Red Cat Holdings, Inc. 10-K

ITEM 1. BUSINESS I. Overview The Company was originally incorporated under the laws of the State of Colorado in 1984 under the name Oravest International, Inc. In November 2016, we changed our name to TimefireVR, Inc. and re-incorporated in Nevada. In May 2019, the Company completed a share exchange agreement with Red Cat Propware (“Propware”) which resulted in the Propware shareholders acquiring an 83% ownership interest, and management control, of the Company. In connection with the share exchange agreement, we changed our name to Red Cat Holdings, Inc. (“Red Cat” or the “Company” or “we”) and our operating focus to the drone industry. Prior to the share exchange agreement, Propware was focused on the research and development of software solutions that could provide secure cloud-based analytics, storage and services for the drone industry. Following the share exchange agreement and its name change, Red Cat has completed a series of acquisitions and financings which have broadened the scope of its activities in the drone industry. These acquisitions included: • In January 2020, we acquired Rotor Riot, LLC (“Rotor Riot”), a reseller of drones and related parts, primarily to the consumer marketplace through its digital storefront located at www.rotorriot.com . The total purchase price was $2.0 million. • In November 2020, the Company acquired Fat Shark Holdings (“Fat Shark”) which sells consumer electronics products to the first-person view (“FPV”) sector of the drone industry. Fat Shark’s flagship products are headsets with a built-in display (or “goggles”) that allow a pilot to see a real-time video feed from a camera typically mounted on an aerial platform or drone. The total purchase price was $8.4 million. • In May 2021, we acquired Skypersonic, Inc. (“Skypersonic”), a provider of drone products and software solutions that enable drone inspection flights that can be executed by pilots anywhere in the world. Skypersonic powers drones to “Fly Anywhere” and “Inspect the Impossible”. Its patented software and hardware solutions allow for inspection services in restricted spaces where GPS is denied or unavailable. The total purchase price was $2.8 million. • In August 2021, the Company acquired Teal Drones ("Teal"), a leader in providing sophisticated and complex unmanned aerial vehicle ("UAV") technology, primarily drones, to government and commercial enterprises, most notably, the military. Teal manufactures drones approved by the U.S. Department of Defense for reconnaissance, public safety, and inspection applications. The total purchase price was $10.0 million. II. Recent Developments During the second half of the fiscal year ending on April 30, 2022, the Company focused on integrating and organizing its acquired businesses. These efforts including refining the establishment of Enterprise and Consumer segments in order to sharpen the Company's focus on the unique opportunities in each sector of the drone industry. The Enterprise segment, consisting of Teal and Skypersonic, is focused on opportunities in the commercial sector and the military. Enterprise's initial strategy was to provide UAV's, primarily drones, to navigate dangerous military environments and confined industrial and commercial interior spaces. The Consumer segment, consisting of Rotor Riot and Fat Shark, is focused on enthusiasts and hobbyists which are expected to increase as drones become more visible and useful in our daily lives. Consumer provides a growing revenue base, strong brand visibility, and is an excellent source of professional pilots. 4 Following the establishment of the Enterprise and Consumer segments in the first quarter of fiscal 2023, management spent much of fiscal 2023 evaluating and establishing the long term business strategy of each segment. This resulted in the Enterprise segment narrowing its near term focus on the military and other government agencies. It was determined that Skypersonic's technology would be re-focused, for the next few years, on government applications and that its technology would be consolidated into the operations of Teal Drones. In the fall of calendar 2022, the Company received inquiries and held discussions regarding the potential acquisition of the Consumer segment, specifically Rotor Riot and Fat Shark. These discussions culminated in the execution of a Stock Purchase Agreement ("SPA”) with Unusual Machines in November 2022. Prior to signing the SPA, the Company completed a comprehensive evaluation of its business segments, including (i) the synergies and challenges of operating two diverse business segments, (ii) the future operating prospects for each segment including revenues, expenses, profits, and cash flows, and (iii) the financial impact of a potential sale of the Consumer segment on the Company. The results of the evaluation indicated a number of significant operating and financial differences between Enterprise and Consumer including (i) Consumer sources a substantial portion of its product from China whereas Enterprise is focused on a "Made in America" policy which is very important to the U.S. government, its primary target customer, (ii) Enterprise is required to meet ITAR export requirements which necessitates that all employees be U.S. persons and undergo a background check whereas Consumer does not have such requirements, (iii) Consumer primarily markets through a social media platform and strategy that focuses on maximizing its public presence whereas Enterprise's marketing efforts in dealing with its government target market are more discrete and (iv) Consumer is focused on reaching profitability whereas Enterprise has been investing in a new manufacturing facility and building strong relationships with government agencies. Collectively, these differences would require the Company to establish separate departments for many common functions including purchasing, human resources, and sales and marketing. Finally, closing of the SPA would strengthen the Company's financial position as it would generate immediate cash and eliminate the funding required to support Consumer until it reached profitability. The Company concluded that the long term business prospects of the Enterprise segment were significantly greater than those of the Consumer segment, and that a sale of Consumer should be completed. The closing of the transaction is contingent upon Unusual