Red Cat Holdings, Inc. 10-K

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA RED CAT HOLDINGS, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page Report of Independent Registered Accounting Firm (PCAOB ID: 5041 ) F-2 Consolidated Balance Sheets as of April 30, 2023 and 2022 F-3 Consolidated Statements of Operations for the years ended April 30, 2023 and 2022 F-4 Consolidated Statements of Changes in Shareholders’ Equity for the years ended April 30, 2023 and 2022 F-5 Consolidated Statements of Cash Flows for the years ended April 30, 2023 and 2022 F-6 Notes to the Consolidated Financial Statements F-7 F- 1 Report of Independent Registered Public Accounting Firm To the shareholders and the board of directors of Red Cat Holdings Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of Red Cat Holdings as of April 30, 2023 and 2022, the related statements of operations, stockholders' equity (deficit), and cash flows for the years then ended, and the related notes (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of April 30, 2023 and 2022, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States. Going Concern Matter The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the financial statements, the Company has suffered recurring losses from operations that raises substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 2. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. Basis for Opinion These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audit. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. Our audit included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audit also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audit provides a reasonable basis for our opinion. Critical Audit Matter Critical audit matters are matters arising from the current-period audit of the financial statements that were communicated or required to be communicated to the audit committee and that (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. We determined that there are no critical audit matters. /S/ BF Borgers CPA PC We have served as the Company's auditor since 2020 Lakewood, CO July 27, 2023 F- 2 RED CAT HOLDINGS Consolidated Balance Sheets April 30, April 30, 2023 2022 ASSETS Current assets Cash $ 3,260,305 $ 4,084,815 Marketable securities 12,814,038 44,790,369 Accounts receivable, net 780,969 495,506 Inventory 11,986,527 3,895,870 Other 3,333,173 2,354,884 Due from related party — 31,853 Total current assets 32,175,012 55,653,297 Goodwill 17,012,832 25,138,750 Intangible assets, net 7,343,004 2,698,531 Property and equipment, net 2,650,358 511,690 Other 307,033 57,033 Operating lease right-of-use assets 704,851 1,019,324 Total long term assets 28,018,078 29,425,328 TOTAL ASSETS $ 60,193,090 $ 85,078,625 LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities Accounts payable $ 1,999,422 $ 1,018,747 Accrued expenses 518,919 1,084,494 Debt obligations - short term 922,138 956,897 Operating lease liabilities 331,258 293,799 Warrant derivative liability 588,205 1,607,497 Customer deposits 400,674 437,930 Due to related party — 40,057 Total current liabilities 4,760,616 5,439,421 Operating lease liabilities 421,280 749,825 Debt obligations - long term 401,569 973,707 Total long term liabilities 822,849 1,723,532 Commitments and contingencies Stockholders' equity Series B preferred stock - shares authorized 4,300,000 ; outstanding 986,676 9,867 9,867 Common stock - shares authorized 500,000,000 ; outstanding 54,568,065 and 53,748,735 54,568 53,749 Additional paid-in capital 109,993,100 106,821,384 Accumulated deficit ( 54,586,793 ) ( 27,499,056 ) Accumulated other comprehensive income ( 861,117 ) ( 1,470,272 ) Total stockholders' equity 54,609,625 77,915,672 TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 60,193,090 $ 85,078,625 See accompanying notes. F- 3 RED CAT HOLDINGS Consolidated Statements of Operations Year ended April 30, 2023 2022 Revenues $ 9,911,780 $ 6,428,963 Cost of goods sold 10,248,575 5,503,448 Gross margin ( 336,795 ) 925,515 Operating expenses Operations 4,411,685 1,353,904 Research and development 5,248,336 2,606,141 Sales and marketing 4,028,007 1,127,532 General and administrative 6,618,596 5,548,589 Stock based compensation 3,656,724 3,291,635 Impairment loss 2,826,918 — Total operating expenses 26,790,266 13,927,801 Operating loss ( 27,127,061 ) ( 13,002,286 ) Other (income) expense Change in fair value of derivative liability ( 1,019,292 ) ( 1,042,129 ) Investment income, net ( 137,787 ) ( 355,769 ) Interest expense 122,004 147,724 Other, net 995,751 ( 62,984 ) Other (income) expense ( 39,324 ) ( 1,313,158 ) Net loss $ ( 27,087,737 ) $ ( 11,689,128 ) Loss per share - basic and diluted $ ( 0.50 ) $ ( 0.24 ) Weighted average shares outstanding - basic and diluted 53,860,199 48,220,265 See accompanying notes. F- 4 RED CAT HOLDINGS Consolidated Statements of Stockholders' Equity Series A Series B Common Stock Additional Accumulated Other Preferred Stock Preferred Stock Paid-in Accumulated Comprehensive Total Shares Amount Shares Amount Shares Amount Capital Deficit Income (Loss) Equity Balances, April 30, 2021 158,704 $ 1,587 1,968,676 $ 19,687 29,431,264 $ 29,431 $ 21,025,518 $ ( 15,809,928 ) $ — $ 5,266,295 Conversion of preferred stock ( 158,704 ) ( 1,587 ) ( 982,000 ) ( 9,820 ) 2,140,329 2,140 9,267 — — — Exercise of warrants — — — — 66,666 67 263,073 — — 263,140 Acquisition of Skypersonic — — — — 707,293 707 2,715,305 — — 2,716,012 Acquisition of Teal — — — — 3,588,272 3,588 10,007,691 — — 10,011,279 Public offerings, net of $ 5,959,800 of issuance costs — — — — 17,333,334 17,333 70,022,871 — — 70,040,204 Stock based compensation — — — — — — 3,291,635 — — 3,291,635 Exercise of stock options — — — — 89,107 89 ( 89 ) — — — Issuance of restricted stock units, net of payroll tax withholding — — — — 280,803 282 ( 764,175 ) — — ( 763,893 ) Shares issued for services — — — — 111,667 112 250,288 — — 250,400 Unrealized loss on marketable securities — — — — — — — — ( 1,474,294 ) ( 1,474,294 ) Currency translation adjustments — — — — — — — — 4,022 4,022 Net Loss — — — — — — — ( 11,689,128 ) — ( 11,689,128 ) Balances, April 30, 2022 — $ — 986,676 $ 9,867 53,748,735 $ 53,749 $ 106,821,384 $ ( 27,499,056 ) $ ( 1,470,272 ) $ 77,915,672 Stock based compensation — — — — — — 3,656,724 — — 3,656,724 Issuance of restricted stock units, net of payroll tax withholding — — — — 779,498 779 ( 523,606 ) — — ( 522,827 ) Shares issued for services — — — — 39,832 40 38,598 — — 38,638 Unrealized gain on marketable securities — — — — — — — — 610,129 610,129 Currency translation adjustments — — — — — — — — ( 974 ) ( 974 ) Net Loss — — — — — — — ( 27,087,737 ) — ( 27,087,737 ) Balances, April 30, 2023 — $ — 986,676 $ 9,867 54,568,065 $ 54,568 $ 109,993,100 $ ( 54,586,793 ) $ ( 861,117 ) $ 54,609,625 See accompanying notes. F- 5 RED CAT HOLDINGS Consolidated Statements of Cash Flows Year ended April 30, 2023 2022 Cash Flows from Operating Activities Net loss $ ( 27,087,737 ) $ ( 11,689,128 ) Adjustments to reconcile net loss to net cash from operations: Stock based compensation Shares 2,038,742 1,844,520 Options 1,617,982 1,447,115 Common stock issued for services 38,638 250,400 Amortization of intangible assets 654,527 224,638 Realized loss from sale of marketable securities 296,012 — Depreciation 311,545 40,165 Change in fair value of derivative ( 1,019,292 ) ( 1,042,129 ) Impairment loss 2,826,918 — Changes in operating assets and liabilities, net of acquisitions Accounts receivable ( 285,463 ) ( 74,317 ) Inventory ( 8,090,657 ) ( 2,229,487 ) Other ( 978,289 ) ( 3,634,604 ) Operating lease right-of-use assets and liabilities 23,387 24,300 Customer deposits ( 37,256 ) 328,841 Accounts payable 980,675 ( 1,173,472 ) Accrued expenses ( 489,152 ) ( 336,162 ) Net cash used in operating activities ( 29,199,420 ) ( 16,019,320 ) Cash Flows from Investing Activities Cash acquired through acquisitions — 24,866 Purchases of property and equipment ( 2,450,213 ) ( 363,689 ) Proceeds from sale of marketable securities 32,290,448 11,355,218 Purchases of marketable securities — ( 57,619,881 ) SAFE Investment agreement ( 250,000 ) — Net cash provided by (used in) investing activities 29,590,235 ( 46,603,486 ) Cash Flows from Financing Activities Proceeds from exercise of warrants — 99,999 Proceeds from related party obligations 13,404 — Payments under related party obligations ( 40,057 ) ( 1,970,757 ) Payments under debt obligations ( 606,897 ) ( 929,952 ) Payments of taxes related to equity awards ( 581,775 ) ( 834,219 ) Proceeds from issuance of common stock, net — 70,065,203 Net cash (used in) provided by financing activities ( 1,215,325 ) 66,430,274 Net (decrease) increase in Cash ( 824,510 ) 3,807,468 Cash, beginning of period 4,084,815 277,347 Cash, end of period 3,260,305 4,084,815 Cash paid for interest 122,103 164,573 Cash paid for income taxes — — Non-cash transactions Fair value of shares Issued in acquisitions $ — $ 12,727,292 Withheld as payment of note receivable $ 18,449 $ 201,873 Unrealized gain (loss) on marketable securities $ 610,129 $ ( 1,474,294 ) Forgiveness of PPP loan $ — $ 300,910 Elimination of derivative liability $ — $ 163,141 Financed purchases of property and equipment $ — $ 144,383 Indirect payment to related party $ — $ 132,200 Taxes related to net share settlement of equity awards $ 32,468 $ 108,969 Conversion of preferred stock into common stock $ — $ 11,407 See accompanying notes. F- 6 RED CAT HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS April 30, 2023 and 2022 Note 1 – The Business Red Cat Holdings (“Red Cat” or the “Company”) was originally incorporated in February 1984. Since April 2016, the Company’s primary business has been to provide products, services and solutions to the drone industry which it presently does through its four wholly owned subsidiaries. Teal Drones is a leader in commercial and government Unmanned Aerial Vehicles (UAV) technology. Fat Shark is a provider of First Person View (FPV) video goggles to the drone industry. Rotor Riot sells FPV drones and equipment to the consumer marketplace through its digital storefront located at www.rotorriot.com. Skypersonic provides software and hardware solutions that enable drones to complete inspection services in locations where GPS (global positioning systems) is not available, yet still record and transmit data even while being operated from thousands of miles away. Significant corporate developments include: A. Fat Shark Acquisition On September 30, 2020, the Company entered into a share purchase agreement (“Share Purchase Agreement”) with Greg French (“French”), the founder and sole shareholder of Fat Shark Holdings (“Fat Shark”), to acquire all of the issued and outstanding shares of Fat Shark and its subsidiaries. The transaction closed on November 2, 2020 and was valued at $ 8,354,076 based on (i) the issuance of 5,227,273 shares of common stock with a value of $ 6,351,076 on the date of closing (ii) a senior secured promissory note in the original principal amount of $ 1,753,000 , and (iii) a cash payment of $ 250,000 . The Share Purchase Agreement included indemnification provisions, a two year non-compete agreement, and registration rights for the shares issued in the transaction. A summary of the purchase price and its related allocation was as follows: Shares issued $ 6,351,076 Promissory note issued 1,753,000 Cash 250,000 Total Purchase Price $ 8,354,076 Assets acquired Cash 201,632 Accounts receivable 249,159 Other assets 384,232 Inventory 223,380 Brand name 1,144,000 Proprietary technology 272,000 Non-compete agreement 16,000 Goodwill $ 6,168,260 Total assets acquired 8,658,663 Liabilities assumed Accounts payable and accrued expenses 279,393 Customer deposits 25,194 Total liabilities assumed 304,587 Total fair value of net assets acquired 8,354,076 Intangible assets included proprietary technology and a non-compete agreement which are being amortized over 5 and 3 years, respectively. The carrying value of brand name is not being amortized but is reviewed quarterly and formally evaluated at year end. The excess of the purchase price above the net assets acquired was recorded as goodwill which is reviewed quarterly and formally evaluated at year end. F- 7 B. Skypersonic Acquisition In May 2021, the Company acquired all of the outstanding stock of Skypersonic, Inc. (“Skypersonic”) in exchange for $3,000,000 of our common stock. The number of shares issuable was based on the volume weighted average price ("VWAP") of our common stock for the 20 trading days ending May 7, 2021. Based on a VWAP of $4.0154, the Company issued 747,124 shares. In addition, the Company also agreed to issue 110,000 shares of common stock to a shareholder. For accounting purposes, the 857,124 shares were valued at $ 3,291,356 based on the closing price of our common stock of $ 3.84 on May 7, 2021. Prior to the closing, the Company provided $ 75,000 to Skypersonic to fund its operating costs. This amount was capitalized as part of the purchase price. In October 2021, the Company and Skypersonic agreed to a reduction in the purchase price of $ 601,622 which resulted in the cancellation of 149,829 shares held in escrow. The final summary of the purchase price and its related allocation is as follows: Shares issued $ 2,716,012 Cash 75,000 Total Purchase Price $ 2,791,012 Assets acquired Cash 13,502 Accounts receivable 51,083 Other assets 12,950 Inventory 50,556 Proprietary technology 826,000 Non-compete agreement 65,000 Goodwill $ 2,826,918 Total assets acquired 3,846,009 Liabilities assumed Accounts payable and accrued expenses 1,054,997 Total liabilities assumed 1,054,997 Total fair value of net assets acquired 2,791,012 Intangible assets included proprietary technology and a non-compete agreement which are being amortized over 5 and 3 years, respectively. The excess of the purchase price above the net assets acquired was recorded as goodwill which is reviewed quarterly and formally evaluated at year end. C. Teal Drones Acquisition On August 31, 2021, the Company closed the acquisition of Teal Drones Inc., (“Teal”). Under the terms of the agreement, the base purchase price of $ 14,000,000 was reduced by $ 1,670,294 of debt assumed by the Company, as well as a working capital deficit adjustment of $ 1,456,953 . Based on the net amount payable of $ 10,872,753 , and a VWAP of $2.908 for the twenty trading days ending August 31, 2022, the Company issued 3,738,911 of common stock. For accounting purposes, the shares were valued at $ 10,431,562 based on the closing price of our common stock of $ 2.79 on August 31, 2021. In December 2021, the Company and Teal agreed to a reduction in the purchase price of $ 438,058 which resulted in the cancellation of 150,639 shares held in escrow. F- 8 The final summary of the purchase price and its related allocation is as follows: Total Purchase Price – shares issued $ 10,011,279 Assets acquired Cash 11,364 Accounts receivable 47,964 Other current assets 15,085 Other assets 48,595 Inventory 1,253,755 Brand name 1,430,000 Proprietary technology 3,869,000 Goodwill $ 8,995,499 Total assets acquired 15,671,262 Liabilities assumed Accounts payable and accrued expenses 1,143,899 Customer deposits 1,766,993 Notes payable 2,749,091 Total liabilities assumed 5,659,983 Total fair value of net assets acquired 10,011,279 Intangible assets includes proprietary technology which is being amortized over 6 years. The carrying value of brand name is not being amortized but is reviewed quarterly and formally evaluated at year end. The excess of the purchase price above the net assets acquired was recorded as goodwill which is reviewed quarterly and formally evaluated at year end. Supplemental Unaudited Pro Forma Financial Information and Other Information There is no pro forma financial information for the year ended April 30, 2023 because all acquisitions had closed prior to the beginning of the reporting period. The following table presents pro forma results as if our acquisition of Teal had occurred on May 1, 2021: Year ended April 30, 2022 Red Cat Teal Consolidated Revenues $ 6,428,963 $ 416,063 $ 6,845,026 Net Loss ( 11,689,128 ) ( 1,467,770 ) ( 13,156,898 ) The acquisition of Skypersonic was completed on May 7, 2021 and its activities during the period from May 1, 2021 to May 7, 2021 were immaterial to the consolidated pro forma results. The unaudited pro forma financial information has been compiled in a manner consistent with the Company's accounting policies, and includes transaction costs, amortization of the acquired intangible assets, and other expenses directly related to the acquisition of Teal. The unaudited pro forma financial information is based on estimates and assumptions which the Company believes are reasonable but not necessarily indicative of the results that would have been realized had the acquisition closed on the date indicated in the tables, nor are they indicative of