Red Cat Holdings, Inc. 10-Q

ITEM 1. FINANCIAL STATEMENTS RED CAT HOLDINGS Condensed Consolidated Balance Sheets (Unaudited) January 31, April 30, 2021 2020 ASSETS Current Assets Cash $ 471,652 $ 236,668 Accounts Receivable, net 312,414 - Inventory 708,017 78,650 Other 505,865 3,020 Total Current Assets 1,997,948 318,338 Goodwill 9,449,333 2,466,073 Intangible assets, net 631,429 20,000 Other 3,853 3,853 TOTAL ASSETS 12,082,563 2,808,264 LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities Accounts payable 873,312 249,050 Accrued Expenses 209,804 89,342 Notes Payable 177,279 118,771 Due to Related Party 395,544 333,684 Customer deposits 96,580 38,419 Derivative liability 9,144,226 - Total Current Liabilities 10,896,745 829,266 Convertible debentures, net 79,187 450,000 Due to Related Party 1,753,000 - Total Long Term Liabilities 1,832,187 450,000 Commitments and contingencies Stockholders' Equity Series A Preferred Stock - shares authorized 2,200,000; outstanding 158,704 and 208,704 1,587 2,087 Series B Preferred Stock - shares authorized 4,300,000; outstanding 2,726,882 and 3,681,623 27,269 36,816 Common stock - shares authorized 500,000,000; outstanding 27,160,926 and 20,011,091 27,161 20,011 Additional paid-in capital 11,961,152 4,043,837 Accumulated deficit (12,663,538 ) (2,573,753 ) Total Stockholders' Equity (646,369 ) 1,528,998 TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 12,082,563 $ 2,808,264 See accompanying notes. 4 RED CAT HOLDINGS Condensed Consolidated Statements Of Operations (Unaudited) Three months ended January 31, Nine months ended January 31, 2021 2020 2021 2020 Revenues $ 2,145,988 $ 34,538 $ 3,122,077 $ 34,538 Cost of goods sold 1,576,265 16,234 2,351,153 16,234 Gross Margin 569,723 18,304 770,924 18,304 Operating Expenses Operations 146,539 - 353,295 - Research and development 167,968 94,979 341,892 354,146 Sales and marketing 48,719 - 97,534 - General and administrative 499,155 212,482 929,874 478,871 Stock based compensation 854,195 149,462 1,068,317 161,529 Total operating expenses 1,716,576 456,923 2,790,912 994,546 Operating loss (1,146,853 ) (438,619 ) (2,019,988 ) (976,242 ) Other Expense Amortization Expense 5,571 - 5,571 - Derivative Expense 4,481,701 - 4,630,288 - Change in Fair Value of Derivative 3,350,135 - 3,433,938 - Other Expense $ 7,837,407 $ - $ 8,069,797 $ - Net loss $ (8,984,260 ) $ (438,619 ) $ (10,089,785 ) $ (976,242 ) Loss per share - basic and diluted $ (0.34 ) $ (0.02 ) $ (0.46 ) $ (0.08 ) Weighted average shares outstanding - basic and diluted 26,232,755 17,732,298 22,161,745 11,556,950 5 RED CAT HOLDINGS, INC. Consolidated Statements of Changes in Stockholders' Equity (Unaudited) Series A Series B Common Stock Additional Preferred Stock Preferred Stock Paid-in Accumulated Total Shares Amount Shares Amount Shares Amount Capital Deficit Equity Balances, April 30, 2019 - - - - $ 179,292 $ 179 $ 784,371 $ (971,822 ) $ (187,272 ) Issuance of common stock 15,355 15 684,685 684,699 Share Exchange Agreement 2,169,068 21,691 4,212,645 42,126 196,667 197 53,740 117,754 Conversion of Preferred Stock (1,960,364 ) (19,604 ) (240,000 ) (2,400 ) 16,536,164 16,536 5,467 - Shares Issued for Services 1,570 2 69,998 70,000 Net Loss (321,502 ) (321,502 ) Balances, July 31, 2019 208,704 2,087 3,972,645 39,726 16,929,048 16,929 1,598,261 (1,293,324 ) 363,679 Stock based compensation 12,067 12,067 Net Loss (216,121 ) (216,121 ) Balances, October 31, 2019 208,704 2,087 3,972,645 39,726 16,929,048 16,929 1,610,328 (1,509,445 ) 159,625 Exercise of warrants 469,874 470 151,769 152,239 Conversion of Preferred Stock (291,022 ) (2,910 ) 242,519 243 2,668 - Merger with Rotor Riot 2,219,650 2,220 1,817,893 1,820,113 Stock based compensation 149,462 149,462 Net Loss (438,619 ) (438,619 ) 6 Balances, January 31, 2020 208,704 2,087 3,681,623 36,816 19,861,091 19,861 3,732,120 (1,948,064 ) 1,842,820 Balances, April 30, 2020 208,704 2,087 3,681,623 36,816 20,011,091 20,011 4,043,837 (2,573,753 ) 1,528,998 Stock based compensation 107,061 107,061 Net Loss (383,244 ) (383,244 ) Balances, July 31, 2020 208,704 2,087 3,681,623 36,816 20,011,091 20,011 4,150,898 (2,956,997 ) 1,252,815 Conversion of Debt 710,444 711 494,314 495,025 Stock based compensation 107,061 107,061 Net Loss (722,281 ) (722,281 ) Balances, October 31, 2020 208,704 $ 2,087 3,681,623 $ 36,816 20,721,535 $ 20,722 $ 4,752,273 $ (3,679,278 ) $ 1,132,620 Acquisition of Fat Shark 5,227,273 5,227 6,345,849 6,351,076 Conversion of Preferred Stock (50,000 ) (500 ) (954,741 ) (9,547 ) 1,212,118 1,212 8,835 - Stock based compensation 854,195 854,195 Net Loss (8,984,260 ) (8,984,260 ) Balances, January 31, 2021 158,704 $ 1,587 2,726,882 $ 27,269 27,160,926 $ 27,161 $ 11,961,152 $ (12,663,538 ) $ (646,369 ) 7 RED CAT HOLDINGS, INC. Condensed Consolidated Cash Flows Statements (Unaudited) Nine months ended January 31, 2021 2020 Cash Flows from Operating Activities Net loss $ (10,089,785 ) $ (976,242 ) Stock based compensation 1,068,317 161,529 Amortization of intangible assets 5,571 - Amortization of debt discount 79,187 - Derivative expense 4,630,288 - Change in fair value of derivative 3,433,938 - Adjustments to reconcile net loss to net cash from operations: Changes in operating assets and liabilities Accounts receivable (63,255 ) - Inventory (405,987 ) 4,105 Other (118,613 ) 77,670 Customer deposits 32,967 - Accounts payable 345,227 38,152 Accrued expenses 165,129 (9,865 ) Net cash used in operating activities (917,016 ) (704,651 ) Cash Flows from Investing Activities Acquired through acquisitions - 46,327 Payment for acquisition, net of cash acquired (48,368 ) - Net cash (used in) provided by investing activities (48,368 ) 46,327 Cash Flows from Financing Activities Proceeds from exercise of warrants - 152,239 Proceeds from related party obligations 79,000 - Payments under related party obligations (17,140 ) - Proceeds from notes payable 424,419 - Payments under notes payable (365,911 ) (4,490 ) Proceeds from convertible debentures 1,080,000 450,000 Net cash provided by financing activities 1,200,368 597,749 Net increase (decrease) Cash 234,984 (60,575 ) Cash, beginning of period 236,668 503,438 Cash, end of period $ 471,652 $ 442,863 Cash paid for interest 10,749 - Cash paid for taxes - - Noncash transactions Common stock issued for services $ - $ 70,000 Fair value of shares exchanged in acquisitions $ 6,351,076 $ 1,937,867 Issuance of Note Payable – Related Party in acquisition $ 1,753,000 $ - Conversion of Notes into common stock $ 450,000 $ - Conversion of accrued interest into common stock $ 45,024 $ - See accompanying notes. 8 RED CAT HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS January 31, 2021 and 2020 (unaudited) Our unaudited interim condensed 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 condensed 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, 2020 of Red Cat Holdings, Inc. (the “Company” or “Red Cat”), filed with the Securities and Exchange Commission (“SEC”) on August 13, 2020. Note 1 - The Business 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. It operates in two sectors of the drone industry. Rotor Riot, LLC, an Ohio limited liability company and a wholly owned subsidiary (“Rotor Riot”), designs and sells drones and related components. Rotor Riot is focused on the consumer market and sells its products through its e-commerce platform operated at www.rotorriot.com. The Company is also developing software solutions to provide secure cloud-based analytics, storage and services for the drone industry. Its initial product candidate is Dronebox, a blockchain technology that records, stores and analyzes flight data and information from a drone, much like the “black box” utilized by the airline industry. The Company plans to offer Dronebox as a Software-as-a-Service platform. The Company closed the acquisition of Fat Shark Holdings (“Fat Shark”) on November 2, 2020. Fat Shark is a leading provider of headsets and goggles for professional FPV (First Person View) racers and drone pilots and has an estimated 85% share of its market. The Company expects that Fat Shark will generate a majority of its revenue over the next 12 months. This acquisition continues the Company’s efforts to become a fully-integrated drone business with a strong supply chain, as well as a provider of software solutions for the drone industry. Recent corporate developments include: A. The Share Exchange Agreement Effective May 15, 2019, we closed a Share Exchange Agreement (the “SEA”) with TimeFireVR, Inc., (“TimeFire”), a Nevada corporation. Under the SEA, we acquired approximately 83.33% of TimeFire’s outstanding share capital on a fully-diluted basis. We issued: (i) 196,667 shares of our common stock, (ii) 2,169,068 shares of our newly-designated Series A Preferred Stock, and (iii) 4,212,645 shares of our newly-designated Series B Preferred Stock. In total, the common stock, Series A Preferred Stock, and Series B Preferred Stock issued under the SEA were valued at $117,754. The transaction was accounted for as a “reverse acquisition” as the stockholders of Red Cat possessed majority voting control of the company immediately following the acquisition. In this reverse merger, the financial results of Red Cat Propware, Inc., (the accounting acquirer), have been presented as the continuing operations of the Company since inception. The transaction was accounted for as follows: Cash $ 24,704 Goodwill 93,050 Total $ 117,754 Series A Preferred Stock is convertible to common stock at a ratio of 8.33 shares of common stock for each share of preferred stock and votes together with the common stock on an as-converted basis. The new Series A Preferred Stock converted automatically to common stock upon the effectiveness of the reverse split of our common stock in August 2019 except for shares subject to an ownership limitation. This common stock and Series A Preferred Stock issued under the SEA constituted approximately 83.33% of our issued and outstanding share capital on a fully-diluted basis on the date of issuance. Series B Preferred Stock is convertible to common stock at a ratio of 0.83 shares of common stock for each share of preferred stock and votes together with the common stock on an as-converted basis. The Series B Preferred Stock issued under the SEA constituted approximately 15.64% of our issued and outstanding share capital on a fully-diluted basis on the date of issuance. 