Machines completing (i) an initial public offering that raises sufficient capital to close the transaction, and (ii) listing on a public stock exchange such as the NYSE or Nasdaq. III. Enterprise Segment The Enterprise segment’s current business strategy is focused on providing integrated robotic hardware and software for use across a variety of applications. Its solutions provide critical situational awareness and actionable intelligence to on-the-ground warfighters and battlefield commanders as well as firefighters and public safety officials. Its mission is to "Dominate the Night" and constantly provide best in class thermal imaging capabilities. Enterprise’s efforts are centered on its Made in America Class 1 drone development program, particularly its Teal 2, and Four Ship products. Enterprise has substantially completed construction of a new manufacturing facility in Salt Lake City and believes that an increased focus by the United States government and American businesses on purchasing products that are “Made in America” provide Enterprise with a competitive advantage. 5 Teal Drones Teal is the core of the Enterprise segment and was founded in 2015 by George Matus, a Thiel fellow. Its first products were consumer based and the first of their kind to be manufactured in the United States. Beginning in October 2018, Teal migrated its business strategy to focus on the government, military, and enterprise sectors (collectively referred to as “Enterprise”). Its first product offering, the “Golden Eagle”, was launched in June 2020. The Golden Eagle is a U.S. Department of Defense approved drone designed for reconnaissance, public safety, and inspection applications. A. Key Business Accomplishments during Fiscal 2023 and to date include: 1. Launches Teal 2, a military-grade sUAS Designed to “Dominate the Night™” Following its acquisition by Red Cat in August 2021, Teal accelerated efforts on the development of its next generation Enterprise drone. These efforts culminated in the launch of the Teal 2 in April 2023. The Teal 2 is the first small, unmanned aircraft system (“sUAS”) designed to “Dominate the Night”, when most military operations take place, through its enhanced capabilities. The Teal 2 offers the latest intelligence, surveillance, and reconnaissance (“ISR”) technology and delivers time-critical information that enables the warfighter to make faster and smarter decisions. Some of the unique features and capabilities of the Teal 2, and the partners who developed and helped integrate these technologies into the Teal 2, include: •Teledyne FLIR whose new Hadron 640R sensor provides the highest resolution thermal imaging in a small (Group 1) form factor which is optimal for nighttime operations. •Tomahawk Robotics whose common control system enables a single operator to simultaneously control up to four Teal 2’s at the same time. •Athena AI, an Artificial Intelligence (“AI”) and computer vision architecture firm. Its technology enhances target recognition and battle tracking which enables wartime commanders to make faster battlefield decisions. •Reveal Technology whose “Farsight” mapping software enables the automatic combining of imagery from multiple drones to produce high fidelity 3D maps. •Immervision, an optical products manufacturer whose navigation camera module is used for surveillance and unmanned systems. Immervision enhances the navigation skills of the Teal 2 at night and in other difficult flying conditions such as in fog, beneath bridges, and inside buildings. The Teal 2 is manufactured exclusively at Teal’s new purpose-built factory in Salt Lake City, Utah. Early-adopter customers included the U.S. Customs and Border Protection which ordered 54 units of the Teal 2. 6 2. Designation of Teal 2 as Blue UAS received from U.S. Department of Defense In June 2023, the Teal 2 received clearance from the U.S. Department of Defense ("DoD") to be designated as a Blue UAS. The DoD defines these drones as NDAA (National Defense Authorization Act) compliant, validated as cyber secure, and safe to fly. This designation enables Teal to fill orders from federal, state, and local government agencies subject to oversight by the DoD, including those orders that were contingent upon receiving certification. In addition, many governments of allied nations are more likely to purchase Blue UAS approved drones. Teal's legacy drone, the Golden Eagle, is also on the cleared list which is believed to number less than 20 in total. After the U.S. Army banned its forces from using Chinese-made quadcopters due to security risks (the drones’ radio controls are unencrypted and the devices could potentially capture and store sensitive information that could be provided to the Chinese government), the U.S. Department of Defense began developing its own alternatives under a defense program known as Blue sUAS. Blue sUAS is an initiative of the Defense Innovation Unit (DIU), the only DoD organization focused on accelerating the adoption of commercial and dual use technology to solve operational challenges at a speed and scale that is faster and higher than normal for government agencies. 3. New Manufacturing Facility Constructed and Scaling Productivity During Fiscal 2023, Teal substantially completed construction of its new manufacturing facility and began to scale production levels. Teal originally moved into the facility, located in Salt Lake City, Utah, in October 2021. In January 2022, Teal doubled the size of the facility, which now totals approximately 25,000 square feet, in order to fully scale production capacity to meet the forecast growth in demand and to house its expanding team of software and technology engineers. At the end of fiscal 2023, production capacity was approximately 100 drones per month. The Company believes that maximum production capacity for this facility can reach 1,000 drones per month over the next 2 to 3 years, provided that additional capital investments are made and manufacturing efficiencies realized. Manufacturing in the United States, “Made in the USA”, is a critical consideration of the U.S. government and other state and local government agencies. 