Unusual Machines, Inc. 10-K

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations You should read the following discussion and analysis of our financial condition and results of operations in conjunction with the audited and unaudited financial statements (prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”)) and related notes included elsewhere in this Annual Report on Form 10-K (this “Form 10-K”). The following discussion contains forward-looking statements that are subject to risks and uncertainties. See “ Special Note Regarding Forward-Looking Statements ” for a discussion of the uncertainties, risks, and assumptions associated with those statements. Actual results could differ materially from those discussed in or implied by forward-looking statements as a result of various factors, including those discussed below and elsewhere in this Form 10-K, particularly in the section entitled “ Risk Factors .” Unless we state otherwise or the context otherwise requires, the terms “we,” “us,” “our” and the “Company” refer to Unusual Machines, Inc. and its subsidiaries. All amounts presented in tables, other than per share amounts, are in thousands unless otherwise noted. Recent Developments Initial Public Offering On February 16, 2024, the Company closed the IPO for the sale of 1,250,000 shares of common stock, at a public offering price of $4.00 per share. The IPO generated gross proceeds of $5.0 million and net proceeds of approximately $3.5 million. Acquisition of Fat Shark and Rotor Riot On November 21, 2022, the Company entered into 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. Fat Shark and Rotor Riot are in the business of designing and marketing consumer drones and FPV goggles. Rotor Riot is also a licensed authorized reseller of consumer drones manufactured by third-parties. Under the terms of the Purchase Agreement, as amended, the Company purchased from Red Cat its Rotor Riot and Fat Shark subsidiaries for $20.0 million comprised of (i) $1.0 million in cash, (ii) a $2.0 million promissory 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. 40 Unusual Machines Results of Operations Years Ended December 31, 2023 and 2022 Revenue During the years ended December 31, 2023 and 2022, we did not generate any revenues and as such did not incur any cost of goods sold. Operating Expenses During the year ended December 31, 2023, we incurred general and administrative expenses totaling $1,794,455 compared to $1,242,732 for the year ended December 31, 2022, resulting in an increase of $551,723 or 44.4%. The increase primarily relates to increased legal expenses and professional fees related to the business combination and for preparation of becoming a public company. Net Loss Net loss for the year ended December 31, 2023, totaled $1,794,455 compared to $1,242,584 for the year ended December 31, 2022, resulting in an increase of $551,871 or 44.4%. The increase in net loss is almost entirely related to the increase in general and administrative expenses as we start to build out our operations for the business combination and becoming a public company. Fat Shark Results of Operations Nine Months Ended January 31, 2024 and 2023 Revenue During the nine months ended January 31, 2024 (or the “2024 period”), Fat Shark generated revenues totaling $1,379,391 compared to $2,060,594 during the nine months ended January 31, 2023 (or the “2023 period”), representing a decrease of $681,203 or 33.1%. Revenues can fluctuate from period to period and are generally reflective of normal changes as the life cycles of the company’s products mature. Lower revenues for the 2024 period related to its newest product, the Dominator, which was launched at the beginning of the 2023 period, and while it generated strong initial sales in the first quarter, sales declined significantly since the 2023 period. Cost of Goods Sold During the nine months ended January 31, 2024, Fat Shark incurred cost of goods sold of $2,557,379 compared to $1,753,695 during the nine months ended January 31, 2023; resulting in an increase of $803,684 or 45.8%. The increase primarily related to an inventory impairment charge of $1,244,920 related to the Dominator goggles during the 2024 period. 