Form: 10-Q

Quarterly report pursuant to Section 13 or 15(d)

December 15, 2022

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

 

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

 

For the quarterly period ended October 31, 2022

or

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

 

For the transition period from ___________ to ___________

 

Commission File Number: 000-31587

 

Red Cat Holdings, Inc.

(Exact name of Registrant as specified in its charter)

 

Nevada   86-0490034
(State or other jurisdiction of incorporation or organization)   (I.R.S. Employer Identification No.)

 

 

 

 

15 Ave. Munoz Rivera, Ste 2200

San Juan, Puerto Rico

 

 

 

 

00901

(Address of principal executive offices)   (Zip Code)

 

(833) 373-3228

(Registrant's telephone number, including area code)

__________________________________

(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Title of Each Class

 

Trading

Symbol(s)

 

 

Name of each exchange on which registered

Common Stock   RCAT   Nasdaq Capital Market

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  No 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes  No  

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

 

Large accelerated filer  Accelerated filer 
Non-accelerated filer   Smaller reporting company 
Emerging growth company   

  

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  No 

 

As of December 15, 2022, there were 54,317,718 shares of the registrant's common stock outstanding. 

 

INDEX TO FORM 10-Q

 

PART I. FINANCIAL INFORMATION Page
     
Item 1. Financial Statements: 3
     
  Unaudited Balance Sheet as of October 31, 2022 and April 30, 2022 3
     
  Unaudited Statements of Operations for the Three and Six Months Ended October 31, 2022 and 2021 4
     
  Unaudited Statement of Changes in Shareholders' Equity for the Three and Six Months Ended October 31, 2022 and 2021 5
     
  Unaudited Statements of Cash Flows for the Six Months Ended October 31, 2022 and 2021 6
     
  Notes to Financial Statements 7
     
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 26
     
Item 3. Quantitative and Qualitative Disclosures about Market Risk 32
     
Item 4. Controls and Procedures 32

 

PART II. OTHER INFORMATION  
     
Item 1. Legal Proceedings 33
     
Item 1A. Risk Factors 33
     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 33
     
Item 3.   Defaults Upon Senior Securities 33
     
Item 4. Mine Safety Disclosures 33
     
Item 5. Other Information 33
     
Item 6. Exhibits 34
     
SIGNATURES 34

 

 

RED CAT HOLDINGS

Consolidated Balance Sheets

(Unaudited)

 

                 
      October 31,       April 30,  
      2022       2022  
ASSETS                
Current assets                
Cash   $ 1,582,751     $ 4,084,815  
Marketable securities     31,302,888       44,790,369  
Accounts receivable, net     917,802       495,506  
Inventory     6,560,092       3,895,870  
Other     4,453,439       2,354,884  
Due from related party              31,853  
Total current assets     44,816,972       55,653,297  
                 
Goodwill     19,839,750       25,138,750  
Intangible assets, net     7,777,741       2,698,531  
Property and equipment, net     1,700,821       511,690  
Other     57,033       57,033  
Operating lease right-of-use assets     852,065       1,019,324  
Total long term assets     30,227,410       29,425,328  
                 
TOTAL ASSETS   $ 75,044,382     $ 85,078,625  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY                
Current liabilities                
Accounts payable   $ 1,649,341     $ 1,018,747  
Accrued expenses     541,097       1,084,494  
Debt obligations - short term     895,257       956,897  
Due to related party              40,057  
Customer deposits     123,308       437,930  
Operating lease liabilities     298,609       293,799  
Warrant derivative liability     1,013,675       1,607,497  
Total current liabilities     4,521,287       5,439,421  
                 
Operating lease liabilities     601,243       749,825  
Debt obligations - long term     694,581       973,707  
Total long term liabilities     1,295,824       1,723,532  
Commitments and contingencies                
                 
Stockholders' equity                
Series B preferred stock - shares authorized 4,300,000; outstanding 986,676 and 986,676     9,867       9,867  
Common stock - shares authorized 500,000,000; outstanding 54,229,539 and 53,748,735     54,229       53,749  
Additional paid-in capital     108,406,712       106,821,384  
Accumulated deficit     (37,555,132 )     (27,499,056 )
Accumulated other comprehensive income     (1,688,405 )     (1,470,272 )
Total stockholders' equity     69,227,271       77,915,672  
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY   $ 75,044,382     $ 85,078,625  

 

 

See accompanying notes. 

 

 

  3  

 

RED CAT HOLDINGS

Consolidated Statements Of Operations

(Unaudited) 

 

                                 
    Three months ended October 31,   Six months ended October 31,
    2022   2021   2022   2021
Revenues   $ 1,530,462     $ 1,863,239     $ 4,599,733     $ 3,259,990  
                                 
Cost of goods sold     1,296,807       1,710,657       4,008,451       3,005,004  
                                 
Gross Margin     233,655       152,582       591,282       254,986  
                                 
Operating Expenses                                
Operations     1,752,873       283,249       2,800,959       460,112  
Research and development     1,354,914       493,441       1,887,684       737,695  
Sales and marketing     731,769       185,385       1,334,000       286,018  
General and administrative     1,919,637       1,050,708       3,037,202       1,926,888  
Stock based compensation     1,246,796       899,937       2,002,267       1,284,023  
Total operating expenses     7,005,989       2,912,720       11,062,112       4,694,736  
Operating loss     (6,772,334 )     (2,760,138 )     (10,470,830 )     (4,439,750 )
                                 
Other Expense (Income)                                
Change in fair value of derivative liability     (686,744 )     (118,813 )     (593,822 )     (273,061 )
Investment income, net     (103,817 )     38,447       (234,113 )     38,447  
Interest expense     32,485       46,017       68,172       63,116  
Other, net     230,219       14,812       345,009       30,121  
Other Expense (Income)   $ (527,857 )   $ (19,537 )   $ (414,754 )   $ (141,377 )
                                 
Net loss   $ (6,244,477 )   $ (2,740,601 )   $ (10,056,076 )   $ (4,298,373 )
                                 
Loss per share - basic and diluted   $ (0.12 )   $ (0.05 )   $ (0.19 )   $ (0.10 )
                                 
Weighted average shares outstanding - basic and diluted     54,078,111       52,147,541       53,928,133       43,110,884  

 

 

See accompanying notes.

 

 

  4  

 

RED CAT HOLDINGS

Consolidated Statements of Stockholders’ Equity

(Unaudited)

 

                                         
    Series A   Series B      Additional       Accumulated Other    
    Preferred Stock   Preferred Stock   Common Stock   Paid-in   Accumulated   Comprehensive   Total
    Shares   Amount   Shares   Amount   Shares   Amount   Capital   Deficit   Income (Loss)   Equity
Balances, April 30, 2021     158,704     $ 1,587       1,968,676     $ 19,687       29,431,264     $ 29,431     $ 21,025,518     $ (15,809,928 )   $        $ 5,266,295  
                                                                                 
Acquisition of Skypersonic     —                  —                  685,321       685       2,630,955                         2,631,640  
                                                                                 
Public offerings, net of $5,959,800 of issuance costs     —                  —                  17,333,334       17,333       70,022,871                         70,040,204  
                                                                                 
Exercise of warrants     —                  —                  66,666       67       263,073                         263,140  
                                                                                 
Conversion of preferred stock     —                  (982,000 )     (9,820 )     818,333       818       9,002                             
                                                                                 
Stock based compensation     —                  —                  —                  384,023                         384,023  
                                                                                 
Vesting of restricted stock     —                  —                  62,500       63                                  63  
                                                                                 
Shares issued for services     —                  —                  91,667       92       191,908                         192,000  
                                                                                 
Currency translation adjustments     —                  —                  —                                    922       922  
                                                                                 
Net loss     —                  —                  —                           (1,557,772 )              (1,557,772 )
                                                                                 
Balances, July 31, 2021     158,704     $ 1,587       986,676     $ 9,867       48,489,085     $ 48,489     $ 94,527,350     $ (17,367,700 )   $ 922     $ 77,220,515  
                                                                                 
Acquisition of Skypersonic     —                  —                  21,972       22       84,350                         84,372  
                                                                                 
Acquisition of Teal Drones     —                  —                  3,588,272       3,588       10,007,691                         10,011,279  
                                                                                 
Conversion of preferred stock     (158,704 )      (1,587 )      —              1,321,996       1,322       265                             
                                                                                 
Stock based compensation     —                  —                  243,585       244       899,693                         899,937  
                                                                                 
Shares issued for services     —                  —                  20,000       20       59,380                         58,400  
                                                                                 
Currency translation adjustments     —                  —                  —                                    669       669  
                                                                                 
Net loss     —                  —                  —                           (2,740,601 )              (2,740,601 )
                                                                                 
Balances, October 31, 2021     —       $          986,676     $ 9,867       53,684,910     $ 53,685     $ 105,577,729     $ (20,108,301 )   $ 1,591     $ 85,534,571  
                                                                                 
Balances, April 30, 2022            $          986,676     $ 9,867       53,748,735     $ 53,749     $ 106,821,384     $ (27,499,056 )   $ (1,470,272 )   $ 77,915,672  
                                                                                 
Stock based compensation     —                  —                  —                  755,471                         755,471  
                                                                                 
Vesting of restricted stock units     —                  —                  69,707       69       (84,145 )                       (84,076 )
                                                                                 
Unrealized gain on marketable securities     —                  —                  —                                    133,582       133,582  
                                                                                 
Currency translation adjustments     —                  —                  —                                    352       352  
                                                                                 
Net loss     —                  —                  —                           (3,811,599 )              (3,811,599 )
                                                                                 
Balances, July 31, 2022            $          986,676     $ 9,867       53,818,442     $ 53,818     $ 107,492,710     $ (31,310,655 )   $ (1,336,338 )   $ 74,909,402  
                                                                                 
Stock based compensation     —                  —                  —                  1,246,796                         1,246,796  
                                                                                 
Vesting of restricted stock units     —                  —                  411,097       411       (332,794 )                       (332,383 )
                                                                                 
Unrealized loss on marketable securities     —                  —                  —                                    (350,811 )     (350,811 )
                                                                                 
Currency translation adjustments     —                  —                  —                                    (1,256 )     (1,256 )
                                                                                 
Net loss     —                  —                  —                           (6,244,477 )              (6,244,477 )
                                                                                 
Balances, October 31, 2022            $          986,676     $ 9,867       54,229,539     $ 54,229     $ 108,406,712     $ (37,555,132 )   $ (1,688,405 )   $ 69,227,271  

 

 

See accompanying notes.