4. Awarded Increase in Prototype Development Contract under U.S. Army Tranche 2 Program In June 2023, the Army authorized Teal to complete additional milestones under the terms of a Statement of Work related to its UAS Tranche 2 program. Under the terms of the Statement of Work, the Army has agreed to fund certain engineering and material costs incurred by Teal to build a next generation prototype based on technical requirements and warfighter feedback. As of June 30, 2023, a total of $2.7 million has been authorized under the Statement of Work. Cumulative billings through April 30, 2023 totaled $879,400 and the Company expects to complete and bill the remaining authorized amount of $1,862,701 in fiscal 2024 as milestones are fulfilled. The Statement of Work provides for 15 separate development milestones, of which 9 have been authorized to date. The Company expects that the Army will authorize that the remaining 6 milestones be completed at a future date. In May 2023, Teal partnered with Doodle Labs on Teal’s small unmanned aerial system (sUAS) prototype. By integrating Doodle Labs’ Helix Mesh Rider Radio, the prototype will be capable of reliably transmitting thermal imagery, encrypted video, and other high-bandwidth data back to a ground station more than three miles away. Mesh Rider Radio uses certified encryption to protect data and flight control functionality, even in contested environments. 7 B. Government Contracts and Orders Enterprise is focusing on U.S. federal government agencies, particularly the military branches, as its initial target market. Its longer term target customer base includes U.S. state and local government agencies, as well as governments of foreign allies. An overview of existing government contracts and recent developments include: 1. U.S. Army Tranche 2 Drone Program In March 2022, Teal was selected by the Department of Defense's (DoD) Defense Innovation Unit (DIU) and U.S. Army to compete in the Short Range Reconnaissance Tranche 2 (SRR T2) Program of Record. The rigorous technical requirements and program objectives of SRR T2 dramatically narrowed the field from thirty-three drone manufacturers down to three vendors. The Army has indicated that Tranche 2 and 3 have been combined and will represent the final tranche of the SRR program. Teal was selected to develop a next-generation sUAS designed for intelligence, surveillance and reconnaissance (ISR) duties, with a focus on autonomous capability, for the U.S. Army. The ultimate goal of the SRR T2 program is to provide a small, rucksack portable, fully encrypted sUAS that provides all Army infantry platoons (consisting of 20-50 soldiers) with situational awareness beyond the next terrain. Following a successful demonstration in September 2021, Teal was notified by the U.S. Army's Short Range Reconnaissance Product Office that it would advance to the prototype phase of the SRR T2 program and was awarded a $1.5M prototype development contract. The value of this contract has since been increased to $2.7 million. The SRR Tranche 1 program began in 2020, and Teal was similarly selected for that program with a prototype contract award as part of its selection. The five drones developed for SRR Tranche 1 became the five drones named to the Blue sUAS list in August 2020 and were subsequently approved by the Department of Defense (DoD) and other U.S. Federal Departments. The Blue sUAS list was originally developed by the Silicon Valley-based Defense Innovation Unit (DIU) which is focused on identifying, and integrating leading commercial technologies into the Government. 2. U.S. Border Patrol $1 Million Purchase Order from U.S. Border Patrol In October 2022, Teal was awarded a $1,046,806 contract from U.S. Customs and Border Protection to provide its high-performance Golden Eagle drones to U.S. Border Patrol. The purchase agreement covered the provision of the drone, plus battery packs and chargers, propellers, gimbal-mounted cameras, carrying cases and operator training sessions, including “train-the-trainer” sessions. Customs and Border Protection Contract Worth up to $90 Million over Five Years In December 2021, Teal was one of only five contractors designated to participate in a firm, fixed price, multiple award blanket purchase agreement (BPA) by the United States Customs and Border Protection. The BPA has an estimated value of $90 million in total over a 5-year period. 8 The Department of Homeland Security agencies can place orders through the BPA for unmanned aircraft systems (UAS). The drones will provide supplemental airborne reconnaissance, surveillance, and tracking capability to enhance situational awareness for field commanders and agents in areas that lack nearby traditional surveillance systems or available manned air support. 3. Other Order for 200 Long-Range, High-Speed Drones for Ukrainian Deployment In May 2023, Red Cat received a purchase order to provide 200 long-range, high-speed FPV (first-person view) drones to Ukrainian drone pilots engaged in conflict with Russia. The FPV drones were delivered to Ukraine in June. These drones have the highest power-to-weight ratio in the industry and provide increased maneuverability, especially when combined with the FPV functionality of the drones. These drones can also fly in GPS-denied and GPS-jammed battlefield conditions. Order from NATO Member Country for Deployment in Ukraine In April 2022, Teal secured an order for 15 Golden Eagle drone units, plus spares and training, from a NATO (North Atlantic Treaty Organization) member country committed to deploy them in the Ukraine. The drones were expected to be used for intelligence, surveillance, and reconnaissance on the front lines, thereby lessening the need to utilize troops to perform such dangerous activities. Numerous European countries have increased their defense budgets, not only to support the Ukraine invasion but to also prepare themselves for future geopolitical conflicts. Many countries and military units are recognizing the strategic benefit of having an adequate inventory of drone units that can be invaluable in reconnaissance and surveillance on the front lines. C. Product Development Product development efforts in fiscal 2023 were focused on the development of the Teal 2 which was officially launched in April 2023 at the Army Aviation Mission Solutions Summit. Significant resources were also expended developing the prototype under the Army's SRR Tranche 2 program. More details on the partners who helped integrate key features into the Teal 2 include: 1. Athena AI for artificial intelligence and computer vision In March 2023, the Company partnered with Athena AI which will provide computer vision capabilities for the Teal 2. Athena, an AI-enabled military decision-support company, has licensed its proprietary computer vision architecture which allows high-speed tracking of objects and, at slower speeds, in-depth data exploitation. Athena spent more than three years curating and analyzing military night-fighting footage, including thermal and low light camera systems, to create computer vision architecture for warfighting after dark. Athena’s solution can identify weapons and various other objects at night, as well as Identification Friend or Foe (IFF) markers, such as military grade light sticks and infrared beacons. 