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 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 Private Placement On October 29, 2024 (the “Closing Date”), we entered into Securities Purchase Agreements (the "SPA”) with accredited investors (each, an "Investor” and together the "Investors”) for a private placement offering ("Private Placement”), for aggregate gross proceeds of $1.95 million before deducting fees to the placement agent and other expenses payable by us in connection with the Private Placement. We intend to use the net proceeds of the Offering for working capital and general corporate purposes. As part of the Private Placement, we issued an aggregate of 1,286,184 units at a per unit purchase price of $1.52 per unit. Each unit consisted of one share of Common Stock and one warrant to purchase one share of the Company’s Common Stock (each an "Investor Warrant”) and collectively, the Investor Warrants”). The Investor Warrants have a term of five and a half years from the Closing Date and may not be exercised for 180 days after the Closing Date and are exercisable at $1.99 per share, subject to certain limitations and adjustments set forth in the Investor Warrants. On February 25, 2025, the 2025 Special Meeting of the Company was held. At the 2025 Special Meeting, the Company’s stockholders voted and approved on a waiver of the provision that certain warrants are only exercisable 180 days after issuance. On February 26, 2025, the Company issued 1,224,606 shares of Common Stock to various warrant holders who exercised their warrants at an exercise price of $1.99. The Company received gross proceeds in the aggregate amount of $2,436,966 as a result of the warrant exercises. The shares of common stock issued are fully registered under the Registration Statement on Form S-1 (SEC Registration Number 333-283494). All of the Investor Warrants were exercised other than Investor Warrants held by Allan Evans, our Chief Executive Officer, Sanford Rich and Robert Lowry, who are each members of our Board. 41 Potential Aloft Acquisition On February 1, 2025, we entered into a Merger Agreement to acquire drone software company, Aloft. We believe that Aloft is a leader in the drone fleet and airspace management sector, powering more than 70% of all FAA-approved Low Altitude Authorization and Notification Capability airspace authorizations in the United States. Aloft has provided more than 1.6 million authorizations in total with 400,000 authorizations provided in 2024. The acquisition is for $14.5 million, almost entirely in the Company’s Common Stock. Customary closing conditions by the parties must be met before closing the merger. For more information, see Risk Factors – Risks Related to our Business and Financial Condition” we may not be successful in consummating the merger if certain closing conditions are not met. Results of Operations We acquired Fat Shark and Rotor Riot on February 16, 2024 and generated no revenue from 2023 through the date of acquisition. For pro forma information unaudited result of operations reflecting our performance if we had owned these subsidiaries as of January 1, 2023, See Note 3 to our Consolidated Financial Statements. Years Ended December 31, 2024 and 2023 Revenue During the year ended December 31, 2024 we generated revenues totaling $5,565,319 compared to $0 during the year ended December 31, 2023, representing an increase of $5,565,319 or 100%. We did not generate any revenues until the closing of the acquisitions of Fat Shark and Rotor Riot on February 16, 2024. Accordingly, our revenues for the year ended December 31, 2024 are affected by not having any revenues for half of the first quarter. Prior to our acquisition, Fat Shark and Rotor Riot had pro forma revenues for the year ended December 31, 2023 of approximately $4.68 million. Revenues almost entirely relate to completed and fulfilled product sales during the year through our Rotor Riot retail channel and from B2B enterprise sales of our Fat Shark and Blue UAS products. Cost of Goods Sold During the year ended December 31, 2024, we incurred cost of goods sold of $4,019,068 compared to $0 during the year ended December 31, 2023, resulting in an increase of $4,019,068 or 100%. Similar to revenues, we did not incur any cost of goods sold until the closing of the acquisitions on February 16, 2024. Prior to our acquisition, Fat Shark and Rotor Riot had pro-forma cost of goods sold for the year ended December 31, 2023 of approximately $4.13 million. Cost of goods sold primarily relate to product costs from our sales but also include certain shipping and tariff costs. Gross Margin During the year ended December 31, 2024, our gross margin was $1,546,251 compared to $0 during the year ended December 31, 2023, resulting in an increase of $1,546,251 or 100%. Our gross margin, as a percentage of sales, totaled 28% during the year ended December 31, 2024, compared to 0% during the year ended December 31, 2023. We anticipate our gross margin to fluctuate period to period depending on certain promotions