results of operations that may occur in the future. Other information related to the Company’s acquisitions include: • The purchase price allocation has been finalized for each acquisition based on the report from the valuation services firm engaged to assist in the identification and valuation of intangible assets acquired . • The fair value of shares issued by the Company as part of the consideration paid is normally based on the volume weighted average price of the Company’s common stock for the twenty days prior to the closing of the transaction. For accounting purposes, the shares issued are valued based on the closing stock price on the date that the transaction closes. F- 9 • Goodwill for Rotor Riot relates to its strong social media presence including more than 200,000 YouTube subscribers. Goodwill for Fat Shark is attributable to its relationship with manufacturing sources in China and the potential to integrate its goggle technologies with the Teal drone. Goodwill for Teal is ascribed to its existing relationship with several U.S. government agencies including its classification as an approved vendor. • The Company expects that the Goodwill recognized in each transaction will be deductible for tax purposes. The Company has reported net losses since its inception and is presently unable to determine when and if the tax benefit of this deduction will be realized. Note 2 – Summary of Significant Accounting Policies Basis of Accounting – The financial statements and accompanying notes are prepared in accordance with generally accepted accounting principles in the United States (“GAAP”). Certain prior period amounts have been restated to conform to the current year presentation. Principles of Consolidation – Our consolidated financial statements include the accounts of our wholly owned operating subsidiaries, which consist of Teal Drones, Fat Shark, Rotor Riot, and Skypersonic, including its wholly owned international subsidiary, Skyset. Intercompany transactions and balances have been eliminated. Use of Estimates – The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates reflected in these financial statements include those used to (i) determine stock-based compensation, (ii) complete purchase price accounting for acquisitions, (iii) accounting for derivatives, (iv) reserves and allowances related to accounts receivable and inventory, and (v) the evaluation of long term assets, including goodwill, for impairment. Cash and Cash Equivalents – At April 30, 2023, we had cash of $3,260,305 in multiple commercial banks and financial services companies. We have not experienced any loss on these cash balances and believe they are not exposed to any significant credit risk. Marketable Securities – Our marketable securities have been classified and accounted for as available-for-sale securities. These securities are primarily invested in corporate bonds and are readily saleable, and therefore, we have classified them as short term. Our available-for-sale securities are carried at fair value with any unrealized gains and losses reported as a component of comprehensive income (loss). Once realized, any gains or losses are recognized in the statement of operations. We have elected to present accrued interest income separately from marketable securities on our consolidated balance sheets. Accrued interest income was $151,671 and $385,730 as of April 30, 2023 and 2022, respectively, and was included in other current assets. We did not write off any accrued interest receivable during the fiscal years ended April 30, 2023 and 2022. Accounts Receivable, net – Accounts receivable are recorded at the invoiced amount less allowances for doubtful accounts. The Company's estimate of the allowance for doubtful accounts is based on a multitude of factors, including historical bad debt levels for its customer base, past experience with a specific customer, the economic environment, and other factors. Accounts receivable balances are written off against the allowance when it is probable that the receivable will not be collected. Inventories – Inventories, which consist of raw materials, work-in-process, and finished goods, are stated at the lower of cost or net realizable value, and are measured using the first-in, first-out method. Cost components include direct materials and direct labor, as well as in-bound freight. At each balance sheet date, the Company evaluates the net realizable value of its inventory using various reference measures including current product selling prices, as well as evaluating for excess quantities and obsolescence. F- 10 Goodwill and Long-lived Assets – Goodwill represents the future economic benefit arising from other assets acquired in an acquisition that are not individually identified and separately recognized. We test goodwill for impairment in accordance with the provisions of ASC 350, Intangibles – Goodwill and Other, (“ASC 350”). Goodwill is tested for impairment at least annually at the reporting unit level or whenever events or changes in circumstances indicate that goodwill might be impaired. ASC 350 provides that an entity has the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then additional impairment testing is not required. However, if an entity concludes otherwise, then it is required to perform an impairment test. The impairment test involves comparing the estimated fair value of a reporting unit with its book value, including goodwill. If the estimated fair value exceeds book value, goodwill is considered not to be impaired. If, however, the fair value of the reporting unit is less than book value, then an impairment loss is recognized in an amount equal to the amount that the book value of the reporting unit exceeds its fair value, not to exceed the total amount of goodwill allocated to the reporting unit. The estimate of fair value of a reporting unit is computed using either an income approach, a market approach, or a combination of both. Under the income approach, we utilize the discounted cash flow method to estimate the fair value of a reporting unit. Significant assumptions inherent in estimating the fair values include the estimated future cash flows, growth assumptions for future revenues (including gross margin, operating expenses, and capital expenditures), and a rate used to discount estimated future cash flow projections to their present value based on estimated weighted average cost of capital (i.e., the selected discount rate). Our assumptions our based on historical data, supplemented by current and anticipated market conditions, estimated growth rates, and management’s plans. Under the market approach, fair value is derived from metrics of publicly traded companies or historically completed transactions of comparable businesses. The selection of comparable businesses is based on the markets in which the reporting units operate and consider risk profiles, size, geography, and diversity of products and services. Property and equipment – Property and equipment is stated at cost less accumulated depreciation which is calculated using the straight-line method over the estimated useful life of the asset. The estimated useful lives of our property and equipment are generally: (i) furniture and fixtures - seven years, (ii) equipment and related - two to five years, and (iii) leasehold improvements - 15 years. Leases – Effective August 1, 2021, the Company adopted Accounting Standards Codification (ASC) 842 titled “Leases” which requires the recognition of assets and liabilities associated with lease agreements. The Company adopted ASC 842 on a modified retrospective transition basis which means that it did not restate financial information for any periods prior to August 1, 2021. Upon adoption, the Company recognized a lease liability obligation of $796,976 and a right-of-use asset for the same amount. The Company determines if a contract is a lease or contains a lease at inception. Operating lease liabilities are measured, on each reporting date, based on the present value of the future minimum lease payments over the remaining lease term. The Company's leases do not provide an implicit rate. Therefore, the Company uses an effective discount rate of 12% based on its last debt financing. Operating lease assets are measured by adjusting the lease liability for lease incentives, initial direct costs incurred and asset impairments. Lease expense for minimum lease payments is recognized on a straight-line basis over the lease term with the operating lease asset reduced by the amount of the expense. Lease terms may include options to extend or terminate a lease when they are reasonably certain to occur. Fair Values, Inputs and Valuation Techniques for Financial Assets and Liabilities and Related Disclosures – The fair value measurements and disclosure guidance defines fair value and establishes a framework for measuring fair value. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the measurement date. In accordance with this guidance, the Company has categorized its recurring basis financial assets and liabilities into a three-level fair value hierarchy based on the priority of the inputs to the valuation technique. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level input that is significant to the fair value measurement in its entirety. The Company's assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability. F- 11 The guidance establishes three levels of the fair value hierarchy as follows: Level 1 : Inputs are unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date; Level 2 : Inputs are observable, unadjusted quoted prices in active markets for similar assets or liabilities, unadjusted quoted prices for identical or similar assets or liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the related assets or liabilities; and Level 3 : Unobservable inputs that are significant to the measurement of the fair value of the assets or liabilities that are supported by little or no market data. Financial Instruments The Company's financial instruments mainly consist of cash, receivables, current assets, accounts payable, accrued expenses and debt. The carrying amounts of cash, receivables, current assets, accounts payable, accrued expenses and current debt approximates fair value due to the short-term nature of these instruments. Derivative Liabilities The Company has financial instruments that are considered derivatives or contain embedded features subject to derivative accounting. Embedded derivatives are valued separately from the host instrument and are recognized as liabilities on the Company's balance sheet. The Company measures these instruments at their estimated fair value and recognizes changes in their estimated fair value in results of operations during the period of change. In October 2020 and January 2021, the Company entered into convertible note agreements which included provisions under which the conversion price was equal to the lesser of an initial stated amount or the conversion price of a future offering. This variable conversion feature was recognized as a derivative. Both financings included the issuance of warrants which contained similar variable conversion features. The Company values these convertible notes and warrants using the multinomial lattice method. The valuation is updated each reporting date with the change in the liability reflected as a change in derivative liability in the statement of operations. Revenue Recognition – The Company recognizes revenue in accordance with ASC 606, “Revenue from Contracts with Customers”, issued by the Financial Accounting Standards Board (“FASB”). This standard includes a comprehensive evaluation of factors to be considered regarding revenue recognition including (i) identifying the promised goods, (ii) evaluating performance obligations, (iii) measuring the transaction price, (iv) allocating the transaction price to the performance obligations if there are multiple components, and (v) recognizing revenue as each obligation is satisfied. The Company’s revenue transactions include a single component, specifically, the shipment of goods to customers as orders are fulfilled. The Company recognizes revenue upon shipment. The timing of the shipment of orders can vary considerably depending upon whether an order is for an item normally maintained in inventory or an order that requires assembly or unique parts. Customer deposits totaled $400,674 and $437,930 at April 30, 2023 and April 30, 2022, respectively. Research and Development – Research and development expenses include payroll, employee benefits, and other headcount-related expenses associated with product development. Research and development expenses also include third-party development and programming costs, as well as a proportionate share of overhead costs such as rent. Costs related to software development are included in research and development expense until technological feasibility is reached, which for our software products, is generally shortly before the products are released to production. Once technological feasibility is reached, such costs are capitalized and amortized as a cost of revenue over the estimated lives of the products. Income Taxes – Deferred taxes are provided on the liability method whereby deferred tax assets are recognized for deductible temporary differences and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. Recent Accounting Pronouncements – Management does not believe that recently issued, but not yet effective accounting pronouncements, if adopted, would have a material effect on the accompanying consolidated financial statements. Foreign Currency – The functional currency of our international subsidiary, Skyset, is the local Italian currency. For that subsidiary, we translate assets and liabilities to U.S. dollars using period-end exchange rates, and average monthly exchange rates for revenues, costs, and expenses. We record translation gains and losses in accumulated other comprehensive income. F- 12 Comprehensive Loss – Comprehensive loss consists of net loss and other gains and losses that are recorded as an element of stockholders' equity but are excluded from net loss. The other gains and losses include foreign currency translation adjustments and unrealized gains or losses on available-for-sale securities. During the year ended April 30, 2023, comprehensive loss was $609,155 lower than net loss, primarily related to unrealized gains on available-for-sale securities totaling $610,129, partially offset by foreign currency translation adjustments of $974. During the year ended April 30, 2022, comprehensive loss was $1,470,272 higher than net loss, primarily related to unrealized losses on available-for-sale securities totaling $1,474,294, partially offset by foreign currency translation adjustments of $4,022. Stock-Based Compensation – S tock options are valued using the estimated grant-date fair value method of accounting in accordance with ASC Topic 718, Compensation – Stock Compensation. Fair value is determined based on the Black-Scholes Model using inputs reflecting our estimates of expected volatility, term and future dividends. We recognize forfeitures as they occur. The fair value of restricted stock is based on our stock price on the date of grant. Compensation costs is recognized on a straight-line basis over the service period which is the vesting term. Basic and Diluted Net Loss per Share – Basic and diluted net loss per share has been calculated by dividing net loss by the weighted average number of shares of common stock outstanding during the period. Common stock equivalents were excluded from the computation of diluted net loss per share of common stock because they were anti-dilutive. The conversion or exercise of these common stock equivalents would dilute earnings per share if we become profitable in the future. Outstanding securities not included in the computation of diluted net loss per share because their effect would have been anti-dilutive included: April 30, 2023 April 30, 2022 Series B Preferred Stock, as converted 822,230 822,230 Stock options 4,784,809 3,694,142 Warrants 1,539,999 1,539,999 Restricted stock 781,060 1,083,675 Total 7,928,098 7,140,046 Related Parties – Parties are considered to be related if they have control or significant influence, directly or indirectly, over us, including key management personnel and members of the Board of Directors. Related Party transactions are disclosed in Note 19. Segment Reporting Since January 2020, we have acquired four separate businesses operating in various aspects of the drone industry. Following the last acquisition, the Company established Enterprise and Consumer segments to sharpen the Company’s focus on the unique opportunities in each sector of the drone industry. The Enterprise segment, which includes Teal Drones and Skypersonic, is focused on opportunities in the commercial sector, including military. Enterprise is