9 By integrating Athena’s technology, the Teal 2 will support dangerous, close fighting, missions at night. The Forward Line of Own Troops (FLOT) can be detected, recognized and geolocated in comparison with the enemy, allowing for precision and safe fires on the target. Athena also supports rapid in-field target-set updates with a turnaround as quickly as 72 hours for new target-detection algorithms. This allows the warfighter to quickly respond to emerging threats and ensure their drone remains in the fight. 2. Invests in Modular Unmanned Aerial Systems Company In March 2023, Red Cat invested $250,000 in Firestorm, an American company developing the first completely Modular Unmanned Aerial System (MUAS) that is 3D printed and payload agnostic. Firestorm is building a new category of fixed-wing UAS with 30-day product iterations, a commitment to open-system architectures, and an additive manufacturing approach that allows them to scale production in an elastic manner. Firestorm’s founding team has deep industry expertise in additive manufacturing, aerospace and defense, and understands how to build and quickly scale dual-use technology companies. 3. Immervision Enhances Low-Light Navigation In January 2023, Teal partnered with Immervision, a Canadian optical products manufacturer whose latest navigation camera module is used for surveillance and unmanned systems. Immervision will enable Teal’s drone to operate effectively in low-light flying conditions. Teal plans to equip the Teal 2 with two Immervision low-light camera modules. In addition to enhancing autonomous navigation at night and in other light-denied situations, such as in fog, beneath bridges and inside buildings, having two cameras provides stereoscopic vision to Teal’s autonomous pilot system. This enables the drone to create a 3D map it can use to navigate and locate itself geographically in low-light situations and in areas where a GPS signal is not available. The camera lens is designed to maximize the concentration of light per pixel on the image sensor to provide the best image quality in low-light conditions across the complete field of view. Immervision’s camera module has been designed to address the challenging requirements of operating safely in low-light conditions where other sensors are inefficient. It is capable of seeing objects in a dark environment at “1 lux”, which is equivalent to “deep twilight.” Teal is integrating the new Immervision camera with its software system to enhance the autonomous flying capabilities of its drones. These include avoiding obstacles and taking off and landing without pilot assistance, as well as automatically generating a 3D map and locating itself without the benefit of a GPS signal. Most military operations are conducted at night, and therefore, having a low-light solution is a key capability. 4. Tomahawk Robotics Enables Simultaneous Control of Air and Ground Based 4-Ship Multi-Vehicle System In October 2022, Teal enhanced the capabilities of its 4-Ship multi-vehicle system through a partnership with Tomahawk Robotics, the leading innovator of common control solutions. This partnership will enable the warfighter in the field to simultaneously control the Teal 2 and other unmanned vehicles, such as rovers and robots on the ground, all within a single application on a single pane of glass. Enabling fighters to coordinate an arsenal of unmanned systems in the air and on the ground gives them a significant advantage in finding and subduing the enemy. 10 In addition, one operator can hand off control of one or more drones, rovers or robots to another operator without shutting down the operation. For example, one operator may keep his group of drones focused on surveillance of an enemy location while handing off control of another drone/robot/rover to pursue an enemy who is leaving the location. Tomahawk’s Kinesis control solutions provide the following capabilities: 1. Multi-vehicle command and control (multiple Teal drones) and multi-domain command and control (Teal drone paired with unmanned ground vehicles). 2. ATAK (Android Team Awareness Kit) information sharing for increased battlefield visualization. 3. Handoff of control to a secondary operator. 4. Providing center field of view coordinates for aided target recognition. 5. Mission-planner level of semi-autonomy with human-in-the-loop decision making. 6. A MOSA (Modular Open Systems Approach) framework that delivers AI-enabled capabilities such as Reveal Technology’s Farsight 3D Mapping software, Athena AI’s Object Detection Classifiers, and other third- party advanced features. 5. Announces Development of Multi-Drone System In May 2022, Teal completed the development and production of a four-drone, multi-vehicle system for defense, government, and public safety markets. The multi-vehicle package will be offered in two configurations: 4-Ship and 4-Ship+. Both configurations allow a single pilot to simultaneously control up to four Teal drones at the same time. The 4-Ship is a complete solution that provides operators with actionable information from multiple vehicles at the same time -- including the display of four simultaneous video feeds -- resulting in faster situational awareness and decision-making in today’s complex environments. It also offers a tremendous savings in manpower, the most expensive component of any drone operation since four pilots are replaced by just one. The 4-Ship+ will include two extra units and an additional linked controller to facilitate handoff of control from one pilot to another. The 4-Ship+ configuration allows a back-up pilot to immediately take over at any time. The additional two drones also allow pilots to bring in units with fresh batteries while units with drained batteries