets. FLYHT also demonstrates to potential customers its impressive return on investment model, how quickly potential customers can improve operational efficiency, and ultimately how much money AFIRS will save them. Dependence on key personnel and consultants FLYHT’s ability to maintain its competency in the industry is dependent on maintaining a specially skilled workforce. The Company’s Design Approval Organization status, delegated by TCCA, enables a smooth implementation of STCs, required to install AFIRS on aircraft. Key staff, with TCCA delegation status, enables the Company to complete STCs in a timely and cost efficient manner. The Company has worked hard over the past few years to distribute the specified knowledge among a number of key individuals. This reduces risk and ensures the Company can still function effectively were it to lose specialized staff. Dependence on new products Over the past few years, the Company has been in the R&D stage of its next generation product, AFIRS 228. FLYHT is confident the product does fill a gap in the industry, as evidenced by sales of the AFIRS 228 throughout 2013. The Company expanded its reach to meet the needs of another sector of the industry, general aviation operators. FLYHT released the Dragon in the fall of 2013, to fill the demand for a portable satellite communications device. The product was invented after industry research was conducted, as well of the Company’s awareness of general aviation operators’ demand for increased connectivity. The Company’s success will ultimately depend on the success of both products, and future enhancements made to both. 27 FLYHT AEROSPACE SOLUTIONS LTD. | ANNUAL REPORT | 2013 28 Availability of key supplies Unearned revenue FLYHT produces and builds all AFIRS 220 units in-house, while AFIRS 228 units are built by a contract manufacturer. The Company relies on partners, suppliers and special parts to complete unit builds. Certain parts can be delayed in shipping or availability, which can cause a delay in building the AFIRS 220 or in receiving AFIRS 228 completed units. FLYHT aims to avoid the risk of not having the necessary supplies by managing inventories and storing extra key parts. The contract manufacturer is a global supplier with the ability to meet FLYHT’s requirements. Additionally, the Company maintains close communication with its partners and suppliers to ensure all key components for the AFIRS units will be available into the future. Proprietary protection Patent rights are extremely important to the continuation of the Company because the AFIRS technology is the Company’s primary revenue source. The Company relies on contract, copyright and trademark laws and has received patents from the United States, China, Turkish and European patent offices. These patents are generally respected in other international jurisdictions as well. The risks involved with proprietary protection lie in other companies claiming patent infringement, though the Company has defended patent claims in court and been successful. FLYHT conducted due diligence on its technology and the conditions of its patent before applying and maintains that it holds unique characteristics from other technologies in the marketplace and does not infringe on the rights of any third parties. Revenue recognition cycle FLYHT’s revenue recognition for AFIRS Uptime sales and parts revenue occurs in a series of steps. The process begins with the receipt of customer deposits, followed by shipment, installation and finally customer usage of the AFIRS product. Customers are required to pay for installation kits prior to the planned shipment date. This prepayment is recorded as a customer deposit, which is recognized as an accrued liability upon receipt. Upon shipment of an installation kit, the customer deposit is reclassified to unearned revenue, where it will remain until the AFIRS UpTime solution has been installed and is fully functional, at which point the installation kit is recognized as AFIRS UpTime sales revenue. When customers order spare parts or Underfloor Stowage Units a prepayment is required, which is recorded as a customer deposit. When the shipment of the ordered part or unit occurs, the customer deposits are recognized as Parts revenue. Customer deposits Customer deposits are amounts received for AFIRS UpTime sales and parts that have not yet been shipped to the customer, and services that have not yet been completed. These deposits are nonrefundable, and are included on the Statement of Financial Position (“SFP”) in trade payables and accrued liabilities. The chart below outlines the movement in the Company’s customer deposits throughout the periods ending December 31, 2013 and 2012. Payment was received for 10 installation kits in the fourth quarter of 2013, compared to 17 received in the fourth quarter of 2012, bringing 2013 year-to-date (“YTD”) total payments for installation kits to 42, compared to a total of 78 in 2012. Q4 2013 $ Q4 2012 $ Variance $ YTD 2013 $ YTD 2012 $ Variance $ Opening balance 622,082 1,033,613 (411,531) 797,070 980,955 (183,885) Payments received from customers 188,809 763,366 (574,557) 1,204,677 3,262,045 (2,057,368) Moved to unearned revenue (259,664) (999,909) 740,245 (1,450,520) (3,445,930) 1,995,410 Balance, December 31 551,227 797,070 (245,843) 551,227 797,070 (245,843) The chart below outlines the movement in the Company’s unearned revenue throughout the periods ending December 31, 2013 and 2012. Revenue was recognized for 15 installation kits in 2013’s fourth quarter compared to 26 in the fourth quarter of 2012. Revenue was recognized for 62 installation kits in 2013, as compared to 59 in 2012. In 2013, 77.7% of the unearned revenue balance at December 31, 2012 was recognized as earned revenue (2012: 71.1%). Q4 2013 $ Q4 2012 $ Variance $ YTD 2013 $ YTD 2012 $ Variance $ Opening balance 1,494,153 2,741,596 (1,247,443) 2,717,245 1,897,204 820,041 AFIRS UpTime sales: shipped, not accepted 259,664 999,909 (740,245) 1,450,520 3,445,930 (1,995,410) AFIRS UpTime usage: prepaid 25,090 116,694 (91,604) 414,228 376,981 37,247 AFIRS UpTime sales: revenue recognized AFIRS UpTime usage: revenue recognized License fees: revenue recognized (578,936) (1,063,933) 484,997 (2,694,292) (2,464,784) (229,508) (31,757) (12,641) (19,116) (526,347) (280,566) (245,781) (64,380) (64,380) - (257,520) (257,520) - Balance, December 31 1,103,834 2,717,245 (1,613,411) 1,103,834 2,717,245 (1,613,411) Revenue For the revenue categories listed in the Revenue sources chart, AFIRS Uptime sales includes the income from an AFIRS hardware sale as well as the parts required to install the unit. AFIRS Uptime usage is the recurring revenue from customers’ usage of data they receive from AFIRS and use of functions such as the satellite phone. Parts revenue includes the sale of spare AFIRS units, spare installation parts, and Underfloor Stowage Units. Services revenue includes technical services, repairs and expertise the Company offers such as the installation of operations control centres, including two FLYHT set up in Nigeria. Overall, total revenue increased 23.7% from $6,469,806 in 2012 to $8,000,364 in 2013. AFIRS Uptime sales increased by 9.9%, AFIRS Uptime usage increased by 17.2%, Parts sales increased by 223.9%, and Services revenue increased by 42.4%. Fourth quarter revenue decreased 12.8% from $2,220,401 in Q4 2012 to $1,936,757 in Q4 2013, due to decreases in AFIRS Uptime sales of 44.3%, Parts sales of 6.4% and Services revenue of 38.0%. These decreases were partially offset by a 39.5% increase in AFIRS Uptime usage. The Company has two types of revenue streams relating to AFIRS equipment, depending on the type of service agreement: rental and sales. In accordance with the Company’s revenue recognition policy for rental type agreements, the arrangement consideration is deferred as unearned revenue and revenue is recognized over the initial term of the contracts. At December 31, 2013, there were no customers with a rental type contract (2012: one customer). For sales type agreements, AFIRS fees are deferred as unearned revenue and corresponding expenses are recorded as work in progress. When the system is fully functional and the customer has accepted the system, the deferred amount is fully recognized in revenue along with the work in progress as cost of sales. Under both forms of agreement, UpTime usage fees are recognized as the service is provided based on actual customer usage each month. The amounts recorded in unearned revenue are nonrefundable. 29 FLYHT AEROSPACE SOLUTIONS LTD. | ANNUAL REPORT | 2013 30 Revenue sources Gross Profit and Cost of Sales Q4 2013 $ Q4 2012 $ Variance $ YTD 2013 $ YTD 2012 $ Variance $ AFIRS UpTime sales 592,483 1,063,933 (471,450) 2,707,839 2,464,784 243,055 AFIRS UpTime usage 1,080,503 774,657 305,846 3,624,718 3,091,626 533,092 Parts Services Total 79,716 85,138 (5,422) 655,562 202,420 453,142 184,055 296,673 (112,618) 1,012,245 710,976 301,269 1,936,757 2,220,401 (283,644) 8,000,364 6,469,806 1,530,558 The Company’s long-term investment in marketing and relationship building has created a strong pipeline of prospective clients around the world. The revenue breakdown based on geographical location is displayed in the next table. Recurring revenue accounted for 45.3% of revenue in 2013, compared to 47.8% in 2012. Approximately 55.8% of the Company’s revenue in the fourth quarter of 2013 was recurring, compared to 34.9% in the fourth quarter of 2012. Recurring revenue as a percentage of overall revenue will fluctuate from period to period depending on the mix of revenue during each period. Recurring revenue from FLYHT’s existing client base is expected to continue to expand throughout 2013 and future years. Geographical sources of revenue The following revenue split is based on the geographical location of customers. North America South/Central America Africa/Middle East Europe Australasia Asia Total North America South/Central America Africa/Middle East Europe Australasia Asia Total Q4 2013 $ 731,995 167,765 590,523 41,488 187,923 217,063 Q4 2012 $ 1,162,883 87,861 817,314 13,036 135,363 3,944 1,936,757 2,220,401 Q4 2013 % Q4 2012 % 37.8 8.7 30.5 2.1 9.7 11.2 100.0 52.3 4.0 36.8 0.6 6.1 0.2 100.0 YTD 2013 $ 3,853,788 460,184 1,391,446 549,718 697,249 1,047,979 8,000,364 YTD 2013 % 48.1 5.8 17.4 6.9 8.7 13.1 100.0 YTD 2012 $ 3,522,317 472,850 1,729,862 150,247 520,843 73,687 6,469,806 YTD 2012 % 54.5 7.3 26.7 2.3 8.1 1.1 100.0 FLYHT’s cost of sales include the direct costs associated with specific revenue types, including the AFIRS unit, installation kits, training and installation support, as well as associated shipping expenses and travel expenses for the Company’s engineering personnel’s on-site installation support. Installations on aircraft are performed by third parties at the customer’s expense. Cost of sales as a percentage of revenue in the fourth quarter of 2013 was 39.6% compared to 34.1% in 2012’s fourth quarter. A review of the annual results shows the cost of sales as a percentage of revenue also decreased from 42.8% in 2012 to 40.8% in 2013. The decrease was due to a difference in the mix of revenue sources, as AFIRS Uptime usage, Parts sales, and Services have higher margins than AFIRS Uptime sales. Gross margin will fluctuate quarter over quarter depending on customer needs and corresponding with the revenue type. Gross margin for the last eight quarters was: Gross Margin % Cost of Sales % Q1 60.4 39.6 Q2 56.9 43.1 Q3 54.5 45.5 2013201320132013 Q4 66.6 33.4 Q1 65.9 34.1 Q2 60.1 39.9 Q3 43.7 56.3 2012 2012 2012 2012 Q4 54.8 45.2 Operating Activities Other income Other income consists of the recognition of the SNC license fee that was deferred as unearned revenue when received, and is being recognized over the initial five-year term of the agreement. Distribution expenses (recovery) Consist of overhead expenses associated with the delivery of products and services to customers, sales and marketing. Major Category Q4 2013 $ Q4 2012 $ Variance $ YTD 2013 $ YTD 2012 $ Variance $ Salaries and benefits 388,747 463,650 (74,903) 1,506,626 1,829,053 (322,427) Share based compensation - (40,645) 40,645 85,071 95,458 (10,387) Contract labour Office Travel Equipment & maintenance Depreciation Marketing Other Total 79,900 87,594 106,426 9,157 11,817 15,797 134,890 120,945 (41,045) 275,059 559,096 (284,037) 81,078 65,429 5,369 13,281 12,550 12,987 6,516 40,997 3,788 (1,464) 3,247 366,439 403,319 25,413 46,129 41,441 121,903 206,949 345,648 315,797 31,820 52,956 61,773 69,604 20,791 87,522 (6,407) (6,827) (20,332) 137,345 834,328 734,644 99,684 2,956,446 3,361,205 (404,759) 31 FLYHT AEROSPACE SOLUTIONS LTD. | ANNUAL REPORT | 2013 32 Salaries and benefits decreased in 2013 as compared to 2012 both in the quarter and YTD mainly due to decreased staffing requirements to meet AFIRS 228 development needs. The decreased costs were allocated between distribution and research and development expenses as the decreased staff’s efforts had been split between meeting the needs of existing and future customers, and AFIRS 228 development. A portion of the decrease was the result of non-renewal of a sales director’s employment agreement. Share based compensation decreased YTD due to a higher option grant in 2012 than in 2013, partially offset by the vesting in the first three quarters of 2013 of options granted in 2012. The recovery in Q4 2012 was due to a decrease in the calculated fair value per share of unvested options. Contract labour decreased compared with the same periods last year. There has been a reduction in contractors supplying distribution related services. Office expenses increased in the quarter and YTD 2013 from 2012 mainly as the result of additional membership fees for industry groups FLYHT has become involved with in 2013, together with an increased YTD rent allocation, offset partially by decreased communication and other costs in 2013 YTD due to cost containment measures. Travel expenses increased in 2013 versus 2012 largely as the result of increased travel and meals associated with sales activities. It is anticipated that as the AFIRS 228 rollout continues, travel expenses will continue to increase on an annual basis and quarterly fluctuations will continue to occur. Equipment and maintenance decreases throughout 2013 were due to costs associated with the movement of the UpTime hosting centre in 2012 to accommodate growth in the installation base that was not repeated in 2013. This decrease is partially offset in the fourth quarter by increased maintenance and costs associated with supporting the growth that prompted the move and with additional steps taken to ensure maximum reliability of UpTime data. Depreciation expense decreased in the quarter and throughout 2013 due to a decrease in the need to acquire capital equipment. Marketing expenses decreased throughout 2013 partially offset by an increase in Q4, due to the reduced requirement for marketing collateral throughout 2013 as well as a reduction in the number of tradeshows attended. The Company has analyzed the effectiveness of tradeshows and has targeted the most beneficial to the business objectives of the Company. Other expenses expenses decreased from 2012 to 2013 due to differences in bad debt adjustments. An increase in reserve of $12,897 was recorded in Q4 2012, whereas the adjustment made in Q4 2013 for potential bad debt amounted to $134,890. Administration expenses Consist of expenses associated with the general operations of the Company that are not directly associated with delivery of services or sales. Major Category Q4 2013 $ Q4 2012 $ Variance $ YTD 2013 $ YTD 2012 $ Variance $ Salaries and benefits 520,345 359,289 161,056 1,498,854 1,253,401 245,453 Share based compensation Contract labour Office Legal fees Audit and accounting Investor relations Brokerage, stock exchange, and transfer agent fees Travel Equipment and maintenance Depreciation Other Total 8,558 25,250 76,660 12,636 27,000 67,432 13,075 (4,517) 260,091 227,808 48,608 (23,358) 141,271 112,366 32,283 28,905 78,561 15,169 21,550 33,250 (1,901) 305,104 324,465 (19,361) (2,533) 36,405 142,378 (105,973) 5,450 122,625 104,855 17,770 34,182 243,975 93,709 150,266 2,865 1,941 924 27,377 26,961 416 24,368 16,025 5,980 18,396 38,319 (13,951) 15,419 7,240 7,608 606 (1,260) 10,788 96,585 55,462 23,920 47,453 106,586 (10,001) 57,844 28,874 17,522 (2,382) (4,954) 29,931 805,515 640,029 165,486 2,859,122 2,496,769 362,353 Salaries and benefits increased throughout 2013 compared with 2012, mainly due to an increase in project management staff to effect greater efficiency, partially offset by the reduction of a full time investor relations staff member, replaced by the reengagement of an Investor Relations (“IR”) consultant in Q3 2012. Share based compensation increased YTD due to the vesting throughout 2013 of options granted to IR consultants in the third quarter of 2012 and the first and fourth quarters of 2013, in addition to employee options issued in the second quarter of 2013. The variance in Q4 is due to a decrease in the calculated fair value per share of unvested options. Contract labour increased YTD due to the engagement in mid-2012 of a consultant working to identify new corporate opportunities. The QTD decrease was due to a non-recurring consulting fee in late 2012. Office expenses decreased in both the fourth quarter and year over year from 2012 to 2013 mainly as the result of a decreased YTD rent allocation. Legal fees decreased in both the quarter and YTD, due to reduced requirements for legal services with regards to research on international business processes and the implementation of the appropriate policies and documentation, the Q2 2012 closure of legal proceedings with the Toronto-based company, and the reduced legal services requirements in the action against SNC throughout 2013 (Contingencies, page 39). Non-recurring legal fees associated with FLYHT’s name change in Q2 2012 also contributed to the quarter and YTD decreases. Audit and accounting increases in the quarter and YTD are mainly due to an increased requirement for international tax consulting. 