Unusual Machines, Inc. 10-K

Item 1. Business Background of Unusual Machines Unusual Machines, Inc. (“Unusual Machines” or the “Company”) is a Puerto Rico corporation, originally incorporated July 11, 2019, with our principal place of business in Orlando, Florida. The Company was incorporated in Puerto Rico under the name “Red Cat Motor Corporation” on July 11, 2019, before changing its name to “AerocarveUS Corporation” on October 20, 2020 and then to “Unusual Machines, Inc.” on July 5, 2022. The Company is in the process of reincorporating as a Nevada corporation. Initial Public Offering On February 16, 2024, the Company closed its Initial Public Offering (the “IPO”) of 1,250,000 shares of common stock at a public offering price of $4.00 per share. The shares are traded on the New York Stock Exchange American (“NYSE American”). Simultaneous with the closing of the IPO, the Company acquired Fat Shark Ltd. (“Fat Shark”) and Rotor Riot, LLC (“Rotor Riot”) from Red Cat Holdings, Inc. (“Red Cat”). The Business Combination & Business Overview On November 21, 2022, the Company entered into a Share Purchase Agreement (the “Purchase Agreement”) with Red Cat and Jeffrey Thompson, the founder and Chief Executive Officer of Red Cat, pursuant to which we agreed to purchase Red Cat’s consumer business consisting of Fat Shark and Rotor Riot (the “Business Combination”). Under the terms of the Purchase Agreement, as amended, the Company purchased Rotor Riot and Fat Shark subsidiaries for $20.0 million (the “Purchase Price”) comprised of (i) $1.0 million in cash, (ii) a $2.0 million promissory note (the “Note”) issued by the Company to Red Cat, and (iii) $17.0 million of the Company’s common stock or 4,250,000 shares of common stock at the $4.00 per share IPO price. Fat Shark is a leader in designing and manufacturing ultra-low latency first-person-view (“FPV”) video goggles for drone pilots, which it markets towards retail distributors including Rotor Riot. Rotor Riot is a rapidly growing e-commerce marketplace, backed by the largest community of FPV drone pilots in the world and retails FPV drones and goggles, parts, tools, drone components, and accessories manufactured by third-parties. Unusual Machines specializes in the production and sale of small drones and essential components and with the acquisitions of Fat Shark and Rotor Riot, it brings brand recognition and a strong curated retail channel in the FPV drone market segment. Unusual Machines intends to build its business both organically and through strategic acquisitions that leverage our retail business to onshore production of critical drone components. With the transition to onshoring production of drone components, the Company intends to expand into B2B channels for customers that require a domestic supply chain. The Drone Industry The drone industry continues to expand to become a powerful business tool and recreational activity, with growth occurring broadly and across our targeted industries. According to Drone Industry Insights, the global drone market is expected to grow to $54.6 billion by 2030, with the commercial market growing at a 7.7% compound annual growth rate (“CAGR”). According to Allied Market Research, the drone component industry is likewise expanding. The drone flight controller market, valued at $15.53 billion in 2021 is expected to reach $28.86 billion by 2031. The drone motor market, valued at $2.6 billion in 2021 is projected to reach $9.9 billion by 2031. 1 Unusual Machines intends to pursue strategic acquisition targets that are cash flow positive and either sell drone parts or allow us to vertically integrate the production of drone parts. The Company believes that very promising, private companies (such as those the company will likely target) are in many instances underfunded and missing out on the ability to go public and bring their innovative products and solutions to a larger set of customers globally. We believe that unlocking this potential will be key to industry consolidation and breaking the dominance of China in the drone industry. First Person View (FPV) Market Segment Fat Shark and Rotor Riot principally operate in the FPV segment of the drone industry. This segment focuses on drones piloted with wearable display devices. These are head mounted displays (“HMDs”) or goggles for drone pilots. These goggles give pilots FPV perspective to control their drone in flight. This is a unique experience where the pilot is interacting with an aircraft through visual immersion. 