drop off to be charged – all without breaking up the four-drone flight pattern. This allows for continuous 360-degree surveillance of any target and overcomes the biggest weakness of any currently fielded drone which is limited battery life. D. Sales and Marketing Since acquiring Teal in August 2021, the Company has built a sales and marketing team which presently consists of 8 direct and support professionals. Most of their efforts in fiscal 2023 were focused on developing relationships with the military agencies of the U.S. Federal Government. While the sales cycle for government agencies can be extensive and take considerable time and effort to establish, they can often become a long-term buyer once initial sales are closed. Key activities in fiscal 2023 related to demonstrating the capabilities of the Teal 2 included: 11 1. Demonstrates Multi-Drone Mapping to US Military In August 2022, Teal demonstrated multi-drone mapping technology that was developed with Reveal Technology. This demonstration was provided to U.S. Army Special Operations Command near Fort Bragg. Military tactical teams’ ability to quickly produce accurate maps of areas targeted for military operations can mean the difference between mission success or failure. Teal teamed with Reveal Technology to enhance Reveal’s “Farsight” mapping software by automatically combining imagery from multiple unmanned aerial systems (UAS) to produce high-fidelity 3D maps. By dramatically increasing the speed of collection, users receive Farsight maps and analytics faster than ever. Introduced in May 2022, the 4-Ship allows a single operator to simultaneously control up to four drones, allowing for instant and ongoing 360-degree surveillance of a target. Farsight gives military teams virtually real-time access to detailed 3D maps of a target area that can be overlaid with: 1. Line-of-sight analysis which allows a team to choose a route at the target area that is least visible to the enemy 2. Terrain analysis and graphing 3. An AI-generated “best route” through a target area based on line-of-sight data, elevation mapping and terrain analysis 4. A vertical measurement tool for determining the height of buildings and structures that may be part of an operation 5. A helicopter landing zone survey to quickly identify the best and safest spot to land These combined features demonstrate that multiple, networked drones far outperform a single drone for gathering and analyzing geographic intelligence. This provides a team with an advanced awareness of the situation as it is on the ground which leads to more successful missions. Prior to Farsight, military teams in the field were often dependent on overtasked and often separate intelligence organizations which resulted in slow-moving intelligence analysis that did not match the fast-paced environment on the ground. Farsight helps overcome this issue by blending state-of-the-art computer vision, AI and computing “at the edge” – computing in the field on handheld devices. All processing for Farsight is completed at the edge and therefore, a network connection is not required which eliminates the need for additional processing capabilities like servers or cloud infrastructure. This not only speeds up the entire process but it also allows for the creation of detailed, actionable maps from virtually anywhere on the globe. Finally, computing at the edge does not increase the team’s electronic signature to the enemy, which as seen in Ukraine, could attract artillery fire. 2. Holds Public Demonstration of Multi-Drone Technology In August 2022, Teal was granted a waiver by the Federal Aviation Administration (FAA) allowing a single pilot to simultaneously control multiple drones for the first public demonstration of the Company’s multi-drone technology. This event was held in October 2022 at Kane Stadium in New Jersey. 12 Historically, few waivers were approved by the FAA for multi-drone operations, and those were only for pre-programmed swarms of light-pixel drones for firework displays or for limited performance testing applications. Teal’s waiver allows dynamic re-tasking by the pilot in command. Instead of flying a pre-coordinated low-risk display, the pilot is authorized to adjust the trajectory of the drones in real time. This minor differentiation has long been a critical missing link needed to implement multi-drone technology in real-world applications such as infrastructure and public safety inspections. Teal secured this waiver by working closely with the FAA to validate multi-drone operation and establish the performance criteria to normalize it by integrating reliability-focused design features and extensive testing of safety-critical components. This waiver is yet another milestone in Teal’s goal of making small drones a ubiquitous tool across industries. This waiver will ideally open the door to future FAA authorizations that allow for multi-drone technology implementation, thereby reducing the cost and complexity of implementing drone technology for customers across verticals like critical asset inspections, public safety, and more. E. Other Teal Information 1. Suppliers Teal purchases inventory from over 35 suppliers. 80% of this inventory is purchased from four vendors. The most critical components are electronics and cameras. Teal's supply chain is NDAA and Blue UAS compliant. All suppliers are approved based on Teal's strict vendor qualification process. 2. Competition Teal's primary competitor is DJI. Though regulation is trending toward further restrictions against Chinese made drones, DJI remains a global industry leader and continues to serve markets that Teal is focused on. Domestic competitors of Teal include Vantage Robotics and Skydio. These companies were selected alongside Teal out of 37 companies to compete in the Short Range Reconnaissance Tranche 2 program. Future competitors may include established defense contractors that are better capitalized and resourced to compete in Teal's markets. Teal competes with a combination of its unique product value propositions (i.e. nighttime capability, modular platform), and scalable domestic manufacturing. Skypersonic Skypersonic enables drones to "Fly Anywhere". Its Skycopter is a miniature drone in a protective cage which can navigate dangerous military environments such as a damaged, bombed building while recording critical ISR data yet not damaging its