 

 

  5  

 

RED CAT HOLDINGS

Consolidated Statements of Cash Flows

(Unaudited)

 

                 
    Six months ended  October 31,
    2022   2021
Cash Flows from Operating Activities                
Net loss   $ (10,056,076 )   $ (4,298,373 )
Stock based compensation - options     890,711       505,821  
Stock based compensation - restricted units     1,111,556       778,202  
Common stock issued for services              250,400  
Amortization of intangible assets     219,790       32,651  
Realized loss from sale of marketable securities     28,416           
Depreciation     91,804       5,455  
Change in fair value of derivative     (593,822 )     (273,061 )
Changes in operating assets and liabilities, net of acquisitions                
Accounts receivable     (422,296 )     27,002  
Inventory     (2,664,222 )     (319,124 )
Other     (2,098,555 )     (3,814,101 )
Operating lease right-of-use assets and liabilities     23,487       10,887  
Customer deposits     (314,622 )     8,753  
Accounts payable     630,594       (976,679 )
Accrued expenses     (380,904 )     (505,340 )
Net cash used in operating activities     (13,534,139 )     (8,567,507 )
                 
Cash Flows from Investing Activities                
Cash acquired through acquisitions              24,866  
Purchases of property and equipment     (1,280,935 )     (30,147 )
Proceeds from maturities of marketable securities     13,241,836       1,855,788  
Purchases of marketable securities              (49,978,445 )
Net cash provided by (used in) investing activities     11,960,901       (48,127,938 )
                 
Cash Flows from Financing Activities                
Proceeds from exercise of warrants              99,999  
Proceeds from related party obligations     13,404       —    
Payments under related party obligations     (40,057 )     (1,866,381 )
Payments under debt obligations     (340,766 )     (320,965 )
Payments of taxes related to equity transactions     (561,407 )         
Proceeds from issuance of common stock, net              70,065,203  
Net cash (used in) provided by financing activities     (928,826 )     67,977,856  
                 
Net (decrease) increase in Cash     (2,502,064 )     11,282,411  
Cash, beginning of period     4,084,815       277,347  
Cash, end of period     1,582,751       11,559,758  
                 
Cash paid for interest     62,862       26,175  
Cash paid for income taxes                  
                 
Non-cash transactions                
Fair value of shares issued in acquisitions   $        $ 12,727,292  
Unrealized loss on marketable securities   $ 217,229     $     
Elimination of derivative liability   $        $ 163,141  
Indirect payment to related party   $        $ 132,200  
Shares withheld as payment of note receivable   $ 18,449     $     
Conversion of preferred stock into common stock   $        $ 11,407  
Taxes related to net share settlement of equity awards   $ 9,448     $     

 

See accompanying notes.

 

 

  6  

 

 RED CAT HOLDINGS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

October 31, 2022 and 2021

(unaudited)

 

Our unaudited interim consolidated financial statements and accompanying notes are prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"). In the opinion of management, the unaudited interim consolidated financial statements reflect all adjustments of a normal recurring nature that are necessary for a fair presentation of the results for the interim periods presented. Interim results are not necessarily indicative of results for a full year. The information included in this Form 10-Q should be read in conjunction with the financial information included in the Annual Report on Form 10-K for the fiscal year ended April 30, 2022 of Red Cat Holdings, Inc. (the "Company"), filed with the Securities and Exchange Commission ("SEC") on July 27, 2022.


 

Note 1 – The Business

 

Red Cat Holdings (“Red Cat” or the “Company”) was originally incorporated in February 1984. Since April 2016, the Company’s primary business has been to provide products, services and solutions to the drone industry which it presently does through its four wholly owned subsidiaries. Teal Drones is a leader in commercial and government Unmanned Aerial Vehicles (UAV) technology. Fat Shark is a provider of First Person View (FPV) video goggles to the drone industry. Rotor Riot sells FPV drones and equipment to the consumer marketplace through its digital storefront located at www.rotorriot.com. Skypersonic provides software and hardware solutions that enable drones to complete inspection services in locations where GPS (global positioning systems) is not available, yet still record and transmit data even while being operated from thousands of miles away.

 

Corporate developments during the two years ended October 31, 2022 include:

  

  A. Fat Shark Acquisition

 

On September 30, 2020, the Company entered into a share purchase agreement (“Share Purchase Agreement”) with Greg French (“French”), the founder and sole shareholder of Fat Shark Holdings (“Fat Shark”), to acquire all of the issued and outstanding shares of Fat Shark and its subsidiaries. The transaction closed on November 2, 2020 and was valued at $8,354,076 based on (i) the issuance of 5,227,273 shares of common stock with a value of $6,351,076 on the date of closing (ii) a senior secured promissory note in the original principal amount of $1,753,000, and (iii) a cash payment of $250,000. The Share Purchase Agreement included indemnification provisions, a two year non-compete agreement, and registration rights for the shares issued in the transaction.

 

A summary of the purchase price and its related allocation was as follows:

 

Shares issued   $ 6,351,076  
Promissory note issued     1,753,000  
Cash     250,000  
Total Purchase Price   $ 8,354,076  

 

Assets acquired    
Cash     201,632  
Accounts receivable     249,159  
Other assets     384,232  
Inventory     223,380  
Brand name     1,144,000  
Proprietary technology     272,000  
Non-compete agreement     16,000  
Total assets acquired     2,490,403  
Liabilities assumed        
Accounts payable and accrued expenses     279,393  
Customer deposits     25,194  
Total liabilities assumed     304,587  
Total fair value of net assets acquired     2,185,816  
Goodwill   $ 6,168,260  

   

  7  

 

The Company engaged a valuation services firm to value the intangible assets acquired and the purchase price allocation is now complete. Intangible assets included proprietary technology and a non-compete agreement which are being amortized over 5 and 3 years, respectively. The carrying value of brand name is not being amortized but is reviewed quarterly and formally evaluated at year end. The excess of the purchase price above the net assets acquired was recorded as goodwill which is reviewed quarterly and formally evaluated at year end. 

 

  B. Skypersonic Acquisition

 

In May 2021, the Company acquired all of the outstanding stock of Skypersonic, Inc. (“Skypersonic”) in exchange for $3,000,000 of our common stock. The number of shares issuable was based on the volume weighted average price ("VWAP") of our common stock for the 20 trading days ending May 7, 2021. Based on a VWAP of $4.0154, the Company issued 747,124 shares. In addition, the Company also agreed to issue 110,000 shares of common stock to a shareholder. For accounting purposes, the 857,124 shares were valued at $3,291,356 based on the closing price of our common stock of $3.84 on May 7, 2021. Prior to the closing, the Company provided $75,000 to Skypersonic to fund its operating costs. This amount was capitalized as part of the purchase price. In October 2021, the Company and Skypersonic agreed to a reduction in the purchase price of $601,622 which resulted in the cancellation of 149,829 shares held in escrow.

 

The final summary of the purchase price and its related allocation is as follows:

 

Shares issued   $ 2,716,012  
Cash     75,000  
Total Purchase Price   $ 2,791,012  

 

Assets acquired    
Cash     13,502  
Accounts receivable     51,083  
Other assets     12,950  
Inventory     50,556  
Proprietary technology     826,000  
Non-compete agreement     65,000  
Total assets acquired     1,019,091  
Liabilities assumed        
Accounts payable and accrued expenses     1,054,997  
Total liabilities assumed     1,054,997  
Total fair value of net assets acquired     (35,906 )
Goodwill   $ 2,826,918  

 

The Company engaged a valuation services firm to value the intangible assets acquired and the purchase price allocation is now complete. Intangible assets included proprietary technology and a non-compete agreement which are being amortized over 5 and 3 years, respectively. The excess of the purchase price above the net assets acquired was recorded as goodwill which is reviewed quarterly and formally evaluated at year end.

 

  C. Teal Drones Acquisition

 

On August 31, 2021, the Company closed the acquisition of Teal Drones Inc., (“Teal”). Under the terms of the agreement, the base purchase price of $14,000,000 was reduced by $1,670,294 of debt assumed by the Company, as well as a working capital deficit adjustment of $1,456,953. Based on the net amount payable of $10,872,753, and a VWAP of $2.908 for the twenty trading days ending August 31, 2022, the Company issued 3,738,911 of common stock. For accounting purposes, the shares were valued at $10,431,562 based on the closing price of our common stock of $2.79 on August 31, 2021. In December 2021, the Company and Teal agreed to a reduction in the purchase price of $438,058 which resulted in the cancellation of 150,639 shares held in escrow. The Stock Consideration may be increased if Teal attains certain revenue levels in the 24-month period following the closing.  The additional consideration begins at $4 million if sales total at least $18 million and ends at $16 million if sales total $36 million.

 

  8  

 

The final summary of the purchase price and its related allocation is as follows:

 

Total Purchase Price – shares issued   $ 10,011,279  

 

Assets acquired    
Cash     11,364  
Accounts receivable     47,964  
Other current assets     15,085  
Other assets     48,595  
Inventory     1,253,755  
Brand name     1,430,000  
Proprietary technology     3,869,000  
Total assets acquired     6,675,763  
Liabilities assumed        
Accounts payable and accrued expenses     1,143,899  
Customer deposits     1,766,993  
Notes payable     2,749,091  
Total liabilities assumed     5,659,983  
Total fair value of net assets acquired     1,015,780
Goodwill   $ 8,995,499  

  

The Company engaged a valuation services firm to value the intangible assets acquired and the purchase price allocation is now complete. Intangible assets included proprietary technology which is being amortized over 6 years. The carrying value of brand name is not being amortized but is reviewed quarterly and formally evaluated at year end. The excess of the purchase price above the net assets acquired was recorded as goodwill which is reviewed quarterly and formally evaluated at year end.

 

On August 31, 2021, Teal entered into an Amended and Restated Loan and Security Agreement with Decathlon Alpha IV, L.P. (“DA4”) (the “Loan Agreement”) in the amount of $1,670,294 (the “Loan”), representing the outstanding principal amount previously due and owing by Teal to DA4. Interest on the Loan accrues at a rate of ten (10%) percent per annum. Principal and interest is payable in monthly installments to $49,275 until maturity on December 31, 2024. The Company assumed the Loan Agreement in connection with the acquisition.

 

Supplemental Unaudited Pro Forma Financial and Other Information

 

There is no pro forma financial information for the six months ended October 31, 2022 because all acquisitions had closed prior to the beginning of the reporting period. The following table presents pro forma results as if our acquisition of Teal had occurred on May 1, 2021:

                                                 
 

Three months ended October 31, 2021

 

Six months ended October 31, 2021

    Red Cat   Teal   Consolidated   Red Cat   Teal   Consolidated
Revenues   $ 1,863,239     $ 104,016     $ 1,967,255     $ 3,259,990     $ 416,063     $ 3,676,053  
                                                 
Net Loss   $ (2,740,601 )   $ (301,783 )   $ (3,042,384 )   $ (4,298,373 )   $ (1,467,770 )   $ (5,766,143 )



The acquisition of Skypersonic was completed on May 7, 2021 and its activities during the period from May 1, 2021 to May 7, 2021 were immaterial to the consolidated pro forma results.

 

The unaudited pro forma financial information has been compiled in a manner consistent with the Company's accounting policies, and includes transaction costs, amortization of the acquired intangible assets, and other expenses directly related to each respective acquisition.  The unaudited pro forma financial information is based on estimates and assumptions which the Company believes are reasonable and are not necessarily indicative of the results that would have been realized had the acquisitions closed on the dates indicated in the tables, nor are they indicative of results of operations that may occur in the future.

 

  9  

 

Other information related to the Company’s acquisitions include:

 

  • The purchase price allocation has been finalized for each acquisition based on the report from the valuation services firm engaged to assist in the identification and valuation of intangible assets acquired.

 

  • The fair value of shares issued by the Company as part of the consideration paid is normally based on the volume weighted average price of the Company’s common stock for the twenty days prior to the closing of the transaction.  For accounting purposes, the shares issued are valued based on the closing stock price on the date that the transaction closes.

 

  • Goodwill for Rotor Riot relates to its strong social media presence including more than 200,000 YouTube subscribers. Goodwill for Fat Shark is attributable to its relationship with manufacturing sources in China and the potential to integrate its goggle technologies with the Teal drone.  Goodwill for Skypersonic relates to the future customers expected to leverage its “Fly Anywhere” technologies in a wide range of commercial environments.  Goodwill for Teal is ascribed to its existing relationship with several U.S. government agencies including its classification as an approved vendor.

 

  • The Company expects that the Goodwill recognized in each transaction will be deductible for tax purposes.  The Company has reported net losses since its inception and is presently unable to determine when and if the tax benefit of this deduction will be realized.

 

 

Note 2 – Summary of Significant Accounting Policies

 

Basis of Accounting – The financial statements and accompanying notes are prepared in accordance with generally accepted accounting principles in the United States (“GAAP”). Certain prior period amounts have been restated to conform to the current year presentation.