41 Gross Margin During the nine months ended January 31, 2024, Fat Shark’s gross margin was ($1,177,988) compared to $306,899 during the nine months ended January 31, 2023, resulting in a decrease of $1,484,887 or 483.8%. Fat Shark’s gross margin, as a percentage of sales, totaled (85.4%) during the nine months ended January 31, 2024, compared to 14.9% during the nine months ended January 31, 2023. The reported gross margin was adversely impacted by an impairment charge of $1,244,920 related to the write-down of Dominator inventory based on sales volumes and product discounts. Operating Expenses During the nine months ended January 31, 2024, Fat Shark’s operations expenses totaled $111,204 compared to $180,805 during the nine months ended January 31, 2023, resulting in a decrease of $69,601 or 38.5%. The decrease during the 2024 period reflects lower professional services fees compared to the 2023 period. During the nine months ended January 31, 2024, Fat Shark incurred research and development expenses totaling $35,669 compared to $208,107 for the nine months ended January 31, 2023, resulting in a decrease of $172,438 or 82.9%. The decrease during the 2024 period reflects lower payroll costs compared to the 2023 period. During the nine months ended January 31, 2024, Fat Shark’s sales and marketing expenses totaled $159 compared to $13,837 for the nine months ended January 31, 2023, resulting in a decrease of $13,678 or 98.9%. Sales and marketing expenses were higher during the 2023 period as the Company was preparing for the launch of the Dominator. During the nine months ended January 31, 2024, Fat Shark incurred general and administrative expenses totaling $14,816 compared to $66,193 for the nine months ended January 31, 2023, resulting in a decrease of $51,377 or 77.6%. The decrease primarily relates to lower office and insurance costs compared to the 2023 period. Net Loss Fat Shark’s net loss for the nine months ended January 31, 2024, totaled $1,401,934 compared to $221,530 for the nine months ended January 31, 2023, resulting in an increase in net loss of $1,180,404 or 532.8%. This increase in net loss relates to the impairment charge related to the Dominator inventory resulting in lower gross margins during the 2024 period. This was partially offset by lower operating expenses compared to the 2023 period. The release of Fat Shark’s new generation product, the Dominator, took place during the 2023 period which resulted in higher revenues and gross margins in the 2023 period. Fat Shark Results of Operations Years Ended April 30, 2023 and 2022 Revenue During the year ended April 30, 2023 (or the “2023 period”), Fat Shark generated revenues totaling $2,317,444 compared to $2,627,792 during the year ended April 30, 2022 (or the “2022 period”), representing a decrease of $310,348 or 11.8%. Revenues can fluctuate from period to period and are generally reflective of normal changes as the life cycles the company’s products mature. Lower revenues for the 2023 period related to its newest product, the Dominator, which was launched at the beginning of the 2022 period, and while it generated strong initial sales in the first quarter, sales declined significantly over the remaining quarters in Fiscal 2023. 42 Cost of Goods Sold During the year ended April 30, 2023, Fat Shark’s incurred cost of goods sold of $2,159,159 compared to $2,569,307 during the year ended April 30, 2022; resulting in a decrease of $410,148 or 16.0%. The decrease related to lower revenues during the 2023 period. Gross Margin During the year ended April 30, 2023, Fat Shark gross margin was $158,285 compared to $58,485 during the year ended April 30, 2022, resulting in an increase of $99,800 or 170.6%. Fat Shark’s gross margin, as a percentage of sales, totaled 6.8% during the year ended April 30, 2023 compared to 2.2% during the year ended April 30, 2022. The lower gross margin in the 2022 period related to price reductions of the prior digital goggle as Fat Shark prepared for the launch of the Dominator early in the 2023 period. Separately, Fat Shark recorded a charge of $182,845 related to the write-off of excess quantities of Dominator inventory based on sales volumes during the second half of the year ended April 30, 2023. Operating Expenses During the year ended April 30, 2023, Fat Shark’s operations expenses totaled $240,945 compared to $252,545 during the year ended April 30, 2022, resulting in a decrease of $11,600 or 4.6%. The decrease during the 2023 period reflects lower professional services fees compared to the 2022 period. During the year ended April 30, 2023, Fat Shark incurred research and development expenses totaling $280,515 compared to $407,881 for the year ended April 30, 2022, resulting in a decrease of $127,366 or 31.2%. The decrease during the 2023 period reflects lower payroll and material costs compared to the 2022 period. During the 2022 period, Fat Shark incurred higher payroll and material costs related to its next generation product release. During the year ended April 30, 2023, Fat Shark’s sales and marketing expenses totaled $16,858 compared to $60,616 for the year ended April 30, 2022, resulting in a decrease of $43,758 or 72.2%. Sales and marketing expenses were higher during the 2022 period as the Company was preparing for the launch of the Dominator. During the year ended April 30, 2023, Fat Shark incurred general and administrative expenses totaling $88,277 compared to $169,096 for the year ended April 30, 2022, resulting in a decrease of $80,819 or 47.8%. The decrease primarily relates to lower payroll, facilities, and business travel costs compared to the 2022 period. Net Loss Fat Shark’s net loss for the year ended April 30, 2023 totaled $546,121 compared to $910,723 for the year ended April 30, 2022, resulting in a decrease of $364,602. This decrease relates to improved gross margins and lower operating expenses during the 2023 period. During the 2022 period, Fat Shark’s gross margin was lower related to pricing discounts on end-of-life cycle products and higher research and development expenses related to the release of the new generation product, the Dominator. Rotor Riot Results of Operations Nine Months Ended January 31, 2024 and 2023 Revenue During the nine months ended January 31, 2024 (or the “2024 period”), Rotor Riot generated revenues totaling $3,122,673 compared to $2,534,514 during the nine months ended January 31, 2023 (or the “2023 period”), representing an increase of $588,159 or 23.2%. Revenues can fluctuate from period to period and are generally reflective of normal changes through the life cycles of the products that the company sells. During the 2024 period, higher revenues were generated by a significant increase in digital marketing spending. 43 Cost of Goods Sold During the nine months ended January 31, 2024, Rotor Riot incurred cost of goods sold of $2,186,039 compared to $2,170,151 during the nine months ended January 31, 2023, resulting in a decrease of $15,888 or 0.7%. The decrease related to higher revenues during the 2024 period. Gross Margin During the nine months ended January 31, 2024, Rotor Riot’s gross margin was $936,634 compared to $364,363 during the nine months ended January 31, 2023, resulting in an increase of $572,271 or 157.1%. Gross margin, as a percentage of sales, totaled 30.0% during the nine months ended January 31, 2024, compared to 14.4% during the nine months ended January 31, 2023. The higher level of gross margin is primarily related to successful efforts to reduce tariff expenses for inventory purchases. Operating Expenses During the nine months ended January 31, 2024, Rotor Riot incurred operations expense totaling $560,660 compared to $303,535 during the nine months ended January 31, 2023, resulting in an increase of $257,125 or 84.7% primarily related to increased payroll costs. Payroll expenses totaled $303,064 in the 2024 period compared to $207,929 in the 2023 period, resulting in an increase of $95,135 or 46%. This increase represented 37.0% of the total increase in operations expenses. The remaining increase is primarily attributable to increased office costs and professional fees. During the nine months ended January 31, 2024, Rotor Riot incurred research and development expenses totaling $78,013 compared to $42,927 for the nine months ended January 31, 2023, resulting in an increase of $35,086 or 81.7%. The increase was entirely due to increased payroll costs. During the nine months ended January 31, 2024, Rotor Riot incurred sales and marketing expenses totaling $978,276 compared to $542,079 for the nine months ended January 31, 2023, resulting in an increase of $436,197 or 80.5%. The increase primarily relates to an increase in payroll and advertising program costs for Rotor Riot. Payroll expenses totaled $297,515 in the 2024 period compared to $190,553 in the 2023 period, resulting in an increase of $106,962 or 56%. Advertising expenses totaled $476,637 in the 2024 period compared to $316,237 in the 2023 period, resulting in an increase of $160,400 or 51%. The increases in payroll and advertising expenses represented 25% and 37%, respectively, of the total increase in sales and marketing expenses. During the nine months ended January 31, 2024, Rotor Riot incurred general and administrative expenses totaling $81,796 compared to $210,128 for the nine months ended January 31, 2023, resulting in a decrease of $128,332 or 61.1%. The decrease is primarily related to lower banking fees and meals, travel, and training in the 2024 period. Net Loss Rotor Riot’s net loss for the nine months ended January 31, 2024, totaled $929,018 compared to $876,551 for the nine months ended January 31, 2023, resulting in a decrease in net loss of $52,467 or 6.0%. The decrease in net loss is primarily related to improved gross margins during the 2024 period. Rotor Riot Results of Operations Year Ended April 30, 2023 and 2022 Revenue During the year ended April 30, 2023 (or the “2023 period”), Rotor Riot generated revenues totaling $3,447,149 compared to $2,028,149 during the year ended April 30, 2022 (or the “2022 period”), representing an increase of $1,419,000 or 70.0%. Revenues can fluctuate from period to period and are generally reflective of normal changes through the life cycles of the products that the company sells. During the 2023 period, higher revenues were generated by a significant increase in digital marketing spending. 