(I corrected some mathematical and logical errors in this article on 12/12/2021, my conclusion is still the same and the difference between my two points is not material in my opinion)
AITX, like many penny stocks, has a quite complicated ownership structure. In addition to more traditional ownership and investment stakes such as traditional debt, convertible debt, and common shares, it also has issued a complicated set of preferred shares. These preferred shares were issued in two sets, or series, called the E Series and F Series. Today’s post will focus on those two sets of preferred shares, especially the F Series, which is the most controversial and has been dubbed a bit of a “boogeyman” by some loud voices.
I am long AITX and have been for almost a year now. But just because I am long does not mean I won’t write about the risky aspects of AITX. Furthermore, I will not avoid writing about anything that could one day be harmful to an investor in AITX who hasn’t done their homework. Because of this, I would be remiss if I ignored a difficult topic on AITX, and one of the more difficult topics on AITX are the E Series and F Series preferred shares.
To help out the AITX community and prospective AITX investors, I wanted to give a detailed breakdown of the E Series and F Series preferred shares and what they mean for the investor.
E Series Detailed Analysis
Let’s start with the simpler series. The E Series, to quote the latest 10k issued for the year-ended February 28, 2021, is described as follows:
The Series E Preferred Stock ranks subordinate to the Company’s common stock as to distributions of assets upon liquidation, dissolution or winding up of the Corporation. The Series E preferred stock is non-redeemable, does not have rights upon liquidation of the Company and does not receive dividends. The outstanding shares of Series E Preferred Stock have the right to take action by written consent or vote based on the number of votes equal to twice the number of votes of all outstanding shares of equity instruments with voting rights. As a result, the holders of Series E Preferred Stock have 2/3rds of the voting power of all shareholders at any time corporate action requires a vote of shareholders.
Let’s break that down. First, the E Series does not give the holders rights to assets, and they don’t pay dividends. Second, and most importantly, the holders of the E Series always have a majority vote in any shareholder related election. To put it simply, common shareholders do not have a say in shareholder votes as long as the E Series holders are exercising their option. Lastly, and this is stated elsewhere, the CEO Steve Reinharz owns 100% of this share class. So, Steve Reinharz essentially has 100% voting authority for the company.
That sounds kind of bad right? Well, it is, and it isn’t. The bad is pretty self-explanatory, if Steve takes the company in a direction the common shareholders don’t like, there isn’t much they can do. However, and I need to make this clear, many companies have an E Series type share class that are never used. The true purpose is to protect the founder, Steve Reinharz, from a hostile takeover and being voted out. These are sometimes referred to as “Poison Pills” against hostile takeovers and generally are issued for the benefit of a company founder. These are everywhere on the OTC.
My take is, don’t worry about E Series. If the company gets bad enough where Steve starts evoking the E Series rights, you have bigger problems than that. Now onto the hard one…
F Series Detailed Analysis
To describe the F Series, let me once again quote the latest 10k issued for the year-ended February 28, 2021:
“The Board of Directors has designated 4,350 shares of Series F Convertible Preferred Stock with a par value of $1.00 per share. As of the date of this report, there are 2,716 shares of Series F Convertible Preferred Stock outstanding.”
So, there’s 2,716 as of February 28,2021 and they can issue up to 4,350.
“…The Series F Convertible Preferred Stock is non-redeemable, does not have rights upon liquidation of the Company, does not have voting rights and does not receive dividends.”
This is the same as the E Series, the F Series does not give the holders rights to assets, and they don’t pay dividends.
“Each holder may, at any time and from time to time convert all, but not less than all, of their shares of Series F Convertible Preferred Stock into a number of fully paid and nonassessable shares of common stock determined by multiplying the number of issued and outstanding shares of common stock of the Company on the date of conversion by three and 45 100ths (3.45) on a pro rata basis.”
Wow, that was a mouthful. Let’s break this down. Each holder can convert all of their F Series shares into common stock. How much common stock? The formula works like this, say I own 100 F Series preferred shares out of the 2,716 total:
Common Stock Received from Conversion = (100/2,716) * (# of Shares Outstanding * 3.45)
Let’s plug in some numbers. On November 19, 2021, AITX has 4,381,710,360 shares outstanding. So, if I owned 100 F Series shares, I would be entitled to: 100/2,716 * (4,381,710,360*3.45) = 556,586,920 common shares. At a share price of 0.03 per common share, that is a $16,697,608 value!
You should be thinking, oh my god if you get that much from 100 F Series shares, you are getting a truckload from the full 2,716! And you’re right, that’s exactly what this means. Let’s do some more math.
(Revised Error Here) Depending on the number of F Series owners there are, they act in a compounding way. For example, say there are common shares 100 shares outstanding and there are two owners of F Series, one owns 10 shares the other owns 90. So 100 common shares and 100 F Series shares. Say the 10 F Series owner converts, they would get (10/100) * 3.45 * 100 common shares equals 34.5 common shares. There’s now 134.5 common shares outstanding. Now our other F Series owner now has 90 out of 90 F Series shares. If they were to convert it would be (90/90) * 3.45 * 134.5 = 464.025.
For AITX, that would bring the potential outstanding share count to well over 15bn. That is a hefty amount of dilution assuming everyone exercises these things.
As a final note, AITX recently stated that these are not convertible until August 2023, buying the company two years of breathing room.
Who Owns these Things?
As you can probably deduce, the primary owner of the F Series shares is the CEO, Steve Reinharz. This is basically his treasure chest in return for all of his sweat equity put into the company and the immense amount of risk he took in developing this company.