 

Principles of Consolidation – Our consolidated financial statements include the accounts of our wholly owned operating subsidiaries, which consist of Teal Drones, Fat Shark, Rotor Riot, and Skypersonic. Intercompany transactions and balances have been eliminated.

 

Use of Estimates – The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates reflected in these financial statements include those used to (i) determine stock-based compensation, (ii) complete purchase price accounting for acquisitions, and (iii) accounting for derivatives.

  

Cash and Cash Equivalents – At October 31, 2022, we had cash of $1,582,751 in multiple commercial banks and financial services companies. We have not experienced any loss on these cash balances and believe they are not exposed to any significant credit risk.

 

Marketable Securities – Our marketable securities have been classified and accounted for as available-for-sale securities. These securities are primarily invested in corporate bonds and are readily saleable, and therefore, we have classified them as short term. Our available-for-sale securities are carried at fair value with any unrealized gains and losses reported as a component of comprehensive income (loss). Once realized, any gains or losses are recognized in the statement of operations.

 

We have elected to present interest income receivable separately from marketable securities on our consolidated balance sheets. Accrued interest receivable was $312,931 and $385,730 as of October 31, 2022 and April 30, 2022, respectively, and was included in other current assets. We did not write off any accrued interest receivable during the six months ended October 31, 2022 and 2021.

 

Accounts Receivable, net – Accounts receivable are recorded at the invoiced amount less allowances for doubtful accounts. The Company's estimate of the allowance for doubtful accounts is based on a multitude of factors, including historical bad debt levels for its customer base, past experience with a specific customer, the economic environment, and other factors. Accounts receivable balances are written off against the allowance when it is probable that the receivable will not be collected.

  

  10  

 

Inventories – Inventories, which consist of raw materials, work-in-process, and finished goods, are stated at the lower of cost or net realizable value, and are measured using the first-in, first-out method. Cost components include direct materials and direct labor, as well as in-bound freight. At each balance sheet date, the Company evaluates ending inventories for excess quantities and obsolescence.

 

Goodwill – Goodwill represents the excess of the purchase price of an acquisition over the estimated fair value of identifiable net assets acquired. The measurement period for the valuation of assets acquired and liabilities assumed ends as soon as information on the facts and circumstances that existed as of the acquisition date becomes known, not to exceed 12 months. Adjustments in a purchase price allocation may require a change in the amounts allocated to goodwill during the periods in which an adjustment is determined.

 

We perform an impairment test at the end of each fiscal year, or more frequently if indications of impairment arise. We have two business segments and evaluate goodwill for impairment based on an evaluation of the fair value of each business segment individually.

 

Property and equipmentProperty and equipment is stated at cost less accumulated depreciation and depreciated using the straight-line method over the estimated useful life of the asset. The estimated useful lives of our property and equipment are generally: (i) furniture and fixtures - seven years, (ii) equipment and related - two to five years, and (iii) leasehold improvements - 15 years.

 

LeasesEffective August 1, 2021, the Company adopted Accounting Standards Codification (ASC) 842 titled “Leases” which requires the recognition of assets and liabilities associated with lease agreements. The Company adopted ASC 842 on a modified retrospective transition basis which means that it did not restate financial information for any periods prior to August 1, 2021. Upon adoption, the Company recognized a lease liability obligation of $796,976 and a right-of-use asset for the same amount.

  

The Company determines if a contract is a lease or contains a lease at inception.  Operating lease liabilities are measured, on each reporting date, based on the present value of the future minimum lease payments over the remaining lease term.  The Company's leases do not provide an implicit rate. Therefore, the Company uses an effective discount rate of 12% based on its last debt financing. Operating lease assets are measured by adjusting the lease liability for lease incentives, initial direct costs incurred and asset impairments.  Lease expense for minimum lease payments is recognized on a straight-line basis over the lease term with the operating lease asset reduced by the amount of the expense. Lease terms may include options to extend or terminate a lease when they are reasonably certain to occur.

 

Fair Values, Inputs and Valuation Techniques for Financial Assets and Liabilities, and Related Disclosures – The fair value measurements and disclosure guidance defines fair value and establishes a framework for measuring fair value. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the measurement date. In accordance with this guidance, the Company has categorized its recurring basis financial assets and liabilities into a three-level fair value hierarchy based on the priority of the inputs to the valuation technique.

  

The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level input that is significant to the fair value measurement in its entirety. The Company's assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability.

 

The guidance establishes three levels of the fair value hierarchy as follows:

 

Level 1: Inputs are unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date;

Level 2: Inputs are observable, unadjusted quoted prices in active markets for similar assets or liabilities, unadjusted quoted prices for identical or similar assets or liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the related assets or liabilities; and

Level 3: Unobservable inputs that are significant to the measurement of the fair value of the assets or liabilities that are supported by little or no market data.

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Disclosures for Non-Financial Assets Measured at Fair Value on a Non-Recurring Basis

 

The Company's financial instruments mainly consist of cash, receivables, current assets, accounts payable, accrued expenses and debt. The carrying amounts of cash, receivables, current assets, accounts payable, accrued expenses and current debt approximates fair value due to the short-term nature of these instruments.

 

Convertible Securities and Derivatives

 

When the Company issues convertible debt or equity instruments that contain embedded derivative instruments that are to be bifurcated and accounted for as liabilities, the total proceeds from the convertible host instruments are first allocated to the bifurcated derivative instruments.  The remaining proceeds, if any, are then allocated to the convertible instruments themselves, resulting in those instruments being recorded at a discount from their face value but no lower than zero. Any excess amount is recognized as a derivative expense.

 

Derivative Liabilities

 

The Company has financial instruments that are considered derivatives or contain embedded features subject to derivative accounting. Embedded derivatives are valued separately from the host instrument and are recognized as liabilities on the Company's balance sheet. The Company measures these instruments at their estimated fair value and recognizes changes in their estimated fair value in results of operations during the period of change. 

  

In October 2020 and January 2021, the Company entered into convertible note agreements which included provisions under which the conversion price was equal to the lesser of an initial stated amount or the conversion price of a future offering. This variable conversion feature was recognized as a derivative. Both financings included the issuance of warrants which contained similar variable conversion features. The Company values these convertible notes and warrants using the multinomial lattice method that values the derivative liability based on a probability weighted discounted cash flow model. The resulting liability is valued at each reporting date and the change in the liability is reflected as change in derivative liability in the statement of operations.

 

Revenue Recognition – The Company recognizes revenue in accordance with ASC 606, “Revenue from Contracts with Customers”, issued by the Financial Accounting Standards Board (“FASB”). This standard includes a comprehensive evaluation of factors to be considered regarding revenue recognition including (i) identifying the promised goods, (ii) evaluating performance obligations, (iii) measuring the transaction price, (iv) allocating the transaction price to the performance obligations if there are multiple components, and (v) recognizing revenue as each obligation is satisfied.  The Company’s revenue transactions include a single component, specifically, the shipment of goods to customers as orders are fulfilled. The Company recognizes revenue upon shipment. The timing of the shipment of orders can vary considerably depending upon whether an order is for an item normally maintained in inventory or an order that requires assembly or unique parts. Customer deposits totaled $123,308 and $437,930 at October 31, 2022 and April 30, 2022, respectively.

 

Research and Development – Research and development expenses include payroll, employee benefits, and other headcount-related expenses associated with product development. Research and development expenses also include third-party development and programming costs, as well as a proportionate share of overhead costs such as rent. Costs related to software development are included in research and development expense until technological feasibility is reached, which for our software products, is generally shortly before the products are released to production. Once technological feasibility is reached, such costs are capitalized and amortized as a cost of revenue over the estimated lives of the products.

 

Income Taxes – Deferred taxes are provided on the liability method; whereby deferred tax assets are recognized for deductible temporary differences and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. 

 

Recent Accounting Pronouncements – Management does not believe that recently issued, but not yet effective accounting pronouncements, if adopted, would have a material effect on the accompanying consolidated financial statements.

 

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Foreign CurrencyThe functional currency of our international subsidiary is the local currency. For that subsidiary, we translate assets and liabilities to U.S. dollars using period-end exchange rates, and average monthly exchange rates for revenues, costs, and expenses. We record translation gains and losses in accumulated other comprehensive income.

  

Comprehensive Loss – Comprehensive loss consists of net loss and other comprehensive loss. Other comprehensive loss refers to gains and losses that are recorded as an element of stockholders' equity and are excluded from net loss. Our other comprehensive loss is comprised of foreign currency translation adjustments and unrealized gains or losses on available-for-sale securities. During the six months ended October 31, 2022 and October 31, 2021, comprehensive loss was $218,133 higher and $1,591 lower than net loss, respectively, related to unrealized losses on available-for-sale securities totaling $217,229 and $0, respectively, as well as by foreign currency translation adjustments of negative $904 and positive $1,591.

 

Stock-Based Compensation – For stock options, we use the estimated grant-date fair value method of accounting in accordance with ASC Topic 718, Compensation – Stock Compensation. Fair value is determined based on the Black-Scholes Model using inputs reflecting our estimates of expected volatility, term and future dividends. We recognize forfeitures as they occur. For restricted stock, we determine the fair value based on our stock price on the date of grant. For both stock options and restricted stock, we recognize compensation costs on a straight-line basis over the service period which is the vesting term.

  

Basic and Diluted Net Loss per Share – Basic and diluted net loss per share has been calculated by dividing net loss by the weighted average number of shares of common stock outstanding during the period. Common stock equivalents were excluded from the computation of diluted net loss per share of common stock because they were anti-dilutive. The conversion or exercise of these common stock equivalents would dilute earnings per share if we become profitable in the future.

 

Outstanding securities not included in the computation of diluted net loss per share because their effect would have been anti-dilutive included the following:

 

    October 31, 2022   April 30, 2022
Series B Preferred Stock, as converted     822,230       822,230  
Stock options     3,994,558       3,694,142  
Warrants     1,539,999       1,539,999  
Restricted stock     1,106,514       1,083,675  
Total     7,463,301       7,140,046  

 

 

Related Parties – Parties are considered to be related to us if they have control or significant influence, directly or indirectly, over us, including key management personnel and members of the Board of Directors. Related Party transactions are disclosed in Note 19.

 

Segment Reporting

 

Since January 2020, we have acquired four separate businesses operating in various aspects of the drone industry. Following the most recent acquisition, the Company focused on integrating and organizing its acquired businesses. These efforts included refining the establishment of Enterprise and Consumer segments to sharpen the Company’s focus on the unique opportunities in each sector of the drone industry. The Enterprise segment, which includes Teal Drones and Skypersonic, is focused on opportunities in the commercial sector, including military. Enterprise is building the infrastructure to manage drone fleets, fly and provide services remotely, and navigate confined industrial interior spaces and dangerous military environments. The Consumer segment, which includes Rotor Riot and Fat Shark, is focused on enthusiasts and hobbyists which are expected to increase as drones become more visible in our daily lives. Effective May 1, 2022, we began to manage our business operations through these business segments. The reportable segments were identified based on how our chief operating decision maker (“CODM”), which is a committee comprised of our Chief Executive Officer (“CEO”), Chief Operating Officer (“COO”) and our Chief Financial Officer (“CFO”), manages our business, makes resource allocation and operating decisions, and evaluates operating performance. See “Note 20 - Segment Reporting”.