33 FLYHT AEROSPACE SOLUTIONS LTD. | ANNUAL REPORT | 2013 34 Investor relations expenses increased in the third quarter of 2013 and YTD, due to the reengagement of an IR consultant near the end of 2012 and the addition of a second IR consultant in the first quarter of 2013. Components requirements decreased in the quarter while increasing YTD, due to a requirement in earlier 2013 for a number of test parts used in developing enhanced functionality of recently developed products. Travel expenses decreased in the quarter and throughout 2013 compared to 2012 as a result of decreased operations staff attendance at industry meetings. It is anticipated that with the roll out of an investor outreach program in conjunction with the engagement of an investor relation advisor, travel expenses will increase over future quarters. Equipment and maintenance decreases are due to the decreased requirement for maintenance on administrative-related equipment in 2013, partially offset in the fourth quarter. Depreciation expense decreased in the quarter and throughout 2013 due to a decrease in the need to acquire capital equipment. Other expense increased in the quarter and year to date due to an employee relocation expense in 2013. Research and development expenses (recovery) Major Category Q4 2013 $ Q4 2012 $ Variance $ YTD 2013 $ YTD 2012 $ Variance $ Salaries and benefits 412,139 302,017 110,122 1,536,904 1,544,718 (7,814) Government grants variance YTD is due to a larger portion of SADI grant funds received in 2012 than 2013. The expense in Q4 2012 was the result of an adjustment to the effective interest rate of the repayment portion of SADI grant funds received. SRED credit expense in Q4 2012 was the result of the Canada Revenue Agency Scientific Research and Experimental Development (“SRED”) program’s final review of the Company’s 2010 SRED claim. Net finance costs Major Category Interest income Net foreign exchange gain Bank service charges Interest expense Q4 2013 $ Q4 2012 $ Variance $ YTD 2013 $ YTD 2012 $ Variance $ - - 4,772 1,315 11 - 5,291 1,641 (11) - (519) (326) 7,093 2,221 - 21,388 10,187 123,460 1,958 10,830 20,721 12,300 70,508 263 (10,830) 667 (2,113) 52,952 Share based compensation Contract labour Office Travel Equipment & maintenance Components Government grants SRED credit Depreciation Other Total - 145,480 94,731 8,210 1,799 25,622 - - 4,415 955 - 68,135 35,261 14,278 13,423 65,908 44,870 31,512 5,607 - 13,542 12,615 927 Government grant accretion 35,413 28,320 77,345 59,470 (6,068) (11,624) 533,107 1,265,032 (731,925) 188,579 303,740 (115,161) 48,734 33,154 60,419 48,704 63,267 (11,685) (15,550) 201,320 (40,286) 264,587 Debenture interest and accretion 200,748 106,061 94,687 657,620 402,275 255,345 Debenture cost amortization Net foreign exchange loss 21,822 75,619 19,744 31,643 2,078 84,136 78,546 5,590 43,976 165,432 - 165,432 Net finance costs 339,689 192,689 147,000 1,060,002 571,562 488,440 (44,870) (130,801) (585,705) 454,904 Interest income decreased in the quarter and YTD as a result of decreased average cash balances in 2013 as compared to 2012. (31,512) (326,195) (327,438) (1,192) 17,661 22,385 - 955 955 - 1,243 (4,724) 955 Net foreign exchange losses were recorded in 2013 compared to Net foreign exchange gains in 2012 due to the relative weakness of the Canadian dollar in relation to the U.S. dollar. Net foreign exchange losses were recorded in the fourth quarter of both 2012 and 2013, also due to the relative weakness of the Canadian dollar in relation to the U.S. dollar. 693,351 581,011 112,340 2,180,227 2,407,737 (227,510) Interest expense decreased YTD mainly due to differences in interest owing on a short-term loan. Salaries and benefits expended on research and development decreased throughout 2013, as the 228B moved toward full production. This was partially offset by increases in Q4 as R&D needs increased due to the requirements for launching the Dragon in late 2013, together with a short-term increase required to complete Chinese installation documentation. Contract labour decreased from 2012 YTD, mainly as the result of reduced utilization of consultants for hardware development. The YTD decrease was partially offset due to the increased activity required for launching the Dragon in late 2013. Office expenses decreased YTD as the result of decreased costs associated with patent applications. Legal requirements associated with the SNC legal action were lower in 2013 than 2012 overall, with an increase in Q4 2013 as compared to Q4 2012. Government grant accretion is the recognition of the effective interest component of the SADI grant, which increased throughout 2013 as more funding was received. Debenture interest increases are the result of increased interest accretion on the debentures issued in December 2010, and also the accretion of interest throughout 2013 on the debentures issued in April and May 2013. Net loss Major Category Q4 2013 $ Q4 2012 $ Variance $ YTD 2013 $ YTD 2012 $ Variance $ Net loss 1,438,795 621,446 817,349 4,063,164 4,883,752 (820,588) Net loss without R&D 745,444 40,436 705,008 1,882,937 2,476,015 (593,078) 35 FLYHT AEROSPACE SOLUTIONS LTD. | ANNUAL REPORT | 2013 36 FOREIGN EXCHANGE All international and a majority of domestic sales of the Company’s products and services are denominated in U.S. dollars. Accordingly, the Company is susceptible to foreign exchange fluctuations. In 2013, 95.4% of the Company’s gross sales were made in U.S. dollars, compared to 96.1% in 2012. The Company expects this to continue since the aviation industry conducts the majority of its transactions in U.S. dollars, thus limiting the opportunity for sales in Canadian dollars or other major currencies. The Company also contracts in U.S. dollars for certain services and products related to cost of sales, which creates a natural hedge. TRANSACTIONS WITH RELATED PARTIES a) Throughout 2012, the Company engaged in transactions with a company owned by a director to supply consulting services. The related party provides business development services such as trade show attendance and corporate introductions related to the business jet initiatives of the Company. b) During the fourth quarter of 2012, the Company did not engage in transactions with a company owned by another director to supply consulting services that had been used throughout 2011 and into the first quarter of 2012. The related party provided business development services such as market analysis and corporate introductions related to the commercial aviation initiatives of the Company. Included in contract labour: Included in accounts payable and accrued liabilities: For the three months ended December 31 For the year ended December 31 2013 $ - - - 2012 $ 22,394 16,219 22,394 2013 $ - 17,984 2012 $ 89,875 41,596 - 107,859 (a) (b) Total December 31 2013 $ - - - 2012 $ 14,915 6,192 14,915 All of the transactions with these related parties were amounts that were agreed upon by the parties and approximated fair value. All other transactions with related parties were normal business transactions related to their positions within the Company. These transactions included expense reimbursements for business travel and other expenses paid by the related party and were measured at exchange amounts that the related party paid to a third party and were substantiated with a third party receipt CONTRACTUAL OBLIGATIONS The following table details the contractual maturities of financial liabilities, including estimated interest payments. 2-12 months $ 1-2 years $ 2-5 years $ > 5 years $ - - - - - - - - - - - - - - - Total $ 600,283 1,921,384 512,806 14,029 116,608 344,026 344,026 2,781,399 2,781,399 1,507,480 8,384,600 1,507,480 11,549,710 18,726 - 216,583 9,970 75,930 3,751,695 4,072,904 December 31, 2013 Accounts payable < 2 months $ 581,557 Accounts payable – SNC* 1,921,384 Compensation and statutory deductions Finance lease liabilities Accrued liabilities Loans and borrowings Total 296,223 4,059 40,678 - 2,843,901 * See contingencies section on page 39. 37 In addition, the Company has repayment obligations related to three Government of Canada loan programs. Under the Industrial Research Assistance Program (“IRAP”), the outstanding balance at December 31, 2013 was nil compared to $66,690 at December 31, 2012. The initial amount was repaid as a percentage of gross revenues over a 5 to 10 year period commencing October 2005. Under the Technology Partnerships Canada (“TPC”) program, the Company has an outstanding balance of $12,364 at December 31, 2013, compared to $28,074 at December 31, 2012. The initial amount is to be repaid based on 15% of the initial contribution, which equates to $19,122 per year for a 10 year repayment period. The yearly repayment is due if the Company has achieved more than a 10% increase in gross revenue over the previous year and the gross revenue exceeds the gross revenue that was set in fiscal 2004 of $556,127. The repayment period commenced January 1, 2005. Under SADI, the Company has, at December 31, 2013, an outstanding repayable balance of $1,967,507, compared to $1,770,756 at December 31, 2012. The amount is repayable over 15 years on a stepped basis commencing April 30, 2014. The initial payment on April 30, 2014 is 3.5% of the total contribution received and increases yearly by 15% until April 30, 2028 when the final payment is 24.5% of the total contribution received. In the fourth quarter of 2013, FLYHT entered into an operating lease agreement covering equipment valued at $27,657 required for a security system in the new premises effective March 1, 2014. The lease has a term of 36 months, with the option to purchase the equipment at the end of the lease term. During the fourth quarter of 2012, FLYHT did not enter into any new lease agreements. Current lease agreements are scheduled to be paid in full in 2014. Minimum lease payments in 2014 for existing finance leases total $14,028. The imputed interest included in the payments is $853 (2012 - $5,240) leaving a total obligation of $13,175 (2012 - $33,138). CRITICAL ACCOUNTING ESTIMATES The Company prepares its consolidated financial statements in accordance with accounting principles generally accepted in Canada. The preparation of these consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, and expenses. These estimates are based on management’s historical experiences and various other assumptions that are believed by management to be reasonable under the circumstances. Such assumptions are evaluated on an ongoing basis and form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results could differ from these estimates. The following are the Company’s critical accounting policies, significant estimates, and assumptions used in preparing our financial statements: 1. The Company maintains an allowance for doubtful accounts for estimated losses that may occur if customers are unable to pay trade balances owing to the Company. This allowance is determined based on a review of specific customers, historical experience, and economic circumstances. 2. The Company evaluates its deferred tax assets at each reporting date and recognizes deferred tax assets to the extent that it is probable that future taxable profits will be available against which they can be utilized. At December 31, 2013, no deferred tax assets were recognized. 3. The Company records amounts for warranty based on historical warranty data and are recognized upon shipment of the underlying products. 4. Intangible assets are stated at cost less accumulated amortization and comprise of a license, customer contracts, and customer relationships. The license has an indefinite life. The customer contracts and relationships are amortized using the straight line method over the remaining life of the assumed contract. Indefinite lived intangible assets are subject to an annual impairment test or more frequently if events or circumstances change that indicate that the carrying value may not be recoverable. 5. The Company recognizes revenue from lease type agreements as agreement consideration, which is recorded as unearned revenue and recognized into revenue over the term of the lease agreement. Sales type agreement consideration is deferred as unearned revenue and corresponding expenses are recorded as work in progress until the system is fully functional and customer acceptance has been obtained, at which time the full deferred amount is recognized in revenue along with the work in progress as cost of sales. For both types of agreements, the revenue from UpTime usage fees is recognized at the end of each month and is based on actual usage during that month. FLYHT AEROSPACE SOLUTIONS LTD. | ANNUAL REPORT | 2013 38 RECENT ACCOUNTING PRONOUNCEMENTS The following new standards, interpretations, amendments and improvements to existing standards issued by the IASB or International Financial Reporting Interpretations Committee (“IFRIC”) were adopted as of January 1, 2013 without any material impact to FLYHT’s financial statements: IFRS 7 Financial Instruments: Disclosures, IFRS 10 Consolidated Financial Statements, IFRS 11 Joint Arrangements, IFRS 12 Disclosure of interests in Other Entities, IFRS 13 Fair Value Measurement, and IAS 9 Employee Future Benefit, IAS 36 Fair Value Measurement (IAS 36 was early adopted by FLYHT). The following new accounting pronouncements have been issued but are not effective and may have an impact on the Company. All of the following new or revised standards permit early adoption with transitional arrangements depending upon the date of initial application: IFRS 7 / IAS 32 – Offsetting Financial Assets and Liabilities clarifies that an entity currently has a legally enforceable right to set-off if it is not contingent on a future event, situations under which it is enforceable, and defines related disclosure requirements (January 1, 2014). IFRS 9 – Financial Instruments replaces the current multiple classification and measurement models for financial assets and liabilities with a single model that has only two classification categories: amortized cost and fair value. (January 1, 2018). IAS 1 – Presentation of Financial Statements requires that an entity present separately the items of OCI that may be reclassified to profit and loss in the future from those that would never be reclassified (annual periods beginning on or after July 1, 2013). IAS 39 – Novation of Derivatives and Continuation of Hedge Accounting provides some relief from the discontinuation of hedge accounting when a novation is made as a consequence of laws or regulations or the introduction of laws or regulations, subject to certain criteria (January 1, 2014). IFRIC 21 Levies requires a liability for a levy be recognized only when the triggering event specified in the legislature occurs, even if an entity has no realistic opportunity to avoid the triggering event (January 1, 2014). The Company has not completed its evaluation of the effect of adopting these standards on its consolidated annual financial statements. 