9 B. Organizational In July 2019, we changed our name from TimeFire VR Inc. to Red Cat Holdings, Inc. In August 2019, we changed our fiscal year to April 30 which was the historical fiscal year of Red Cat Propware, Inc. In August 2019, we effected a reverse stock split (the “Reverse Stock Split”) of our outstanding shares of common stock at a ratio of one-for-twelve hundred (1 for 1,200). All references in this report to shares of the Company’s common stock, including prices per share of its common stock, reflect the Reverse Stock Split. C. Merger Agreement with Rotor Riot, LLC On December 31, 2019, the Company entered into an Agreement of Merger (the “Merger Agreement”) with Rotor Riot and the three members of Rotor Riot. On January 23, 2020, the Merger was consummated under which Rotor Riot Acquisition Corp, a wholly owned Delaware subsidiary of the Company, merged with and into Rotor Riot, with Rotor Riot continuing as the surviving entity and a wholly owned subsidiary of the Company. Under the Merger Agreement, each member of Rotor Riot received its pro rata portion of the total number of shares of the Company’s common stock issued based on (A)(i) $3,700,000 minus (ii) $915,563 (which included certain debt and other obligations of Rotor Riot and its Chief Executive Officer that the Company agreed to assume (the “Assumed Obligations”) divided by (B) the variable weighted average price (“VWAP”) of the Company’s common stock for the twenty trading days prior to the closing of the Merger. Based on a share issuance value of $2,784,437 and a VWAP of $1.25445, the Company issued an aggregate of 2,219,650 shares of common stock to the members of Rotor Riot. Following the closing of the Merger Agreement, the former members of Rotor Riot owned approximately 10.4% of the Company. In addition, the Company’s management controls the operating decisions of the combined company. Accordingly, we have accounted for the transaction as an acquisition of Rotor Riot by the Company. Based on purchase price accounting, we have recognized the assets and liabilities of Rotor Riot at fair value with the excess of the purchase price over the net assets acquired recognized as goodwill. The table below reflects the Company’s estimates of the acquisition date values of the purchase consideration, assets acquired, and liabilities assumed. The shares issued were valued at $1,820,113 (2,219,650 shares issued times $0.82 per share which equaled the closing price of the Company’s common stock on the date that the merger agreement was consummated). I. Purchase Price Shares issued $ 1,820,114 Promissory note issued $ 175,000 Total Purchase Price $ 1,995,114 II. Purchase Price Allocation Assets Acquired Cash $ 21,623 Accounts receivable 28,500 Other assets 3,853 Inventory 127,411 Trademark 20,000 Brand Name 578,000 Customer Relationships 39,000 Goodwill 1,756,023 Total assets acquired $ 2,574,410 Liabilities Assumed Accounts Payable and accrued expenses $ 171,651 Notes payable 209,799 Due to Related Party 197,846 Total liabilities assumed 579,296 Net assets acquired $ 1,995,114 10 During the quarter ended January 31, 2021, the Company adjusted the initial carrying value of Goodwill to reflect the values of other intangible assets acquired as determined by an independent valuation services firm. These included Customer Relationships with a value of $39,000 and Brand Name with a value of $578,000. Customer relationships are being amortized over 7 years. The carrying value of Brand Name will be evaluated on a quarterly basis, including a formal evaluation at year end. D. 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 which matures on November 1, 2023, and (iii) a cash payment of $250,000. The Share Purchase Agreement includes 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 initial purchase price allocation is as follows: I. Purchase Price Shares issued $ 6,351,076 Promissory note issued 1,753,000 Cash 250,000 Total Purchase Price $ 8,354,076 II. Purchase Price Allocation Assets Acquired Cash $ 201,632 Accounts receivable 249,159 Other assets 384,232 Inventory 223,380 Goodwill 7,600,260 Total assets acquired $ 8,658,663 Liabilities Assumed Accounts Payable and accrued expenses $ 279,393 Customer Deposits 25,194 Total liabilities assumed 304,587 Net assets acquired $ 8,354,076 The foregoing amounts reflect our current estimates of fair value as of the November 2, 2020 acquisition date. The Company expects to recognize fair values associated with the customer relationships acquired, as well as the Fat Shark brand name, but has not yet accumulated sufficient information to assign such values. As additional information becomes known regarding the acquired assets and assumed liabilities, management may make adjustments to the opening balance sheet up to the end of the measurement period, which is a one-year period following the acquisition date. The determination of the fair values of the acquired assets and liabilities assumed (and the related determination of estimated lives of depreciable tangible and intangible assets) requires significant judgement. Convertible Note Offering On October 5, 2020, the Company closed a private offering of convertible promissory notes (the “2020 Notes”) in the aggregate principal amount of $600,000 which included the issuance of five-year warrants to purchase an aggregate of 399,998 shares of common stock. The 2020 Notes accrue interest at the rate of 12% per annum and are payable two years from the date of issuance. The 2020 Notes are convertible into common stock at a conversion price equal to the lower of (i) $1.00 per share or, (ii) at a price equal to 75% of the price of an offering of common stock that results in the listing for trading on certain stock exchanges (a “Qualified Offering”). The 2020 Notes also contain protection from dilution which would lower the conversion price in the event of a lower priced issuance. An event of default could also result in a reduction of the conversion price. 