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INFRARED SYSTEMS INTERNATIONAL - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) The management discussions contain certain forward-looking statements and information that are based on the beliefs of management as well as assumptions made by and information currently available to management. When used in this document, the words "anticipate," "believe," "estimate," "expect," "intend," "will," "plan," "should," "seek," and similar expressions, are intended to identify forward-looking statements. Such statements reflect the current view of management regarding future events and are subject to certain risks, uncertainties and assumptions. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual actions or results may vary materially from those described herein as anticipated, believed, estimated, expected or intended. The following discussion and analysis should be read in conjunction with the company's consolidated financial statements and related footnotes for the year ended September 30, 2010. The discussion of results, causes and trends should not be construed to imply any conclusion that such results or trends will necessarily continue in the future. Overview Infrared Systems International (ISI) was formed under the laws of the State of Nevada on April 11, 2006 as a wholly-owned subsidiary of CSBI (then known as Advance Technologies, Inc.) to pursue a narrowly defined business objective called infrared security systems. On July 11, 2007, CSBI acquired American SXAN Biotech, Inc. a Delaware Corporation doing business exclusively in the People's Republic of China under a registered capital corporation, Tieli XiaoXingAnling Forest Frog Breeding Co, Ltd. As a result of the acquisition, the stockholders of American SXAN Biotech, Inc. acquired control of CSBI. Pursuant to one of the terms of the acquisition, all of the assets and liabilities of CSBI as of the date of the acquisition were transferred into ISI. Since that time, ISI had conducted not only the infrared security systems development for which it was formed but also the other prior activities of CSBI. In March 2010, ISI transferred all of the assets and liabilities of ISI into a newly created wholly-owned subsidiary, Infrared Applications, Inc. (IAI). Since that time, IAI continues to operate the previous business of ISI under this newly created company. On April 12, 2010, ISI sold a majority interest in its common stock to Take Flight Equities, Inc (TFE). As part of the agreement, a change in control took place and William Wright was appointed CEO of ISI. Also included in the agreement were provisions for the future distribution of the IAI assets to the ISI shareholders of record on March 23, 2010 within 15 months of the agreement. On April 19, 2010, the Company acquired 100% of the outstanding common stock of Focus Systems, Inc. (Focus) from Propalms, Inc. (Propalms) in exchange for 3,000,000 Common shares and 250,000 Preferred Series A shares of the Company. Additionally, the Company issued 500,000 shares of Preferred A stock to Propalms and Propalms was to invest up to $250,000 into the company over a period of 120 days. Propalms subsequently invested $17,809 and returned 464,382 Preferred Series A shares to the Company. The primary purpose of the acquisition is to provide the Company with an operating business in the cloud computing, remote desktop, and Voice over IP telecommunications space. Included in the acquisition, the Company recognized the fair market value of property, plant and equipment at $5,000 based on as search of age comparable equipment available in the local market. Liabilities acquired in the acquisition totaled $305,595. Focus is held and operated as a wholly-owned subsidiary of ISI. IAI, and prior to its formation in 2010, its parents, has been engaged in the development of infrared products for commercial applications. Since 2006, IAI has focused its activities on the development of infrared security systems for the automatic detection of intruders. No other material products have been developed by IAI (or prior to its formation its parents) for more than four years, although IAI has various proprietary technology developed by its parent prior to that time. One June 15, 2010, a patent was issued by the US Patent Office to Infrared Applications Inc. PN: 7,738,008 B1, Ball, "Infrared Security System & Method". Focus was formed in August of 2007 as a technology company providing remote desktop - cloud computing - services and Voice over Internet Protocol (VoIP) phone services to small and mid-sized businesses. For the calendar year 2008, Focus operated a regional Internet Service Provider (ISP) business under a management agreement with a third party. ISI's revenues during the past three years have been derived from only two sources: a 1997 license agreement relating to proprietary technology utilized by Kollsman Instruments for its Enhanced Visions System for commercial aviation; and acting on behalf of a Taiwanese company in connection with the acquisition and modification of infrared camera systems in the U.S. for thermal imaging of the human body for medical purposes and exporting the modified products to the Taiwanese company. The services rendered for the Taiwanese corporation are commercial labor and transportation, and no technology of ISI is involved. On July 26, 2010, TFE defaulted in its payment obligations under the note and voting control of the stock was subsequently transferred to Gary Ball. On January 27, 2011, TFE began making payments on the promissory note. On December 20, 2010, the Company filed an 8-K announcing the acquisition of an interest in AquaLiv, Inc. ("AquaLiv") on December 16, 2010. Pursuant to the Agreement included in the filing, the Company acquired 50% of the outstanding stock of AquaLiv from Craig Hoffman for $400,000 paid in the form of 400,000 shares of Infrared Systems Series A Preferred stock valued at $1.00 per share. The Company concluded, pursuant to the guidance