6. Revenue from the sale of Underfloor Stowage Units and other parts is recognized when the unit is shipped, title is transferred, and collection is reasonably assured. Certain customers have prepaid for products or services not yet delivered. These amounts are included in trade payables and accrued liabilities on the SFP, and are recorded as revenue in the period in which such products or services are delivered. 7. Technical services are provided based upon orders and contracts with customers that include fixed or determinable prices that are based upon daily, hourly or contracted rates. Revenue is recognized as services are rendered and when collectability is reasonably assured. . FINANCIAL INSTRUMENTS The Company is exposed to fluctuations in the exchange rates between the Canadian dollar and other currencies with respect to assets, sales, and purchases. The Company monitors fluctuations and may take action if deemed necessary to mitigate its risk. The Company is exposed to changes in interest rates as a result of the operating loan, bearing interest based on the Company’s lenders’ prime rate. All outstanding debentures have a fixed rate of interest and therefore do not expose the Company’s cash flow to interest rate changes. There is a credit risk associated with accounts receivable where the customer fails to pay invoices. The Company extends credit generally to credit- worthy or well-established customers. In the case of agreement consideration or product sales, the invoiced amount is generally payable before the product is shipped to the customer. The Company assesses the financial risk of a customer and based on that analysis may require that a deposit payment be made before a service is provided. As well, for monthly recurring revenue the Company has the ability to disable AFIRS UpTime in cases where the customer has not fulfilled its financial obligations. CONTINGENCIES The Company took action against SNC and is defending itself against an action by SNC related to the development of the AFIRS 228. The Company has accrued a liability of $1,921,384, which represents the total amount of invoices received from SNC. The Company maintains that the claims are without merit and that the services invoiced were not provided. Management intends to vigorously defend the matter and believes the outcome will be in its favour. In November 2011, the Company formally notified SNC that they were in material breach of the License and Manufacturing Agreement that was entered into between the two parties on December 28, 2008. The Company demanded payment of $1,329,976 USD and $2,650,000 CDN and terminated the agreement. As well, the Company applied to the Alberta courts for arbitration under the provisions of the agreement. The courts granted the request for arbitration on November 29, 2011. Subsequent to the grant, SNC refused to recognize the jurisdiction of the court and has contested the cancellation of the agreement and the arbitration. In November 2011, SNC filed an action in Utah alleging that FLYHT failed to pay $2,042,000 USD. As all invoices presented to the Company by SNC have been accrued, management does not expect the outcome to have a material effect on the Company’s financial position. SUBSEQUENT EVENT As of April 14, 2014, the Company issued a total of 4,228,280 shares due to warrant and option exercises for total proceeds of $1,333,387, including: a) 1,971,500 warrants exercised at $0.30 for proceeds of $591,450 b) 1,405,780 warrants exercised at $0.40 for proceeds of $562,312 c) 718,500 options exercised at $0.25 for proceeds of $179,625 39 FLYHT AEROSPACE SOLUTIONS LTD. | ANNUAL REPORT | 2013 40 INDEPENDENT AUDITORS’ REPORT To the Shareholders of FLYHT Aerospace Solutions Ltd. We have audited the accompanying consolidated financial statements of FLYHT Aerospace Solutions Ltd., which comprise the consolidated statements of financial position as at December 31, 2013 and December 31, 2012, the consolidated statements of comprehensive income (loss), changes in equity (deficiency) and cash flows for the years then ended, and notes, comprising a summary of significant accounting policies and other explanatory information. Management’s Responsibility for the Consolidated Financial Statements Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with International Financial Reporting Standards, and for such internal control as management determines is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error. Auditors’ Responsibility Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with Canadian generally accepted auditing standards. Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on our judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, we consider internal control relevant to the entity’s preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that the audit evidence we have obtained in our audits is sufficient and appropriate to provide a basis for our audit opinion. Opinion In our opinion, the consolidated financial statements present fairly, in all material respects, the consolidated financial position of FLYHT Aerospace Solutions Ltd. as at December 31, 2013 and December 31, 2012, and its consolidated financial performance and its consolidated cash flows for the years then ended in accordance with International Financial Reporting Standards. Emphasis of Matter Without modifying our opinion, we draw attention to Note 2 (e) in the consolidated financial statements, which indicates that FLYHT Aerospace Solutions Ltd. has a net loss and negative cash flows from operating activities for the year ended December 31, 2013 and, as at that date, its current liabilities exceeded its current assets. These conditions, along with other matters as set forth in Note 2 (e) in the consolidated financial statements, indicate the existence of a material uncertainty that may cast significant doubt about FLYHT Aerospace Solutions Ltd’s ability to continue as a going concern.. Chartered Accountants April 14, 2014 Calgary, Canada 41 CONSOLIDATED STATEMENT OF FINANCIAL POSITION December 31, 2013 $ December 31, 2012 $ Assets Current assets Cash and cash equivalents (note 6) Restricted cash (note 13) Trade and other receivables (note 7) Deposits and prepaid expenses Inventory (note 8) Total current assets Non-current assets Property and equipment (note 9) Rental assets Intangible assets (note 10) Inventory (note 8) Total non-current assets Total assets Liabilities Current liabilities Trade payables and accrued liabilities (note 11) Unearned revenue (note 12) Loans and borrowings (note 13) Finance lease obligations Current tax liabilities (note 25) Total current liabilities Non-current liabilities Loans and borrowings (note 13) Finance lease obligations Provisions (note 15) Total non-current liabilities Total liabilities Equity (deficiency) Share capital (note 16) Convertible debenture – equity feature (note 13) Warrants (note 16) Contributed surplus Accumulated other comprehensive income (loss) Deficit Total equity (deficiency) Total liabilities and equity (deficiency) 5,184,803 250,000 784,426 145,554 1,308,243 7,673,026 191,695 - 34,992 536,249 762,936 8,435,962 3,704,496 1,103,834 3,745,513 13,175 895 8,567,913 1,992,028 - 148,428 2,140,456 10,708,369 48,318,003 231,318 1,057,652 7,458,093 - (59,337,473) (2,272,407) 8,435,962 676,246 250,000 1,209,497 99,464 1,663,918 3,899,125 240,725 38,726 62,623 727,773 1,069,847 4,968,972 3,658,254 2,717,245 271,832 19,963 4,078 6,671,372 3,104,967 13,175 46,452 3,164,594 9,835,966 39,877,966 231,318 3,340,222 6,957,809 - (55,274,309) (4,866,994) 4,968,972 See accompanying notes to consolidated financial statements. Going concern (note 2e), Contingencies (note 27) On behalf of the board Director – Douglas Marlin Director – Paul Takalo FLYHT AEROSPACE SOLUTIONS LTD. | ANNUAL REPORT | 2013 42 CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (LOSS) CONSOLIDATED STATEMENT OF CHANGES IN EQUITY (DEFICIENCY) For the years ended December 31, 2013 and 2012 Revenue (note 18) Cost of sales Gross profit Other (income) (note 19) Distribution expenses (note 21) Administration expenses (note 22) Research and development expenses (note 23) Results from operating activities Finance (income) (note 24) Finance costs (note 24) Net finance costs Loss for the year before income tax Income tax expense (note 25) Total comprehensive loss for the year Earnings (loss) per share Basic and diluted loss per share (note 17) See accompanying notes to consolidated financial statements. For the year ended December 31 2013 $ 8,000,364 3,264,786 4,735,578 (257,520) 2,956,446 2,859,122 2,180,227 (3,002,697) (2,221) 1,062,223 (1,060,002) (4,062,699) 465 (4,063,164) (0.03) 2012 $ 6,469,806 2,769,996 3,699,810 (257,520) 3,361,205 2,496,769 2,407,737 (4,308,381) (12,788) 584,350 (571,562) (4,879,943) 3,809 (4,883,752) (0.04) Share Capital $ Convertible Debenture $ Warrants $ Contributed Surplus $ Foreign Currency Translation Reserve* $ Deficit $ Total Equity (Deficit) $ Balance at January 1, 2012 Loss for the year Total comprehensive loss for the year Contributions by and distributions to owners Issue of common shares Share issue cost Bifurcation of warrants issued Issues of warrants Share-based payment transactions Share options exercised Total contributions by and distributions to owners 36,741,492 - 231,318 - 2,499,778 - 6,622,606 - - 4,349,940 (492,227) (723,417) - - 2,178 3,136,474 - - - - - - - - - - - - 840,444 - - 840,444 - - - - - 335,881 (678) 335,203 Balance at December 31, 2012 39,877,966 231,318 3,340,222 6,957,809 Balance at January 1, 2013 Loss for the year 39,877,966 - 231,318 - 3,340,222 - 6,957,809 - Total comprehensive loss for the year Contributions by and distributions to owners Issue of common shares Share issue cost Share-based payment transactions Share options exercised Warrants exercised Warrants expired Total contributions by and distributions to owners - 157,280 (3,121) - 148,007 8,137,871 - - - - - - - - - - - - - - - - (2,085,885) (196,685) 358,705 (55,107) - 196,685 8,440,037 - (2,282,570) 500,284 Balance at December 31, 2013 48,318,003 231,318 1,057,652 7,458,093 *Accumulated other comprehensive income (loss) - See accompanying notes to consolidated financial statements. - - - - - - - - - - - - - - - - - - - - - - (50,390,557) (4,883,752) (4,295,363) (4,883,752) (4,883,752) (4,883,752) - - - - - - - 4,349,940 (492,227) (723,417) 840,444 335,881 1,500 4,312,121 (55,274,309) (4,866,994) (55,274,309) (4,063,164) (4,866,994) (4,063,164) (4,063,164) (4,063,164) - - - - - - - 157,280 (3,121) 358,706 92,900 6,051,986 - 6,657,751 (59,337,473) (2,272,407) 43 FLYHT AEROSPACE SOLUTIONS LTD. | ANNUAL REPORT | 2013 44 CONSOLIDATED STATEMENT OF CASH FLOWS NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS For the year ended December 31 1. REPORTING ENTITY Cash flows from operating activities Loss for the year Adjustments for: Depreciation Depreciation of rental assets Amortization of intangible assets Convertible debenture accretion Payment of debenture interest Amortization of debenture issue costs Government grant accretion Government grant (note 3g, 23) Loss on disposal of property and equipment and rental assets Equity-settled share-based payment transactions Change in inventories Change in trade and other receivable Change in deposits and prepaid expenses Change in trade payables and accrued liabilities Change in provisions Change in unearned revenue Unrealized foreign exchange Interest expense Interest paid Income tax expense Income tax paid Net cash used in operating activities Cash flows from investing activities Acquisitions of property and equipment Disposal (acquisitions) of rental assets Interest income Interest received Net cash used in investing activities Cash flows from financing activities Share issue (cost) recovery Proceeds from issue of shares and warrants Proceeds from issue of debenture Proceeds from exercise of share options and warrants Proceeds from government grant Repayment of loans and borrowings Payment of finance lease liabilities Net cash from financing activities Net decrease in cash and cash equivalents Cash and cash equivalents at January 1 Effect of exchange rate fluctuations on cash held Cash and cash equivalents See accompanying notes to consolidated financial statements. 2013 $ (4,063,164) 87,710 11,735 27,631 657,620 (406,836) 84,135 123,460 (130,801) - 358,706 547,199 400,326 (46,090) (87,174) 101,976 (1,613,411) 173,240 10,187 (10,187) 465 (3,648) (3,776,921) (38,680) 26,991 (2,221) 2,221 (11,689) (3,121) 157,280 1,918,813 6,144,886 196,751 (82,400) (19,963) 8,312,246 4,523,636 676,246 (15,079) 5,184,803 2012 $ (4,883,752) 104,215 24,131 138,594 402,275 (252,720) 78,546 70,508 (585,705) 61,116 335,881 (605,753) (541,660) 99,612 (1,202,968) (934) 820,041 (191) 12,300 (12,300) 3,809 (4,168) (5,939,123) (8,280) 3,894 (1,958) 1,958 (4,386) (375,200) 4,349,940 - 1,500 879,854 (86,973) (48,715) 4,720,406 (1,223,103) 1,928,065 (28,716) 676,246 FLYHT Aerospace Solutions Ltd. (the “Company” or “FLYHT”) was founded in 1998 under the name AeroMechanical Services Ltd. FLYHT is a public company incorporated under the Canada Business Corporations Act, and is domiciled in Canada. The Company has been listed on the TSX Venture Exchange since March 2003, first as TSX.V: AMA. On May 10, 2012, the Company announced that shareholders approved a name change from AeroMechanical Services Ltd. to FLYHT Aerospace Solutions Ltd. On May 17, 2012 FLYHT received approval from the Toronto Stock Exchange to trade under the new symbol FLY. The Company’s head office is 300E, 1144 – 29th Avenue NE, Calgary, Alberta T2E 7P1. The consolidated financial statements of the Company as at and for the years ended December 31, 2013 and 2012 consist of the Company and its subsidiaries. FLYHT is a designer, developer, and service provider to the global aerospace industry. The Company supports aviation customers in different sectors including commercial, business, leasing and military operators. FLYHT’s headquarters are located in Calgary, Canada with sales representation in China, the Middle East, South America, the United States and Europe. 