11 The Company may prepay any portion of the 2020 Notes, without penalty or premium, upon ten business days’ notice. No conversion will be completed if it would result in the noteholder, including its affiliates, owning more than 9.99% of the Company’s outstanding common stock immediately after completing such conversion. The Warrants are exercisable at $1.50 per share. The exercise price will be reduced to a price equal to 75% of the price per share of the common stock offered in a Qualified Offering. On January 27, 2021, the Company closed a private offering of convertible promissory notes (the “2021 Notes”) in the aggregate principal amount of $500,000 which included the issuance of five-year warrants to purchase a number of shares of common stock equal to 135% of the dollar amount of the Note. The 2021 Notes accrue interest at the rate of 12% per annum and are payable two years from the date of issuance. The 2021 Notes are convertible into common stock at a conversion price equal to the lower of (i) $1.00 per share, if the conversion occurs prior a Qualified Offering, or (ii) a 25% discount of the price per share of common stock offered in the Qualified Offering, if the conversion occurs simultaneous with the Qualified Offering. The Company may prepay any portion of the 2021 Notes, without penalty or premium, upon ten business days’ notice. 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 the Qualified Offering. Note 2 - Going Concern The financial statements have been prepared on a going concern basis which contemplates the realization of assets and the settlement of liabilities and commitments in the normal course of business. As reflected in our accompanying financial statements, we have negative working capital of $8,898,797 at January 31, 2021 and have accumulated losses totaling approximately $12.7 million through January 31, 2021. Management recognizes that these operating results and our financial position raise substantial doubt about our ability to continue as a going concern. The financial statements do not include any adjustments related to the recoverability and classification of recorded asset amounts and the classification of liabilities that might be necessary should we be unable to continue as a going concern. We are presently seeking to address these going concern doubts through a number of actions including efforts to (a) raise capital through the public markets, (b) release additional commercial products and (c) pursue acquisitions of complementary, revenue generating companies which are accretive to our operating results. We can provide no assurance that any of these efforts will be successful or, that even if successful, that they will alleviate doubts about our ability to continue as a going concern. Note 3 - Summary of Significant Accounting Policies Basis of Accounting - The financial statements and accompanying notes are prepared in accordance with GAAP. Principles of Consolidation – Our condensed consolidated financial statements include the accounts of our subsidiaries, Red Cat Propware, Inc., Rotor Riot, LLC, and Fat Sharking Holdings. 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 and (ii) complete purchase price accounting for acquisitions. Cash – At January 31, 2021, we had cash of $471,652 in multiple commercial banks and financial services companies. We have not experienced any loss on these accounts and believe they are not exposed to any significant credit risk. Other Assets – Other Assets at January 31, 2021 include $473,545 of prepaid inventory, $22,948 of prepaid expenses, and $9,372 of security deposits. Leases – Leases at January 31, 2021 are short term in nature and do not require accounting under the lease accounting standards. 12 Goodwill – Goodwill represents the excess of the purchase price of an acquisition over the estimated fair value of identifiable net assets acquired. The measurement periods 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 the adjustments are determined. We perform an impairment test at the end of each fiscal year, or more frequently if indications of impairment arise. We have a single reporting unit, and consequently, evaluate goodwill for impairment based on an evaluation of the fair value of the Company as a whole. Fair Value of Financial instruments – FASB ASC 820, “Fair Value Measurements and Disclosures” (“ASC 820”), provides rules for assets and liabilities measured at fair value on a recurring basis. ASC 820 establishes a common definition for fair value to be applied to existing generally accepted accounting principles that require the use of fair value measurements, and establishes a framework for measuring fair value and expands disclosure about such fair value measurements. ASC 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Additionally, ASC 820 requires the use of valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. These inputs are prioritized below: Level 1: Observable inputs such as quoted market prices in active markets for identical assets or liabilities Level 2: Observable market-based inputs or unobservable inputs that are corroborated by market data Level 3: Unobservable inputs for which there is little or no market data, which require the use of the reporting entity’s own assumptions. The Company accounts for its derivative liabilities, at fair value, on a recurring basis under level 2. Convertible Securities and Derivatives – The Company estimates the fair values of the debt and warrants, and allocates the proceeds pro rata based on these values. The allocation of proceeds to the warrants results in the debt instrument being recorded at a discount from the face amount of the debt and the value allocated to the warrant is recorded to additional paid-in capital. When the convertible debt or equity instruments 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. 