 

 

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Note 3 – Marketable Securities

 

The following tables set forth information related to our marketable securities as of October 31, 2022: 

 

I. Cost, unrealized gains or losses, and fair values  

 

    Cost   Unrealized Gains (Losses)   Fair Value
Asset-backed securities   $ 1,663,414     $ (27,702 )   $ 1,635,712  
Corporate bonds     31,330,997       (1,663,821 )     29,667,176  
Total   $ 32,994,411     $ (1,691,523 )   $ 31,302,888  

 

II. Contractual Maturities

 

    One Year or Less   One to
Five Years
  Over Five Years   Total
Asset-backed securities   $        $ 1,635,712     $        $ 1,635,712  
Corporate bonds     14,785,077       14,577,260       304,839       29,667,176  
Total   $ 14,785,077     $ 16,212,972     $ 304,839     $ 31,302,888  

  

III. Fair Value Hierarchy

 

    Level 1   Level 2   Level 3   Total
Asset-backed securities   $        $ 1,635,712     $        $ 1,635,712  
Corporate bonds              29,667,176                29,667,176  
Total   $        $ 31,302,888     $        $ 31,302,888  

 

 

Note 4 – Inventories

 

Inventories consisted of the following:

 

    October 31, 2022   April 30, 2022
Raw materials   $ 3,221,442     $ 2,831,713  
Work-in-process     291,870       173,112  
Finished goods     3,046,780       891,045  
Total   $ 6,560,092     $ 3,895,870  

  

Inventory purchase orders outstanding totaled approximately $29.3 million. The global supply chain for materials required to produce our drones continues to experience significant disruptions and delays. While we have increased our order lead times and quantities, we retain the right to cancel or modify these orders prior to their shipment.

 

 

Note 5 – Other Current Assets

 

Other current assets included:

 

    October 31, 2022   April 30, 2022
Prepaid inventory   $ 3,705,853     $ 1,707,085  
Accrued interest income     312,931       385,730  
Prepaid expenses     434,655       262,069  
Total   $ 4,453,439     $ 2,354,884  

 

 

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Note 6 – Due From Related Party

 

In January 2022, the Company determined that an employee had relocated in 2021 but their compensation had not been subject to the income tax withholding required by the new jurisdiction. The amount subject to taxation included $155,624 of cash compensation and $1,413,332 of income associated with the vesting of restricted stock ("Stock Compensation"). In March 2022, the Company entered into a note agreement (the "Note") with the employee in the amount of $510,323, representing the estimated taxes owed by the employee related to the Stock Compensation. Under the terms of the Note, 104,166 shares of common stock with a fair value of $280,832, which had vested during calendar 2021, were withheld by the Company and applied against the Note. The employee agreed not to sell or transfer 110,983 shares of common stock held at the Company's transfer agent until the Note was repaid. In addition, the employee has 20,833 shares of restricted stock vesting monthly in calendar 2022, of which 3,000 shares will be withheld with the fair value of those shares applied against the Note. Any shares issued to the employee in 2022 will be held at the transfer agent until the Note is repaid in full. The Note matures on December 31, 2022. The Company filed amended payroll tax returns on March 16, 2022. In March and April 2022, the Company made payments to the relevant tax authorities totaling $712,646 representing $510,323 owed by the employee, $31,604 owed by the Company, and $170,719 of penalties and interest. The Note was repaid in full in August 2022.

 

 

Note 7 – Intangible Assets

 

Intangible assets relate to acquisitions completed by the Company, including those described in Note 1. Intangible assets were as follows:

 

                               
    October 31, 2022   April 30, 2022
    Gross Value   Accumulated Amortization   Net Value  

Gross

Value

  Accumulated Amortization   Net Value
Proprietary technology   $ 4,967,000       (422,773 )   $ 4,544,227     $ 1,098,000     $ (219,267 )   $ 878,733  
Non-compete agreements     81,000       (43,166 )     37,834       81,000       (29,667 )     51,333  
Customer relationships     39,000       (15,320 )     23,680       39,000       (12,535 )     26,465  
Total finite-lived assets     5,087,000       (481,259 )     4,605,741       1,218,000       (261,469 )     956,531  
Brand name     3,152,000                3,152,000       1,722,000                1,722,000  
Trademark     20,000                20,000       20,000                20,000  
Total indefinite-lived assets     3,172,000                3,172,000       1,742,000                1,742,000  
Total intangible assets, net   $ 8,259,000     $ (481,259 )   $ 7,777,741     $ 2,960,000     $ (261,469 )   $ 2,698,531  

 

Proprietary technology and non-compete agreements are being amortized over five to six years and three years, respectively. Customer relationships is being amortized over seven years. Goodwill and Brand name are not amortized but evaluated for impairment on a quarterly basis.

 

As of October 31, 2022, expected amortization expense for finite-lived intangible assets for the next five years is as follows:

 

Fiscal Year Ended:    
  2023     $ 434,738  
  2024       866,805  
  2025       842,471  
  2026       815,271  
  2027       786,679  
  Thereafter       859,777  
  Total     $ 4,605,741  

  

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Goodwill is a separately stated intangible asset and represents the excess of the purchase price of acquisitions above the net assets acquired. The composition of, and changes in goodwill, consist of:

 

  Date   Acquisition   Goodwill
  January 2020     Rotor Riot   $ 1,849,073  
  November 2020     Fat Shark     6,168,260  
  Balance at April 30, 2021           8,017,333  
  May 2021     Skypersonic     2,826,918  
  August 2021     Teal Drones     8,995,499  
  Balance at April 30, 2022 and October 31, 2022         $ 19,839,750  

  

 

Note 8 – Property and Equipment

 

Property and equipment consist of assets with an estimated useful life greater than one year and are reported net of accumulated depreciation. The reported values are periodically assessed for impairment, and were as follows:

 

    October 31, 2022   April 30, 2022
Equipment and related   $ 1,003,488     $ 509,376  
Leasehold improvements     930,986       149,330  
Furniture and fixtures     54,254       42,746  
Accumulated depreciation     (287,907 )     (189,762 )
Net carrying value   $ 1,700,821     $ 511,690  

  

Depreciation expense totaled $91,804 and $5,455 for the six months ended October 31, 2022 and 2021, respectively.

 

 

Note 9 – Operating Leases

 

As of October 31, 2022, the Company had operating type leases for real estate and no finance type leases. The Company’s leases have remaining lease terms of up to 4.58 years, some of which may include options to extend for up to 5 years. Operating lease expense totaled $201,004 for the six months ended October 31, 2022, including period cost for short-term, cancellable, and variable leases, not included in lease liabilities, of $19,725 for the six months ended October 31, 2022.

 

Leases on which the Company made rent payments during the reporting period included:

 

Location   Monthly Rent   Expiration
South Salt Lake, Utah   $ 22,000       December 2024  
Orlando, Florida   $ 4,692       January 2025  
San Juan, Puerto Rico   $ 2,226       June 2027  
Troy, Michigan   $ 2,667       May 2022  
Orlando, Florida   $ 1,690       September 2022  

  

Supplemental information related to operating leases for the six months ended October 31, 2022 was:

 

     
Operating cash paid to settle lease liabilities   $176,887  
Weighted average remaining lease term (in years)     2.83  
Weighted average discount rate     12%

 

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Future lease payments at October 31, 2022 were as follows:

 

Fiscal Year Ended:    
  2023     $ 197,723  
  2024       403,878  
  2025       304,676  
  2026       76,619  
  2027       79,300  
  Thereafter       6,627  
  Total     $ 1,068,823  

  

 

Note 10 – Debt Obligations

 

  A. Decathlon Capital

In August 2021, Teal restructured its loan agreement with Decathlon Capital. The principal amount of $1,670,294 bears interest at 10% and is payable in monthly installments of $49,275 through its December 31, 2024 maturity date. The balance outstanding at October 31, 2022 totaled $1,139,516.

  

  B. Pelion Note

In May 2021, Teal entered into a note agreement totaling $350,000 which is payable upon demand. The Note bears interest at the applicable Federal Rate as of the date of the Note which was 0.13% on the date of issuance. Accrued interest totaled $652 at October 31, 2022.

 

  C. Vendor Settlement

In May 2020, Teal entered into a settlement agreement with a vendor that had been providing contract manufacturing services. At August 31, 2021, the Company assumed the outstanding balance of $387,500 which was payable in monthly installments of $37,500 with a final payment of $12,500 that was made in July 2022.

 

  D. SBA Loan

In February 2021, Teal received a Small Business Administration Paycheck Protection Program (“SBA PPP”) loan in the amount of $300,910. The loan was unsecured, non-recourse, and accrued interest at one percent annually. The loan was used to fund qualifying payroll, rent and utilities. In February 2022, the principal balance of $300,910 and accrued interest of $3,001 were forgiven.

 

  E. Shopify Capital

Shopify Capital is an affiliate of Shopify, Inc. which provides sales software and services to the Company.  The Company processes customer transactions ordered on the e-commerce site for Rotor Riot through Shopify.  Shopify Capital has entered into multiple agreements with the Company in which it has "purchased receivables" at a discount.  Shopify retains a portion of the Company's daily receipts until the purchased receivables have been paid.  The Company recognizes the discount as a transaction fee, in full, in the month in which the agreement is executed.  Agreements with activity during the two years ended October 31, 2022 included:

 

 Date of Transaction    Purchased Receivables   Payment to Company   Transaction Fees    Withholding Rate    Fully Repaid In
September 2020   $209,050   $185,000   $24,050   17%   May 2021
April 2021   $236,500   $215,000   $21,500   17%   January 2022

    

  F. Corporate Equity

Beginning in October 2021, and amended in January 2022, Teal financed a total of $120,000 of leasehold improvements with Corporate Equity. The loan bears interest at 8.25% annually and requires monthly payments of $3,595 through December 2024. The balance outstanding at October 31, 2022 and April 30, 2022 totaled $84,971 and $102,599 respectively.

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  G. Revenue Financing Arrangement

In April 2021, Teal entered into an agreement under which it sold future customer payments, at a discount, to Forward Financing. At August 31, 2021, the Company assumed the outstanding balance of $38,758. Repayment of the remaining balance was completed in January 2022.

 

  H. Ascentium Capital

In September 2021, Teal entered into a financing agreement with Ascentium Capital to fund the purchase of a fixed asset totaling $24,383. Monthly payments of $656 are payable through October 2024. The balance outstanding at October 31, 2022 totaled $15,351.

 

  I. PayPal

PayPal is an electronic commerce company that facilitates payments between parties through online funds transfers. The Company processes certain customer payments ordered on its e-commerce site through PayPal. The Company has entered into multiple agreements under which PayPal provides an advance on customer payments, and then retains a portion of customer payments until the advance is repaid.  PayPal charges a fee which the Company recognizes in full upon entering an agreement. A November 2019 agreement under which PayPal advanced $100,000 and charged a transaction fee of $6,900 was completed in January 2021. A January 2021 agreement under which PayPal advanced $75,444 and charged a transaction fee of $2,444 was completed in August 2021. 

 

  J. Summary

Outstanding principal payments on debt obligations are due as follows:

 

Fiscal 2023   $ 616,131  
Fiscal 2024     572,139  
Fiscal 2025     401,568  
Total   $ 1,589,838  
Short term – through October 31, 2023   $ 895,257  
Long term – thereafter   $ 694,581  

 

 

Note 11 – Due to Related Party

 

  A. Founder of Fat Shark

 

In connection with the acquisition of Fat Shark in November 2020, the Company issued a secured promissory note for $1,753,000 to the seller. The note accrued interest at 3% annually and matured in full in November 2023. In May 2021, the Company made an initial payment of $132,200 by directing a refund from a vendor based in China to the noteholder who is also based in China. The remaining balance of $1,620,800 plus accrued interest totaling $45,129 was paid in September 2021.

 

  B. BRIT, LLC

 

In January 2020, in connection with the acquisition of Rotor Riot, the Company issued a promissory note for $175,000 to the seller, BRIT, LLC. The note accrued interest at 4.75% annually. In October 2021, the outstanding balance of $85,172 plus accrued interest totaling $12,942 was paid.