44 Cost of Goods Sold During the year ended April 30, 2023, Rotor Riot incurred cost of goods sold of $3,015,398 compared to $1,587,674 during the year ended April 30, 2022, resulting in an increase of $1,427,724 or 89.9%. The increase related to higher revenues during the 2023 period. Gross Margin During the year ended April 30, 2023, Rotor Riot’s gross margin was $431,751 compared to $440,475 during the year ended April 30, 2022, resulting in a decrease of $8,724 or 2.0%. Gross margin, as a percentage of sales, totaled 12.5% during the year ended April 30, 2023 compared to 21.7% during the year ended April 30, 2022. The lower level of gross margin is primarily related to higher costs of products being sold including increases in material costs due to the global supply chain issues. Operating Expenses During the year ended April 30, 2023, Rotor Riot incurred operations expense totaling $403,912 compared to $372,473 during the year ended April 30, 2022, resulting in an increase of $31,439 or 8.4% primarily related to increased payroll costs. During the year ended April 30, 2023, Rotor Riot incurred research and development expenses totaling $65,487 compared to $58,719 for the year ended April 30, 2022, resulting in an increase of $6,768 or 11.5%. The increase primarily relates to increased payroll costs. During the year ended April 30, 2023, Rotor Riot incurred sales and marketing expenses totaling $845,526 compared to $220,007 for the year ended April 30, 2022, resulting in an increase of $625,519 or 284.3%. The increase primarily relates to an increase in payroll and advertising program costs for Rotor Riot. During the year ended April 30, 2023, Rotor Riot incurred general and administrative expenses totaling $311,301 compared to $220,366 for the year ended April 30, 2022, resulting in an increase of $90,935 or 41.3%. The increase is primarily related to increased information technology costs associated with the implementation of more sophisticated software systems. Additionally, payroll, office, travel and professional fees also increased. Net Loss Rotor Riot’s net loss for the year ended April 30, 2023 totaled $1,387,866 compared to $596,878 for the year ended April 30, 2022, resulting in an increase of $790,988 or 132.5%. The increase in net loss is primarily related to increased stock compensation, general and administrative, and sales and marketing expenses. Unusual Machines Cash Flows Years Ended December 31, 2023 and 2022 Operating Activities Net cash used in operating activities was $2,201,485 during the year ended December 31, 2023 compared to net cash used in operating activities of $1,231,794 during the year ended December 31, 2022, representing an increase of $969,691 or 78.7%. This increase in net cash used primarily resulted from our increase in net loss of $551,871, increase in deferred offering costs of $337,108 and working capital of $84,482 offset by non-cash expenses of $4,715. 45 Investing Activities Net cash used in investing activities was $3,164 during the year ended December 31, 2023 compared to net cash used in operating activities of $4,575 during the year ended December 31, 2022, representing a decrease of $1,411 or 30.8%. This decrease in net cash used related to timing of purchasing additional computer equipment. Financing Activities Net cash provided by financing activities totaled $0 during the year ended December 31, 2023 compared to $549,900 during the year ended December 31, 2023, resulting in a decrease in net cash provided by financing activities of $549,900 or 100%. The decrease is entirely related to proceeds received from exempt private offerings of our common stock. Fat Shark Cash Flows Nine Months Ended January 31, 2024 and 2023 Operating Activities Fat Shark net cash provided by operating activities was $420,974 during the nine months ended January 31, 2024, compared to net cash used in operating activities of $3,515,745 during the nine months ended January 31, 2023, representing an increase of $3,936,539 or 112.0% in net cash provided by operating activities. This increase in net cash provided by operating activities primarily resulted from Fat Shark’s