building the infrastructure to manage drone fleets, fly and provide services remotely, and navigate confined industrial interior spaces and dangerous military environments. The Consumer segment, which includes Rotor Riot and Fat Shark, is focused on enthusiasts and hobbyists which are expected to increase as drones become more visible in our daily lives. Effective May 1, 2022, we began to manage our business operations through these business segments. The reportable segments were identified based on how our chief operating decision maker (“CODM”), which is a committee comprised of our Chief Executive Officer (“CEO”), Chief Operating Officer (“COO”) and our Chief Financial Officer (“CFO”), manages our business, makes resource allocation and operating decisions, and evaluates operating performance. See “Note 20 - Segment Reporting”. Liquidity and Going Concern – The Company has never been profitable and its net losses have been increasing related to acquisitions, as well as costs incurred to pursue its long-term growth strategy. During the year ended April 30, 2023, the Company incurred a net loss of $ 27,087,737 and used cash in operating activities of $ 29,199,420 . As of April 30, 2023, the Company has working capital of $ 27,414,396 . While the Company has historically been successful in raising capital to meet its working capital requirements, the ability to continue raising such capital to enable the Company to continue its growth is not guaranteed. Therefore, there is substantial doubt about the Company’s ability to continue as a going concern as the Company will require additional liquidity to continue its operations and meet its financial obligations for twelve months from the date these consolidated financial statements are issued. The Company is evaluating strategies to obtain the required funding and exploring opportunities to reduce expenses. F- 13 If the Company is unable to raise additional capital, there is a risk that the Company could default on additional obligations; and could be required to discontinue or significantly reduce the scope of its operations. The consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts, or the amount and classification of liabilities or any other adjustment that might be necessary should the Company be unable to continue as a going concern. Note 3 – Marketable Securities Marketable securities consisted solely of corporate bonds at April 30, 2023 and were classified at Level 2 in the Fair Value Hierarchy. Fair value, cost basis, and unrealized losses totaled $ 12,814,038 , $ 13,678,203 , and $ 864,165 at April 30, 2023, respectively. Contractual maturities of one year or less, one to three years and more than three years totaled $ 2,138,088 , $ 10,523,950 and $ 152,000 , respectively. Note 4 – Inventories Inventories as of April 30 consisted of: 2023 2022 Raw materials $ 8,132,196 $ 2,831,713 Work-in-process 509,381 173,112 Finished goods 3,344,950 891,045 Total $ 11,986,527 $ 3,895,870 Note 5 – Other Current Assets Other current assets as of April 30 consisted of: 2023 2022 Prepaid inventory $ 2,421,538 $ 1,707,085 Accrued interest income 151,671 385,730 Prepaid expenses 759,964 262,069 Total $ 3,333,173 $ 2,354,884 Note 6 – Due From Related Party In January 2022, the Company determined that a senior executive had relocated in 2021 but their compensation had not been subject to the income tax withholding required by the new jurisdiction. The amount subject to taxation included $ 155,624 of cash compensation and $ 1,413,332 of income associated with the vesting of restricted stock ("Stock Compensation"). In March 2022, the Company entered into a note agreement (the "Note") with the employee in the amount of $ 510,323 , representing the estimated taxes owed by the employee related to the Stock Compensation. Under the terms of the Note, 104,166 shares of common stock with a fair value of $ 280,832 , which had vested during calendar 2021, were withheld by the Company and applied against the Note. The employee agreed not to sell or transfer 110,983 shares of common stock held at the Company's transfer agent until the Note was repaid. In addition, the employee has 20,833 shares of restricted stock vesting monthly in calendar 2022, of which 3,000 shares were withheld with the fair value of those shares applied against the Note. Shares issued to the employee in 2022 were held at the transfer agent until the Note was repaid. The Note matured on December 31, 2022. The Company filed amended payroll tax returns on March 16, 2022. In March and April 2022, the Company made payments to the relevant tax authorities totaling $ 712,646 representing $ 510,323 owed by the employee, $ 31,604 owed by the Company, and $ 170,719 of penalties and interest. The Note was repaid in full in August 2022. F- 14 Note 7 – Intangible Assets Intangible assets relate to acquisitions completed by the Company, as described in Note 1, and were as follows at April 30: 2023 2022 Gross Carrying Amount Accumulated Amortization Net Carrying Value Gross Carrying Amount Accumulated Amortization Net Carrying Value Proprietary technology $ 4,967,000 $ ( 841,223 ) $ 4,125,777 $ 1,098,000 $ ( 219,267 ) $ 878,733 Non-compete agreements 81,000 ( 56,667 ) 24,333 81,000 ( 29,667 ) 51,333 Customer relationships 39,000 ( 18,106 ) 20,894 39,000 ( 12,535 ) 26,465 Total finite-lived assets 5,087,000 ( 915,996 ) 4,171,004 1,218,000 ( 261,469 ) 956,531 Brand name 3,152,000 — 3,152,000 1,722,000 — 1,722,000 Trademark 20,000 — 20,000 20,000 — 20,000 Total indefinite-lived assets 3,172,000 — 3,172,000 1,742,000 — 1,742,000 Total intangible assets, net $ 8,259,000 $ ( 915,996 ) $ 7,343,004 $ 2,960,000 $ ( 261,469 ) $ 2,698,531 Proprietary technology and non-compete agreements are being amortized over five to six years and three years, respectively. Customer relationships are being amortized over seven years. Goodwill and Brand name are not amortized but evaluated for impairment on a quarterly basis. As of April 30, 2023, expected amortization expense for finite-lived intangible assets for the next five years is as follows: Fiscal Year Ended: 2024 $ 866,805 2025 842,471 202 6 815,271 2027 786,679 2028 644,833 Thereafter 214,945 Total $ 4,171,004 Goodwill represents the future economic benefit arising from other assets acquired in an acquisition that are not individually identified and separately recognized. The composition of, and changes in goodwill, consist of: Date Acquisition Goodwill January 2020 Rotor Riot $ 1,849,073 November 2020 Fat Shark 6,168,260 May 2021 Skypersonic 2,826,918 August 2021 Teal Drones 8,995,499 Balance at April 30, 2022 19,839,750 Impairment loss Skypersonic ( 2,826,918 ) Balance at April 30, 2023 $ 17,012,832 Following the establishment of the Enterprise and Consumer segments, management evaluated the long term business strategy of each segment. This resulted in the Enterprise segment narrowing its focus on the military and other government agencies. It was determined that Skypersonic's technology would be re-focused for the near term on military applications and consolidated into the operations of Teal Drones. The Company completes a formal evaluation of the carrying value of its intangible assets, including goodwill, at the end of each fiscal year. Based on (i) the operating results for Skypersonic since its acquisition in May 2021, (i) its consolidation into Teal, (iii) our current expectations of its future business conditions and trends, and (iv) our projected revenues, expenses, and cash flows related to Skypersonic, the Company completed an assessment of the carrying amount of Skypersonic's goodwill and recognized an impairment charge of $ 2,826,918 . F- 15 Note 8 – Property and Equipment Property and equipment consist of assets with an estimated useful life greater than one year and are reported net of accumulated depreciation. The reported values are periodically assessed for impairment, and were as follows as of April 30: 2023 2022 Equipment and other $ 1,386,373 $ 509,376 Leasehold improvements 1,473,890 149,330 Furniture and equipment 132,752 42,746 Accumulated depreciation ( 342,657 ) ( 189,762 ) Net carrying value $ 2,650,358 $ 511,690 Depreciation expense totaled $ 311,545 and $ 40,165 for the fiscal years ended April 30, 2023 and 2022, respectively. Note 9 – Other Long Term Assets Other long term assets as of April 30 consisted of: 2023 2022 SAFE agreement $ 250,000 $ — Security deposits 57,033 57,033 Total $ 307,033 $ 57,033 In