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 received. Customers pay at the time they order and 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 $96,580 and $38,419 at January 31, 2021 and April 30, 2020, 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. 13 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 condensed consolidated financial statements. Comprehensive Loss –During the three and nine months ended January 31, 2021 and 2020, there were no differences between net loss and comprehensive loss. Therefore, the consolidated statements of comprehensive loss have been omitted. Stock-Based Compensation – We use the estimated grant-date fair value method of accounting in accordance with ASC Topic 718, Compensation – Stock Compensation. Fair value is determined using the Black-Scholes Model using inputs reflecting our estimates of expected volatility, term and future dividends. We plan to estimate the forfeiture rate based on our historical experience but have made no such allowance to date as our first issuances of stock based awards occurred in October 2019 and we have not experienced any forfeitures to date. We recognize compensation costs on a straight line basis over the service period which is generally 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 exercise of these common stock equivalents would dilute earnings per share if we become profitable in the future. 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 13. Note 4 - Notes Payable A. 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. In November 2019, Rotor Riot entered into an agreement with PayPal under which it borrowed $100,000. The note was repaid in January 2021. In January 2021, Rotor Riot borrowed $75,444 from PayPal which is being repaid through daily payments equal to 20% of the net amount of each customer payment. The balance outstanding at January 31, 2021 was $75,369. B. 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 finance charge, in full, in the month in which the agreement is executed. The Company assumed an existing agreement when it acquired Rotor Riot in January 2020. This agreement was repaid in May 2020. Since then, the Company has entered into the following agreements with Shopify: Date of Transaction Purchased Receivables Payment to Company Withholding Rate Status at January 31, 2021 May 2020 $158,200 $140,000 17% Completed – October 2020 September 2020 $209,050 $185,000 17% $101,910 Outstanding Note 5 - Due to Related Party A. Short Term I. Note Payable to BRIT, LLC BRIT, LLC, formally known as Brains Riding in Tanks, LLC, was the largest shareholder of Rotor Riot. Following the Merger, BRIT is a significant shareholder in the Company. The controlling shareholder of BRIT is now employed in a management role with the Company. 14 Under the terms of the Merger Agreement, the Company issued a promissory note to BRIT, LLC in the principal amount of $175,000. The promissory note bears interest at 4.75% annually and provides for monthly principal payments of $3,500. The outstanding principal amount and all accrued interest is due on the earlier of (a) January 23, 2021 or (b) the closing of an equity offering by the Company of at least $3,500,000. The principal balance and accrued interest on the note totaled $153,814 and $8,517 at January 31, 2021, respectively. II. Obligations of BRIT, LLC BRIT incurred certain financial obligations in support of the operations of Rotor Riot which the Company assumed responsibility to pay at the effective time of the Merger. These obligations bear interest at annual rates ranging from 7.5% to 21.74%. The outstanding balance totaled $167,730 at January 31, 2021. III. Payable to Aerocarve In August 2020 and December 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 owed at January 31, 2021 was $74,000. B. Long Term I. Payable to Greg French In connection with the acquisition of Fat Shark as of November 2, 2020, the Company issued a secured promissory note in the amount of One Million Seven Hundred Fifty-Three Thousand Dollars ($1,753,000) to the seller, Greg French, which matures on November 1, 2023. The note bears interest at 3% annually . Note 6 - Convertible Debentures In November 2019, we issued a convertible note in the principal amount of $300,000 to one accredited investor and in December 2019, we issued a convertible note in the principal amount of $125,000 to a director and a convertible note in the principal amount of $25,000 to our chief executive officer (collectively, the “2019 Notes”). In September and October 2020, the entire $450,000 of 2019 Notes, plus accrued interest totaling $45,204, was converted into 710,444 shares of common stock. The Notes had a term of 2 years and accrued interest at an annual rate of 12% through the date of conversion. In October 2020, we closed a private offering in which we sold $600,000 of convertible promissory notes (“Promissory Notes”) and issued warrants to purchase 399,998 shares of common stock. The Promissory Notes accrue interest at 12% annually, and the principal and accrued interest is due two (2) years from the date of issuance. The