change in inventory, other assets which consists primarily of prepaid inventory, and accounts receivable totaling $6,069,286, offset by a decrease in net loss of $1,180,404 which includes an inventory impairment charge of $927,765, non-cash expenses of $8,973 and changes in working capital of $943,370. Financing Activities Fat Shark net cash used in financing activities totaled $475,318 during the nine months ended January 31, 2024, compared to net cash provided by financing activities of $3,429,027 during the nine months ended January 31, 2023. The cash used in financing activities in 2024 consisted entirely of payments under debt obligations. The cash provided by financing activities in 2023 consisted entirely of proceeds from a related party. Fat Shark Cash Flows Years Ended April 30, 2023 and 2022 Operating Activities Fat Shark net cash used in operating activities was $3,688,211 during the year ended April 30, 2023 compared to net cash used in operating activities of $783,810 during the year ended April 30, 2022, representing an increase of $2,904,401 or 370.5%. This increase in net cash used primarily resulted from Fat Shark’s increase in inventory and other assets which consists primarily of prepaid inventory of $3,607,636 offset by a decrease in net loss of $364,602, non-cash expenses of $19,341 and changes in working capital of $319,292. Financing Activities Fat Shark net cash provided by financing activities totaled $3,664,732 during the year ended April 30, 2023 compared to $848,195 during the year ended April 30, 2022. The cash provided by financing activities in 2023 consisted entirely of proceeds from a related party. The cash provided by financing activities in 2022 consisted of $2,468,995 of proceeds from a related party offset by $1,620,880 payments on debt obligations. 46 Rotor Riot Cash Flows Nine Months Ended January 31, 2024 and 2023 Operating Activities Rotor Riot net cash used in operating activities was $1,202,275 during the nine months ended January 31, 2024, compared to net cash used in operating activities of $1,287,238 during the nine months ended January 31, 2023, representing a decrease of $84,963 or 6.6%. This decrease in net cash used primarily resulted from Rotor Riot’s decrease in net loss of $52,467, an increase in non-cash related expenses of $46,944, offset by an increase in changes in working capital of $90,486. Financing Activities Rotor Riot net cash provided by financing activities totaled $1,296,914 during the nine months ended January 31, 2024, compared to $1,328,750 during the nine months ended January 31, 2023. The cash provided by financing activities in 2024 consisted of proceeds from a related party of $1,198,473, and proceeds from debt obligations of $262,856, offset by payments on debt obligations of $164,415. Cash provided by financing activities in 2023 consisted of $1,328,750 of proceeds from a related party. Rotor Riot Cash Flows Years Ended April 30, 2023 and 2022 Operating Activities Rotor Riot net cash used in operating activities was $1,358,620 during the year ended April 30, 2023 compared to net cash used in operating activities of $678,206 during the year ended April 30, 2022, representing an increase of $680,414 or 100.3%. This increase in net cash used primarily resulted from Rotor Riot’s increase in net loss of $790,988 offset by non-cash expense of $40,355 and changes in working capital of $70,219. Financing Activities Rotor Riot net cash provided by financing activities totaled $1,339,491 during the year ended April 30, 2023 compared to $591,339 during the year ended April 30, 2022. The cash provided by financing activities in 2023 consisted entirely of proceeds from a related party of $1,339,491. Cash provided by financing activities in 2022 consisted of $860,384 of proceeds from a related party offset by payments on debt obligations of $269,045. Unusual Machines Liquidity and Capital Resources As of December 31, 2023, we had current assets totaling $1,528,162 primarily consisting of cash balances of $894,773 and deferred offering costs of $512,758. Our current liabilities as of December 31, 2023 totaled $114,497, consisting entirely of accounts payable and accrued expenses. Our net working capital as of December 31, 2023 was $1,413,665. On February 16, 2024, we completed our IPO for the sale of 1,250,000 shares of common stock at a public offering price of $4.00 per share for gross proceeds of $5.0 million. After paying certain underwriting discounts and commissions, business combination expenses and other expenses related to the IPO, we received approximately $3.5 million in net proceeds. Our cash balance as of March 21, 2024 was approximately $3.2 million. 