and products that are sold during the period and the margins we generated during the quarter are in line with our expectations and normal operating margins. Operating Expenses During the year ended December 31, 2024, operations expenses totaled $959,740 compared to $0 during the year ended December 31, 2023, resulting in an increase of $959,740 or 100%. Prior to the closing of the acquisitions in February 2024, we did not have any operations expenses. Operations expenses primarily relate to our direct operations including our warehouse personnel and warehouse expenses. During the year ended December 31, 2024, research and development expenses totaled $90,584 compared to $0 for the year ended December 31, 2023, resulting in an increase of $90,584 or 100%. Prior to the closing of the acquisitions in February 2024, we did not have any research and development expenses during 2023. Research and development expense primarily relates to new product development as we continue to partner with manufacturers to bring drone component manufacturing to the United States and include expenses incurred related to our Blue UAS products. 42 During the year ended December 31, 2024, sales and marketing expenses totaled $1,091,268 compared to $0 for the year ended December 31, 2023, resulting in an increase of $1,091,268 or 100%. Prior to the closing of the acquisitions in February 2024, we did not have any sales and marketing expenses. Sales and marketing expenses primarily relate to advertising spend related to Rotor Riot, costs related to our Rotor Riot show production and payroll expenses for our marketing personnel. During the year ended December 31, 2024, general and administrative expenses totaling $6,250,939 compared to $2,377,862 for the year ended December 31, 2023, resulting in an increase of $3,873,077 or 163%. General and administrative expenses incurred during 2024 include expenses related to operations for a public company including legal and other professional fees, public company insurance expense, and other costs associated with being public. In addition, we also incurred $2,320,206 in non-cash stock compensation expense. General and administrative expenses incurred during 2023 primarily related to expenses incurred as we operated as a management company to acquire Fat Shark and Rotor Riot and take the Company public. We incurred $600,000 of non-cash stock compensation expenses in 2023. The increase relates to increased expenses related to closing the IPO including legal and accounting fees, additional transition and integration related expenses, higher stock compensation expense, and costs related to operating Fat Shark and Rotor Riot. During the year ended December 31, 2024, we recognized a loss on impairment of goodwill of $10,073,326 compared to $0 for the year ended December 31, 2023, resulting in an increase of $10,073,326 or 100%. The loss on goodwill impairment relates to the difference in the fair value calculation of goodwill from the acquisitions of Rotor Riot and Fat Shark as compared to the carrying value as of the measurement date. We did not have any goodwill in the prior year as the acquisitions had not yet been completed. Other Expenses During the year ended December 31, 2024, other expenses totaled $15,002,061 compared to $0 during the year ended December 31, 2023, resulting in an increase of $15,002,061 or 100%. Other expenses mostly consists of non-cash related charges including $16,146,205 for the change in fair value from our derivatives including the conversional option feature on the note payable and the warrant liability. It is offset by a non-cash gain on debt extinguishment of $1,259,979. Finally, other expenses included $116,981 for interest expense that the Company paid in relation to its Note Payable during the year and interest income of $1,146. We did incur these same costs in 2023 as we did not have operational activities until after our IPO and the completion of the acquisitions. Net Loss Our net loss for the year ended December 31, 2024, totaled $31,980,468 including non-cash charges of approximately $26.7 million. This compared to $2,383,462 for the year ended December 31, 2023, resulting in an increase in net loss of $29,597,006. The increase in net loss primarily relates to a change in fair value of derivatives and warrant liabilities of $16,146,205, a loss on impairment of goodwill of $10,073,326, the increase in general and administrative expenses related to closing the IPO and stock compensation expense with additional increase in expenses for operations, sales and marketing expenses we incurred since the acquisition from Fat Shark and Rotor Riot, and interest expense of $116,981. Interest expense is from our debt incurred from our IPO that was converted to equity in August and December 2024. This was partially offset by generating gross margin related to the revenue and cost of goods sold from sales for Fat Shark and Rotor Riot, a gain on debt extinguishment of $1,259,979, and income tax benefit of $13,360. Cash Flows Prior to the closing of our