2. BASIS OF PREPARATION (a) Statement of compliance These consolidated annual financial statements have been prepared in accordance with International Financial Reporting Standards (“IFRS”). These consolidated financial statements were approved by the Board of Directors on April 14, 2014. (b) Basis of measurement The consolidated financial statements have been prepared on a historical cost basis except for financial instruments at fair value through profit or loss, which are measured at fair value in the statement of financial position (“SFP”). (c) Functional and presentation currency These consolidated financial statements are presented in Canadian dollars, which is the Company’s functional currency. (d) Use of estimates and judgments The preparation of the consolidated financial statements requires management to make judgments, estimates and assumptions that affect the application of accounting policies and the reported amounts of assets, liabilities, income and expenses. Actual results may differ from these estimates. Estimates and underlying assumptions are reviewed on an ongoing basis. Revisions to accounting estimates are recognized in the period in which the estimates are revised and in any future periods affected. Critical judgments in applying accounting policies and key estimates having the most significant effect on the amounts recognized in the consolidated financial statements include: • Inventories: judgment is required in determining amounts to be classified as non-current, and in determining potential impairment. Regular analysis is performed on inventory items, including a review of the age of outstanding inventory, historical movement patterns, contracted sales requirements, physical obsolescence, and technological advances (notes 3c, 3j, 8) • Trade and other receivables: estimates regarding collectability, and potential impairment are made taking into account the age of outstanding receivables, customer payment history, and specific indicators (notes 3j, 7, 26) • Revenue recognition: recognition of AFIRS UpTime revenue relies on a determination of the point when a system is fully functional, and when customer acceptance has been received. Services revenue is recognized in proportion to the stage of completion of the transaction at the reporting date, which requires an estimate of the services performed to date as a portion of the total services to be performed. (notes 3k, 12, 18) 45 FLYHT AEROSPACE SOLUTIONS LTD. | ANNUAL REPORT | 2013 46 2. BASIS OF PREPARATION (CONTINUED) (e) Going concern These consolidated financial statements have been prepared on the basis that the Company will continue to realize its assets and meet its obligations in the ordinary course of business. As at December 31, 2013, the Company had negative working capital of $894,887, a deficit of $59,337,473, a net loss of $4,063,164 and negative cash flow used in operations of $3,776,921. The Company has incurred significant operating losses and negative cash flows from operations over the past years. The Company’s ability to continue as a going concern is dependent upon attaining profitable operations and/or obtaining additional financing to fund its ongoing operations. The Company’s ability to attain profitable operations and positive cash flow in the future is dependent upon various factors including its ability to acquire new customer contracts, the success of management’s continued cost containment strategy, the completion of research and development (“R&D”) projects, and general economic conditions. In addition to capital required for regular business activities, the Company will be required to pay debenture interest payable in the fourth quarter of 2014 totaling $3,664,920, unless the holders exercise the conversion option. It is the Company’s intention to continue to fund operations by adding revenue and its resulting cash flow as well as continue to manage outgoing cash flows. If the need arises due to market opportunities the Company may meet those needs via the capital markets. These material uncertainties may cast significant doubt upon the Company’s ability to continue as a going concern. There is no assurance that the Company will be successful in attaining and sustaining profitable operations and cash flow or raising additional capital to meet its working capital requirements. If the Company is unable to satisfy its working capital requirements from these sources, the Company’s ability to continue as a going concern and to achieve its intended business objectives will be adversely affected. These consolidated financial statements do not reflect adjustments that would otherwise be necessary if the going concern assumption was not valid, such as revaluation to liquidation values and reclassification of statement of financial position items. 3. SIGNIFICANT ACCOUNTING POLICIES The accounting policies set out below have been applied consistently to all periods presented in these consolidated annual financial statements. These accounting policies have been applied consistently by FLYHT’s subsidiaries. (a) Basis of consolidation (i) Business combinations For acquisitions of businesses, the Company measures goodwill as the fair value of the consideration transferred including the recognized amount of any non-controlling interest in the acquiree, less the net recognized amount (fair value) of the identifiable assets acquired and liabilities assumed, all measured as of the acquisition date. When the excess is negative, a bargain purchase gain is recognized immediately in profit or loss. The Company will elect on a transaction-by-transaction basis whether to measure non-controlling interest at its fair value, or at its proportionate share of the recognized amount of the identifiable net assets, at the acquisition date. Transaction costs, other than those associated with the issue of debt or equity securities, that the Company incurs in connection with a business combination will be expensed as incurred. (ii) Subsidiaries Subsidiaries are entities controlled by FLYHT. The financial statements of subsidiaries are included in the consolidated financial statements from the date that control commences until the date that control ceases. The accounting policies of subsidiaries have been changed when necessary to align them with the policies adopted by the Company. These consolidated financial statements consolidate the accounts of FLYHT and its wholly owned subsidiaries, FLYHT Inc., AeroMechanical Services USA Inc., FLYHT Corp., FLYHT India Corp and TFM Inc. The latter four subsidiaries are inactive.. (iii) Transactions eliminated on consolidation Intra-group balances, transactions, and any unrealized income and expenses arising from intra-group transactions are eliminated in preparing the consolidated financial statements. 3. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) (b) Financial instruments (i) Non-derivative financial assets The Company initially recognizes loans, receivables and deposits on the date they are originated. All other financial assets (including assets designated at fair value through profit or loss) are recognized initially on the trade date at which the Company becomes a party to the contractual provisions of the instrument. The Company derecognizes a financial asset when the contractual rights to the cash flows from the asset expire or it transfers the rights to receive the contractual cash flows on the financial asset in a transaction in which substantially all the risks and rewards of ownership of the financial asset are transferred. Any interest in transferred financial assets that is created or retained by the Company is recognized as a separate asset or liability. Financial assets and liabilities are offset and the net amount presented in the statement of financial position when, and only when, the Company has a legal right to offset the amounts and intends either to settle on a net basis or to realize the asset and settle the liability simultaneously. Loans and receivables are financial assets with fixed or determinable payments that are not quoted in an active market. Such assets are recognized initially at fair value plus any directly attributable transaction costs. Subsequent to initial recognition, loans and receivables are measured at amortized cost using the effective interest method, less any impairment losses. Loans and receivables comprise trade and other receivables, and cash and cash equivalents. (ii) Non-derivative financial liabilities The Company initially recognizes debt securities issued and subordinated liabilities on the date that they are originated. All other financial liabilities (including liabilities designated at fair value through profit or loss) are recognized initially on the trade date at which the Company becomes a party to the contractual provisions of the instrument. The Company derecognizes a financial liability when its contractual obligations are discharged, cancelled or expire. The Company has the following non-derivative financial liabilities: debentures, trade payables and accrued liabilities, loans and borrowings, and finance lease obligations. These financial liabilities are recognized initially at fair value less any directly attributable transaction costs. Subsequent to initial recognition, these financial liabilities are measured at amortized cost using the effective interest rate method.. (iii) Share capital Common shares are classified as equity. Incremental costs directly attributable to the issue of common shares and share options are recognized as a deduction from equity, net of any tax effects. Warrants are classified as equity. Incremental costs directly attributable to the issue of warrants are recognized as a deduction from equity, net of any tax effects. The fair value of warrants is estimated using the Black-Scholes option pricing model. (iv) Compound financial instruments Compound financial instruments issued by the Company comprise convertible secured subordinate debentures that can be converted to common shares at the option of the holder, and the number of shares to be issued does not vary with changes in their fair value. The liability component of a compound financial instrument is recognized initially at the fair value of a similar liability that does not have an equity conversion option. The equity component is recognized initially at the difference between the fair value of the compound financial instrument as a whole and the fair value of the liability component. Any directly attributable transaction costs are allocated to the liability and equity components in proportion to their initial carrying amounts. 47 FLYHT AEROSPACE SOLUTIONS LTD. | ANNUAL REPORT | 2013 48 3. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) (b) Financial instruments (Continued) Subsequent to initial recognition, the liability component of a compound financial instrument is measured at amortized cost using the effective interest method. The equity component of a compound financial instrument is not re-measured subsequent to initial recognition. Interest relating to the financial liability is recognized in profit or loss. On conversion, the financial liability is reclassified to equity and no gain or loss is recognized. (c) Inventories Inventories are measured at the lower of cost and net realizable value. The cost of inventories includes expenditures incurred in acquiring the inventories, production or conversion costs, and other costs incurred in bringing them to their existing location and condition. The amount of inventory that is expected to be recovered more than 12 months after the reporting date is presented as a non-current asset. Net realizable value is the estimated selling price in the ordinary course of business, less the estimated costs of completion and selling expenses. Any writedown to net realizable value is recognized as an expense. Reversals of previous writedowns are recognized in profit or loss in the period when the reversal occurs. AFIRS raw material inventories include general parts, which are held pending installation and sales to customers. The weighted average cost method is used. The carrying cost of AFIRS finished goods includes AFIRS raw material component costs plus a standard labour allocation. AFIRS finished goods consists of AFIRS units that have been assembled and are held pending sale to customers. The weighted average cost method is used for components, while the labour component allocated to each unit is valued using a standard cost. Installations-in-progress includes product costs, and other direct project costs. When the system is fully functional, the installations-in-progress balance is recognized as cost of sales to correspond with the full unearned revenue amount then recognized as revenue. The production of Underfloor Stowage Units is outsourced and the weighted average cost method is used. (d) Property and equipment (i) Recognition and measurement Items of property and equipment are measured at cost less accumulated depreciation and accumulated impairment losses. Cost includes expenditures that are directly attributable to the acquisition of the asset including those that are directly attributable to bringing the asset to the location and working condition for its intended use. Software that is integral to the functionality of the related equipment is recognized as property and equipment, otherwise it is considered an intangible asset. 3. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) (d) Property and equipment (Continued) The depreciation rates are as follows: Computers Software Equipment Leasehold improvements 30% declining balance 12 months straight line 20% declining balance Term of lease (5 years) Estimates of depreciation methods, useful lives and residual values are reviewed at each reporting date and adjusted if appropriate. Any changes in these estimates are accounted for prospectively. (iv) Research and development (“R&D”) Expenditure on research activities is expensed as incurred. R&D costs consist primarily of consulting expenses and parts related to the design, testing, and manufacture of Automated Flight Information Reporting System (“AFIRSTM”) and the design and testing of UpTime, the Dragon, FIRST, FLYHTStream, and FLYHT Fuel Management System. Other R&D costs include testing and certification. Development activities involve a plan or design for the production of new or substantially improved products and processes. Development expenditure is capitalized only if development costs can be measured reliably, the product or process is technically and commercially feasible, future economic benefits are probable, and the Company intends to and has sufficient resources to complete development and to use or sell the asset. The expenditure capitalized includes the cost of materials, direct labour and overhead costs that are directly attributable to preparing the asset for its intended use, and borrowing costs on qualifying assets for which the commencement date for capitalization is on or after January 1, 2010. Other development expenditure is recognized in profit or loss as incurred. Capitalized development expenditure is measured at cost less accumulated amortization and accumulated impairment losses.. (v) Subsequent expenditure Subsequent expenditure is capitalized only when it increases the future economic benefits embodied in the specific asset to which it relates. All other expenditures are recognized in profit or loss as incurred. (vi) Amortization Amortization is calculated based on the asset’s cost less its residual value. Gains and losses on disposal of an item of property and equipment are determined by comparing the proceeds from disposal with the carrying amount of property and equipment. Net gains (losses) are recognized in profit or loss. Estimates of amortization methods, useful lives and residual values are reviewed at each reporting date and adjusted if appropriate. Any changes in these estimates are accounted for prospectively. (ii) Subsequent costs (e) Leased assets The cost of replacing a part of an item of property and equipment is recognized in the carrying amount of the item if it is probable that the future economic benefits embodied within the part will flow to the Company, and its cost can be measured reliably. The carrying amount of the replaced part is derecognized. The costs of the day-to-day servicing of property and equipment are recognized in profit or loss as incurred. (iii) Depreciation Depreciation is calculated using the depreciable amount, which is the cost of an asset less its residual value. Depreciation is recognized in profit or loss at rates calculated to write-off assets over their estimated useful lives since this most closely reflects the expected pattern of consumption of the future economic benefits embodied in the assets. Leased assets are depreciated over the shorter of the lease term and their useful lives unless it is reasonably certain that the Company will obtain ownership by the end of the lease term. Leases where the Company assumes substantially all the risks and rewards of ownership are classified as finance leases. Upon initial recognition, the leased asset is measured at an amount equal to the lower of its fair value and the present value of the minimum lease payments. Subsequent to initial recognition, the asset is accounted for according to the accounting policy applicable to that asset. Other leases are operating leases and the Company does not recognize the leased assets in its statement of financial position. Initial direct costs for operating leases are expensed immediately. As a lessee, FLYHT has several finance leases for computer hardware and leasehold improvements. As a lessee, FLYHT has an operating lease for its premises. As a lessor, rental assets are recorded at cost in FLYHT’s statement of financial position and consist of AFIRS units that are leased and in use in customer aircraft under lease type agreements. Depreciation is provided for active leased units on a straight-line basis over nine years. Spare units at customer sites are not depreciated until swapped into service. 