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, and the FPV goggles are all interconnected via radio. This effect 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. There are four common categories of FPV flight – freestyle flight, racing, cinema photography, and defense. In freestyle, the pilot navigates around obstacles focused on acrobatics and exploring the environment around the aircraft through the HMD. FPV racing describes a spectator sport where pilots fly their drones in competitions through a series of obstacles, flags, and gates in a racetrack. Cinema photography is the process of viewing and recording a subject matter from the air from the viewpoint of the pilot. Defense is a newer market segment characterized by the use cases emerging in the Ukrainian conflict. Plans for Growth, Development, and Expansion Unusual Machine’s plans to strengthen its market position through continued organic revenue growth. In parallel, the Company intends to aggressively invest in the extension of their business from just B2C sales to B2B sales of drone components. Unusual Machine’s business strategy includes (i) increasing its overall customer base with its products and rapid adoption; (ii) investing in new products and IP, starting with the Fat Shark and Rotor Riot acquisitions that were completed with our IPO, (iii) expanding and growing Unusual Machine’s customer base and revenue streams from its existing customer base using a “land-and-expand” model that establishes initial relationships and grows those relationships through the provision of high quality products and services, (iv) enhancing the company’s products to improve the integration of third-party solutions, and (v) seeking strategic partnerships and sponsorships with companies that want access to the FPV community. Customers Revenues for Fat Shark are principally generated through distributors and for Rotor Riot online through its e-commerce site, www.rotorriot.com. Both Fat Shark and Rotor Riot market their products and services to recreational and professional drone pilots and hobbyists. Competition Rotor Riot competes with a number of significantly larger, better capitalized companies. SZ DJI Technology Co., Ltd., commonly known as DJI, is the dominant market leader with a global market share estimated at more than 70%, according to industry research firms. Other competitors include GetFPV and Lumenier. Race Day Quads is a larger, direct competitor in the FPV sector. Rotor Riot competes against these competitors by leveraging its visibility on the internet through its Facebook page which has more than 38,000 followers and its Rotor Riot YouTube channel which has more than 272,000 subscribers. We believe that 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 along with other FPV headset companies including Skyzone FPV, Orqa, 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. 2 Suppliers Rotor Riot purchases inventory from approximately 50 suppliers although 57% of this inventory is purchased from four vendors. The two most critical components are electronics and frames. Approximately 95% of Rotor Riot’s inventory is purchased directly from Chinese vendors, all of which could be subject to varying tariffs. The United States has continuously increased tariffs since 2019, which Rotor Riot is currently subject to and range from 2% to 25%. These tariffs increase the cost of goods which reduces the company’s profit margins. Fat Shark has sources over 90% of its components and inventory from a single Chinese supplier, Shenzhen Fatshark Co. Ltd. See Item 13 – Certain Relationships and Related Party Transactions and Director Independence for additional information. Government Regulation and Federal Policy National Defense Authorization Act and American Security Drone Act In December 2023, Congress passed the National Defense Authorization Act (“NDAA”), which includes the American Security Drones Act (“ASDA”). The bill prohibits, starting in January 2026, federal agencies and federally funded programs from purchasing or using drones manufactured in countries that are viewed as threats to U.S. national security, 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 and operating 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 (1) to procure a covered unmanned aircraft system that is manufactured or assembled by a covered foreign entity or (2) in connection with the operation of such a drone or unmanned aircraft system. · Requires the Comptroller General of the United States to submit a report to Congress no later than 275 days after the enactment of the NDAA 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. 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 December 2023, the FAA reported the registration of almost 791,000 drones, of which approximately 370,000 were commercial and approximately 416,000 were recreational. In addition, more than 370,000 remote pilots were certified. 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. Environmental Considerations Compliance with applicable environmental laws since inception has not had a material effect upon the Company’s capital expenditures, earnings or competitive position. However, drones are battery operated which use electricity for charging. To that extent, except for users who use solar and other non-electrical power to charge drones, users of drones the company sells burn carbon which negatively affects the environment. Further, the SEC’s climate change rules, when passed, will likely increase our compliance costs. 