IPO and the acquisitions of Fat Shark and Rotor Riot, we did not have any cash inflows from operations and all cash outflows related to our activities related to our IPO. Our future cash flows from operating activities will be significantly impacted by revenues received, our investment in sales and marketing to drive growth, and general and administrative expenses related to operating a public company. Our ability to meet future liquidity needs will be driven by our operating performance and the extent of continued investment in our operations. Failure to generate sufficient revenues and related cash flows could have a material adverse effect on our ability to meet our liquidity needs and achieve our business objectives. Operating Activities Net cash used in operating activities was $3,996,367 during the year ended December 31, 2024, compared to net cash used in operating activities of $1,776,552 during the year ended December 31, 2023, representing an increase of $2,219,815 or 125%. This change in net cash used primarily resulted from our increase in net loss of $29,597,006 and an increase in prepaid expenses of $83,749 and accounts receivable of $59,777, offset by a decrease in inventory of $455,101, an increase in other assets of $36,196, an increase in accounts payable and accrued expenses of $284,124, other liabilities of $34,238 and non-cash expenses of $26,711,058which is primarily from a loss on impairment of goodwill and a change in fair value of derivatives. Investing Activities Net cash used in investing activities was $852,801 during the year ended December 31, 2024 compared to net cash used in investing activities of $3,164 during the year ended December 31, 2023, representing an increase of $849,637. This change in net cash used in investing activities related to the $1,000,000 we paid to purchase Fat Shark and Rotor Riot, offset by $147,199 in cash acquired as compared to $3,164 used for purchase of computer equipment during 2023. 43 Financing Activities Net cash provided by financing activities totaled $7,711,718 during the year ended December 31, 2024, compared to net cash used in financing activities of $424,933 during the year ended December 31, 2023, resulting in an increase in net cash provided by financing activities of $8,136,651. The change relates to proceeds received from multiple activities during 2024 including our IPO in February 2024 of $5,000,000, the Private Placement in October 2024 of $2,047,105 and warrant exercises in December 2024 of $1,523,700 offset by change in offering costs of $434,154. Liquidity and Capital Resources As of December 31, 2024, we had current assets totaling $6,095,629 primarily consisting of cash balances of $3,757,323, inventory of $1,335,503 and prepaid deposits for inventory of $904,728. Our current liabilities as of December 31, 2024 totaled $933,669, primarily consisting of accounts payable and accrued expenses of $668,732 and customer deposits and other current liabilities of $264,937. Our net working capital as of December 31, 2024 was $5,161,960. On October 29, 2024, we completed a private placement offering for the sale of 1,286,184 shares of Common Stock at a price of $1.52 per share for aggregate gross proceeds of $1.95 million before deducting fees to the placement agent and other expenses payable by us in connection with the private placement. We retained approximately $1.8 million in net proceeds. In December 2024, two investors and note holders exercised their option to convert $3,000,000 of the then outstanding Convertible Note into 1,507,538 shares of Common Stock at a price of $1.99 per share. After the conversion and as of December 31, 2024, we no longer have any debt outstanding. In December 2024, we also had several investors exercise 684,000 warrants with cash and we issued 684,000 shares of our Common Stock for total cash proceeds of $1,523,700. On February 26, 2025, multiple investors exercised 1,224,606 warrants at $1.99 per warrant from the October 2024 Private Placement and we issued 1,224,606 shares of our Common Stock and received cash proceeds of $2,436,966. As of March 25, 2025, we have approximately $5.0 million in cash. We believe that the net proceeds from our 2024 financings, warrant exercises, revenues, 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. 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. 44 Business Combinations The Fat Shark and Rotor Riot acquisitions are accounted for as a business combination under ASC 805. We recognized the assets acquired and liabilities assumed at fair value as of the date of acquisition. The fair value is determined based on assumptions used in valuations and estimates determined by management, which are subjective. Impairment of 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. Goodwill represents costs in excess of fair values assigned to the underlying identifiable net assets of acquired businesses. Intangible assets from acquired business are recognized at fair value on the acquisition date. 