environment or the drone. Its Skylogic software system enables the drone to record the inspection or surveillance data even though GPS communications are not available in such restricted environments. Skyloc is a stand-alone, real time, software system which enables the drone to record and transmit data even while being operated from thousands of miles away. The Company believes that Skypersonic can enable military operators to complete ISR in a safer, quicker, and more efficient manner. Traditionally, such activities are completed by soldiers on foot patrol who normally need to travel into dangerous military environments where the enemy can be waiting to attack. Additional dangers exist when the soldiers need to explore extreme heights or constrained spaces, such as bombed buildings, in order to secure the required ISR. 13 Following establishment of the Enterprise segment, which includes Skypersonic and Teal, the Company determined to narrow Enterprise's near term focus on the military and other government agencies. This decision reflected (i) a decision to exclusively focus the Company's limited financial resources on its strongest near term business prospects and (ii) recognition of the ability to deploy the Skycopter in dangerous military environments. Enterprise intends to expand its sales and marketing efforts to other commercial applications once its military platform is fully established. A. Recent Accomplishments 1. Delivers Drones, Rover, and Piloting Platform to NASA’s Simulated Mars Missions In November 2022, Skypersonic delivered the hardware and software for a rover and drone system that the crew members of NASA’s Simulated Mars Mission will use to remotely explore Martian-like terrain around Earth – all from their 1,700-square-foot simulated Martian habitat at the Johnson Space Center in Houston, Texas. Crew members will spend one year living and working in a habitat designed and built to simulate life on the Red Planet. The Skypersonic drones and rover will be taken to an area on Earth that is similar to Martian terrain – such as a desert or mountainous region – where they will be controlled remotely by crew members in Houston. The exercise is designed to test the ability of astronauts on Mars to remotely explore the planet with drones and rovers. Skypersonic's real-time transoceanic remote piloting platform will drive the piloting of both the drones and the rover. NASA personnel trained on piloting the drones with Skypersonic’s Martian Simulator, a computer-simulation of the Martian environment based on actual photographs and video of the surface of Mars. Skypersonic was initially awarded a five-year contract with NASA in September 2021. 2. Validated Technology Platform on an Active Volcano In August 2022, Skypersonic validated its software and hardware on Mt. Etna, an active volcano in Sicily where the landscape is similar to Martian geology. Using its ground-breaking Long Range Real-Time Remote Piloting System, the drone and rover on the active volcano in Italy were controlled by personnel in Houston, Texas, in real time. Whereas most drones cannot be piloted without connecting to the GPS network, Skycopter uses technology that is able to control and track the drone in locations – such as Mars – where GPS is not available. 3. Inspected Italian Utility Plant with drone piloted from the United States In June 2022, Skypersonic completed an inspection of a utility plant in Turin, Italy using a drone controlled by a pilot physically located in Orlando, Florida. The drone was controlled relying solely on an internet connection from a normal cellphone. The pilot had never visited the plant, nor had he seen any drawings or photos of the floorplan or the layout which included many staircases, ducts, equipment, and other obstacles. Using the Company’s Skyloc operating system, the drone was piloted without using GPS (Global Positioning System) which is traditionally used for outdoor flights but which is often not available in closed, restricted environments. 14 4. Two-year Facility Inspection Program completed with General Motors In May 2022, Skypersonic completed a two-year program with General Motors (“GM”) using the Skycopter™ to perform crane rail inspections in all 19 of its North American stamping (metalworking) facilities. The Skycopter was able to capture critical information that is relevant to the maintenance of GM’s facilities and their internal structures in a relatively short amount of time. Information was captured in two to three hours versus what would normally take eight to twelve hours and require shutting the facility down completely, erecting scaffolds, and hoisting personnel in the air and onto the rails for manual inspection, saving not only significant time but also substantial costs. The Skycopter provided an inspection and data collection service that is faster than traditional methods while also providing a much safer work environment for employees. The full inspection program took over two years to complete, including the initial planning and pilot training phases, while the inspection process required 14 months. The program consisted of the video recording of 50,000 cumulative feet of crane rails captured from more than 200 flight hours. The Skycopter was piloted by General Motors personnel at all times following completion of an initial pilot training program with Skypersonic. General Motors is also evaluating the use of the Skycopter in other inspection applications across additional plants and facilities. IV. Consumer Segment The Consumer Segment focuses on selling drones and related parts to enthusiasts and hobbyists. Fat Shark and Rotor Riot operate in this segment . The Consumer segment focuses on drones piloted with wearable display devices. These are head mounted displays (“HMDs”), similar to goggles, for drone pilots. HMDs give pilots a “first person view” (“FPV”) to control their drone in flight. This is a unique experience where the pilot is interacting with an aircraft through visual immersion. The pilot sees only what the drone sees, as if sitting in the pilot seat. This experience is accomplished by live streaming footage from a camera mounted on the nose of the drone directly into specially designed goggles worn by the pilot. The image is transmitted via radio (traditionally analog but increasingly digital) to the pilot. The drone remote control unit, the drone device, and the FPV goggles are all connected via radio. This requires sophisticated electronics that transmit visual information with sufficient speed and reliability to allow pilot control over the drone in real-time. Pilots routinely achieve speeds of over 90 mph in racing and other mission critical applications. An FPV pilot must experience a near complete transfer of their visual consciousness into the body of their piloted device. There are three common categories of FPV flight – freestyle flight, racing, and aerial photography. In freestyle, the pilot navigates around obstacles focused on acrobatics and exploring the environment. FPV racing describes a growing spectator sport where pilots fly their drones in competitions through a series of obstacles, flags, and gates in a racetrack. Aerial photography is the process of viewing and recording a subject matter from the air from the viewpoint of the pilot. 