 

The Company also assumed a line of credit obligation totaling $47,853 which bears interest at 6.67% annually. The remaining balance of $37,196 plus accrued interest totaling $292 was paid in October 2022.

 

  C. Aerocarve

 

In 2020, the Company received advances totaling $79,000 from Aerocarve, which is controlled by the Company's Chief Executive Officer. The parties agreed that the funds would bear interest at 5% annually until repaid. The balance was repaid in full in May 2021.

 

 

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Note 12 – Convertible Notes

  

October 2020 Financing

 

In October 2020, the Company closed a private offering of convertible promissory notes (the "2020 Notes") in the aggregate principal amount of $600,000. The 2020 Notes accrued interest at 12% annually, had a two-year term, and were convertible into common stock at the lower of $1.00 or a 25% discount of the price per share of Common Stock offered in a future, qualified offering. The financing also included the issuance of warrants to purchase 399,998 shares of common stock. The Warrants are exercisable for a period of five years at a price equal to the lower of (1) $1.50 per share, or (2) at a price equal to 75% of the price per share of the common stock offered in a future, qualified offering.

  

The Company determined that the provision associated with a potential reduction in the conversion price of the notes and the exercise price of the warrant represented an embedded derivative financial liability. The derivative liability was initially valued at $728,587 using a multinomial lattice model with $460,588 and $267,999 related to the derivative features of the notes and warrants, respectively. In addition, $580,000 of the proceeds were applied as a debt discount to reduce the initial carrying value of the 2020 Notes to zero with the remaining $20,000 applied against transaction fees. The excess of the liability over the net proceeds totaled $148,587 which was recognized as a derivative expense in the fiscal year ended April 30, 2021.

 

As of October 31, 2022, (a) the 2020 Notes were fully converted into common stock and the related derivative liability eliminated, and (b) 266,666 of the warrants were outstanding with a derivative liability of $330,493.

 

January 2021 Financing

 

In January 2021, the Company closed a private offering of convertible promissory notes (the "2021 Notes") in the aggregate principal amount of $500,000. The 2021 Notes accrued interest at 12% annually, had a two-year term, and were convertible into shares of the Company's common stock at the lower of $1.00 or a 25% discount of the price per share of Common Stock offered in a future, qualified offering. The financing also included the issuance of warrants to purchase 675,000 shares of common stock. The Warrants are exercisable for a period of five years at a price equal to the lower of (i) $1.50 per share, or (ii) a 25% discount to the price per share of common stock offered in a future qualified offering.

 

The Company determined that the provision associated with a potential reduction in the conversion price of the notes and the exercise price of the warrant represented an embedded derivative financial liability. The derivative liability was initially valued at $4,981,701 using a multinomial lattice model with $2,111,035 and $2,870,666 related to the derivative features of the notes and warrants, respectively. In addition, $500,000 was applied as a debt discount to reduce the initial carrying value of the 2021 notes to zero. The excess of the liability over the net proceeds totaled $4,481,701 which was recognized as a derivative expense in the fiscal year ended April 30, 2021.

 

As of October 31, 2022, (a) the 2021 Notes were fully converted into common stock and the related derivative liability eliminated, and (b) 540,000 of the warrants were outstanding with a derivative liability of $683,182.

 

 

Note 13 – Income Taxes

 

Our operating subsidiary, Red Cat Propware, Inc., is incorporated and based in Puerto Rico which is a commonwealth of the United States. We are not subject to taxation by the United States as Puerto Rico has its own taxing authority. Since inception, we have incurred net losses in each year of operations. Our current provision for the reporting periods presented in these financial statements consisted of a tax benefit against which we applied a full valuation allowance, resulting in no current provision for income taxes. In addition, there was no deferred provision for any of these reporting periods.

 

At October 31, 2022 and April 30, 2022, we had accumulated deficits of approximately $37,500,000 and $27,500,000, respectively. Deferred tax assets related to the future benefit of these net operating losses for tax purposes totaled approximately $6,937,500 and $5,087,500, respectively, calculated using the base Puerto Rico corporate tax rate of 18.5%. Currently, we focus on projected future taxable income in evaluating whether it is more likely than not that these deferred assets will be realized. Based on the fact that we have not generated an operating profit since inception, we have applied a full valuation allowance against our deferred tax assets at October 31, 2022 and April 30, 2022.

 

  19  

 

 

Note 14 – Common Stock

 

Our common stock has a par value of $0.001 per share. We are authorized to issue 500,000,000 shares of common stock. Each share of common stock is entitled to one vote. A summary of shares of common stock issued by the Company since April 30, 2021 is as follows:

 

Description of Shares   Shares Issued
Shares outstanding as of April 30, 2021     29,431,264  
Conversion of Series A preferred stock     1,321,996  
Conversion of Series B preferred stock     818,333  
Exercise of warrants     66,666  
Acquisition of Skypersonic on May 7, 2021, see Note 1     707,293  
Acquisition of Teal Drones on August 31, 2021, see Note 1     3,588,272  
Public offerings which generated gross proceeds of $76 million and net proceeds of approximately $70.1 million     17,333,334  
Exercise of stock options     89,107  
Vesting of restricted stock units to employees, net of shares withheld of 225,869 to pay taxes and 92,812 to repay a Note     225,637  
Vesting of restricted stock units to Board of Directors     48,124  
Vesting of restricted stock units to consultants     7,042  
Shares issued for services     111,667  
Shares outstanding as of April 30, 2022     53,748,735  
Vesting of restricted stock units to employees, net of shares withheld of 512,643 to pay taxes and 9,000 to repay a Note     446,325  
Vesting of restricted stock units to Board of Directors     30,078  
Vesting of restricted stock units to consultants     4,401  
Share outstanding as of October 31, 2022     54,229,539  

 

 

Note 15 – Preferred Stock

 

Series A Preferred Stock outstanding totaled 158,704 at April 30, 2021, and were converted into 1,321,996 shares of common stock on August 10, 2021.

 

Series B Preferred Stock (“Series B Stock”) is convertible into common stock at a ratio of 0.8334 shares of common stock for each share of Series B Stock held and votes together with the common stock on an as-if-converted basis. Shares outstanding at October 31, 2022 totaled 986,676 which are convertible into 822,230 shares of common stock.

 

 

Note 16 – Warrants

 

The company issued five-year warrants in connection with two convertible note financings. The warrants have an initial exercise price of $1.50 which may be reduced to a 25% discount of the price per share of Common Stock offered in a future qualified offering. The warrants were valued using the multinominal lattice model and are considered derivative liabilities under ASC 815-40. The value of the warrants was included in the determination of the initial accounting for each financing including the calculation of the derivative liability and related expense.

 

A summary of the warrants issued and their fair values were:

 

    Upon Issuance   Outstanding at October 31, 2022
Date of Transaction   Number of Warrants   Initial Fair Value   Number of Warrants   Fair Value
  October 2020        399,998     $ 267,999       266,666     $ 330,493  
  January 2021       675,000     $ 2,870,666       540,000     $ 683,182  

 

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In March and April 2021, we received $201,249 related to the exercise of 201,666 of the warrants. Since these exercises resulted in the elimination of the derivative liability in the warrants, the derivative liability was reduced by $694,305 with a corresponding increase in additional paid in capital. In June 2021, we received $99,999 in connection with the exercise of 66,666 warrants which resulted in the elimination of $163,141 of the derivative liability in the warrants.

 

In May 2021, the Company issued warrants to purchase 200,000 shares of common stock to the placement agent of its common stock offering. The warrants have a five-year term and an exercise price of $5.00.

   

In July 2021, the Company issued warrants to purchase 533,333 shares of common stock to the placement agent of its common stock offering. The warrants have a five-year term and an exercise price of $5.625.

 

The following table presents the range of assumptions used to estimate the fair values of warrants granted during the six months ended October 31:

 

      2022       2021  
Risk-free interest rate              0.790.85%  
Expected dividend yield                  
Expected term (in years)     —         5.00  
Expected volatility              222.45223.17%  

  

The following table summarizes the changes in warrants outstanding since April 30, 2021.

 

   

 

Number of Shares 

 

 

Weighted-average Exercise Price per Share

 

 Weighted-average Remaining Contractual Term

(in years) 

 

 

Aggregate Intrinsic Value 

  Balance as of April 30, 2021 873,332     1.50        4.62     2,218,263  
  Granted     733,333      $ 5.45                  
  Exercised     (66,666 )     1.50                  
  Outstanding as of April 30, 2022 1,539,999     3.38       3.89     $ 427,533  
  Granted                            
  Exercised                           
  Outstanding at October 31, 2022 1,539,999    $ 3.38       3.38     $  

  

 

Note 17 – Share Based Awards

 

The 2019 Equity Incentive Plan (the "Plan") allows us to incentivize key employees, consultants, and directors with long term compensation awards such as stock options, restricted stock, and restricted stock units (collectively, the "Awards"). The number of shares issuable in connection with Awards under the Plan may not exceed 8,750,000.

 

A. Options 

 

The range of assumptions used to calculate the fair value of options granted during the six months ended October 31 was:

 

      2022       2021  
Exercise Price   $ 2.38     $ 2.412.60  
Stock price on date of grant     2.38       2.412.60  
Risk-free interest rate     3.34 %     0.471.57%  
Dividend yield                  
Expected term (years)     8.25       3.75 10.00  
Volatility     260.06 %     210.68214.17%  

    

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A summary of options activity under the Plan since April 30, 2021 was:

 

Options   Shares   Weighted-Average Exercise Price   Weighted-Average Remaining Contractual Term   Aggregate Intrinsic Value
Outstanding as of April 30, 2021     2,197,475     $ 1.79       8.68        4,943,870   
Granted     1,681,000       2.58                  
Exercised     (150,000     2.49                  
Forfeited or expired     (34,333     2.11                  
Outstanding as of April 30, 2022     3,694,142     2.17       8.56        1,407,545   
Granted     397,000       2.38                  
Exercised                               
Forfeited or expired     (96,584     2.48                  
Outstanding as of October 31, 2022     3,994,558     2.18       8.22     608,162  
Exercisable as of October 31, 2022     2,569,306     $ 2.06       7.48     $ 559,578  

  

The aggregate intrinsic value of outstanding options represents the excess of the stock price at the indicated date over the exercise price of each option. As of October 31, 2022 and October 31, 2021, there was $3,277,073 and $4,429,626 of unrecognized stock-based compensation expense related to unvested stock options which is expected to be recognized over the weighted average periods of 1.24 and 1.31 years, respectively. 

 

B. Restricted Stock

 

A summary of restricted stock activity under the Plan since April 30, 2021 was:

 

Restricted Stock   Shares   Weighted Average Grant-Date Fair Value Per Share
Unvested and outstanding as of April 30, 2021     687,500     $ 2.69  
Granted     995,659       2.55  
Vested     (599,484 )     2.64  
Forfeited                  
Unvested and outstanding as of April 30, 2022     1,083,675       2.59  
Granted     696,000       2.27  
Vested     (673,161 )     2.45  
Forfeited                  
Unvested and outstanding as of October 31, 2022     1,106,514     $ 2.48  

   

Stock Compensation

 

Stock compensation expense by functional operating expense was:

           
   

Three months ended

October 31,

 

Six months ended

October 31,

    2022   2021   2022   2021
Operations   $ 225,879     $ 311,346     $ 384,310     $ 374,607  
Research and development     209,497       84,751       354,295       141,231  
Sales and marketing     162,269       114,088       269,343       158,832  
General and administrative     649,151       389,752       994,319       609,353  
Total   $ 1,246,796     $ 899,937     $ 2,002,267     $ 1,284,023  

 

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Stock compensation expense pertaining to options totaled $890,711 and $505,821 for the six months ended October 31, 2022 and 2021, respectively. Stock compensation expense pertaining to restricted stock units totaled $1,111,556 and $778,202 for the six months ended October 31, 2022 and 2021, respectively.