Promissory Notes are convertible into shares of our common stock at a price equal to the lower of $1.00, or (b) at a price equal to 75% of the price of securities sold in a Qualified Offering. The terms of a Promissory Note will be amended if a holder believes that a security issued, or amended, after the issuance of the Promissory Note includes any term or provision more favorable than those provided in the Notes. The warrants are exercisable for five (5) years and entitle the holder to purchase common shares at a price equal to the lower of (i) $1.50, or (ii) a 25% discount to the price per share of common stock offered in a Qualified Offering. In March 2021, the Company received notice from 100% of the holders of their intent to convert the entire amount of their Notes, plus accrued interest, into shares of common stock. The conversion and issuance had not yet been processed and completed at the date of the filing of this report on Form 10-Q. 15 In January 2021, we closed a private offering, resulting in gross proceeds of $500,000, of Units consisting of (i) a convertible note and (ii) a warrant to purchase the number of shares of common stock equal to 135% of the dollar amount of the Note. The convertible notes (the “Notes”) accrue interest at 12% annually, and the principal and accrued interest is due two (2) years from the date of issuance. The Notes are convertible into shares of our common stock at a price equal to the lower of (a) $1.00, if the conversion occurs prior to a “Qualified Offering”, or (b) a 25% discount of the price per share of common stock offered in a Qualified Offering. The Notes may be converted at any time by the holder but will automatically convert upon the closing of a Qualified Offering. The terms of a Note will be amended if a holder believes that a security issued, or amended, after the issuance of the Note includes any term or provision more favorable than those provided in the Notes. The conversion price of the Notes will be reduced if the Company issues any security at an effective price lower than the conversion price of the Notes. The warrants are exercisable for five (5) years and entitle the holder to purchase common shares at a price equal to the lower of (i) $1.50, or (ii) a 25% discount to the price per share of common stock offered in a Qualified Offering. In March 2021, the Company received notice from 100% of the holders of their intent to convert the entire amount of their Notes, plus accrued interest, into shares of common stock. The conversion and issuance had not yet been processed and completed at the date of the filing of this report on Form 10-Q. Note 7 - 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 which passed the Export Services Act, also known as Act 20, in 2012. Under Act 20, eligible businesses are subject to a special corporate tax rate of 4%. 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 January 31, 2021 and April 30, 2020, we had accumulated deficits of approximately $12,700,000 and $2,600,000, respectively. Deferred tax assets related to the future benefit of these net operating losses for tax purposes totaled approximately $508,000 and $104,000, respectively, based on the Act 20 rate of 4%. 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 January 31, 2021 and April 30, 2020. Note 8 - 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. Note 9 - Preferred Stock Our Series A Preferred Stock (“Series A Stock”) is convertible to common stock at a ratio of 8.33 shares of common stock for each share of Series A Stock, and votes together with the common stock on an as-converted basis. The Series A Preferred Stock was originally issued under the Securities Exchange Agreement, as further described in Note 1. The Series A Stock was automatically converted into shares of common stock upon the effectiveness of our reverse stock split in August 2019, except for 208,704 shares which were subject to a limitation on the number of shares of common stock that can be held by the holder of those shares of Series A Stock. Conversions of Series A Stock into Common Stock since August 2019 are as follows: Date Series A Common Stock November 2020 50,000 416,500 16 Our 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-converted basis. The Series B Preferred Stock was originally issued under the Exchange Agreement, as further described in Note 1. Conversions of Series B Stock into Common Stock are as follows: Date Series B Common Stock July 2019 240,000 200,000 November 2019 60,000 50,000 December 2019 January 2021 231,022 954,741 192,519 795,618 Note 10 - Warrants In September 2019, we received $152,239 in connection with the exercise of 469,874 warrants which had been issued in May 2019 as part of the Share Exchange Agreement. We also assumed a fully vested, restricted stock unit agreement requiring the issuance of 41,667 shares of common stock in May 2021, as well as a warrant to purchase 5,556 shares of common stock at an exercise price of $60.00 per share. This warrant expires in March 2021. In October 2020, the Company issued five-year warrants to purchase a total of 399,998 shares in connection with the issuance of $600,000 of convertible notes. The warrants have an initial exercise price of $1.50 which may be reduced to (i) a 25% discount of the price per share of Common Stock offered in a future qualified offering and also include a ratchet provision . The warrants were valued at $267,999 using the multinomial lattice model and are