15 Consumer is working to increase customer adoption of Fat Shark's new digital based headset systems. The shift from analog to digital is critical to Fat Shark's strategy for long term product sales. DJI was first to market with digital FPV headsets for 2 years and gained a substantial majority market share for this product. This has slowed the initial sales of Fat Sharks product offerings. Overcoming this is paramount to preventing DJI from cornering the customer base and securing market position for Fat Shark. For this effort, Consumer has coordinated both subsidiaries, Fat Shark and Rotor Riot, to promote sales of Fat Shark digital headsets. Consumer has increased targeted paid advertisements on Facebook, Google, and other platforms. These ads are directed toward both existing FPV customers as well as acquiring new customers from tangential markets such as photography. The ads direct sales through the Rotor Riot online store as well as other vendors of Fat Shark digital products. Additionally, Consumer has offered discounted bundles via the Rotor Riot online store. These bundles combine Fat Shark's digital headsets with ready to fly drones built by Rotor Riot. These bundles provide the customer with cost savings and an easier entry point into Fat Shark's digital ecosystem. A. Launch of Innovative Dominator Drone FPV Goggle In May 2022, Fat Shark launched a new FPV (first-person viewer) drone headset – the Dominator. The Dominator is a low latency, 1080p digital goggle with an extended flight range over existing systems. B. Customers Revenues for the Consumer segment are principally generated through distributors (for Fat Shark) and online (for Rotor Riot through its e-commerce site, www.rotorriot.com ). Consumer markets its products and services to recreational and professional drone pilots and hobbyists. C. Competition Rotor Riot competes with a number of significantly larger, better capitalized companies. SZ DJI Technology Company, Ltd., commonly known as DJI, is the dominant market leader in the Consumer Segment with a global market share estimated at more than 70%, according to industry research firms. Other competitors include Parrot and Lumenier. Race Day Quads is a larger, direct competitor in the FPV sector. Consumer competes against these financially stronger companies by leveraging its visibility on the internet through its Facebook page which has more than 37,000 members and its Rotor Riot channel which has more than 267,000 subscribers. The Rotor Riot brand has been at the center of the racing and freestyle culture of drones since registering its domain name in 2015. Fat Shark also competes with DJI as well as other FPV headset companies including Skyzone, Orca, and HD Zero. The Fat Shark brand has been synonymous with FPV headsets since the emergence of the market in 2008. Fat Shark continues to compete through partnerships with other FPV companies and a focus on manufacturing and product quality. 16 D. Suppliers Rotor Riot purchases inventory from over 80 suppliers although 44% of this inventory is purchased from four vendors. The two most critical components are electronics and frames. The United States has continuously increased tariffs on the inventory that Rotor Riot purchases from China. Since 2019, tariffs ranging from 2% to 25% have been imposed on 88% of Rotor Riot’s inventory. 68% of Rotor Riot's inventory is purchased directly from Chinese based vendors, and all these items are subject to tariffs. An additional 20% is purchased from vendors that are affected by the tariffs resulting in higher costs for Rotor Riot. 28% of Rotor Riot’s inventory consists of DJI products which are subject to the highest 25% tariff rate. These tariffs increase the cost of goods which reduces the company’s profit margins. To date, Rotor Riot has been unable to find comparable non-Chinese products and vendors. V. The Drone Industry The Drone industry continues to expand beyond its military origin to become a powerful business tool and recreational activity. We expect both of these markets to continue to grow. • The global commercial drone market size was estimated at approximately $30 billion in 2022. It is anticipated to expand at a compounded annual growth rate of almost 39% from 2023 to 2030 (grandviewresearch.com). • The military drone market is expected to reach more than $11 billion by 2024 (dronesourced.com). • The drone services market is expected to grow to more than $60 billion by 2025 (Insider Intelligence). • Consumer drone market is projected to increase from $4.3 billion in 2022 to approximately $20 billion by 2030, with a compounded annual growth rate of 20.8% from 2023 to 2030 (snsinsider.com). A. Government Regulation and Federal Policy 1. The Federal Aviation Administration The Federal Aviation Administration (“FAA”) of the United States Department of Transportation is responsible for the regulation and oversight of civil aviation within the U.S. Its primary mission is to ensure the safety of civil aviation. The FAA has adopted the name “unmanned aircraft” (“UA”) to describe aircraft systems without a flight crew on board. More common names include drone, Unmanned Aerial Vehicle (“UAV”) and remotely operated aircraft. The FAA began issuing regulations governing drones in 2005 with their scope and frequency expanding in recent years with the significant increase in the number of drones sold. In December 2015, the FAA announced that all drones weighing more than 250 grams, or 0.55 pounds, must be registered with the FAA. As of July 2023, the FAA reported the registration of almost 870,000 drones, of which approximately 350,000 were commercial and approximately 520,000 were recreational. In addition, more than 330,000 remote pilots were certified. 