49 FLYHT AEROSPACE SOLUTIONS LTD. | ANNUAL REPORT | 2013 50 3. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) 3. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) (f) Intangible assets (i) Warranties Intangible assets that are acquired by the Company and have finite useful lives are measured at cost less accumulated amortization and accumulated impairment losses. Customer contracts and relationships are amortized over the remaining life of the contracts that were assumed on acquisition of Wingspeed Corporation’s assets (residual value is zero). This method most closely reflects the expected pattern of consumption of the future economic benefits embodied in the assets. The useful initial lives range from two to four years as per the terms of the contracts. Acquired intangible assets with indefinite useful lives are stated at cost and are not amortized. The license with Bombardier that allows FLYHT access to technical documents has an indefinite life and is not amortized. The Company presently has dealings with Bombardier and sees no end to that relationship. An intangible asset is derecognized on disposal or when no future economic benefits are expected from its use or disposal. (g) Government assistance (i) Government grants Government grants related to qualifying research expenditures are recognized in profit or loss to match the costs that they are intended to compensate when there is reasonable assurance that they will be received and the Company will comply with the conditions associated with the grant. (ii) Government loans Low-interest or interest-free government loans are measured initially at their fair value and interest is imputed on the loan in subsequent periods. The benefit of the below-market interest rate is measured as the difference between the fair value of the loan on initial recognition and the amount received. This benefit is accounted for according to the type of grant. (h) Lease payments (i) Operating lease payments Payments made under operating leases are recognized in profit or loss on an accrual basis over the term of the lease. Initial direct costs for operating leases are immediately expensed. (ii) Finance lease payments Minimum lease payments made under finance leases are apportioned between finance costs and a reduction of the outstanding liability. The finance cost is allocated to each period during the lease term so as to produce a constant periodic rate of interest on the remaining balance of the liability. (i) Provisions A provision is recognized if, as a result of a past event, the Company has a present legal or constructive obligation that can be estimated reliably, and it is probable that an outflow of economic benefits will be required to settle the obligation. Provisions are determined by discounting the expected future cash flows at a pre-tax rate that reflects current market assessments of the time value of money and the risks specific to the liability. The unwinding of the discount is recognized as finance cost. The Company warrants that the AFIRS products shall be free of defects during the term of each agreement and any renewals. Also, FLYHT warrants that it will deliver all data services required by the customer accurately and on-time. A provision for warranties is recognized when the underlying products or services are sold. The provision is based on historical warranty data. (j) Impairment (i) Financial assets (including receivables) A financial asset not carried at fair value through profit or loss is assessed at each reporting date to determine whether there is objective evidence that it is impaired. A financial asset is impaired if objective evidence indicates that a loss event has occurred after the initial recognition of the asset, and that the loss event had a negative effect on the estimated future cash flows of that asset that can be estimated reliably. Objective evidence that financial assets are impaired can include default or delinquency by a debtor, restructuring of an amount due to the Company on terms that the Company would not consider otherwise, or indications that a debtor will enter bankruptcy. The Company assesses impairment of each customer’s receivable balance by analyzing historical trends of the probability of default, timing of recoveries and the amount of loss incurred, adjusted for management’s judgment as to whether current economic and credit conditions are such that the actual losses are likely to be greater or less than suggested by historical trends. An impairment loss regarding a financial asset measured at amortized cost is calculated as the difference between its carrying amount and the present value of the estimated future cash flows discounted at the asset’s original effective interest rate. Losses are recognized in profit or loss and reflected in an allowance account against receivables. Interest on the impaired asset continues to be recognized through the unwinding of the discount. When a subsequent event causes the amount of impairment loss to decrease, the decrease in impairment loss is reversed through profit or loss. (ii) Non-financial assets The carrying amounts of the Company’s non-financial assets, other than inventories, are reviewed at each reporting date to determine whether there is any indication of impairment. If any such indication exists, then the asset’s recoverable amount is estimated. For intangible assets that have indefinite useful lives, the recoverable amount is estimated at year end. The Company’s non-financial assets that are subject to impairment include: property and equipment, rental assets, and intangible assets. The recoverable amount of an asset is the greater of its value in use and its fair value less costs to sell. In assessing value in use, the estimated future cash flows are discounted to their present value using a pre-tax discount rate that reflects current market assessments of the time value of money and the risks specific to the asset. Fair value less costs to sell is assessed on an asset by asset basis at the point in time when a sale may be probable. For the purpose of impairment testing, assets that cannot be tested individually are grouped together into the smallest group of assets that generates cash inflows from continuing use that are largely independent of the cash inflows of other assets or groups of assets (the “cash-generating unit”, or “CGU”). The Company’s corporate assets do not generate separate cash inflows. If there is an indication that a corporate asset may be impaired, then the recoverable amount is determined for the CGU to which the corporate asset belongs. An impairment loss is recognized in profit or loss if the carrying amount of an asset or its CGU exceeds its estimated recoverable amount. Impairment losses are allocated to reduce the carrying amounts of the assets in the CGU on a pro rata basis. Impairment losses recognized in prior periods are assessed at each reporting date for any indications that the loss has decreased or no longer exists. An impairment loss is reversed if there has been a change in the estimates used to determine the recoverable amount. An impairment loss is reversed only to the extent that the asset’s carrying amount does not exceed the carrying amount that would have been determined, net of depreciation or amortization, had no impairment loss been recognized. 51 FLYHT AEROSPACE SOLUTIONS LTD. | ANNUAL REPORT | 2013 52 3. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) 3. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) (k) Revenue (i) AFIRS UpTime sales (a) Sales type agreements AFIRS fees from sales type service agreements are deferred as unearned revenue and corresponding expenses are recorded as an asset (installations in progress). Once the system (including the AFIRS unit and installation kit) is fully functional and accepted by the customer, the full deferred amount is recognized in revenue along with the installations in progress as cost of sales. (b) Lease type agreements The Company rents AFIRS units to some customers under operating leases. Under the terms of the lease agreements, the AFIRS units remain the property of FLYHT and title does not transfer to the customer nor is there an option for the customer to purchase the AFIRS unit at the end of the lease. The upfront fee from leased AFIRS contracts is initially recorded as unearned revenue and recognized as revenue on a straight line basis over the first term of the lease agreement upon shipment of the AFIRS unit. (ii) AFIRS UpTime usage Revenue from UpTime usage fees is recognized at the end of each month and is based on actual usage during that month. (iii) Parts sales Revenue from the sale of goods is measured at the fair value of the consideration received or receivable. Revenue is recognized when persuasive evidence exists, usually in the form of an executed sales agreement, that the significant risks and rewards of ownership have been transferred to the buyer, recovery of the consideration is probable, there is no continuing management involvement with the goods, and the amount of revenue can be measured reliably. Revenue from the sale of Underfloor Stowage Units is recognized when the unit is shipped, title is transferred, and collection is reasonably assured. (iv) Services Technical services are provided based on orders and contracts with customers that include fixed or determinable prices that are based on daily, hourly, or contracted rates. Revenue is recognized in proportion to the stage of completion of the transaction at the reporting date. (v) Other income License fees and royalties paid for the use of FLYHT’s assets (i.e., trademarks, patents, and software) are recognized on an accrual basis. (l) Employee benefits (i) Short-term employee benefits Short-term employee benefit obligations are measured on an undiscounted basis and are expensed as the related service is provided. The Company follows accrual accounting for wages, salaries, commissions and variable compensation payments. The commission policy outlines how commissions are calculated and when payment is made to employees. (l) Employee benefits (Continued) (ii) Share-based payment transactions The grant date fair value of share-based payment awards granted to employees is recognized as an expense, with a corresponding increase in equity, over the period that the employees unconditionally become entitled to the awards. Share-based payment transactions are equity-settled. Share options granted to directors and employees are measured using the fair value of the equity instruments granted at the grant date, which is determined using the Black-Scholes option pricing model. If options are promised to an employee before the grant date, the Company recognizes the expense at the service commencement date based on fair value. Once the grant date is established, the earlier estimate is revised so that the expense is recognized based on the actual grant date fair value. FLYHT estimates the expected forfeiture rate at the option grant date and updates the estimate over time as new information becomes available. Forfeitures may occur if employees terminate their employment before the options vest. (m) Share-based payment transactions to non-employees (i) Stock options granted to consultants The Company grants stock options to consultants. These share-based payment transactions are equity-settled. Transactions with non-employees are measured based on the fair value of the goods or services received, at the receipt date. Fair value is measured at the date the Company obtains the goods or the counterparty renders service. FLYHT estimates the expected forfeiture rate at the option grant date and updates the estimate over time as new information becomes available. Forfeitures may occur if consultants do not fulfill their obligations before the options vest. (ii) Agent warrants When the Company issues common shares, warrants, and debentures through brokered private placements, agent warrants are issued to the agents as consideration for their services. Warrants are classified as equity. Incremental costs directly attributable to the issue of warrants are recognized as a deduction from equity, net of any tax effects. The fair value of warrants is estimated using the Black-Scholes option pricing model. (n) Finance income and finance costs Finance income comprises interest income which is recognized as it accrues in profit or loss, using the effective interest method. The Company earns income on its cash and cash equivalents (bank deposits) and its restricted cash (Guaranteed Investment Certificates). Interest is recognized as it accrues in profit or loss, using the effective interest method. Finance costs comprise interest expense and accretion on borrowings, and unwinding of the discount on provisions and are recognized in profit or loss using the effective interest method. Foreign currency gains and losses are reported on a net basis, as either finance income or finance costs. 53 FLYHT AEROSPACE SOLUTIONS LTD. | ANNUAL REPORT | 2013 54 3. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) 3. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) (o) Foreign currency (i) Foreign currency transactions Foreign currency transactions are translated to Canadian dollars at the exchange rate in effect on the transaction date. Foreign currency denominated monetary assets and liabilities at each reporting date are retranslated to the functional currency at the exchange rate in effect on that date. The foreign currency gain or loss on monetary items is the difference between amortized cost in the functional currency at the beginning of the period, adjusted for effective interest and payments during the period, and the amortized cost in foreign currency translated at the exchange rate at the end of the reporting period. Non-monetary items that are measured in terms of historical cost in a foreign currency are translated using the exchange rate in effect on the date of the transaction. Foreign currency differences arising on retranslation are recognized in profit or loss. (ii) Foreign operations The assets and liabilities of foreign operations are translated to Canadian dollars at exchange rates in effect at the reporting date. The income and expenses of foreign operations are translated to Canadian dollars at exchange rates in effect on the transaction dates. Foreign currency differences are recognized in other comprehensive income in the cumulative translation account. (q) Earnings per share The Company presents basic and diluted earnings per share (“EPS”) data for its common shares. Basic EPS is calculated by dividing the profit or loss attributable to common shareholders of the Company by the weighted average number of common shares outstanding during the period. Diluted EPS is determined each period by adjusting the profit or loss attributable to common shareholders and the weighted average number of common shares outstanding, for the effects of all dilutive potential common shares, which comprise debentures, convertible debentures, share options, and warrants. 