in FASB ASC 810-10-25-38 (previously FIN 46R) that AquaLiv is a Variable Interest Entity, that we are the primary beneficiary with a controlling financial interest in AquaLiv, and we are required to consolidate its financials accordingly. The remaining 50% non-controlling interest of AquaLiv is owned by Craig Hoffman. Mr. Hoffman remains as AquaLiv's President and CEO following the transaction. AquaLiv, Inc. is a life sciences research and development company best known for its health-enhancing water purification system. Recent advancements in AquaLiv's technology uncovered a new field of biological information science. With direct applications in the industries of water purification, environmental science, agriculture, animal husbandry, personal use products, and medicine, AquaLiv is ready to expand its innovative product offering. On June 22, 2011, the Company completed the distribution of the IAI assets in accordance with a previously executed agreement. Under the agreement, all of the outstanding stock of IAI has been transferred to Gary Ball ("Ball") in accordance with the Agreement. Subsequent to this event, Ball shall be responsible to make, if any, a Subsidiary Stock Distribution to the Company's shareholders of record as of March 23, 2010, upon the earlier of the foregoing occurrence: (i) the net proceeds from the sale of substantially all of the assets of IAI or (ii) Ball elects to make a Subsidiary Stock Distribution. Any cost incurred in connection with a Subsidiary Distribution shall be the responsibility of Ball. There is no certainty as to when or if a Subsidiary Stock Distribution will occur. (8) Table of Contents ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Con't AquaLiv, Inc. Our research has revealed that all substances have an inherent information signature. Biological systems naturally understand this information and respond to it. While science has not previously detected this powerful aspect of our natural world, AquaLiv's technology can already record, catalog, and mix this bioinformation into unique composites. These composites are designed for specific applications and then programmed into water for delivery to biological systems. With direct applications in the industries of water purification, environmental science, agriculture, animal husbandry, personal use products, and medicine, AquaLiv is poised to provide innovative ingredient-free solutions to the world's problems. AquaLiv Water System - The AquaLiv water system addresses every aspect of water to make it whole and full of vital nutrients. The system requires no electicity, is eco-friendly, removes most impurities (including harmful sodium fluoride), and creates a healthful and stable alkaline pH. Users of the AquaLiv Water System have reported stabilized blood sugar, improvements in both high and low blood pressure, reduced allergy symptoms, less headaches, better digestion, and healthy glowing skin. Some diabetics have even reported that AquaLiv helped them decrease their insulin requirements. AquaLiv Water Stick - AquaLiv Water Stick is a non-toxic and 100% natural mineral clay ceramic stick that features AquaLiv's BioT™ Bioinformation Technology. While a bit complex and scientific to explain in detail, simply put, the BioT™ Ceramic enhances water with the qualities of several vitamins and herbs. This revolutionary technology turns regular water into a powerful tonic that boosts immunity and encourages wellness. Researchers observed reduced inflammation and common colds in addition to improved hydration, digestion, strength and stamina. AquaLiv has selected several hundred of the world's most renowned medicinal herbs and compounds and blended them in perfect combinations to maximize the potential of the human body. Available in early 2011 will be the Wellness water stick, which has proven to boost the immunity and wellbeing of over 300 test participants. Additional initiatives include an Athletic Performance water stick, and more to follow. Infotone Face Mist - Infotone Face Mist contains a non-toxic and 100% natural mineral clay ceramic ball that features AquaLiv's BioT™ Bioinformation Technology. This revolutionary technology turns regular water into a powerful tonic that when misted over the face encourages optimal hydration and clear, youthful, glowing skin. Researchers observed improved hydration, suppleness, firmness, and texture and reduced dryness, oxidation, wrinkles, skin pigmentation, and blemishes. Infotone Face Mist stands apart from other facial water misters because it isn't just a typical water mister. In fact, no other water mister on the market today utilizes AquaLiv's BioT™ Bioinformation Technology. Infotone is the first cosmetic of its kind. AgSmart™ Rice - AgSmart™ Rice has demonstrated over 100% crop yield increase over test control yield (same seeds, same practices, adjacent parcel) while decreasing duration before harvest by one month. It is also more resistant to pests, disease, and storms. All AgSmart™ products are 100% natural and organic standards compliant. Based on our experience, we do not expect all farms to achieve a 100% yield increase, but rather a 30-60% increase will be average. Focus Systems, Inc. Remote Desktop and Cloud Computing- A remote device runs the client software that implements the chosen protocol(s) and allows the user to access an entire desktop environment that is being projected from a remote server or group of servers. Although the remote device may be a personal computer running an agent, the remote device, sometimes called a "Thin Client," does not need to have a large amount of memory or storage. In fact, it may offer no local storage at all. The remote device does not need to be based upon the same hardware architecture or operating system as used by the remote servers. It is quite possible for a small, hand held device based upon an X-scale processor running some embedded operating system to display Linux, Windows, UNIX or even Z/OS applications. The Company believes that there are inherent