The actual number breakdown as of November 2021 is a bit hazy, but I’ve been able to deduce the following from their regulatory filings as of the 10Q for the period ended 8/31/2021:
- There are 2,532 shares outstanding. The difference between the 2,532 from here and the 2,716 from above is that the company bought out Garrett Parsons’ shares when he left the company.
- Steve Reinharz owns 2,450 of the F Series, which is about 96.7% of the class.
- The remaining shares are owned by a couple other investors who either purchased them outright to fund the company or took them in exchange for the forgiveness of debt or more favorable debt terms.
What does this Mean for the Company?
In short, Steve has the discretion to dilute his F Series ownership to raise money for the company. Think of these financial instruments going forward as a way to raise funds for the company, or create some value. For example, he has done it in the past to make debt terms more favorable. For example, they issued some in exchange for lowering the interest rate on variable interest rate loan which was based on a percent of revenue. Like I’ve mentioned before on dilution, if they are issued in return for a fair price it is net neutral to the investors, if it is issued in return for a bad price, it is net negative for investors, and so on.
The primary owner of these shares is the CEO Steve Reinharz and the majority of his ownership stake in the company is via these shares. It’s a bit unconventional, but it essentially is just protecting him from future dilution the company needs to make and keeps him with an ownership stake that can essentially never be less than roughly 70%. Remember, his common shares due to him from the F Series will just grow with any future new shares issued because it is a multiple of the common share count.
Opinion time, I think in the next 1-2 years Steve will have the company buy him out of his F Series preferred shares, along with the other investors, for a hefty fee either in cash or stock, but at a discount to what it could have been. I cannot see a way AITX up lists to the NASDAQ with the F Series class still in existence. If I am doing my best Nostradamus impersonation, there will be a buy-out of the F Series at the same time if not sooner.
What does this Mean for the Investor?
To be frank, it is not great for the common stock investor that these exist. If these ever get fully exercised, your position will be diluted by a factor of 3.45 compounded by the number of F Series owners. That sounds terrible right? Let’s think this through…
First, the market isn’t stupid, well maybe more than normal on the OTC, but every serious major AITX common stock investor knows that the F Series exists. I’m about to say everyone’s favorite phrase… the F Series is already priced in. If everyone knows its coming, the market price will reflect it. We see price shocks when unexpected things happen. Investment firms are currently pumping millions of dollars into AITX via the S-3 share issuances, and believe me they don’t want to lose (and they know how to read a 10K). So, take solace in the fact that the shares you bought likely already reflect the probability of the F Series dilution potentially happening one day.
Speaking of “potentially”, there is also the option that Steve never actually exercises his shares. It may actually be in his interest to not do it. For all of the points above, it is a really bad look from an emotional perspective for the CEO to dump approx. 3.45 times the number of shares into the outstanding share pool. Even though it’s likely mostly priced in, that sort of shock to the supply of stock would be catastrophic to the company, essentially undermining his own personal wealth. All the more reason why I think the F Series will be bought out.
Lastly, as an extension of the second point, Steve may just be holding these has an “ace in the hole” in the case of an acquisition. Essentially, he will require a massive buy-out from the acquirer if it ever gets to that stage.
In the end, as the investor, when you prepare your models, you need to assume the worst and that every single F Series owner will exercise their shares in August 2023. So, take whatever your estimated share count is in 2023 in your model, and do the math I did in the example above to compound the F Series conversions into your outstanding share count. I will have more articles on modeling AITX out, but you will find that you can still find realistic attractive prices for AITX even with them being ultra-high risk, high reward. But please, do not forget about this fact when modeling.
I really like Steve as the CEO of AITX, and I am an investor. But the F Series is something he does not get into very much detail on. In his video here, you will find that he does not get into the mathematics at all. He just talks about how it can be a conversion into common shares, it protects the founder/early investors, and how great it was that they pushed off the conversion to August 2023 (which is true, it is good).
However, he fails to mention that it’s compounding 3.45 times the share count! 15.0bn plus shares are a ton of shares potentially worth hundreds of millions, if not billions, depending on the company success. Maybe he is uncomfortable about it because the majority of his personal AITX wealth is tied up in the F Series? Maybe he stays quieter on it because it isn’t exactly a bullish sign for investors?
Regardless of what he says in interviews, it’s fully disclosed in all of their regulatory filings, and it is disclosed quite plainly. He is not, nor is the company, being deceptive about these securities. So, in the end, the only person you have to blame is yourself if you get blindsided by this.
In short, the E Series is not an issue to me. The F Series is an issue that needs to be dealt with, most likely through a buy-out. But it is not the boogeyman many people make it out to be, it is just another factor to your models. You, as the investor, have a duty to educate yourself on these securities and to factor them into your models. It is written plain as day in regulatory filings.
So, despite the scariness of the F Series on the face of them, it does not, in my opinion, make AITX un-investable. At the end of the day, AITX is a high-risk high-reward play. You may make a ton of money, or you may lose everything. Such is life in the pennies! As with all other stocks, do you due diligence, figure out your intrinsic value, update as more info comes out, and invest when it hits a fair price.
For further reading and AITX analysis, check out all of my articles HERE as well as in the sidebar.
DISCLAIMER – I CURRENTLY HOLD A LONG POSITION IN $AITX. THIS ARTICLE IS NOT FINANCIAL ADVICE AND IS INTENDED ONLY FOR EDUCATIONAL PURPOSES.