considered derivative liabilities under ASC 815-40. In January 2021, the Company issued five-year warrants to purchase a total of 675,000 shares in connection with the issuance of $500,000 of convertible notes. The warrants have an initial exercise price of $1.50 which may be reduced to (i) a 25% discount of the price per share of Common Stock offered in a future qualified offering and also include a ratchet provision . The warrants were valued at $2,870,666 using the multinomial lattice model and are considered derivative liabilities under ASC 815-40. The following table presents the assumptions used to estimate the fair values of the warrants: January 31, 2021 Expected volatility 86-104 % Expected dividends 0 % Expected term 4.67-5 Years Risk-free interest rate 0.10-0.41 % The following table summarizes the changes in warrants outstanding issued to non-employees of the Company during the nine months ended January 31, 2021. Number of Warrants Weighted Average Exercise Price Weighted Average Grant Date Fair Value Expiration Date (yrs) Value if Exercised Balance as of April 30, 2020 - - - - $ - Granted 1,074,998 1.50 4.17 5.00 1,612,497 Exercised - - - - - Cancelled/Expired - - - - - Outstanding as of January 31, 2021 1,074,998 $ 1.50 $ 4.17 4.87 $ 1,612,497 17 Note 11 - Share Based Awards Effective August 2019, shareholders approved the 2019 Equity Incentive Plan (the “Plan”) which 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. October 2019 Issuances In October 2019, we issued options to purchase 350,000 shares of common stock valued at $477,500. Options to purchase 200,000 shares vest ratably over a two-year period and expire in October 2029. Options to purchase 150,000 shares vest ratably over a three-year period and expire in October 2024. All of the options were issued at an exercise price of $2.10 which equaled the stock price on the date of issuance. We used the Black-Scholes Model to estimate the fair value of the stock options issued using the following assumptions: (i) expected volatility – 75%, (ii) risk free interest rate – 1.59% or 1.74%, (iii) expected life – 5 or 10 years, and (iv) expected dividend yield of 0%. B. January 2020 Issuances In January 2020, we issued options to purchase 1,100,000 shares of common stock exercisable at $0.82 vesting quarterly over a three-year period. These options were valued at $707,300. We also issued options to purchase 147,475 shares of common stock exercisable at $0.82. These options were valued at $94,826 and were vested in full upon issuance. All of these options were issued at an exercise price which equaled the stock price on the date of issuance. We used the Black-Scholes Model to estimate the fair value of the stock options issued using the following assumptions: (i) expected volatility – 75%, (ii) risk free interest rate – 1.74%, (iii) expected life – 10 years, and (iv) expected dividend yield of zero. C. January 2021 Issuances In January 2021, we issued 1,000,000 shares of restricted common stock which was valued at $2,690,000 based on our stock price of $2.69 on the date of issuance. 250,000 of shares vested immediately with the remaining 750,000 vesting in thirty-six monthly installments subject to acceleration if certain performance milestones are attained. In January 2021, we issued options to purchase 100,000 shares of common stock at an exercise price of $2.69 which equaled the stock price on the date of issuance. 50,000 options vested immediately with the remaining 50,000 vesting ratably on the first and second anniversary dates. The options were valued at $147,581 using the Black Scholes model and the following assumptions: (i) expected volatility – 88.37%, (ii) risk free interest rate – 0.38%, (iii) expected life – 5.87 years, and (iv) expected dividend yield of 0%. D. Summary Stock compensation expense for the three and nine months ended January 31, 2021 was as follows: 3 months 9 months General and administrative $ 336,301 $ 525,559 Research and development 179,157 199,047 Operations 170,612 175,586 Sales and marketing 168,125 168,125 $ 854,195 $ 1,068,317 Stock compensation expense for the three months and nine months ended January 31, 2020 was $149,462 and $161,529, respectively. Options exercisable as of January 31, 2021 totaled 964,143. The remaining weighted average contractual term of the options outstanding at January 31, 2021 was 6.63 years. The aggregate intrinsic value of outstanding options, representing the excess of the stock price at January 31, 2021 of $5.00 over the exercise price of each option, was $7,062,446. 18 Note 12 - Financial Instruments The Company has financial instruments that are considered derivatives or contain embedded features subject to derivative accounting related to 10 convertible notes issued totaling $1,100,000 which included a ratchet provision in the conversion price of the lower of $1.00 or 25% discount of the price per share of Common Stock offered in a future “Qualified Offering”. Attached to these notes as additional consideration was 1,074,998 5-year warrants with a conversion price of the lower of 1.50 or 25% discount of the price per share of Common Stock offered in the Qualified Offering and also include a ratchet provision. Embedded derivatives are valued separately from the host instrument and are recognized as derivative liabilities in 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. The Company has estimated the fair value of these embedded derivatives for convertible