3 Employees and Human Capital Resources As of December 31, 2023, the Company had three full-time employees. However, with the completion of and acquisitions of Fat Shark and Rotor Riot, the Company had 14 full-time employees as of March 21, 2024. Intellectual Property The Company has consolidated its IP into a subsidiary, UMAC IP Holdings Corp. The IP portfolio primarily includes design and utility patents related to FPV headsets. None of the patents are currently licensed and IP is generated in the general course of doing engineering design. The following table summarizes currently issued patents (indicated by “Issued”) including the grant dates thereof, and patent applications (indicated by “Pending or Published”). As the chart indicates, some of these patents are in the U.S., where when issued the patent protection generally applies for 20 years from the date the patent application was made (subject to potential extension, if applied for and granted). In general, patent protection provides the patent holder with a monopoly on the invention within its scope for the duration of the patent. Country Status Patent No Application Date Grant Date Title United States Issued 29/610,543 7/13/2017 UNMANNED AERIAL VEHICLE Canada Issued 179088 1/11/2018 UNMANNED AERIAL VEHICLE China Issued 201830008387.4 1/11/2018 UNMANNED AERIAL VEHICLE EU Issued 4665040 1/12/2018 UNMANNED AERIAL VEHICLE Korea Issued 30-2018-1689 1/11/2018 UNMANNED AERIAL VEHICLE United States Issued 15/684,814 8/23/2017 UNMANNED AERIAL VEHICLE Canada Abandoned 3009413 6/26/2018 UNMANNED AERIAL VEHICLE China Pending 201810895541.3 8/8/2018 UNMANNED AERIAL VEHICLE EU Pending EP18179512.1 6/25/2018 UNMANNED AERIAL VEHICLE United States Issued 29/610,554 7/13/2017 PRINTED CIRCUIT BOARD Canada Issued 179089 1/11/2018 PRINTED CIRCUIT BOARD China Issued 201830008494.7 1/11/2018 PRINTED CIRCUIT BOARD EU Issued 4665032 1/12/2018 PRINTED CIRCUIT BOARD Korea Issued 30-2018-1690 1/11/2018 PRINTED CIRCUIT BOARD China Pending 201810324925.X 4/12/2018 SINGLE-PANEL HEAD-MOUNTED DISPLAY EU Pending 19159958.8 3/4/2019 SINGLE-PANEL HEAD-MOUNTED DISPLAY United States Issued 16/002,200 6/7/2018 SINGLE-PANEL HEAD-MOUNTED DISPLAY China Pending 202010150301.8 3/6/2020 APPARATUS FOR ATTACHING ACCESSORIES TO A FIRST-PERSON VIEW HEADSET United States Published 17/187,838 2/28/2021 APPARATUS FOR ATTACHING ACCESSORIES TO A FIRST-PERSON VIEW HEADSET United States Pending 29/783,966 5/17/2021 HEADSET China Pending 202130741102.X 11/11/2021 VR GLASSES Canada, European Union Countries, Japan, United Kingdom Pending Not yet assigned 11/12/2021 HEADSET 4 Trademark Portfolio The following table summarizes current registered trademarks (indicated by “Registered”) including the registration dates. As the chart indicates, these trademarks are registered in the U.S. and abroad. Country Status Trademark Reg. No. Reg. Date. App. No. App. Date. Class Next Deadline US Registered ROTOR RIOT 5,175,159 4/4/2017 87/074,341 6/16/2016 16, 25, 35, 41 AOU due 4/4/2023 Australia Registered ROTOR RIOT 1814854 4/18/2017 1814854 12/9/2016 16, 25, 35, 41 Renewal due 12/9/2026 Canada Registered ROTOR RIOT TMA1013525 1/22/2019 1813182 12/8/2016 16, 25, 35, 41 Renewal due 1/22/2034 EU Registered ROTOR RIOT 016152688 5/14/2017 016152688 12/12/2016 16, 25, 35, 41 Renewal due 12/12/2026 UK Registered ROTOR RIOT UK00916152688 5/14/2017 UK00916152688 12/12/2016 16, 25, 35, 41 Renewal due 12/12/2026 US Registered Rotor Riot Logo 5,175,160 4/4/2017 87/074,378 6/16/2016 16, 25, 35, 41 AOU due 4/4/2023 Australia Registered Rotor Riot Logo 1814855 4/18/2017 1814855 12/9/2016 16, 25, 35, 41 Renewal due 12/9/2026 Canada Registered Rotor Riot Logo TMA1013624 1/22/2019 1813183 12/8/2016 16, 25, 35, 41 Renewal due 1/22/2034 EU Registered Rotor Riot Logo 016152837 5/14/2017 016152837 12/12/2016 16, 25, 35, 41 Renewal due 12/12/2026 UK Registered Rotor Riot Logo UK00916152837 5/14/2017 UK00916152837 12/12/2016 16, 25, 35, 41 Renewal due 12/12/2026 Unusual Machines has recently filed for a trademark on our logo. Research and Development Research and development activities are part of Unusual Machine’s business, and the Company will follow a disciplined approach to investing our resources to create new drone technologies and solutions. In the years ending December 31, 2023 and 2022, Fat Shark’s research and development costs were approximately 13.0% and 9.8%, respectively, of its revenues. A fundamental part of this approach is a well-defined screening process that helps us identify commercial opportunities that support desired technological capabilities in the markets we serve.