 

 

Note 18 – Derivatives

 

The Company completed financings in October 2020 and January 2021 which included notes and warrants containing embedded features subject to derivative accounting. See Note 12 for a full description of these financings. Both the notes and the warrants included provisions which provided for a reduction in the conversion and exercise prices, respectively, if the Company completed a future qualified offering at a lower price. These provisions represent embedded derivatives which are valued separately from the host instrument (meaning the notes and warrants) and recognized as derivative liabilities on the Company's balance sheet. The Company initially measures these financial instruments at their estimated fair value and recognizes changes in their estimated fair value in results of operations during the period of change. The Company also measures these financial instruments on the date of settlement (meaning when the note is converted, or the warrant is exercised) at their estimated fair value and recognizes changes in their estimated fair value in results of operations. Any discount in the carrying value of the note is fully amortized on the date of settlement and recognized as interest expense. The Company estimated the fair value of these embedded derivatives using a multinomial lattice model. The range of underlying assumptions used in the binomial model to determine the fair value of the derivative warrant liability upon settlement of the derivative liability and as of October 31, 2022 and April 30, 2022 are set forth below. In addition, the Company's stock price on each measurement date was used in the model.

 

      October 31, 2022       April 30, 2022  
Risk-free interest rate     2.834.51%       0.522.87%  
Expected dividend yield                  
Expected term (in years)      2.92 3.50       3.42 4.50  
Expected volatility      190.09235.23%       211.02292.28%  

  

As of October 31, 2022 all of the notes had been converted into common stock and 806,666 of the warrants were outstanding. Changes in the derivative liability during the six months ended October 31, 2022 and the year ended April 30, 2022 were as follows:

 

    October 31, 2022   April 30, 2022
Balance, beginning of period   $ 1,607,497     $ 2,812,767  
Additions                  
Eliminated upon conversion of notes/exercise of warrants              (163,141 )
Changes in fair value     (593,822 )     (1,042,129 )
Balance, end of period   $ 1,013,675     $ 1,607,497  

  

Changes in fair value primarily relate to changes in the Company’s stock price during the period with increases in the stock price increasing the liability and decreases in the stock price reducing the liability.

 

 

Note 19 - Related-Party Transactions

 

In July 2021, the Company entered into a consulting agreement with a director resulting in monthly payments of $6,000. In addition, the Company issued 150,000 options to purchase common stock at $2.51 which vested quarterly over the one-year term of the agreement. In January 2022, the agreement was amended to increase the monthly payments to $10,000. The agreement expired in June 2022.

 

In January 2022, the Company entered into a note agreement with an employee in the principal amount of $510,323, as further described in Note 6.

 

Additional related party transactions are disclosed in Note 11.

 

 

Note 20 - Segment Reporting

 

We define our segments as those operations whose results are regularly reviewed by our CODM to analyze performance and allocate resources. Therefore, segment information is prepared on the same basis that management reviews financial information for operational decision-making purposes. Our CODM is a committee comprised of our CEO, COO, and CFO.

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The Enterprise segment is focused on opportunities in the commercial sector, including military. Enterprise is building the infrastructure to manage drone fleets, fly and provide services remotely, and navigate confined industrial interior spaces and dangerous military environments.

 

The Consumer segment is focused on enthusiasts and hobbyists which are expected to increase as drones become more visible in our daily lives.

 

Our CODM allocates resources to and assesses the performance of our two operating segments based on the operating segments’ net sales and gross profit. The following table sets forth information by reportable segment for the three and six months ended October 31, 2022, respectively. 

                 
    For the three months ended October 31, 2022
    Enterprise   Consumer   Corporate   Total
Revenues   $ 747,612     $ 782,850     $        $ 1,530,462  
Cost of goods sold     623,761       673,046                1,296,807  
Gross margin     123,851       109,804                233,655  
                                 
Operating expenses     3,615,614       531,349       2,859,026       7,005,989  
Operating loss     (3,491,763 )     (421,545 )     (2,859,026 )     (6,772,334 )
                                 
Other expenses, net     96,015       (8,050 )     (615,822 )     (527,857
Net loss   $ (3,587,778 )   $ (413,495 )   $ (2,243,204 )   $ (6,244,477 )

 

                 
    For the six months ended October 31, 2022
    Enterprise   Consumer   Corporate   Total
Revenues   $ 1,874,163     $ 2,725,570     $        $ 4,599,733  
Cost of goods sold     1,668,192       2,340,259                4,008,451  
Gross margin     205,971       385,311                591,282  
                                 
Operating expenses     5,276,977       1,026,377       4,758,758       11,062,112  
Operating loss     (5,071,006 )     (641,066 )     (4,758,758 )     (10,470,830 )
                                 
Other expenses, net     159,244       (8,174 )     (565,824 )     (414,754 ) 
Net loss   $ (5,230,250 )   $ (632,892 )   $ (4,192,934 )   $ (10,056,076 )

  

The following table sets forth specific asset categories which are reviewed by our CODM in the evaluation of operating segments:

                 
    As of October 31, 2022
    Enterprise   Consumer   Corporate   Total
Accounts receivable, net   $ 874,439     $ 43,363     $        $ 917,802  
Inventory, net     4,332,532       2,227,560                6,560,092  
Inventory deposits   $ 1,164,884     $ 2,540,969     $        $ 3,705,853  

 

  

Note 21 – Subsequent Events

 

Subsequent events have been evaluated through the date of this filing and there are no subsequent events which require disclosure except as set forth below:

 

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Sale of Consumer Segment

 

On November 21, 2022, the Company entered into a Stock Purchase Agreement (the "SPA") with Unusual Machines, Inc. (“UM”) and Jeffrey Thompson, the founder and Chief Executive Officer of the Company (the “Principal Stockholder”), related to the sale of the Company’s consumer business consisting of Rotor Riot, (“RR”), and Fat Shark Holdings (“FS”), for $18 million in cash and securities of UM.

 

The purchase price consists of (i) $5 million in cash (as increased for positive working capital and decreased for negative working capital at closing) plus (ii) $2.5 million in a convertible senior note of UM (the “Senior Note”) plus (iii) $10.5 million in Series A convertible preferred stock of UM (the “Series A Stock”).  The Senior Note and Series A Stock will be convertible into Common Stock at the lesser of $4.00 per share or the IPO price of UM. The Senior Note and Series A Stock shall contain beneficial ownership blockers under which conversion shall be limited to 4.99% and/or 9.99% of the total voting power of UM, and may be further subject to limitations on voting and conversion required in order to conform with requirements of NASDAQ related to the issuance of more than 19.99% of the outstanding Common Stock in accordance with NASDAQ Rule 5635(d). The Senior Note and Series A Stock will include anti-dilution protection in the case of issuances by UM at a price lower than the then applicable conversion price for so long as the Senior Note or Series A Stock remains outstanding under which the conversion price will be reduced to such lower price as UM shall issue or agree to issue any of its securities.

 

Under the terms of the SPA the Principal Stockholder and UM have agreed to indemnification obligations, which shall survive for a period of 9 months, subject to certain limitations, which includes a basket of $250,000 before any claim can be asserted and a cap equal to the value of the escrow shares, other than in cases involving fraud. The Principal Stockholder agreed to deposit 450,000 shares of UM common stock owned to secure any indemnification obligations.

 

As a condition to closing, UM shall enter into an employment agreement with its Chief Executive Officer including non-compete provisions, which cannot be amended or waived without the prior written consent of the Company. UM, RR and FS will also be subject to non-competition agreements restricting activities involving Class I ISR drones, and for military, government, and enterprise customers.

 

The closing of the SPA is subject to customary closing conditions which include shareholder approval by the Company’s shareholders following filing with the SEC and mailing of the Company’s Proxy Statement on Schedule 14A and the approval of the transactions by a majority of the disinterested shareholders of the Company. The Principal Stockholder, who holds approximately 24% of the voting power of the Company, shall abstain from the vote on approval of the SPA. On November 21, 2022, the Board of Directors of the Company approved the SPA and its submission to shareholders for approval. In addition, closing of the SPA is subject to successful completion of an initial public offering (the “IPO”) by UM in the minimum amount of $15 million, and the listing of UM’s common stock on NASDAQ. The SPA requires the Company to cooperate with UM in connection with the IPO and to deliver audited financial statements of RR and FS. UM has agreed to register all of the common stock for which the Senior Note is convertible in the IPO for resale by the Company, or to pay the note in full with proceeds of the offering at closing, at UM’s election. In addition, UM has agreed to enter into a registration rights agreement for 100% of the common stock for which the Series A Stock may be converted and to use its best efforts to file and have declared effective such registration statement, on demand and on a piggy-back basis in connection with any other registration statements filed by UM.

 

 

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ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion should be read in conjunction with our unaudited condensed consolidated financial statements and related notes and other financial data included elsewhere in this Quarterly Report on Form 10-Q.

 

Management's Discussion and Analysis contains forward-looking statements that involve risks and uncertainties, such as statements relating to our liquidity, and our plans for our business focusing on providing products, services and solutions to the drone industry. Any statements that are not historical fact are forward-looking statements. When used, the words "believe," "plan," "intend," "anticipate," "target," "estimate," "expect," and the like, and/or future-tense or conditional constructions ("will," "may," "could," "should," etc.), or similar expressions, identify certain of these forward-looking statements. These forward-looking statements are subject to risks and uncertainties that could cause actual results or events to differ materially from those expressed or implied by the forward-looking statements in this Quarterly Report on Form 10-Q. The Company's actual results and the timing of events could differ materially from those anticipated in these forward-looking statements as a result of many factors. Investors should also review the risk factors in the Company's Annual Report on Form 10-K filed with the SEC on July 27, 2022.

 

All forward-looking statements speak only as of the date on which they are made. The Company does not undertake any obligation to update such forward-looking statements to reflect events that occur or circumstances that exist after the date of this Quarterly Report on Form 10-Q except as required by federal securities law.

  


Recent Developments

 

Corporate developments during the two years ended October 31, 2022 include:

 

Capital Transactions

 

S-1 Offering

 

On May 4, 2021, the Company closed a firm commitment underwritten public offering (the "S-1 Offering") for the sale of 4,000,000 shares of common stock, at a public offering price of $4.00 per share, to ThinkEquity, a division of Fordham Financial Management, Inc., as representative of the underwriters ("ThinkEquity"), pursuant to an underwriting agreement with Think Equity. The shares were sold pursuant to a registration statement on Form S-1, as amended (File No. 333-253491), filed with the SEC, which was declared effective by the Commission on April 29, 2021 (the "S-1 Registration Statement").  

 

S-3 Offering

 

On July 21, 2021 the Company closed a firm commitment underwritten public offering (the "S-3 Offering") for the sale of 13,333,334 shares of common stock at a purchase price of $4.50 per share to ThinkEquity. The shares were sold pursuant to a registration statement on Form S-3, as amended (File No. 333-256216), filed with the SEC, which was declared effective by the SEC on June 14, 2021 and a Supplement to the Prospectus contained in a registration statement filed with the SEC on July 19, 2021.  



 

Plan of Operations

 

Since April 2016, the Company's primary business has been to provide products, services, and solutions to the drone industry which it presently does through its four wholly owned subsidiaries. Beginning in January 2020, the Company expanded the scope of its drone products and services through four acquisitions, including: 

 

A. In January 2020, the Company acquired Rotor Riot, a provider of First Person View (FPV) drones and equipment, primarily to the consumer marketplace. The purchase price was $1,995,114.