November 2022, the Company entered into a SAFE (Simple Agreement for Future Equity) agreement with Firestorm Labs, Inc. (“Firestorm”) under which it made a payment $ 250,000 to Firestorm in exchange for the right to certain shares of Firestorm stock. The SAFE permits the Company to participate in a future equity financing of Firestorm by converting the $ 250,000 into shares of Preferred Stock of Firestorm. If there is a change in control of Firestorm or a public offering of shares of its stock, then the Company shall have the right to receive cash payments, or shares of stock, whichever has greater value. The Company’s investment in the SAFE agreement has been recorded on the cost method of accounting. The Company plans to evaluate the investment for any indications of impairment in value on a quarterly basis. No factors indicative of impairment were identified during the fiscal year ended April 30, 2023. Note 10 – Operating Leases As of April 30, 2023, t he Company had operating type leases for real estate and no finance type leases. The Company’s leases have remaining lease terms of up to 4.08 years, some of which may include options to extend for up to 5 years. Operating lease expense totaled $ 395,248 for the year ended April 30, 2023, including period cost for short-term, cancelable, and variable leases, not included in lease liabilities, of $ 22,475 for the year ended April 30, 2023. Leases on which the Company made rent payments during the reporting period included: Location Monthly Rent Expiration South Salt Lake, Utah $ 22,667 December 2024 Orlando, Florida $ 4,520 January 2025 San Juan, Puerto Rico $ 5,647 June 2027 Troy, Michigan $ 550 May 2022 Supplemental information related to operating leases for the year ended April 30, 2023 was: Operating cash paid to settle lease liabilities $ 371,230 Weighted average remaining lease term (in years) 2.40 Weighted average discount rate 12 % F- 16 Future lease payments at April 30, 2023 were as follows: Fiscal Year Ended: 2024 403,878 2025 304,676 2026 76,619 2027 79,300 2028 6,627 Total $ 871,100 Note 11 – Debt Obligations A. Decathlon Capital On August 31, 2021, Teal entered into an Amended and Restated Loan and Security Agreement with Decathlon Alpha IV, L.P. (“DA4”) (the “Loan Agreement”) in the amount of $ 1,670,294 (the “Loan”), representing the outstanding principal amount previously due and owing by Teal to DA4. Interest on the Loan accrues at a rate of ten ( 10 %) percent per annum. Principal and interest is payable in monthly installments of $ 49,275 until maturity on December 31, 2024. The balance outstanding at April 30, 2023 totaled $ 895,709 . B. Pelion Note In May 2021, Teal entered into a note agreement totaling $ 350,000 which is payable upon demand. The Note bears interest at the applicable Federal Rate as of the date of the Note which was 0.13 % on the date of issuance. Accrued interest totaled $ 878 at April 30, 2023. C. Vendor Settlement In connection with the acquisition of Teal on August 31, 2021, the Company assumed an obligation with a contract manufacturing firm. The assumed balance of $ 387,500 was repaid in monthly installments of $ 37,500 through July 2022. D. SBA Loan In February 2021, Teal received a Small Business Administration Paycheck Protection Program (“SBA PPP”) loan in the amount of $ 300,910 . The loan was unsecured, non-recourse, and accrued interest at one percent annually. The loan was used to fund qualifying payroll, rent and utilities. In February 2022, the principal balance of $ 300,910 and accrued interest of $ 3,001 were forgiven. E. Shopify Capital Shopify Capital is an affiliate of Shopify, Inc. which provides sales software and services to the Company. The Company processes customer transactions ordered on the e-commerce site for Rotor Riot through Shopify. Shopify Capital has entered into multiple agreements with the Company in which it has "purchased receivables" at a discount. Shopify retains a portion of the Company's daily receipts until the purchased receivables have been paid. The Company recognizes the discount as a transaction fee, in full, in the month in which the agreement is executed. Agreements with activity during the two years ended April 30, 2023 included: Date of Transaction Purchased Receivables Payment to Company Transaction Fees Withholding Rate Fully Repaid In September 2020 $ 209,050 $ 185,000 $ 24,050 17 % May 2021 April 2021 $ 236,500 $ 215,000 $ 21,500 17 % January 2022 F. Corporate Equity Beginning in October 2021, and amended in January 2022, Teal financed a total of $ 120,000 of leasehold improvements with Corporate Equity. The loan bears interest at 8.25 % annually and requires monthly payments of $ 3,595 through December 2024. The balance outstanding at April 30, 2023 totaled $ 66,586 . F- 17 G. Revenue Financing Arrangement In April 2021, Teal entered into an agreement under which it sold future customer payments, at a discount, to Forward Financing. At August 31, 2021, the Company assumed the outstanding balance of $ 38,758 . Repayment of the remaining balance was completed in January 2022. H. Ascentium Capital In September 2021, Teal entered into a financing agreement with Ascentium Capital to fund the purchase of a fixed asset totaling $ 24,383 . Monthly payments of $ 656 are payable through October 2024. The balance outstanding at April 30, 2023 totaled $ 11,412 . I. PayPal PayPal is an electronic commerce company that facilitates payments between parties through online funds transfers. The Company processes certain customer payments ordered on its e-commerce site through PayPal. The Company has entered into multiple agreements under which PayPal provides an advance on customer payments, and then retains a portion of customer payments until the advance is repaid. PayPal charges a fee which the Company recognizes in full upon entering an agreement. A November 2019 agreement under which PayPal advanced $ 100,000 and charged a transaction fee of $6,900 was completed in January 2021. A January 2021 agreement under which PayPal advanced $ 75,444 and charged a transaction fee of $ 2,444 was completed in August 2021. J. Summary Outstanding principal payments are due as follows: Fiscal 2024 922,138 Fiscal 2025 401,569 Total $ 1,323,707 Short term – through April 30, 2024 $ 922,138 Long term – thereafter $ 401,569 Note 12 – Due to Related Party A. Founder of Fat Shark In connection with the acquisition of Fat Shark in November 2020, the Company issued a secured promissory note for $ 1,753,000 to the seller. The note accrued interest at 3 % annually and matured in full in November 2023. In May 2021, the Company made an initial payment of $ 132,200 by directing a refund from a vendor based in China to the noteholder who is also based in China. The remaining balance of $ 1,620,800 plus accrued interest totaling $ 45,129 was paid in September 2021. B. BRIT, LLC In January 2020, in connection with the acquisition of Rotor Riot, the Company issued a promissory note for $ 175,000 to the seller, BRIT, LLC. The note accrued interest at 4.75 % annually. In October 2021, the outstanding balance of $ 85,172 plus accrued interest totaling $ 12,942 was paid. The Company also assumed a line of credit obligation totaling $ 47,853 which incurred interest at 6.67 % annually. The remaining balance of $ 37,196 plus accrued interest totaling $ 292 was paid in October 2022. C. Aerocarve In 2020, the Company received advances totaling $ 79,000 from Aerocarve which is controlled by the Company's Chief Executive Officer. The parties agreed that the funds would bear interest at 5 % annually until repaid. The balance was repaid in full in May 2021. F- 18 Note 13 – Income Taxes Our operating subsidiary, Red Cat Propware, Inc., is incorporated and based in Puerto Rico which is a commonwealth of the United States. We are not subject to taxation by the United States as Puerto Rico has its own taxing authority. Since inception, we have incurred net losses in each year of operations. Our current provision for the reporting periods presented in these financial statements consisted of a tax benefit against which we applied a full valuation allowance, resulting in no current provision for income taxes. In addition, there was no deferred provision for any of these reporting periods. At April 30, 2023 and April 30, 2022, we had accumulated deficits of approximately $ 54,600,000 and $ 27,500,000 , respectively. Deferred tax assets related to the future benefit of these net operating