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. Valuation of Inventory Our policy for valuation of inventory requires us to evaluate the net realizable value of our inventory using various reference measures including current product selling prices, as well as evaluating for excess quantities and obsolescence. We may be required to record inventory write-downs if actual inventory values are less favorable than those estimates by management. Accounts Receivable We carry our accounts receivable at invoiced amounts. We evaluate our accounts receivable on a periodic basis and establish an allowance for credit losses based on a history of past write-offs and collections and current credit conditions. Accounts are written-off as uncollectible at the discretion of management. Revenue Recognition We receive revenues from the sale of products from both retail distributers and individual consumers. Sales revenue is recognized when the products are shipped and the price is fixed or determinable, no other significant obligations of the Company exist and collectability is probable. Revenue is recognized when the title to the products has been passed to the customer, which is the date the products are shipped to the customer. This is the date the performance obligation has been met. Stock Based Compensation Certain employees and directors have received grants of restricted common shares in our company. Other employees received grants of stock options in our Company. These awards are accounted for in accordance with guidance prescribed for accounting for equity-based compensation. Based on this guidance and the terms of the awards, the awards are equity classified. The fair value of restricted stock awards is based on the fair value of the Company’s Common Stock on the date of grant and expensed over the vesting period. The fair value of each stock option award is determined using the Black-Scholes option-pricing model which values options based on the stock price at the grant date, the expected life of the option, the estimated volatility of the stock, and the risk-free interest rate over the expected life of the option. The expected volatility was determined considering comparable companies historical stock prices as a peer group for the fiscal year the grant occurred and prior fiscal years for a period equal to the expected life of the option. The risk-free interest rate was the rate available from the St. Louis Federal Reserve Bank with a term equal to the expected life of the option. The expected life of the option was estimated based on a mid-point method calculation. In addition, the Company issued shares of our Common Stock in 2023 to consultants for services performed. Prior to our IPO in February 2024, we were a private company with no active public market for our Common Stock. Therefore, we have periodically determined the overall value of our company and the estimated per share fair value of our common equity at their various dates and valuations based on a per share valuation using the private funding transactions as an estimate. These values and estimates are subjective. 45 Derivatives and Fair Value The fair value of our derivative liabilities are determined using the binomial option pricing model which values the liability on the stock price at the grant date, the estimate volatility of the stock, the estimate of the expected term, the risk-free interest rate over the expected term, and certain estimates and probabilities of different outcomes. Management performed an assessment on the convertible option feature included in the note payable to determine if the optional conversion feature should be bifurcated from the host contract and accounted for separately as a liability pursuant to ASC 815. This assessment includes judgment from management to determine if the derivative is clearly and closely related to the debt and if it meets certain definitions of a derivative. The Company classifies warrants issued for the purchase of shares of its common stock as either equity or liability instruments based on an assessment of the specific terms and conditions of each respective contract. The assessment considers whether the warrants are freestanding financial instruments or embedded in a host instrument, whether the warrants meet the definition of a liability pursuant to ASC 480, whether the warrants meet the definition of a derivative under ASC 815, and whether the warrants meet all of the requirements for equity classification under ASC 815. This assessment, which requires the use of professional judgment, is conducted at the time of warrant issuance and as of each subsequent quarterly period end date while the warrants are outstanding. For issued or modified warrants that meet all of the criteria for equity classification, the warrants are required to be recorded as a component of equity at the time of issuance. For issued or modified warrants that do not meet all the criteria for equity classification, the warrants are required to be recorded as liabilities at their fair value. 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.