47 To date, our operations have been funded exclusively by exempt private offerings of our common stock. In September of 2021, we closed a private offering of 4,552,000 shares of common stock at a price of $0.50 per share for total proceeds of $2,276,000. On December 31, 2021, we closed an additional private offering of 482,500 shares of common stock at a price of $4.00 per share for total gross proceeds of $1,930,000, of which we received net proceeds of $1,842,000 after fees and other expenses. On July 25, 2022, we closed an additional private offering of 150,000 shares of common stock at a price of $4.00 per share for total proceeds of $600,000. We believe that the net proceeds from our February 2024 IPO and existing cash balances will be sufficient to fund our current operating plans through at least the next 12 months. We have based these estimates, however, on assumptions that may prove to be wrong, and we could spend our available financial resources much faster than we currently expect and need to raise additional funds sooner than we anticipate. If we are unable to raise capital when needed or on acceptable terms, we may be forced to delay, reduce or eliminate certain operational efforts. We do not anticipate any significant cost increases post Fat Shark and Rotor Riot acquisitions and with consideration of the combined companies’ net loss and cash position, we expect we will have sufficient working capital to support our operations for at least 12 months following the closing of the IPO. Going Concern The reports from the independent registered public accounting firm for the fiscal year ended April 30, 2023 for Fat Shark Holdings Ltd. and for the fiscal year ended April 30, 2023 for Rotor Riot, LLC, includes an explanatory paragraph stating each company has recurring net losses from operations, has negative operating cash flows, does not yet generate revenue from operations and will need additional working capital for ongoing operations. These factors, among others, raise substantial doubt about each company's ability to continue as a going concern. With the closing of our IPO in February 2024, we expect each will no longer operate as a going concern. Critical Accounting Policies and Estimates Our financial statements and accompanying notes have been prepared in accordance with GAAP applied on a consistent basis. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. We regularly evaluate the accounting policies and estimates that we use to prepare our financial statements. A complete summary of these policies is included in the notes to our financial statements. In general, management’s estimates are based on historical experience, on information from third party professionals, and on various other assumptions that are believed to be reasonable under the facts and circumstances. Actual results could differ from those estimates made by management. Property and equipment are stated at cost. Depreciation and amortization are computed using straight-line methods over the estimated useful lives of the related assets. When property and equipment is retired or otherwise disposed of, the related cost and accumulated depreciation are removed from the respective accounts, and any resulting gain or loss on disposition is reflected in operations. Repairs and maintenance are expensed as incurred; expenditures for additions, improvements and replacements are capitalized. The various classes of fixed assets are depreciated over their estimated useful lives as follows: Computer equipment – 3 years Goodwill represents the excess of the purchase price of an acquisition over the estimated fair value of identifiable net assets acquired. The measurement periods for the valuation of assets acquired and liabilities assumed ends as soon as information on the facts and circumstances that existed as of the acquisition date becomes known, not to exceed 12 months. Adjustments in a purchase price allocation may require a change in the amounts allocated to goodwill during the periods in which the adjustments are determined. 48 Off-Balance Sheet Arrangements We have no off-balance sheet arrangements. Recently Issued Accounting Pronouncements The Company has implemented all new accounting pronouncements that are in effect. These pronouncements did not have any material impact on the financial statements unless otherwise disclosed, and the Company does not believe that there are any other new accounting pronouncements that have been issued that might have a material impact on its financial position or results of operations. Item 7A. Quantitative and Qualitative Disclosures about Market Risk As a smaller reporting company, we are not required to provide this information. 49