losses for tax purposes totaled approximately $ 10,101,000 and $ 5,087,500 , respectively, calculated using the base Puerto Rico corporate tax rate of 18.5%. Currently, we focus on projected future taxable income in evaluating whether it is more likely than not that these deferred assets will be realized. Based on the fact that we have not generated an operating profit since inception, we have applied a full valuation allowance against our deferred tax assets at April 30, 2023 and 2022. Note 14 – Common Stock Our common stock has a par value of $0.001 per share. We are authorized to issue 500,000,000 shares of common stock. Each share of common stock is entitled to one vote. A summary of shares of common stock issued by the Company since April 30, 2021 is as follows: Description of Shares Shares Issued Shares outstanding as of April 30, 2021 29,431,264 Conversion of Series A preferred stock 1,321,996 Conversion of Series B preferred stock 818,333 Exercise of warrants 66,666 Acquisition of Skypersonic on May 7, 2021, see Note 1 707,293 Acquisition of Teal Drones on August 31, 2021, see Note 1 3,588,272 Public offerings which generated gross proceeds of $76 million and net proceeds of approximately $70.1 million 17,333,334 Exercise of stock options 89,107 Vesting of restricted stock to employees, net of 225,869 shares withheld to pay taxes and 92,812 to repay a Note 225,637 Vesting of restricted stock to Board of Directors 48,124 Vesting of restricted stock to consultants 7,042 Shares issued for services 111,667 Shares outstanding as of April 30, 2022 53,748,735 Vesting of restricted stock to employees, net of shares withheld of 273,874 to pay taxes and 9,000 to repay a Note 653,308 Vesting of restricted stock to Board of Directors 116,507 Vesting of restricted stock to consultants 9,683 Shares issued for services 39,832 Shares outstanding as of April 30, 2023 54,568,065 F- 19 Note 15 – Preferred Stock Series A Preferred Stock outstanding totaled 158,704 at April 30, 2021, and were converted into 1,321,996 shares of common stock on August 10, 2021. Series B Preferred Stock (“Series B Stock”) is convertible into common stock at a ratio of 0.8334 shares of common stock for each share of Series B Stock held and votes together with the common stock on an as-if-converted basis. Shares outstanding at April 30, 2023 totaled 986,676 which are convertible into 822,230 shares of common stock. Note 16 – Warrants The company issued five-year warrants in connection with two convertible note financings. The warrants have an exercise price of $ 1.50 which may be reduced to a 25% discount of the price per share of Common Stock offered in a future qualified offering. The warrants were valued using the multinominal lattice model and are considered derivative liabilities under ASC 815-40. The value of the warrants was included in the determination of the initial accounting for each financing including the calculation of the derivative liability and related expense. A summary of the warrants issued and their fair values were: Upon Issuance Outstanding at April 30, 2023 Date of Transaction Number of Warrants Initial Fair Value Number of Warrants Fair Value October 2020 399,998 $ 267,999 266,666 $ 184,008 January 2021 675,000 $ 2,870,666 540,000 $ 404,197 In March and April 2021, we received $ 201,249 related to the exercise of 201,666 of the warrants. Since these exercises resulted in the elimination of the derivative liability in the warrants, the derivative liability was reduced by $ 694,305 with a corresponding increase in additional paid in capital. In June 2021, we received $ 99,999 in connection with the exercise of 66,666 warrants which resulted in the elimination of $ 163,141 of the derivative liability in the warrants. In May 2021, the Company issued warrants to purchase 200,000 shares of common stock to the placement agent of its common stock offering. The warrants have a five-year term and an exercise price of $ 5.00 . In July 2021, the Company issued warrants to purchase 533,333 shares of common stock to the placement agent of its common stock offering. The warrants have a five-year term and an exercise price of $ 5.625 . The following table presents the range of assumptions used to estimate the fair values of warrants granted during the year ended April 30: 2023 2022 Risk-free interest rate — 0.79 – 0.85 % Expected dividend yield — — Expected term (in years) — 5.00 Expected volatility — 222.45 – 223.17 % F- 20 The following table summarizes the changes in warrants outstanding since April 30, 2021. Number of Shares Weighted-average Exercise Price per Share Weighted-average Remaining Contractual Term (in years) Aggregate Intrinsic Value Balance as of April 30, 2021 873,332 1.50 4.62 $ 2,218,263 Granted 733,333 $ 5.45 Exercised ( 66,666 ) 1.50 Outstanding as of April 30, 2022 1,539,999 3.38 3.89 $ 427,533 Granted — Exercised — Outstanding at April 30, 2023 1,539,999 $ 3.38 2.89 $ — Note 17 – Share Based Awards The 2019 Equity Incentive Plan (the "Plan") allows us to incentivize key employees, consultants, and directors with long term compensation awards such as stock options, restricted stock, and restricted stock units (collectively, the "Awards"). The number of shares issuable in connection with Awards under the Plan may not exceed 8,750,000 . A. Options The range of assumptions used to calculate the fair value of options granted during the year ended April 30 was: 2023 2022 Exercise Price $ 0.89 – 2.38 $ 1.69 – 2.82 Stock price on date of grant 0.89 – 2.38 1.69 – 2.82 Risk-free interest rate 3.34 – 4.18 % 0.47 – 1.91 % Dividend yield — — Expected term (years) 6.25 – 8.25 3.75 – 10.00 Volatility 245.57 – 260.06 % 210.68 – 273.46 % A summary of options activity under the Plan since April 30, 2021 is as follows: Shares Weighted-Average Exercise Price Weighted-Average Remaining Contractual Term Aggregate Intrinsic Value Outstanding as of April 30, 2021 2,197,475 $ 1.79 8.68 4,943,870 Granted 1,681,000 2.58 Exercised ( 150,000 ) 2.49 Forfeited or expired ( 34,333 ) 2.11 Outstanding as of April 30, 2022 3,694,142 2.17 8.56 1,407,545 Granted 1,503,500 1.40 Exercised — — Forfeited or expired ( 412,833 ) 2.67 Outstanding as of April 30, 2023 4,784,809 1.88 8.72 74,586 Exercisable as of April 30, 2023 3,025,184 $ 2.00 7.25 $ 74,586 F- 21 The aggregate intrinsic value of outstanding options represents the excess of the stock price at the indicated date over the exercise price of each option. As of April 30, 2023 and April 30, 2022, there was $ 2,940,239 and $ 3,357,701 of unrecognized stock-based compensation expense related to unvested stock options which is expected to be recognized over the weighted average periods of 1.94 and 2.20 years, respectively. B. Restricted Stock A summary of restricted stock activity under the Plan since April 30, 2021 was: Shares Weighted Average Grant-Date Fair Value Per Share Unvested and outstanding as of April 30, 2021 687,500 $ 2.69 Granted 995,659 2.55 Vested ( 599,484 ) 2.64 Forfeited — — Unvested and outstanding as of April 30, 2022 1,083,675 2.59 Granted 780,884 2.14 Vested ( 1,062,372 ) 2.42 Forfeited ( 21,127 ) 2.13 Unvested and outstanding as of April 30, 2023 781,060 $ 2.44 As of April 30, 2023 and April 30, 2022, there was $ 1,385,325 and $ 2,544,105 of unrecognized stock-based compensation expense related to unvested restricted stock units which is expected to be recognized over the weighted average periods of 1.22 and 1.84 years, respectively. C. Stock Compensation Stock compensation expense by functional category was: 2023 2022 General and administrative $ 1,608,715 $ 1,521,951 Research and development 692,947 516,456 Operations 788,909 783,781 Sales and marketing 566,153 469,447 Total $ 3,656,724 $ 3,291,635 Stock compensation expense pertaining to options totaled $ 1,617,982 and $ 1,447,115 for the year ended April 30, 2023 and 2022, respectively. Stock compensation expense pertaining to restricted stock totaled $ 2,038,742 and $ 1,844,520 for the year ended April 30, 2023 and 2022, respectively. Note 18 – Derivatives The Company completed financings in October 2020 and January 2021 which included notes and warrants containing embedded features subject to derivative accounting. Both the notes and the warrants included provisions which provided for a reduction in the conversion and exercise prices, respectively, if the Company completed a future qualified offering at a lower price. These provisions represent embedded derivatives