benefits of operating in a completely portable desktop office environment. Remote desktop users can access their same computer desktop from the office, at home, a mobile device, or virtually anywhere in the world. Access to central data and shared recourses will increase productivity and reduce cost for businesses. The remote environment is controlled, managed and updated by the Company from a centralized location, further reducing operating costs for its customers. VoIP Phone Service - VoIP phone service is a method for taking analog audio signals (similar to the kind you hear when you talk on the phone) and turning them into digital data that can be transmitted over the Internet. This allows VoIP service to replace traditional landline service for business and residential customers. Since VoIP phone service is digital, companies can run both data and voice over the same network infrastructure greatly reducing costs. This reduction in cost is experienced in both the initial start up phase, as well as the ongoing maintenance and services fees associated with phone service. Company management believes that the trend away from traditional phone service to digital VoIP services will continue to grow. (9) Table of Contents ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Con't Infrared Applications, Inc. Enhanced Vision System - Our revenue primarily comes from royalties derived through licensing our technology to a single customer, Kollsman. The licensing agreement with Kollsman grants to Kollsman a worldwide, exclusive license under ISI proprietary data to make, sell, maintain and repair products utilizing such data or patents for use on any aircraft licensed to operate by the Federal Aviation Administration or by equivalent foreign regulatory agencies. Royalty payments are required for each Enhanced Vision System (EVS) unit sold utilizing a licensed product, based upon the number of units sold. Pursuant to the license agreement, the royalty currently is $800 per unit. We recognize our royalty revenues when Kollsman sells aircraft systems. In accordance with the license agreement, the royalty fee has been earned by us. The collection of the royalty is reasonably assured because the customer has timely made all payments required under the license agreement since it was signed in July 1997. Infrared Applications, Inc. became a discontinued operation on June 22, 2011 following the distribution of those assets as outlined in a previously executed agreement. Revenue and expenses have been reported through June 22, 2011. Overview of Operations The serious crash of the world's financial markets and credit institutions are of a major concern to us. The technology industry, especially as it applies to the small business sector, has slowed drastically during the recession. New service orders for both remote desktop and VoIP products have been slow since acquisition. Management is working on increasing exposure for its remote desktop product and is working to expand its VoIP phone service from the small business market into the residential market as well. Additionally, management is investigating possible acquisitions that would be accretive to the core business and enable the growth of its revenues both locally and abroad. Recent advancements in AquaLiv's technology uncovered a new field of biological information science. With direct applications in the industries of water purification, environmental science, agriculture, animal husbandry, personal use products, and medicine, AquaLiv is ready to expand its innovative product offering. While the economy has slowed in recent years, recent sales campaigns have produced positive results for AquaLiv. Liquidity and Capital Resources National and global economic conditions have continued to be challenging and unprecedented, particularly in the investment, credit and financial markets. Concerns continue about the impact and the effect the Federal government's stimulus packages, inflation, volatile energy costs, availability and expenses of credit, stock market swings and the national unemployment will play a role in our future. Businesses today are at risk due to limited credit, illiquid credit markets, and an increasingly cautious finance community, all of which leads many institutional investors and private investors to reduce and/or cease funding to borrowers. If the current economic and credit market conditions continue in this manner, more businesses will close and consumer's confidence will wane even further. Our company is experiencing a direct impact of the above mentioned economic conditions because certain private investors, although optimistic of our industry's long-term outlook and our business model/plan, are not willing at this time to commit funds until they see an upward trend in the national economy. In addition, many individuals across the nation are facing uncertainties with their continued employment, coupled with higher living costs, are curtailing or eliminating their spending habits and refraining from making changes in their operations. Results of Operations for the Three and Nine Months Ended June 30, 2011 compared with the Three and Nine Months Ended June 30, 2010. Revenues The revenues for the three months ending June 30, 2011 were $168,850 as compared to $71,297 in the quarter ending June 30, 2010. Revenues were $471,478 for the nine months ended June 30, 2011, as compared to $102,497 for the nine months ended June 30, 2010. Sales revenue was added in the first quarter of 2011 as a direct result of the AquaLiv acquisition and comprised of 61.4% and 71.7% of our revenue for the three and nine months ending June 30, 2011, respectively, compared to the same three and nine month periods in 2010, where zero sales revenue was recorded. Likewise, as a result of the Focus Systems acquisition in the third quarter of 2010, service revenue accounted for 6.8% and 7.1% of our revenues for the three and nine months ending June 30, 2011, respectively, compared to the same three and nine month