4. NEW STANDARDS AND INTERPRETATIONS NOT YET ADOPTED The following standards, interpretations, amendments and improvements to existing standards issued by the IASB or International Financial Reporting Interpretations Committee (“IFRIC”) were adopted as of January 1, 2013 without any material impact to FLYHT’s Financial Statements: IFRS 7 Financial Instruments: Disclosures, IFRS 10 Consolidated Financial Statements, IFRS 11 Joint Arrangements, IFRS 12 Disclosure of interests in Other Entities, IFRS 13 Fair Value Measurement, and IAS 9 Employee Future Benefit, IAS 36 Fair Value Measurement (IAS 36 was early adopted by FLYHT) The following new accounting pronouncements have been issued but are not effective and may have an impact on the Company. All of the following new or revised standards and amendments to existing standards permit early adoption with transitional arrangements depending upon the date of initial application:: IFRS 7 / IAS 32 – Offsetting Financial Assets and Liabilities clarifies that an entity currently has a legally enforceable right to set-off if it is not contingent on a future event, situations under which it is enforceable, and defines related disclosure requirements (January 1, 2014). Foreign exchange gains or losses arising from a monetary item receivable from or payable to a foreign operation, the settlement of which is neither planned nor likely to occur in the foreseeable future and which, in substance, is considered to form part of the net investment in the foreign operation, are recognized in other comprehensive income in the cumulative amount of foreign currency translation differences. IFRS 9 – Financial Instruments replaces the current multiple classification and measurement models for financial assets and liabilities with a single model that has only two classification categories: amortized cost and fair value. (transitional date still to be determined by the International Accounting Standards Board (“IASB”)). (p) Income tax Income tax expense comprises current and deferred tax. Current tax and deferred tax are recognized in profit or loss except to the extent that it relates to a business combination, or items recognized directly in equity or in other comprehensive income. Current tax is the expected tax payable or receivable on the taxable income or loss for the year, using tax rates enacted or substantively enacted at the reporting date, and any adjustment to tax payable in respect of previous years. Deferred tax is recognized in respect to temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for taxation purposes. Deferred tax is not recognized for the following temporary differences: the initial recognition of assets or liabilities in a transaction that is not a business combination and that affects neither accounting nor taxable profit or loss, and differences relating to investments in subsidiaries to the extent that it is probable that they will not reverse in the foreseeable future. Deferred tax is measured at the tax rates that are expected to be applied to temporary differences when they reverse, based on the laws that have been enacted or substantively enacted by the reporting date. Deferred tax assets and liabilities are offset if there is a legally enforceable right to offset current tax liabilities and assets, and they relate to income taxes levied by the same tax authority on the same taxable entity, or on different tax entities, but they intend to settle current tax liabilities and assets on a net basis or their tax assets and liabilities will be realized simultaneously. A deferred tax asset is recognized for unused tax losses, tax credits and deductible temporary differences, to the extent that it is probable that future taxable profits will be available against which they can be utilized. Deferred tax assets are reviewed at each reporting date and are reduced to the extent that it is no longer probable that the related tax benefit will be realized. When a taxable temporary difference arises from the initial recognition of the equity component separately from the liability component of a compound financial instrument, the resulting deferred tax liability is charged directly to the carrying amount of the equity component. IAS 1 – Presentation of Financial Statements requires that an entity present separately the items of OCI that may be reclassified to profit and loss in the future from those that would never be reclassified (annual periods beginning on or after July 1, 2013). IAS 39 – Novation of Derivatives and Continuation of Hedge Accounting provides some relief from the discontinuation of hedge accounting when a novation is made as a consequence of laws or regulations or the introduction of laws or regulations, subject to certain criteria (January 1, 2014). IAS 36 Fair Value Measurement reverses the requirement to disclose the recoverable amount of every cash-generating unit to which significant goodwill or indefinite-lived intangible assets have been allocated, updating the requirement to only apply when an impairment loss has been recognized or reversed (January 1, 2014). IFRIC 21 Levies requires a liability for a levy be recognized only when the triggering event specified in the legislature occurs, even if an entity has no realistic opportunity to avoid the triggering event (January 1, 2014). The Company has not completed its evaluation of the effect of adopting these standards on its consolidated annual financial statements. 55 FLYHT AEROSPACE SOLUTIONS LTD. | ANNUAL REPORT | 2013 56 5. DETERMINATION OF FAIR VALUES 9. PROPERTY AND EQUIPMENT A number of the Company’s accounting policies and disclosures require the determination of fair value, for both financial and non-financial assets and liabilities. Fair values have been determined for measurement and/or disclosure purposes based on the following methods. (a) Share based payment transactions: measured using the Black-Scholes option pricing model; (b) Loans and borrowings: for measurement purposes, fair value is calculated based on the present value of future principal and interest cash flows, discounted at the market rate of interest at the inception of the loan. In respect of the liability component of convertible debenture, the market rate of interest is determined by reference to similar liabilities that do not have a conversion feature. In respect of the convertible debentures and the debentures, as there has been no material change in the Company’s market rate subsequent to the issuance dates, carrying value approximates fair value; and (c) Trade and other receivables, trade payables and accrued liabilities: carrying value approximates fair value, due to the short-term nature of the instruments. 6. CASH AND CASH EQUIVALENTS Cash and cash equivalents consist of cash balances and bank deposits with an original maturity of three months or less. 7. TRADE AND OTHER RECEIVABLES Trade receivables Non-trade receivables and accrued receivables Total December 31, 2013 December 31, 2012 $ 771,244 13,182 784,426 $ 882,990 326,507 1,209,497 Non-trade receivables consist of earned interest income receivable, input tax credits, and government grants receivable. The Company’s exposure to credit and currency risks is disclosed in note 26. 8. INVENTORY AFIRS raw materials AFIRS finished goods Installations in progress Balance Less current portion Non-current portion December 31, 2013 December 31, 2012 $ 806,872 406,475 631,145 1,844,492 (1,308,243) 536,249 $ 1,157,382 249,703 984,606 2,391,691 (1,663,918) 727,773 2013 Cost Balance at January 1 Additions Disposals Balance at December 31 Accumulated Depreciation Balance at January 1 Depreciation for the year Disposals Balance at December 31 Carrying Amounts At January 1 At December 31 2012 Cost Balance at January 1 Additions Disposals Balance at December 31 Accumulated Depreciation Balance at January 1 Depreciation for the year Disposals Balance at December 31 Carrying Amounts At January 1 At December 31 Computers and Software $ 894,360 4,559 - 898,919 760,111 43,694 - 803,805 134,249 95,114 Equipment $ 230,297 - - 230,297 157,452 14,569 - 172,021 72,845 58,276 Leasehold improvements $ 132,851 34,121 - 166,972 99,220 29,447 - 128,667 33,631 38,305 Computers and Software $ Equipment $ Leasehold improvements $ Total $ 1,257,508 38,680 - 1,296,188 1,016,783 87,710 - 1,104,493 240,725 191,695 Total $ 886,080 8,280 - 894,360 703,554 56,557 - 760,111 182,526 134,249 230,297 132,851 1,249,228 - - - - 8,280 - 230,297 132,851 1,257,508 139,241 18,211 - 157,452 91,056 72,845 69,773 29,447 - 99,220 63,078 33,631 912,568 104,215 - 1,016,783 336,660 240,725 In 2013, AFIRS materials and changes in AFIRS units and installations in progress recognized as cost of sales amounted to $1,941,847 (2012: $1,389,017). Included in this amount was a write down of inventories amounting to $251,635 in 2013 (2012: recovery of $13,899) resulting from a complete review of slow moving inventory parts. All inventories are pledged as security for the bank loan and debentures. The Company leases equipment under several finance lease agreements. Certain leases provide FLYHT with the option to purchase the equipment at the end of the lease term. At December 31, 2013, the net carrying amount of leased property and equipment was $41,619 (2012: $59,456). As of December 31, 2013, all property and equipment are pledged as security for the bank loan and debentures (note 13). In the fourth quarter of 2013 FLYHT entered into an agreement to purchase equipment for a security system valued at $27,657 to be installed in the new premises effective March 1, 2014. 57 FLYHT AEROSPACE SOLUTIONS LTD. | ANNUAL REPORT | 2013 58 10. INTANGIBLE ASSETS 11. TRADE PAYABLES AND ACCRUED LIABILITIES 2013 Cost Balance at January 1 Balance at December 31 Amortization Balance at January 1 Amortization for the year Balance at December 31 Carrying amounts At January 1 At December 31 2012 Cost Balance at January 1 Balance at December 31 Amortization Balance at January 1 Amortization for the year Balance at December 31 Carrying amounts At January 1 At December 31 License Customer contracts $ 34,992 34,992 - - - 34,992 34,992 $ 466,510 466,510 438,879 27,631 466,510 27,631 - License Customer contracts $ 34,992 34,992 - - - 34,992 34,992 $ 466,510 466,510 300,285 138,594 438,879 166,225 27,631 Total $ 501,502 501,502 438,879 27,6314 466,510 62,623 34,992 Total $ 501,502 501,502 300,285 138,594 438,879 201,217 62,623 The license with Bombardier allows FLYHT access to technical documents. It has an indefinite life, is not amortized, and is tested for impairment annually. The Company presently has dealings with Bombardier and forsees no end to that relationship. FLYHT provides the contracted customers with UpTime data services. The fair value of the contracts acquired was amortized over the contract period, ending in March 2013. Amortization of intangibles is included in the statement of comprehensive income as cost of sales. All intangible assets are pledged as security for the bank loan and debentures. Trade payables Non-refundable customer deposits Compensation and statutory deductions Accrued liabilities Total December 31, 2013 December 31, 2012 $ 2,454,242 620,840 512,806 116,608 3,704,496 $ 2,334,164 797,070 316,058 210,962 3,658,254 Compensation and statutory deductions include accrued vacation pay, variable compensation, and statutory payroll deductions. 12. UNEARNED REVENUE Unearned revenue classified as current consists of sales type agreements revenue that will be recognized when the AFIRS system is fully functional, and rental type agreements revenue and license fees expected to be recognized as income in the next year. The license and manufacturing agreement with SNC gives SNC the right to manufacture the Company’s AFIRS product and market the AFIRS UpTime technology and products to the global military market. This license fee is deferred as unearned revenue and revenue was recognized on a straight-line basis over the five year term of the agreement and has been fully recognized as of December 31, 2013 (See note 19). All amounts recorded in unearned revenue are non-refundable. Balance January 1 AFIRS UpTime sales: shipped, not accepted AFIRS UpTime usage: prepaid AFIRS UpTime sales: revenue recognized AFIRS UpTime usage: revenue recognized License fees: revenue recognized Balance December 31 2013 $ 2,717,245 1,450,520 414,228 (2,694,292) (526,346) (257,520) 1,103,834 2012 $ 1,897,204 3,445,930 376,981 (2,464,784) (280,566) (257,520) 2,717,245 59 FLYHT AEROSPACE SOLUTIONS LTD. | ANNUAL REPORT | 2013 60 13. LOANS AND BORROWINGS Bank loan The Company currently has no bank debt and has available to it an operating demand loan up to a maximum of $250,000 (2012: $250,000). The operating loan bears interest at Canadian chartered bank prime plus 1.5%. The operating demand loan is secured by an assignment of cash collateral in the amount of $250,000 and a general security agreement including a first ranking security interest in all personal property. The amount of the cash collateral has been disclosed as restricted cash. As at December 31, 2013 and 2012, the facility had not been drawn. Government loans The IRAP loan was repaid in full in the third quarter of 2013. The loan was non-interest bearing and was repaid annually, based on 1.11% of gross revenues, commencing October 2005 and was unsecured. The current portion was calculated based on the actual gross revenues in the previous quarter plus the Company’s revenue projections for the next nine months. The TPC loan is non-interest bearing and unsecured. The loan is repayable annually, based on 15% of the initial contribution when the Company has achieved more than 10% growth in gross revenues above the previous year’s gross revenue and the gross revenue for the year is greater than the base amount. The base amount is defined as the Company’s gross revenue in fiscal 2004, which was at $556,127. On February 23, 2011, the Company signed a contribution agreement with Industry Canada under the SADI program for the development of the next generation product, AFIRS 228. Under the terms of the agreement, SADI has made repayable unsecured contributions to the Company of 30% of the eligible project costs to December 30, 2012 totaling $1,967,507. The amount is repayable over 15 years commencing April 30, 2014. The payments are on a stepped basis starting April 30, 2014. Payments comprise 3.5% of the contribution and increase 15% yearly until April 30, 2028, when the final payment is 24.5% of the contribution. The amount to be repaid is 165% of the original contribution. At December 31, 2013, the Company had received a cumulative total of $1,967,507 (December 31, 2012: $1,770,756). Convertible debentures The debenture issued December 23, 2010 has a face value of $3,159,000. The debenture matures on December 23, 2014 and bears interest at a rate of 8% per annum, accrued and paid annually in arrears commencing December 31, 2011. The debentures are convertible into common shares at a conversion rate of $0.40 per share at any time prior to maturity. The debentures are secured against all personal property of the Company, with the exception of the Company’s intellectual property, and are subordinated in right of payment to all existing and future bank and/or governmental indebtedness of the Company. The fair value of the conversion feature was determined at the time of issue as the difference between the principal value of the debentures and the discounted cash flows assuming an 18% rate. The conversion feature is classified as equity and amounts to $231,318 as at December 