which are valued separately from the host instrument (meaning the notes and warrants) and recognized as derivative liabilities on the Company's balance sheet. The Company initially measures these financial instruments at their estimated fair value and recognizes changes in their estimated fair value in results of operations during the period of change. The Company also measures these financial instruments on the date of settlement (meaning when the note is converted, or the warrant is exercised) at their estimated fair value and recognizes changes in their estimated fair value in results of operations. Any discount in the carrying value of the note is fully amortized on the date of settlement and recognized as interest expense. The Company estimated the fair value of these embedded derivatives using a multinomial lattice model. The range of underlying assumptions used in the binomial model to determine the fair value of the derivative warrant liability upon settlement of the derivative liability and as of April 30, 2023 and 2022 are set forth below. In addition, the Company's stock price on each measurement date was used in the model. F- 22 April 30, 2023 April 30, 2022 Risk-free interest rate 2.83 – 4.51 % 0.52 – 2.87 % Expected dividend yield — — Expected term (in years) 2.42 – 3.50 3.42 – 4.50 Expected volatility 138.49 – 235.23 % 211.02 – 292.28 % As of April 30, 2023, all of the notes had been converted into common stock and 806,666 of the warrants were outstanding. Changes in the derivative liability during the year ended April 30, 2023 and 2022 were as follows: 2023 2022 Balance, beginning of period $ 1,607,497 $ 2,812,767 Additions — — Eliminated upon conversion of notes/exercise of warrants — ( 163,141 ) Changes in fair value ( 1,019,292 ) ( 1,042,129 ) Balance, end of period $ 588,205 $ 1,607,497 Changes in fair value primarily relate to changes in the Company’s stock price during the period, with increases in the stock price increasing the liability and decreases in the stock price reducing the liability. Note 19 – Related-Party Transactions In July 2021, the Company entered into a consulting agreement with a director resulting in monthly payments of $ 6,000 . In addition, the Company issued 150,000 options to purchase common stock at $ 2.51 which vested quarterly over the one-year term of the agreement. In January 2022, the agreement was amended to increase the monthly payments to $ 10,000 . The agreement expired in June 2022. In January 2022, the Company entered into a note agreement with an employee in the principal amount of $510,323, as further described in Note 6. Additional related party transactions are disclosed in Note 12. Note 20 - Segment Reporting We define our segments as those operations whose results are regularly reviewed by our Chief Operating Decision Maker (“CODM”) to analyze performance and allocate resources. Therefore, segment information is prepared on the same basis that management reviews financial information for operational decision-making purposes. Our CODM is a committee comprised of our CEO, COO, and CFO. The Enterprise segment is focused on opportunities in the commercial and military sectors. Enterprise is building the infrastructure to manage drone fleets, fly and provide services remotely, and navigate confined industrial interior spaces and dangerous military environments. The Consumer segment is focused on enthusiasts and hobbyists which are expected to increase as drones become more visible in our daily lives. F- 23 Our CODM allocates resources to and assesses the performance of our two operating segments based on the operating segments’ net sales and gross profit. The following table sets forth information by reportable segment for the year ended April 30, 2023. For the year ended April 30, 2023 Enterprise Consumer Corporate Total Revenues $ 4,620,834 $ 5,290,946 $ — $ 9,911,780 Cost of goods sold 5,455,145 4,793,430 — 10,248,575 Gross margin ( 834,311 ) 497,516 — ( 336,795 ) Operating expenses 12,343,174 2,252,821 12,194,271 26,790,266 Operating loss ( 13,177,485 ) ( 1,755,305 ) ( 12,194,271 ) ( 27,127,061 ) Other expenses, net 432,817 ( 24,919 ) ( 447,222 ) ( 39,324 ) Net loss $ ( 13,610,302 ) ( 1,730,386 ) ( 11,747,049 ) ( 27,087,737 ) The following table sets forth specific asset categories which are reviewed by our CODM in the evaluation of operating segments: As of April 30, 2023 Enterprise Consumer Corporate Total Accounts receivable, net $ 719,862 $ 61,107 $ — $ 780,969 Inventory, net 8,920,573 3,065,954 — 11,986,527 Inventory deposits $ 359,500 $ 2,062,038 $ — $ 2,421,538 Note 21 - Sale of Consumer Segment On November 21, 2022, the Board of Directors approved a Stock Purchase Agreement (the "SPA") between the Company, Unusual Machines, Inc. (“UM”) and Jeffrey Thompson, the founder and Chief Executive Officer of the Company (the “Principal Stockholder”), related to the sale of the Company’s consumer business consisting of Rotor Riot, (“RR”), and Fat Shark Holdings (“FS”), to UM for cash and stock consideration totaling $18 million. On November 21, 2022, the Board of Directors approved the SPA and its submission to shareholders for approval. On March 8, 2023, shareholders approved the sale to UM. On April 13, 2023, the SPA was amended (the “Amendment”) and the total purchase price increased to $20 million. Under the Amendment, the cash consideration payable at closing was reduced to $3.0 million, as may be adjusted for working capital on the closing date (increased for positive working capital and decreased for negative working capital), and the non-cash consideration adjusted to provide for payment of $17 million in shares of UM’s common stock (the “Unusual Common Stock”) issued at the initial public offering price for the Unusual Common Stock. All of the Unusual Common Stock will be subject to a lock-up of 180 days and be eligible for registration. The Company estimates that working capital at closing will range between $2.0 to $4.5 million. In addition, closing of the SPA is subject to successful completion of an initial public offering (the “IPO”) by UM in the minimum amount of $5 million, and the listing of UM’s common stock listing on a public stock exchange such as the NYSE or Nasdaq. UM filed a registration statement on Form S-1 for an initial public offering of its Common Stock with the SEC. UM is required to deposit $1.0 million cash with the Company upon effectiveness of the registration statement with the SEC. F- 24 Note 22 – Commitments and Contingencies Legal Proceedings In the ordinary course of business, we may be involved, at times, in various legal proceedings involving a variety of matters. We do not believe there are any pending legal proceedings that will have a material adverse effect on our business, consolidated financial position, results of operations, or cash flows. However, the outcome of such legal matters is inherently unpredictable and subject to significant uncertainties. We have not recorded any litigation reserves as of April 30, 2023. One pending legal matter is an action filed against Teal Drones and the Company in a U.S. District Court in California. The complaint asserts claims for breach of contract, and the unlawful conversion and sale of shares of common stock that plaintiff alleges to have purchased in Teal prior to its acquisition by the Company. The complaint also alleges breach of fiduciary duty and seeks in excess of $1 million in damages. The Company believes the complaint is without merit and is vigorously contesting the complaint. Note 23 - Subsequent Events On July 13, 2023, the parties executed Amendment No. 2 to the Share Purchase Agreement (the "SPA") which extends the term of the Agreement to September 30, 2023. On the closing date, the Principal Stockholder, Jeffrey Thompson, will enter into a lock-up agreement under which he will agree not to sell 100,000 shares of common stock of Unusual Machines for nine months from the effective date of the UM Registration Statement. These shares shall provide security for Red Cat's and the Thompson's indemnification obligations under the Agreement. In addition, Unusual agrees to register 300,000 shares of Unusual Common Stock that it will issue to Red Cat upon closing the SPA in a Registration Statement to be filed within 120 days after the Closing. F- 25 PART III ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE There were no changes in or disagreements with accountants on accounting and financial disclosure.