 

B. In November 2020, the Company acquired Fat Shark Holdings, a provider of FPV video goggles to the drone industry. The purchase price was $8,354,076.

 

  26  

 

C. In May 2021, the Company acquired Skypersonic which provides hardware and software solutions that enable drones to complete inspection services in locations where GPS is not available, yet still record and transmit data even while being operated from thousands of miles away. The purchase price was $2,791,012.

 

D. In August 2021, the Company acquired Teal Drones, a leader in commercial and government UAV (Unmanned Aerial Vehicles) technology. The purchase price was $10,011,279.

 

Following the Teal acquisition, we focused on integrating and organizing these businesses.  Effective May 1, 2022, we established the Enterprise and Consumer segments in order to sharpen our focus on the unique opportunities in each sector.  The Enterprise segment, which includes Teal Drones and Skypersonic, is focused on opportunities in the commercial sector, including military.  Enterprise is building the infrastructure to manage drone fleets, fly and provide services remotely, and navigate confined industrial interior spaces and dangerous military environments.  The Consumer segment, which includes Fat Shark and Rotor Riot, is focused on hobbyists and enthusiasts which are expected to increase as drones become more visible in our daily lives.

 

In November 2021, we entered into an agreement to sell our Consumer segment to Unusual Machines for total consideration of $18 million, including $ 5 million in cash, at closing, and $13 million in securities of Unusual Machines.  The Company has determined to focus its efforts and capital on military and defense where it believes that there are more opportunities to create. long term shareholder value. The transaction is expected to close in the first half of calendar 2023 but is contingent upon Unusual Machines completing (i) an initial public offering that raises sufficient capital to close the transaction, and (ii) a listing of its common stock on Nasdaq.  There can be no assurances that the transaction will successfully close.

 

 

Results of Operations

 

The analysis of the Company's results of operations for the three and six months ended October 31, 2022 compared to the three and six months ended October 31, 2021 is significantly impacted by the acquisition of Teal Drones on August 31, 2021. Teal is the Company’s largest operating subsidiary. Since acquiring Teal, the Company has more than tripled the number of employees and significantly expanded its facilities. As a result, the comparison of the three and six months ended October 31, 2022 to the three and six months ended October 31, 2021 yields more significant changes than might normally occur.

  

Three Months Ended October 31, 2022 and October 31, 2021

 

Revenues

 

Revenues totaled $1,530,462 during the three months ended October 31, 2022 (or the "2022 period") compared to $1,863,239 for the three months ended October 31, 2021 (or the "2021 period"), representing a decrease of $332,777, or 18%. Consumer revenues totaled $782,850 during the 2022 period compared to $1,354,807 during the 2021 period, resulting in a decrease of $571,957, or 42%. Fat Shark launched its newest product, the Dominator, in the prior fiscal quarter during which the Consumer segment generated record quarterly revenues.  During the three months ended October 31, 2022, sales decreased sharply for Fat Shark which often happens in the quarter after the launch of new consumer products.  Fat Shark revenues totaled $46,322 during the 2022 period compared to $847,606 during the 2021 period, resulting in a decrease of $801,284, or 95%.  Enterprise revenues totaled $747,612 during the 2022 period compared to $508,432 during the 2021 period, resulting in an increase of $239,180, or 47%. This increase primarily related to Teal, which contributed a full three months of revenue in the 2022 period compared to only two months during the 2021 period. Teal accounted for 81% of Enterprise revenues during the 2022 period. 

 

Cost of Goods Sold

 

Cost of Goods totaled $1,296,807 in the 2022 period compared to $1,710,657 in the 2021 period, representing a decrease of $413,850, or 24%. The decrease directly related to lower revenues which decreased by 18% in the 2022 period compared to the 2021 period. 

 

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Gross Margin

 

Gross margin totaled $233,655 during the three months ended October 31, 2022 compared to $152,582 during the three months ended October 31, 2021, representing an increase of $81,073, or approximately 53%. On a percentage basis, gross margin was 15% during the 2022 period compared to 8% during the 2021 period. The percentage basis increase primarily related to Fat Shark which realized higher margins in the 2022 period related to the launch of its Dominator goggles compared to the 2021 period when it lowered prices to expedite the sale of products near the end of their life cycle. These changes in product offerings increased gross margin for Fat Shark from negative 13% in the 2021 period to positive 6% in the 2022 period.

  

Operating Expenses

 

Operations expense totaled $1,752,873 during the 2022 period compared to $283,249 during the 2021 period, resulting in an increase of $1,469,624, or almost 5 times. Approximately 95% of the increase, or $1,398,669, related to Teal which was acquired on August 31, 2021.  Since acquiring Teal, we have more than tripled its headcount and expanded its facilities. Approximately 38% of Teal's costs related to payroll, 31% to employee-related office expenses, 16% to overhead with the balance spread ratably across numerous categories including facilities, travel, and information technology.

 

Research and development expenses totaled $1,354,914 during the three months ended October 31, 2022 compared to $493,441 during the three months ended October 31, 2021, representing an increase of $861,473, or greater than 100%. Substantially all of the increase related to Teal which was acquired on August 31, 2021.  Since acquiring Teal, we have more than tripled its headcount and expanded its facilities.  Approximately 51% of Teal's expenses related to payroll with 27% related to office, and 21% related to professional fees.

 

Sales and marketing costs totaled $731,769 during the 2022 period compared to $185,385 during the 2021 period, resulting in an increase of $546,384, or almost three times. Payroll costs totaled $385,938 in the 2022 period compared to $108,297 resulting in an increase of $277,641 which represented 51% of the total increase in sales and marketing costs. Meals, travel, and training costs totaled $139,746 in the 2022 period compared to $2,356 resulting in an increase of $137,390 which represented 25% of the total increase. In addition, higher advertising costs represented 12% of the increase.

 

General and administrative expenses totaled $1,919,637 during the three months ended October 31, 2022 compared to $1,050,708 during the three months ended October 31, 2021, representing an increase of $868,929, or 83%. Payroll costs totaled $712,338 in the 2022 period compared to $211,954 in the 2021 period resulting in an increase of $500,384, or 58% of the total increase in general and administrative expenses. Legal and lobbying services costs increased by $241,294 representing 28% of the total increase.

 

During the three months ended October 31, 2022, we incurred stock-based compensation costs of $1,246,796 compared to $899,937 in the 2021 period, resulting in an increase of $346,859 or 39%. Since the 2021 period, the Company has issued 1,159,000 additional options which resulted in incremental stock based compensation costs of $213,351 in the 2022 period. In addition, costs related to restricted stock awards totaled $814,108 during the 2022 period compared to $581,610 during the 2021 period, representing an increase of $232,498, or 67% of the total increase.

 

Other Income

 

Other Income totaled $527,857 during the 2022 period compared to $19,537 during the 2021 period, representing an increase of $508,320. The largest component change was the recognition of income of $686,744 during the 2022 period related to the change in the fair value of derivative liability compared to income of $118,813 during the 2021 period, representing an increase of $567,931. Changes in the fair value of the derivative liability are most significantly impacted by changes in the Company's stock price. A decrease in the stock price during the 2022 period resulted in a decrease in the carrying value of the liability, and therefore, the recognition of income.  In addition, the Company recognized net investment income of $103,817 in the 2022 period compared to net expense of 38,447 during the 2021 period. Early in fiscal 2022, the Company completed two offerings of common stock which generated net proceeds of approximately $70 million. These funds were primarily invested in high quality, corporate debt which generated investment income during the 2022 period. Depreciation and amortization expense, included in other, totaled $227,162 in the 2022 period compared to $21,780 in the 2021 period, resulting in an increase of $205,382, or more than 100%. Since the end of the 2021 period, we have incurred capital expenditures totaling $735,993 through the end of the 2022 period which has resulted in higher depreciation expense. 

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Net Loss

 

Net Loss totaled $6,244,477 during the three months ended October 31, 2022 compared to $2,740,601 during the three months ended October 31, 2021, representing an increase of $3,503,876, or greater than 100%.  The acquisition of Teal Drones on August 31, 2021 accounted for the majority of the increase.  Since acquiring Teal, we have more than tripled its headcount and significantly expanded its facilities. Net loss for Teal during the 2022 period totaled $3,098,709 compared to $441,118 for the 2021 period, representing an increase of $2,657,597, or more than 6 times.  The higher net loss for Teal represented 76% of the increase in the consolidated net loss. 

  

Six Months Ended October 31, 2022 and October 31, 2021

 

Revenues

 

Revenues during the six months ended October 31, 2022 (or the "2022 period") totaled $4,599,733 compared to $3,259,990 for the six months ended October 31, 2021 (or the "2021 period"), representing an increase of $1,339,743, or 41%. Consumer revenues totaled $2,725,570 during the 2022 period compared to $2,710,482 during the 2021 period, resulting in an increase of $15,088, or 1%. Enterprise revenues totaled $1,874,163 during the 2022 period compared to $549,508 during the 2021 period, resulting in an increase of $1,324,655, or greater than 100%. The increase related to Teal, which we acquired on August 31, 2021, and which accounted for 91% of Enterprise revenues during the 2022 period. 

 

Cost of Goods Sold

 

Cost of Goods totaled $4,008,451 in the 2022 period compared to $3,005,004 in the 2021 period, representing an increase of $1,003,447, or 33%. The increase directly related to higher revenues which increased by 41% in the 2022 period compared to the 2021 period.

 

Gross Margin

 

Gross margin totaled $591,282 during the six months ended October 31, 2022 compared to $254,986 during the six months ended October 31, 2021, representing an increase of $336,296, or greater than 100%. On a percentage basis, gross margin was 13% during the 2022 period compared to 8% during the 2021 period. The percentage basis increase primarily related to Fat Shark which realized higher margins in the 2022 period related to the launch of its Dominator goggles compared to the 2021 period when it lowered prices to expedite the sale of products near the end of their life cycle. These changes in product offerings increased gross margin for Fat Shark from 0% in the 2021 period to 13% in the 2022 period. 

 

Operating Expenses

 

Operations expense totaled $2,800,959 during the 2022 period compared to $460,112 during the 2021 period, resulting in an increase of $2,340,847, or more than four times. Approximately 93% of the increase, or $2,176,219, related to Teal which was acquired on August 31, 2021, and therefore, only operated for 2 months in the 2021 period compared to a full six months in the 2022 period.  In addition, we have more than tripled Teal's headcount and doubled the size of its facilities. Approximately 48% of Teal's costs related to payroll, 24% to employee-related office expenses, and 12% to overhead expenses with the balance spread ratably across numerous categories including information technology, facilities, and travel.

 

Research and development expenses totaled $1,887,684 during the six months ended October 31, 2022 compared to $737,695 during the six months ended October 31, 2021, representing an increase of $1,149,989, or greater than 100%. The entire increase can be attributed to Teal, with approximately 54% its expenses related to payroll, 26% related to office, and 17% related to professional fees.

 

Sales and marketing costs totaled $1,334,000 during the 2022 period compared to $286,018 during the 2021 period, resulting in an increase of $1,047,982, or almost four times. Payroll costs, related to hiring at Teal, totaled $676,641 in the 2022 period compared to $158,376 resulting in an increase of $518,265 which represented 49% of the total increase in sales and marketing costs. Travel and related costs totaled $232,239 in the 2022 period compared to $2,356 resulting in an increase of $229,883 which represented 22% of the total increase. In addition, higher advertising and show production costs represented 15% of the increase while professional fees accounted for 10%.