17 In January 2021, the FAA finalized rules requiring that drones be identifiable remotely. These rules are effective for drone manufacturers beginning in September 2022 and for drone pilots in September 2023. The FAA believes that remote ID technologies will enhance safety and security by allowing the FAA, law enforcement, and federal security agencies to identify drones flying in their jurisdiction. These efforts lay the foundation for more complex operations, such as those beyond visual line of sight at low altitudes, as the FAA and the drone industry move toward a traffic management ecosystem for Unmanned Aircraft System flights separate from, but complimentary to, the air traffic management system. The Company believes that the oversight of the FAA is beneficial to the drone industry generally, and the Company specifically. Approximately 10 % of the drones sold by Rotor Riot are below the weight threshold required to register. The remaining 90% have more functionality, are more likely to be used for commercial purposes, and therefore, should be registered. 2. Infrastructure Bill In November 2021, Congress passed the Infrastructure Investment and Jobs Act which may provide multiple business opportunities for the drone industry. Drones already play a vital role in many of the programs covered by the bill, including railways, roads and bridges, storm preparation, electrical grid strengthening and sewage maintenance. With more than $280 billion earmarked for these programs alone, the Company believes there is a significant opportunity to expand its existing relationship with the Department of Defense and NASA to include other agencies of the Federal Government. These services include enabling rapid inspections and surveillance to ensure efficiency and identifying potential issues developing on roadways or electrical grids prior to their becoming disabled. Drones also provide the ability to efficiently manage maintenance once improvements have been completed. Congress has also been debating an additional $50 million allocation for both 2022 and 2023 as part of the "Drone Infrastructure Inspection Grant Act" which would provide funding specifically for drone use, thereby adding new opportunities for the Company in the context of the larger bill. In addition, the Company strongly supports the "Build America, Buy America Act" component of the bill which emphasizes the need for infrastructure improvements and maintenance to be completed by American companies for the benefit of U.S. citizens. Specifically, the bill states: "United States taxpayer dollars invested in public infrastructure should not be used to reward companies that have moved their operations, investment dollars, and jobs to foreign countries or foreign factories, particularly those that do not share the commitment of the United States to environmental, worker, and workplace safety protections." Red Cat Holdings was founded as an American company and each of its acquisitions has been completed within the U.S. borders to help strengthen the U.S. economy and provide U.S.-based jobs. With Teal’s new drone manufacturing facility up and running in Utah, the Company is well positioned to provide drones and services to support the needs of these infrastructure programs. 18 3. American Security Drone Act In February 2023, two Congressman introduced the "American Security Drone Act of 2023" which would prohibit the purchase of drones from countries identified as national security threats such as China. The basis for the legislation is that purchases from these countries (i) pose a significant threat to national security, (ii) represent efforts to infiltrate and influence American society, and (iii) risk the theft of personal and business data. Specifically, the American Security Drone Act: • Prohibits federal departments and agencies from procuring certain foreign commercial off-the-shelf drone or covered unmanned aircraft system manufactured or assembled in countries identified as national security threats, and provides a timeline to end current use of these drones. • Prohibits the use of federal funds awarded through certain contracts, grants, or cooperative agreements to state or local governments from being used to purchase foreign commercial off-the-shelf drones or covered unmanned aircraft systems manufactured or assembled in a country identified as a national security threat. • Requires the Comptroller General of the United States to submit a report to Congress detailing the amount of foreign commercial off-the-shelf drones and covered unmanned aircraft systems procured by federal departments and agencies from countries identified as national security threats. VI. Other Corporate Information A. Environmental Considerations While the operations of many businesses have some form of negative impact on the environment, drones have a unique ability to provide a positive contribution. Many of these relate to a drone’s ability to reach places in a more efficient manner, and include such activities as: • aerial mapping and nature monitoring; • maintenance of renewal energy sources such as solar panels and wind turbines; • disaster relief monitoring and relief delivery; and • agricultural sustainability solutions B. Intellectual Property The company has consolidated its intellectual property into a subsidiary, UAVPatent Corp. The subsidiary holds 36 issued patents and registered designs and 16 pending patents and registered designs. The Intellectual Property (“IP”) portfolio includes design and utility patents ranging from FPV headsets to the architecture for Skyperonic's Fly Anywhere platform. None of the patents are currently licensed and IP is generated in the general course of doing engineering design. UAVPatent Corp also has the trademarks on the Rotor Riot, Fat Shark, Teal, Skypersonic, and Red Cat brands and logos. 19 C. Employees As of June 30, 2023, the Company had 76 full-time employees. D. Research and Development During the years ended April 30, 2023 and 2022, we incurred research and development costs of $5,248,336 and $2,606,141, respectively, excluding $692,947 and $516,456 of stock-based compensation, respectively.