31, 2013 (December 31, 2012: $231,318). If the debentures are converted to shares, a portion of the value of the conversion feature recognized in shareholders’ equity will be classified to share capital along with the conversion price paid. Debentures In two tranches on April 18 and May 28, 2013, the Company issued an aggregate $2,110,000 of debentures in a debt offering. The debentures mature on June 30, 2016 and bear interest at a rate of 12% per annum on the contributed amounts, which shall be accrued and paid annually in arrears commencing December 1, 2013. Purchasers of debentures received a capital discount premium of 10% on the financing, meaning that for every $1.00 debenture acquired, FLYHT shall owe, on the maturity date, principal equal to $1.10 to the debenture holder. The purchasers of the debentures were also issued one common share of the Corporation for every $1.00 principal amount of debentures acquired pursuant to the offering. A total of 2,110,000 common shares were issued under these tranches. All of the securities issued thereunder were subject to a 4-month hold period. The debentures are not listed on any stock exchange and are not convertible into common shares. The debentures are secured against all personal property of FLYHT, including FLYHT’s intellectual property and are subordinated in right of payment to all existing and future secured bank and/or governmental indebtedness of FLYHT and any existing security already registered against FLYHT’s assets. The fair value of the debenture was determined at the time of issue as the difference between the principal value of the debentures and the discounted cash flows assuming an 18% rate. 13. LOANS AND BORROWINGS (CONTINUED) IRAP TPC SADI Debenture payable Convertible debenture payable Balance December 31 Less current portion Non-current portion 14. OPERATING LEASES 2013 $ - 12,364 818,828 2,006,397 2,899,952 5,737,541 (3,745,513) 1,992,028 2012 $ 66,690 28,074 629,419 - 2,652,616 3,376,799 (271,832) 3,104,967 The Company’s lease for its operating premises (a) ends effective February 28, 2014. A lease has been entered into for a new operating premises (b), effective March 1, 2014. Operating lease rentals are payable as follows: Premises (b) $ Total Premises $ 2014 2015 2016 2017 2018 2019 2020 2021 Total Premises (a) $ 81,637 - - - - - - - 342,292 410,750 410,750 433,419 437,952 437,952 437,952 72,992 81,637 2,984,059 Operating lease payments made in 2013 totaled $488,060 (2012: $472,142). 15. PROVISIONS Product warranty - non-current provision Balance January 1 Provision made during the period Provision used during the period Balance December 31 2013 $ 46,452 263,979 (162,003) 148,428 A provision for warranties is recognized when the underlying products or services are sold. The provision is based on historical warranty data. 423,929 410,750 410,750 433,419 437,952 437,952 437,952 72,992 3,065,696 2012 $ 47,027 39,801 (40,376) 46,452 61 FLYHT AEROSPACE SOLUTIONS LTD. | ANNUAL REPORT | 2013 62 16. CAPITAL AND OTHER COMPONENTS OF EQUITY 16. CAPITAL AND OTHER COMPONENTS OF EQUITY (CONTINUED) Share capital Authorized: Unlimited numbers of common shares, and classes A, B and C preferred shares, issuable in series, having no par value. The preferred shares may be issued in one or more series. The directors are authorized to fix the number of shares in each series and to determine the designation, rights, privileges, restrictions and conditions attached to the shares in each series. Issued and outstanding: Common shares: Balance January 1, 2012 Issued for cash Share issue costs Share issue costs – agent warrants Bifurcation of warrants Exercise of employee options Contributed surplus from exercise of employee options Balance December 31, 2012 Issued for cash Share issue costs Exercise of employee options Contributed surplus from exercise of employee options Exercise of warrants Contributed surplus from exercise of warrants Balance December 31, 2013 Number of shares 118,630,466 21,749,700 - - - 6,000 - 140,386,166 2,110,000 - 314,000 - 16,007,102 - 158,817,268 Value $ 36,741,492 4,349,940 (375,200) (117,027) (723,417) 1,500 678 39,877,966 157,280 (3,121) 92,900 55,107 6,051,986 2,085,885 48,318,003 In four tranches in June and July 2012 the Company issued 20,749,700 share units pursuant to a combination of brokered and non-brokered private placements at $0.20 per share unit resulting in gross proceeds of $4,149,940. Each share unit consists of one common share and one-half share purchase warrant. Each full share unit warrant entitles the holder to acquire one common share at a price of $0.30 until 24 months after the issue date of the share purchase warrant. As at December 31, 2012 share purchase warrants outstanding totaled 10,374,850 from the four tranches: 4,595,750 will expire June 22, 2014; 1,437,500, June 27, 2014; 1,889,100, June 29, 2014 and 2,452,000 July 4, 2014. The net cash proceeds after issuance costs of the brokered and non-brokered private placements totaled $3,784,367. A further 1,223,509 agent warrants were issued which entitle the holder to acquire one common share at a price of $0.20 until 24 months after the issue date of the agent warrant. The expiry details are: 606,935, June 22, 2014; 8,750, June 27, 2014; 264,474, June 29, 2014; and 343,350 July 4, 2014. On September 27, 2012 the Company issued 1,000,000 common shares at $0.20 per share in connection with a non-brokered private placement resulting in gross proceeds of $200,000 The net cash proceeds after issuance costs was $198,115. In 2012 an additional 6,000 common shares were issued to directors, officers, employees and consultants on the exercise of options. The weighted average exercise price of these common shares was $0.25, resulting in cash proceeds of $1,500. In two tranches on April 18 and May 28, 2013, the Company issued debentures in a debt offering (note 13). The purchasers of the debentures were issued one common share of the Corporation for every $1.00 principal amount of debentures acquired pursuant to the offering. A total of 2,110,000 common shares were issued under these tranches. All of the securities issued thereunder were subject to a four-month hold period. In 2013 a total of 16,007,102 warrants were exercised, each exercisable into one common share for total proceeds of $6,051,986: (a) 1,071,522 warrants were exercised with an exercise price of $0.20 per share for proceeds of $214,304, (b) 1,365,500 warrants were exercised with an exercise price of $0.30 per share for proceeds of $409,650, and (c) 13,570,080 warrants were exercised with an exercise price of $0.40 per share for proceeds of $5,428,032 Also in 2013, a total of 314,000 stock options were exercised for total proceeds of $92,900, with each stock option exercised into one common share: (d) 224,000 stock options were exercised with an exercise price of $0.25 for proceeds of $56,000, and (e) 90,000 stock options were exercised with an exercise price of $0.41 per share for proceeds of $36,900 Stock option plan The Company grants stock options to its directors, officers, employees and consultants. In the first quarter of 2013 the Company granted 487,500 stock options to two consultants under the stock option plan. The stock options expire December 31, 2016, and have an exercise price of $0.25 per share. Of the options granted, 87,500 were issued to a consultant and vested immediately and 400,000 were issued to an investor relations consultant and vested 25% per quarter March 31, June 30, September 30, and December 31, 2013. The fair value of the 87,500 options granted was determined using the Black-Scholes option pricing model. The fair value of the 400,000 options granted was determined based on the estimated fair value of services to be received. In the second quarter of 2013 the Company granted 2,211,500 stock options to employees and directors under the stock option plan. The stock options vest immediately, expire December 31, 2016, and have an exercise price of $0.25 per share. The options were granted at an exercise price not less than fair market value of the stock on the date of issuance. In the third quarter of 2013 the Company granted 100,000 stock options to an employee under the stock option plan. The stock options vest immediately, expire December 31, 2016, and have an exercise price of $0.25 per share. The options were granted at an exercise price not less than fair market value of the stock on the date of issuance. In the fourth quarter the Company granted 800,000 options effective January 1, 2014, comprised of 400,000 options to each of two IR consultants (subject to the approval of the TSX Venture Exchange, received on Jan 2, and Feb 25, 2014). These options were recorded as outstanding as of December 31, 2013. An aggregate 200,000 options (100,000 per IR consultant) will vest on March 31, June 30, September 30 and December 31, 2014. The options have an exercise price of $0.45 and expire December 31, 2016. The Company has a policy of reserving up to 10% of the outstanding common shares for issuance to eligible participants. As at December 31, 2013, there were 15,881,726 (2012: 14,038,617) common shares reserved for this purpose. All outstanding options issued to date vested immediately at the grant date with the exception of: (a) 400,000 options granted to an investor relations (“IR”) consultant effective September 20, 2012 and 400,000 granted to an investor relations consultant effective January 1, 2013 which had vested by December 31, 2013, and (b) 1,200,000 options granted effective January 1, 2014, comprised of 400,000 options to each of three IR consultants. Vesting provisions provide that 25% of the total stock options issued under these three agreements vest to each of the IR consultants per quarter over the first one-year period. 63 FLYHT AEROSPACE SOLUTIONS LTD. | ANNUAL REPORT | 2013 64 16. CAPITAL AND OTHER COMPONENTS OF EQUITY (CONTINUED) 16. CAPITAL AND OTHER COMPONENTS OF EQUITY (CONTINUED) There remain 800,000 unvested options as at December 31, 2013 (2012: 1,375,000). A summary of the Company’s outstanding and exercisable stock options as at December 31, 2013 and 2012 and changes during these years is presented below. The weighted average fair value of the agent warrants granted in 2012 was $0.07. The fair value of the warrants granted was estimated using the Black-Scholes option pricing model with the following weighted average assumptions: 2013 Number of options Outstanding, January 1 Options granted Options exercised Options expired Outstanding, December 31 Exercisable, December 31 6,270,500 3,599,000 (314,000) (2,083,000) 7,472,500 6,672,500 Weighted average exercise price $ 0.26 0.29 0.30 0.28 0.27 0.25 2012 Number of options 4,485,991 2,607,500 (6,000) (816,991) 6,270,500 4,895,500 Weighted average exercise price $ 0.28 0.25 0.25 0.31 0.26 0.28 Weighted average life remaining for the options outstanding and exercisable is 2.2 years. The exercise prices for options outstanding at December 31, 2013 were as follows: Exercise price: $0.25 $0.25 $0.25 $0.45 Total All options Exercisable options Number 1,752,500 2,593,000 2,327,000 800,000 7,472,500 Weighted average remaining contractual life (years) 1.0 2.0 3.0 3.0 2.2 Number 1,752,500 2,593,000 2,327,000 - 6,672,500 Weighted average remaining contractual life (years) 1.0 2.0 3.0 - 2.1 The weighted average fair value of the options granted during the year that were valued using the Black-Scholes option pricing model was $0.12 (2012: $0.14), estimated based on the following assumptions. The fair value of the options granted and valued using the Black-Scholes option pricing model were valued with the following weighted average assumptions: Risk-free interest rate Expected life (years) Volatility in the price of the Company’s common shares Dividend yield rate 2013 1.24% 3.65 99% 0.00% Warrants Outstanding January 1, 2012 Issued on private placement Agent warrants granted Outstanding December 31, 2012 Warrants exercised Warrants expired Outstanding December 31, 2013 65 Number of warrants Weighted average exercise price 20,535,610 10,374,850 1,223,509 32,133,969 (16,007,102) (1,415,000) 14,711,867 $ 0.47 0.30 0.20 0.40 0.38 0.40 0.23 2012 1.38% 3.60 99% 0.00% Value $ 2,499,778 723,417 117,027 3,340,222 (2,085,885) (196,685) 1,057,652 Risk-free interest rate Expected life (years) Volatility in the price of the Company’s common shares Dividend yield rate 17. EARNINGS PER SHARE Basic earnings per share 2013 - - - - 2012 1.05% 2.00 76% 0.00% The calculation of basic and diluted earnings per share for the year ended December 31, 2013 was based on a weighted average number of common shares outstanding of 142,691,525 (2012: 129,567,629). The calculation of diluted earnings per share did not include stock options of 7,872,500 (2012: 6,270,500), warrants of 14,711,867 (2012: 32,133,969) and convertible debentures of 7,897,500 because they would be anti-dilutive. 18. REVENUE AFIRS Uptime sales AFIRS Uptime usage Parts sales Services Total 2013 $ 2,707,838 3,624,719 655,561 1,012,245 8,000,364 2012 $ 2,464,784 3,091,626 202,420 710,976 6,469,806 AFIRS Uptime sales includes revenue for both lease and sales type contracts. AFIRS Uptime usage includes UpTime monthly voice and data usage fees. Parts sales includes spare AFIRS units, spare installation kit parts and Underfloor Stowage Units. Services include technical, repair, and installation support services. 19. OTHER INCOME Other income consists of the recognition of the SNC license fee that was deferred as unearned revenue when received and was recognized over the initial five year term of the agreement (note 12). FLYHT AEROSPACE SOLUTIONS LTD. | ANNUAL REPORT | 2013 66 20. OPERATING SEGMENTS The Company has one operating segment. Geographical Information The following revenue is based on the geographical location of customers. North America South / Central America Africa / Middle East Europe Australasia Asia Total 22. ADMINISTRATION EXPENSES For the year ended December 31 For the year ended December 31 2013 $ 3,853,788 460,184 1,391,446 549,718 697,249 1,047,979 8,000,364 2012 $ 3,522,317 472,850 1,729,862 150,247 520,843 73,687 6,469,806 Salaries and benefits Stock based compensation Contract labour Office Legal fees Audit and accounting Investor relations Brokerage, stock exchange, and transfer agent fees Travel Equipment and maintenance Depreciation Other Total 2013 $ 1,498,854 260,091 141,271 305,104 36,405 122,625 243,975 27,377 96,585 55,462 23,920 47,453 2,859,122 2012 $ 1,253,401 227,808 112,366 324,465 142,378 104,855 93,709 26,961 106,586 57,844 28,874 17,522 2,496,769 All non-current assets (property and equipment and intangible assets) reside in Canada. Major customers 23. RESEARCH AND DEVELOPMENT EXPENSES To date, all development costs have been expensed as incurred. Revenues from the three largest customers represent approximately 31.1% of the Company’s total revenues for the year ended December 31, 2013 (2012: 23.7%). 