 

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General and administrative expenses totaled $3,037,202 during the six months ended October 31, 2022 compared to $1,926,888 during the six months ended October 31, 2021, representing an increase of $1,110,314, or 58%. Payroll costs totaled $1,122,882 in the 2022 period compared to $409,387 in the 2021 period resulting in an increase of $713,495, or 64% of the total increase in general and administrative expenses. Legal and lobbying services costs increased by $269,938 representing 24% of the total increase.

 

During the six months ended October 31, 2022, we incurred stock-based compensation costs of $2,002,267 compared to $1,284,023 in the 2021 period, resulting in an increase of $718,244 or 56%.  Since the 2021 period, the Company has issued 1,159,000 additional options which resulted in incremental stock based compensation costs of $354,343 in the 2022 period. In addition, costs related to restricted stock awards totaled $1,111,556 during the 2022 period compared to $778,202 during the 2021 period.

 

Other Income

 

Other income totaled $414,754 during the 2022 period compared to $141,377 during the 2021 period, representing an increase of $273,377. The largest component change was the recognition of income of $593,822 during the 2022 period related to the change in the fair value of derivative liability compared to income of $273,061 during the 2021 period, representing an increase of $320,761. Changes in the fair value of the derivative liability are most significantly impacted by changes in the Company's stock price. A decrease in the stock price during the 2022 period resulted in a decrease in the carrying value of the liability, and therefore, the recognition of income. In addition, the Company recognized net investment income of $234,113 in the 2022 period compared to expense of 38,447 during the 2021 period. Early in fiscal 2022, the Company completed two offerings of common stock which generated net proceeds of approximately $70 million. These funds were primarily invested in high quality, corporate debt which generated investment income during the 2022 period. Depreciation and amortization expense, included in other, totaled $311,594 in the 2022 period compared to $38,106 in the 2021 period, resulting in an increase of $273,488, or more than 100%. Since the end of the 2021 period, we have incurred capital expenditures totaling $1,280,935 through the end of the 2022 period which has resulted in higher depreciation expense. 

 

Net Loss

 

Net Loss totaled $10,056,076 during the six months ended October 31, 2022 compared to $4,298,373 during the six months ended October 31, 2021, representing an increase of $5,757,703, or greater than 100%. The acquisition of Teal Drones in August 2021 accounted for the majority of the increase. Since acquiring Teal, we have more than tripled its headcount and significantly expanded its facilities. Net loss for Teal during the 2022 period totaled $4,805,548 compared to $441,118 for the 2021 period, representing an increase of $4,364,430, or almost ten times. The higher net loss for Teal represented 76% of the increase in the consolidated net loss.

 

Cash Flows

  

Operating Activities

 

Net cash used in operating activities was $13,534,139 during the six months ended October 31, 2022, compared to net cash used in operating activities of $8,567,507 during the six months ended October 31, 2021, representing an increase of $4,966,632, or 58%. Net cash used in operations, net of non-cash expenses totaling $1,748,455, equaled $8,307,621 in the 2022 period compared to $2,998,905, net of non-cash expenses totaling $1,299,468 in the 2021 period, resulting in an increase of $5,308,716, or greater than 100%. The higher use of cash primarily related to the acquisition of Teal Drones in August 2021 which resulted in a full six months of operations in the 2022 period compared to two months of operations in the 2021 period.  Net cash used related to changes in operating assets and liabilities totaled $5,226,518 during the six months ended October 31, 2022, compared to $5,568,602 during the six months ended October 31, 2021, representing a decrease of $342,084, or 6%. Changes in operating assets and liabilities can fluctuate significantly from period to period depending upon the timing and level of multiple factors, including inventory purchases and vendor payments. 

 

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Investing Activities

 

Net cash provided by investing activities was $11,960,901 during the six months ended October 31, 2022, compared to net cash used in investing activities of $48,127,938 during the six months ended October 31, 2021 resulting in an increase of $60,088,839, or greater than 100%. During the 2022 period, net proceeds of $13,241,836 from the maturities of marketable securities were used to fund operations, and $1,280,935 was used to purchase property and equipment, primarily related to the expansion of the manufacturing facilities for Teal. During the 2021 period, almost $50 million of proceeds from stock offerings were invested in marketable securities.

 

Financing Activities

 

Net cash used in financing activities totaled $928,826 during the six months ended October 31, 2022, compared to net cash provided by financing activities of $67,977,856 during the six months ended October 31, 2021. Financing activities can vary from period to period depending upon market conditions, both at a macro-level and specific to the Company. During the 2021 period, the Company received net proceeds of approximately $70 million in connection with two offerings of common stock.

 

Liquidity and Capital Resources

 

At October 31, 2022, the Company reported current assets totaling $44,816,972, current liabilities totaling $4,521,287 and net working capital of $40,295,685. Cash and marketable securities totaled $32,885,639 at October 31, 2022. Inventory related balances, including pre-paid inventory, totaled $10,265,945. We continue to maintain higher-than-normal inventory balances related to the global supply chain issues, including chip shortages, which have been ongoing for more than a year. At October 31, 2022, the Company was in a strong liquidity and capital position relative to its operating results for the quarter ended October 31, 2022 and its expected cash requirements for the next twelve months.

  

Capital Transactions

 

 

S-1 Offering

 

On May 4, 2021, the Company closed a firm commitment underwritten public offering (the "S-1 Offering") for the sale of 4,000,000 shares of common stock, at a public offering price of $4.00 per share, to ThinkEquity, a division of Fordham Financial Management, Inc., as representative of the underwriters ("ThinkEquity"), pursuant to an underwriting agreement with Think Equity. The shares were sold pursuant to a registration statement on Form S-1, as amended (File No. 333-253491), filed with the SEC, which was declared effective by the Commission on April 29, 2021 (the "S-1 Registration Statement").  

 

  

S-3 Offering

 

On July 21, 2021 the Company closed a firm commitment underwritten public offering (the "S-3 Offering") for the sale of 13,333,334 shares of common stock at a purchase price of $4.50 per share to ThinkEquity. The shares were sold pursuant to a registration statement on Form S-3, as amended (File No. 333-256216), filed with the SEC, which was declared effective by the SEC on June 14, 2021 and a Supplement to the Prospectus contained in a registration statement filed with the SEC on July 19, 2021.  

 

 

Going Concern

 

We only began generating revenues in January 2020 and have reported net losses since inception.  We expect to report net losses for at least the next twelve months.  To date, we have funded our operations through debt and equity transactions.  In May and July 2021, we completed common stock offerings which generated gross proceeds of approximately $70 million.  At October 31, 2022, we reported cash and investment balances of approximately $33 million.  We expect these financial resources to be sufficient to fund our operations for at least the next twelve months.  However, we can provide no assurance that these financial resources will be sufficient to fund our operations until we reach profitability.  If we are unable to become profitable before expending our current financial resources, we will need to raise additional capital through equity or debt transactions.  We can provide no assurance that such additional financing, if required, will be available to us on acceptable terms, or at all. If we are unable to become profitable or obtain sufficient funding, our business, prospects, financial condition and results of operations will be materially and adversely affected, and we may be unable to continue as a going concern.  

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Critical Accounting Policies and Estimates

 

Our financial statements and accompanying notes have been prepared in accordance with GAAP applied on a consistent basis. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods.

 

We regularly evaluate the accounting policies and estimates that we use to prepare our financial statements. A complete summary of these policies is included in the notes to our financial statements. In general, management's estimates are based on historical experience, information from third party professionals, and on various other assumptions that are believed to be reasonable under the facts and circumstances. Actual results could differ from those estimates made by management. 

 

Significant estimates reflected in these financial statements include those used to (i) determine stock-based compensation, (ii) complete purchase price accounting for acquisitions, and (iii) accounting for derivatives.

 

Off-Balance Sheet Arrangements

 

We have no off-balance sheet arrangements.

 

Recently Issued Accounting Pronouncements

 

The Company has implemented all new accounting pronouncements that are in effect. These pronouncements did not have any material impact on the financial statements unless otherwise disclosed, and the Company does not believe that there are any other new accounting pronouncements that have been issued that might have a material impact on its financial position or results of operations. 

 

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

We are a smaller reporting company and are not required to provide this information.

 

 

ITEM 4. CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls and Procedures

 

Disclosure controls and procedures are controls and procedures that are designed to ensure that information required to be disclosed in our reports filed under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC's rules. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by our company in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. Our management carried out an evaluation under the supervision and with the participation of our Principal Executive Officer and Principal Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rules 13a-15(e) and 15d-15(e) under the Exchange Act. Based upon that evaluation, our Principal Executive Officer and Principal Financial Officer have concluded that our disclosure controls and procedures were effective as of October 31, 2022.

 

Changes in Internal Control over Financial Reporting

 

During the period covered by this report, there were no changes in our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. 

  

 

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PART II - OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

On March 15, 2022, Robert Stang filed an action against Teal Drones, Inc. and George Matus in the United States District Court for the Northern District of California, Robert Stang v. Teal Drones, Inc. and George Matus (No. 22-cv-01586-JSC) and on September 15, 2022 filed a First Amended Complaint naming our former director Benjamin Lambert as an additional defendant.  The complaint asserts claims for breach of contract and unlawful conversion and sale of shares of common stock that plaintiff alleges to have purchased.  The Complaint also alleges breach of fiduciary duty and seeks in excess of $1 million in damages. The Company has filed an Answer and on November 4, 2022 a Motion to Dismiss on behalf of Mr. Lambert.  In connection with the action the Company has notified the sellers of Teal of its intention to pursue indemnification claims under the Teal acquisition agreement and escrow. 

 

On December 5, 2022 the Company and Teal filed a First Amended Complaint in an action brought against Autonodyne LLC and its founder Daniel Schwinn in the Court of Chancery of the State of Delaware alleging, among other things, breach of an exclusive license agreement by Autonodyne, LLC dated May 23, 2022 and tortious interference by Mr. Schwinn, Red Cat Holdings, Inc. and Teal Drones, Inc. v. Autonodyne LLC and Daniel Schwinn (No. 2022-0878-NAC).  On October 21, 2022, Autonodyne and Schwinn filed a Motion to Dismiss the Complaint and Motion for Confidential Treatment. 

 

 

ITEM 1A. RISK FACTORS

 

We are a smaller reporting company as defined by Rule 12b-2 of the Securities Exchange Act of 1934 (the "Exchange Act") and are not required to provide the information. Our most recent risk factor disclosures may be review in our Annual Report on Form 10-K for the year ended April 30, 2022, as filed with the SEC on July 27, 2022.

 

 

ITEM 2. RECENT UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS 

 

There were no sales of equity securities sold during the period covered by this Report that were not registered under the Securities Act and were not previously reported in a Current Report on Form 8-K filed by the Company.

 

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

 

None.  

 

 

ITEM 4. MINE SAFETY DISCLOSURES

 

Not applicable 

 

 

ITEM 5. OTHER INFORMATION

 

None.  

 

 

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ITEM 6. EXHIBITS

 

Exhibit   Description
31.1   Certification of Principal Executive Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2   Certification of Principal Financial and accounting Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1   Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2   Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

101.INS   XBRL Instance Document
101.SCH   XBRL Taxonomy Extension Schema Document
101.CAL   XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF   XBRL Taxonomy Extension Definition Linkbase Document
101.LAB   XBRL Taxonomy Extension Label Linkbase Document
101.PRE   XBRL Taxonomy Extension Presentation Linkbase Document

-------

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

Date: December 15, 2022  

Red Cat Holdings, Inc.

 

 

By: /s/ Jeffrey Thompson

Jeffrey Thompson

Chief Executive Officer

(Principal Executive Officer)

     
Date: December 15, 2022   By: /s/ Joseph P. Hernon
   

Joseph Hernon

Chief Financial Officer

(Principal Financial and Accounting Officer)

 

 

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