debentures and associated warrants using a multinomial lattice model as of January 31, 2021. The fair values of the derivative instruments are measured each quarter, which resulted in a loss of $3,433,938 and derivative expense of $4,630,288 during the nine months ended January 31, 2021. As of January 31, 2021, the fair market value of the derivatives aggregated $9,144,226, using the following assumptions: estimated 1.67-5.00-year term, estimated volatility of 86.74-104.01%, and a discount rate of 0.10-0.41%. Financial instruments measured at fair value on a recurring basis at January 31, 2021, are summarized as follows: Level 1 Level 2 Level 3 Total Fair value of derivatives $ - $ 9,144,226 $ - $ 9,144,226 Note 13 - Related-Party Transactions Shares Issued for Services – In May 2019, we issued 1,570 shares of common stock valued at $70,000 to a shareholder for legal services provided to us. In April 2020, we issued 150,000 shares of common stock with a fair market value of $204,000 to a different law firm for services provided to us. Convertible Note Financing – In December 2019, we completed a convertible note financing with a member of the Board of Directors for $125,000 and with our Chief Executive Officer for $25,000. The same Board member invested $300,000 and $100,000 in the convertible note financings completed in October 2020 and January 2021, respectively. Another board member invested $50,000 in the convertible note financing completed in January 2021. See Note 6 for details on the terms of the transaction. Payable to Aerocarve – In August 2020 and December 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. During the three months ended January 31, 2021, the Company made principal repayments of this note totaling $5,000. 19 Note 14 - 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: On February 11, 2021, the Company and Red Cat Skypersonic, Inc., a Nevada corporation (“Acquisition Sub”), entered into Share Purchase and Liquidity Event Agreements (the “Skypersonic Agreements”) with Giuseppe Santangelo the founder and majority shareholder of Skypersonic, Inc., a Michigan corporation (“Skypersonic”) and the holders of common stock and SAFE agreements representing 97.46% of Skypersonic (the “Sellers”), pursuant to which, subject to the satisfaction of certain closing conditions, Acquisition Sub will acquire all of the issued and outstanding share capital of Skypersonic in consideration for an aggregate of $3,000,000 in shares (the “Share Consideration”) of the Company’s common stock, based upon the VWAP of the Company’s common stock at closing of the transaction (the “Skypersonic Transaction”). Fifty (50%) percent of the Share Consideration (the “Escrow Shares”) is required to be deposited in an escrow account pursuant to the Skypersonic Agreements for a period of twelve (12) months as security for indemnification obligations and any purchase price adjustments due to working capital deficiencies and any other claims or expenses arising under the Skypersonic Agreements. Under the Skypersonic Agreements, closing date working capital deficits in excess of $300,000 shall result in a reduction of the Share Consideration on a dollar of dollar basis. The Company agreed that in the event that within 12 months following closing of the Acquisition, the Company issues common stock for a price per share less than $2.50 per share in a public offering of equity or convertible securities in which the Company raises a minimum of $2,000,000 (“Qualified Offering”), the Company shall issue Sellers additional shares of common stock equal to the difference between the number of shares issued and the quotient of the purchase price divided by the price of securities sold in the Qualified Offering. Mr. Santangelo and certain principal shareholders have agreed to indemnification obligations, on a pro-rata basis, subject to certain limitations, which shall survive for a period of eighteen (18) months following closing, and which include a basket amount of $25,000 before any claim can be asserted and a cap equal to the value of the Escrow Shares or the Share Consideration. For a period of three (3) years following closing, Mr. Santangelo shall not engage in a business competing with or providing products, services or solutions to the drone industry, first person view (“FPV”) business, navigation and software solutions that provide analytics, storage or services for or in conjunction with the drone industry. The closing of the Skypersonic Transaction is subject to customary closing conditions and is expected to close on or before May 14, 2021. The Company does not deem the Skypersonic financial condition and results of operations to be material to the overall financial condition and results of operations of the Company on a consolidated basis. On February 15, 2021, the Company’s Fat Shark subsidiary agreed to provide a short-term bridge loan to Skypersonic in the amount of $75,000 under a Senior Secured Promissory Note, due May 14, 2021 (the “Bridge Loan”). Advances under the Bridge Loan accrue interest at a rate of six (6%) percent per annum. The Bridge Loan is secured by shares of Skypersonic common stock pledged as collateral. In March 2021, holders of $1,100,000 of Convertible debentures converted their debentures, plus $47,491 of accrued interest into 1,147,491 shares of common stock. These conversions represented 100% of the convertible debentures issued in October 2020 and January 2021, as described in Note 6. 20