21. DISTRIBUTION EXPENSES For the year ended December 31 In 2013, FLYHT received payment for one claim totaling $196,751 (2012: $879,854) from SADI which is a repayable contribution. It was determined that the repayable contribution is at below market interest rates and therefore the payments were accounted for as a loan payable of $65,950 and a grant of $130,801. The grant portion was determined at the time of installment receipt as the difference between the principal value of the installment and the discounted cash flows assuming an 18% rate. The grant portion reimbursed a portion of FLYHT’s costs related to the development of the AFIRS 228. This grant was classified as related to income. FLYHT used the net presentation approach by reducing R&D expenses. Salaries and benefits Stock based compensation Contract labour Office Travel Equipment & maintenance Depreciation Marketing Other Total 2013 $ 1,506,626 85,071 275,059 366,439 403,319 25,413 46,129 41,441 206,949 2,956,446 2012 $ 1,829,053 95,458 559,096 345,648 315,797 31,820 52,956 61,773 69,604 3,361,205 Salaries and benefits Stock based compensation Contract labour Office Travel Equipment and maintenance Components Government grants SRED tax credit Depreciation Other Total For the year ended December 31 2013 $ 1,536,904 13,542 533,107 188,579 48,734 33,154 264,587 (130,801) (326,195) 17,661 955 2,180,227 2012 $ 1,544,718 12,615 1,265,032 303,740 60,419 48,704 63,267 (585,705) (327,438) 22,385 - 2,407,737 67 FLYHT AEROSPACE SOLUTIONS LTD. | ANNUAL REPORT | 2013 68 24. FINANCE INCOME AND FINANCE COSTS Recognized in profit or loss: For the year ended December 31 25. INCOME TAX EXPENSE (CONTINUED) The Company has non-capital losses for income tax purposes of approximately $36,067,569 which are available to be applied against future year’s taxable income. The benefit of these non-capital losses has not been recognized in the consolidated financial statements because it is not probable that future taxable profit will be available against which FLYHT can use the benefits. These losses will expire as follows: Interest income on bank deposits Net foreign exchange gain Finance income Bank service charges Interest expense Government grant interest expense Debenture interest expense and accretion Debenture issuance cost amortization Net foreign exchange loss Finance costs 25. INCOME TAX EXPENSE Current income tax expense Deferred income tax expense 2013 $ 465 - 465 2012 $ 3,809 - 3,809 Unrecognized deferred tax assets Deferred tax assets have not been recognized in respect to the following items: Capital assets Intangibles Inventory Non-capital loss carry-forwards Share issue costs Scientific research and experimental development expenditures 2013 $ 2,221 - 2,221 21,388 10,187 123,460 657,620 84,136 165,432 1,062,223 2013 156,933 113,870 405 9,599,862 90,225 6,203,715 16,165,101 2012 $ 1,958 10,830 12,788 20,721 12,300 70,508 402,275 78,546 - 584,350 2012 191,859 113,958 4,327 9,122,110 179,014 6,286,853 15,898,121 Amount $ 2,570,288 2,461,959 3,390,309 5,596,948 6,997,140 2,791,748 6,596,636 4,351,802 2,313,255 997,514 38,067,569 Year 2014 2015 2026 2027 2028 2029 2030 2031 2032 2033 Total Reconciliation of effective tax rate Loss for the period Total income tax expense Loss excluding income tax Tax Rate Expected income tax recovery Change in tax rate and other Non-deductible expenses Stock based compensation Change in unrecognized temporary differences 2013 $ (4,063,164) 465 (4,062,699) 25.0% (1,015,675) 486,748 171,827 89,676 267,889 465 2012 $ (4,883,752) 3,809 (4,879,943) 25.0% (1,219,986) (374,542) 7,484 83,970 1,506,883 3,809 26. FINANCIAL RISK MANAGEMENT The Company’s operating activities expose it to a variety of financial risks, including credit, liquidity and market risks associated with the Company’s financial assets and liabilities. FLYHT has established procedures and policies to minimize its exposure to these risks, and continually monitors its exposure to all significant risks to assess the impact on its operating activities. The following details the Company’s exposure to credit, liquidity, currency, and other market risks. 69 FLYHT AEROSPACE SOLUTIONS LTD. | ANNUAL REPORT | 2013 70 26. FINANCIAL RISK MANAGEMENT (CONTINUED) 26. FINANCIAL RISK MANAGEMENT (CONTINUED) Credit risk The following table details the contractual maturities of financial liabilities, including estimated interest payments. The Company’s exposure to credit risk is influenced mainly by the individual characteristics of each customer. Management considers the demographics of the Company’s customer base, including the default risk of the industry and country in which customers operate. Approximately 11.7% (2012: 9.0%) of the Company’s 2013 revenue is attributable to transactions with a single customer; however, geographically there is no concentration of credit risk. Each new customer is analyzed individually for creditworthiness before the Company’s standard payment and delivery terms and conditions are offered. Customers that fail to meet the Company’s benchmark creditworthiness may transact with FLYHT only on a prepayment basis. The AFIRS solution is subject to a retention of title clause, so that in the event of non-payment the Company will have a secured claim. To further minimize credit exposure, the sale of most AFIRS solutions requires payment in advance of any product shipment. At each reporting date, the Company establishes an allowance for impairment that represents its estimate of incurred losses. The aging of receivables at the reporting date was: December 31, 2013 Accounts receivable Impairment Net receivable December 31, 2012 Accounts receivable Impairment Net receivable 0-30 days $ 404,658 (4,705) 399,953 0-30 days $ 757,953 (5,073) 752,880 31-60 days $ 129,737 (7,058) 122,679 31-60 days $ 385,839 (7,572) 378,267 61-90 days $ 175,233 (30,216) 145,017 61-90 days $ 48,448 - 48,448 91+ days $ 272,805 (156,028) 116,777 91+ days $ 30,251 (349) 29,902 Total $ 982,433 (198,007) 784,426 Total $ 1,222,491 (12,994) 1,209,497 The Company believes that the unimpaired amounts that are past due by more than 30 days are still collectible, based on historic payment behavior. The movement in the allowance for impairment in respect of trade and other receivables for the years ended December 31, 2013 and 2012 was: Balance, January 1 Provision Amounts written off Impairments recovered Balance, December 31 Liquidity risk 2013 $ 12,994 198,007 (12,645) (349) 198,007 2012 $ 102,079 4,763 (69,268) (24,580) 12,994 The Company’s approach to managing liquidity is to ensure that it will always have sufficient liquidity to meet its liabilities when due, without incurring unacceptable losses or risking damage to the Company’s reputation. The Company manages its liquidity risks by having cash available, by maintaining a conservative capital structure, by prudently managing its credit risks, and by maintaining its relationship with the capital markets to meet any near-term liquidity requirements. The Company had a working capital deficiency at December 31, 2013, explained further in note 2(e). December 31, 2013 Accounts payable Accounts payable – SNC (note 27a) Compensation and statutory deductions Finance lease liabilities Accrued liabilities Loans and borrowings Total December 31, 2012 Accounts payable Accounts payable – SNC (note 27a) Compensation and statutory deductions Finance lease liabilities Accrued liabilities Loans and borrowings Total Currency risk < 2 months $ 581,557 2-12 months $ 18,726 1,921,384 296,223 4,059 40,678 - 2,843,901 - 216,583 9,970 75,930 3,751,695 4,072,904 < 2 months $ 531,548 2-12 months $ 12,045 1,790,571 136,007 4,058 20,046 24,785 2,507,015 - 180,051 20,291 190,916 313,736 717,039 1-2 years $ 2-5 years $ > 5 years $ - - - - - - - - - - - - - - - 344,026 344,026 2,781,399 2,781,399 1,507,480 1,507,480 1-2 years $ 2-5 years $ > 5 years $ - - - 14,029 - 3,482,088 3,496,117 - - - - - - - - - - 245,218 245,218 1,464,132 1,464,132 Total $ 600,283 1,921,384 512,806 14,029 116,608 8,384,600 11,549,710 Total $ 543,593 1,790,571 316,058 38,378 210,962 5,529,959 8,429,521 A significant portion of the Company’s revenues and a portion of its expenses are denominated in U.S. dollars. Management estimates that a 1% weakening of the Canadian dollar relative to the U.S. dollar would increase net earnings by approximately $76,314 (2012: $62,317) and a strengthening of the Canadian dollar would decrease net earnings by approximately $76,314 (2012: $62,317). The Company mitigates its cash flow exposures by the international nature of the business where a portion of its cost of goods sold are in currencies that naturally hedge a portion of U.S. dollar revenue. The Company has not engaged in activities to manage its cash flow foreign currency exposure through the use of financial instruments. The Company has exposure to foreign exchange risk for working capital items denominated in U.S. dollars. At December 31, 2013, negative working capital denominated in U.S. dollars was approximately $1,180,745 (2012: negative $1,367,243). As a result a 1% weakening of the Canadian dollar would decrease net earnings by approximately $11,807 (2012: $13,672) and a strengthening of the Canadian dollar would increase net earnings by approximately $11,807 (2012: $13,672). The Company mitigates its working capital exposure by managing its U.S. dollar denominated working capital items to limit the requirement to convert either to or from U.S. dollars to fulfill working capital payment requirements. Although there are limited expenses under contracts denominated in EUR and GBP, fluctuations in these currencies would result in insignificant foreign exchange variances. In respect of other monetary assets and liabilities denominated in foreign currencies, the Company ensures that its net exposure is kept to an acceptable level by buying or selling foreign currencies at spot rates when necessary to address short-term imbalances. 71 FLYHT AEROSPACE SOLUTIONS LTD. | ANNUAL REPORT | 2013 72 26. FINANCIAL RISK MANAGEMENT (CONTINUED) 28. RELATED PARTIES (CONTINUED) Interest rate risk Borrowings issued at variable rates result in exposure to interest rate risk, which would affect future cash flows if interest rates were to rise. Fluctuations in the prime interest rate could result in exposure for the Company with regards to the bank credit facility, which bears interest at Canadian chartered bank prime plus 1.5%. The Company’s exposure to interest rate risk as at December 31, 2013 and 2012 was minimal as the credit facility had not been drawn. Market risk Market risk is the risk that changes in market conditions, such as foreign exchange rates, interest rates and equity prices will affect the Company’s income or the value of its financial instruments. The Company’s objective in managing market risk is to manage and control exposure, while optimizing return. Fair values versus carrying amounts The fair values of financial assets and liabilities approximate carrying values. Capital management FLYHT’s objectives when managing capital are to safeguard the Company’s ability to continue as a going concern. In order to maintain or adjust the capital structure, the Company may issue new debt, sell assets to reduce debt, or issue new shares. There were no changes in the Company’s approach to capital management during the year. 27. CONTINGENCY The Company took action against SNC and is defending itself against an action by SNC related to the development of the AFIRS 228. The Company has accrued a liability of $1,921,384, which represents the total amount of invoices received from SNC. The Company maintains that the claims are without merit and that the services invoiced were not provided. Management intends to vigorously defend the matter and believes the outcome will be in its favour. In November 2011, the Company formally notified SNC that they were in material breach of the License and Manufacturing Agreement that was entered into between the two parties on December 28, 2008. The Company demanded payment of $1,329,976 USD and $2,650,000 CDN and terminated the agreement. As well, the Company applied to the Alberta courts for arbitration under the provisions of the agreement. The courts granted the request for arbitration on November 29, 2011. Subsequent to the grant, SNC refused to recognize the jurisdiction of the court and has contested the cancellation of the agreement and the arbitration. In November 2011, SNC filed an action in Utah alleging that FLYHT failed to pay $2,042,000 USD. As all invoices presented to the Company by SNC have been accrued (note 11), management does not expect the outcome to have a material effect on the Company’s financial position. 28. RELATED PARTIES (a) Throughout 2012 the Company engaged in transactions with a company owned by a director to supply consulting services. The related party provided business development services such as trade show attendance and corporate introductions related to the business jet initiatives of the Company. (b) Throughout 2012 the Company engaged in transactions with a company owned by a director to supply consulting services. The related party provided business development services such as market analysis and corporate introductions related to the commercial aviation initiatives of the Company. Included in contract labour: Included in accounts payable and accrued liabilities: For the year ended December 31 2013 $ - - - 2012 $ 89,875 17,984 107,859 December 31 2013 $ - - - 2012 $ 14,915 - 14,915 (a) (b) Total All of the transactions with these related parties were amounts that were agreed upon by the parties and approximated fair value. All other transactions with related parties were normal business transactions related to their positions within the Company. These transactions included expense reimbursements for business travel and other expenses paid by the related party and were measured at exchange amounts that the related party paid to a third party and were substantiated with a third party receipt. Transactions with key management personnel Key management personnel includes all persons with direct or indirect authority and responsibility for planning, directing and controlling the activities of the Company, and includes directors and the FLYHT’s executive team. In addition to salary and variable compensation, the Company also provides non-cash benefits to key management personnel. Certain executive officers are entitled to a mutual term of notice of six months. Compensation for this group comprised: Salary Director fees Variable compensation Share-based payments Short-term employee benefits Total Directors of the Company control 4.1% (2012: 4.7%) of the voting shares of the Company 2013 $ 736,500 109,359 192,264 94,550 57,254 1,189,927 2012 $ 815,596 84,023 169,218 195,393 89,935 1,354,165 Subsidiaries FLYHT Inc. AeroMechanical Services USA Inc. FLYHT Corp. FLYHT India Corp. TFM Inc. 29. SUBSEQUENT EVENT Country of Incorporation Ownership interest United States United States Canada Canada Canada 100% 100% 100% 100% 100% As of April 14, 2014, the Company issued a total of 4,228,280 shares due to warrant and option exercises for total proceeds of $1,333,387, including: a) 1,971,500 warrants exercised at $0.30 for proceeds of $591,450 b) 1,405,780 warrants exercised at $0.40 for proceeds of $562,312 c) 718,500 options exercised at $0.25 for proceeds of $179,625 73 FLYHT AEROSPACE SOLUTIONS LTD. | ANNUAL REPORT | 2013 74 CORPORATE INFORMATION REGISTRAR AND TRANSFER AGENT Valiant Trust Company Telephone: 1-866-313-1872 Email: inquires@valianttrust.com www.valianttrust.com SHARE LISTING Shares are traded on the TSX Venture Exchange Ticker Symbol: FLY INVESTOR RELATIONS Email: investors@flyht.com Telephone: 1-403-250-9956 Toll free: 1-866-250-9956 www.flyht.com The Howard Group Inc. Dave Burwell Email: dave@howardgroupinc.com Telephone: 1-403-410-7907 www.howardgroupinc.com Kin Communications Inc. Fred Leigh Email: FLY@kincommunications.com Telephone: (866) or (604) 684-6730 Bristol Capital Ltd. Glen Akselrod Email: glen@bristolir.com Telephone: 1-905-326-1888 www.bristolir.com DIRECTORS Doug Marlin Bill Tempany Mike Brown Paul Takalo, CA Jacques Kavafian Jack Olcott Richard Hayden OFFICERS Bill Tempany Matt Bradley Chairman, FLYHT Aerospace Solutions Ltd. & President, Marlin Ventures Ltd. Chief Executive Officer, FLYHT Aerospace Solutions Ltd. Partner, Geselbracht Brown Vice-President, Standen’s Limited Director President, General Aviation Company Director Chief Executive Officer President Thomas French, CGA Chief Financial Officer Derek Graham Chief Technical Officer Jeff Brunner VP Certification Engineering and China Operations AUDITOR KPMG LLP Calgary, Alberta LEGAL COUNSEL Chris Croteau Tingle Merrett LLP HEAD OFFICE 300E, 1144 - 29 Avenue NE Calgary, Alberta T2E 7P1 75 FLYHT AEROSPACE SOLUTIONS LTD. | ANNUAL REPORT | 2013 300 E, 1144 – 29 Ave NE Calgary, AB, T2E 7P1 Canada Phone: 1.866.250.9956 Fax: 1.403.291.9717 www.flyht.com

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