periods in 2010, where zero service revenue was recorded. The Company's royalty revenue has remained relatively consistent in terms of gross dollars, but has accounted for less of our overall revenue compared to prior years. Royalty revenue accounted for 31.7.1% and 21.2% during the three and nine months ending June 30, 2011, respectively, compared to the same three and nine month periods in 2010, where 78.4% and 84.7%, respectively, of our revenue was derived from royalty revenue. Royalty revenue was discontinued on June 22, 2011. Revenue recognition is accounted for as follow: Sales revenue is billed, paid, and shipped in the same period each month; Royalty revenue is recorded as earned in the month it is received; and service revenue is bill in advance on the first day of the month that service is rendered. Cost of Goods Sold Cost of goods sold for the three and nine months ending June 30, 2011 were $45,756 (27.1% of total revenues) and $151,802 (32.2% of total revenues), respectively, compared to $4,273 (6% of total revenues) and $4,273 (4.2% of total revenues), respectively, for the same three and nine month periods ending June 30, 2010. Operating Expenses Operating expenses for the three months ending June 30, 2011 were $176,724 as compared to $457,643 for the quarter ending June 30, 2010. The increase of $34,910 in consulting fees, decrease of $2,624 in management fees, increase of $32,904 in payroll expense, decrease of $7,117 in professional fees, decrease of $1,609 in research and development, increase of $3,115 in travel expense, decrease of $529 in general and administrative fees, and the decreases of $305,000 and $34,970, respectively, for the one-time losses on goodwill impairment of Focus and IAI, is due in part to the decreased costs of running additional businesses compared to the quarter ending June 30, 2010. The operating expenses for the nine months ending June 30, 2011 were $831,916 as compared to $526,867 for the nine months ending June 30, 2010. The increase of $57,038 in consulting fees, increase of $38,204 in management fees, increase of $86,407 in payroll expense, increase of $5,001 in professional fees, increase of $4,893 in research and development, increase of $4,987 in travel expense, increase of $133,004 in general and administrative fees, the one-time increase of $315,484 in loss on goodwill impairment, AquaLiv (due to the one time write down of goodwill attributed to the acquisition of that business), and the decreases of $305,000 and $34,970, respectively, for the one-time losses on goodwill impairment of Focus and IAI, is due in part to the increased costs of running additional businesses compared to the nine months ending June 30, 2010. The Company expects operating expenses to decrease due to the distribution of the IAI assets in one respect, however, the Company also anticipates increases in certain operating expenses if the Company is successful in expanding its current services and operations. Other Income and Expense Interest expense for the three months ended June 30, 2011 was $4,551 as compared to $4,050 for the three months ended June 31, 2010, and was $10,895 for the nine months ended June 30, 2011 as compared to $5,879 for the nine months ended June 30, 2010. The increase in interest expense is due to an increase in credit card debt and net borrowing. Net (Loss) Before Provision for Income Taxes The net gain for the three months ended June 30, 2011 was $16,172 as compared to a net loss of $394,670 for the three months ended June 31, 2010. The net gain is attributed to the one-time gain on distribution of IAI in our other income, which off-set increases in reoccurring operating expenses due to the subsidiary changes and business additions to the Company. The net loss for the nine months ended June 30, 2011 was $429,381 as compared to $434,523 for the nine months ended June 30, 2010. The decrease in net loss is attributed to the increase in our operating expenses due to the subsidiary changes and business additions to the Company, as well as the one time write off of goodwill attributed to the AquaLiv acquisition, and the off-set from the one-time gain on distribution of IAI in our other income. Cash Flows The June 30, 2010 Cash Flow Statement was restated to present cash flows in the proper classification, operating, investing and financing. The net increase in cash for the period did not change. Cash flows from operating activities were ($170,637) for the nine months ended June 30, 2011 as compared to ($214,411) for the nine months ended June 30, 2010 due to a lower net loss and less cash paid for operating activities during the period. Cash flows for investing activities were ($15,870) for the nine months ended June 30, 2011as compared to ($1,000) for the nine months ended June 30, 2010 due to an increase investment in long term inventory. Cash flows provided by financing activities were $189,000 for the nine months ended June 30, 2011, which were related to proceeds from capital stock issuance, compared to $220,781 for the nine months ended June 30, 2010, which were related to proceeds from capital stock issuance and note payable issuance. Going Concern We have limited working capital and limited revenues from sales of products, services, or licenses. During 2011, a majority of our revenues were generated from a single licensee and our operating expenses are greater than our revenues. These factors have caused our accountants to express substantial doubt about our ability to continue as a going concern. The accompanying financial statements do not include any adjustment that might be necessary if we are unable to continue as a going concern. Our ability to continue as a going concern has caused the Board of Directors to continue to look for sources of investment capital, and investigate merger and acquisition opportunities. We will look to further diversify our holdings and sources of cash flow. Off-Balance Sheet Arrangements There are no off-balance sheet arrangements. (10) Table of Contents |