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,” “Unusual Machines,” 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 At the Market Agreement On August 28, 2025, we entered into a Capital on Demand Sales Agreement (the "Sales Agreement”) with Jones Trading Institutional Services LLC ("Jones”), pursuant to which we may issue and sell over time and from time to time up to $300,000,000 worth of shares of our common stock (the "Shares”). Sales of the Shares, if any, may be made by any method permitted by law deemed to be an "at the market” offering as defined in Rule 415 of the Securities Act of 1933 (the "Securities Act”), including without limitation sales made directly on or through the NYSE American, the trading market for the Company’s common stock, or any other existing trading market in the United States for the Company’s common stock, sales made to or through a dealer other than on an exchange or otherwise, sales made directly to Jones as principal in negotiated transactions at market prices prevailing at the time of sale or at prices related to such prevailing market prices, and/or in any other method permitted by law. Jones will use commercially reasonable efforts to sell on behalf of us all the Shares requested to be sold by us, consistent with its normal trading and sales practices, subject to the terms of the Sales Agreement. Under the Agreement, Jones will be entitled to compensation of 3.0% of the gross proceeds from the sales of the Shares sold under the Sales Agreement. In addition, we have agreed to reimburse Jones for the fees and disbursements of its counsel, in an amount not to exceed $55,000. In addition, we shall reimburse Jones for legal fees of its counsel up to $3,750 for each quarterly due diligence update. The Shares are being offered and sold pursuant to a prospectus supplement filed with the Securities and Exchange Commission (the “SEC”). During the month of October 2025, we sold 4,666,600 shares of common stock at an average price of $15.46 per share under the Agreement for total gross proceeds of approximately $72.1 million. We paid Jones approximately $2.2 million related to the sales of common stock under the Sales Agreement. 35 Recent Customer Purchase Orders On January 15, 2026, we secured a $2.1 million order from a customer for domestically assembled drone systems for defense and government applications which includes Rotor Riot Brave flight controllers and ESCs, Fat Shark Aura analog cameras and video transmitters, HDO+ headsets and Unusual Machines motors. The order is expected to be fulfilled over the first two quarters of 2026. On December 22, 2025, we secured a $3.75 million order from Performance Drone Works (“PDW”) to support the scaling of PDW’s FPV program. The order includes FPV headsets as the Company continues to expand and scale their U.S. based manufacturing including domestic motors and other components. On October 15, 2025, we secured an order from the U.S. Army’s 101 st Airborne Division for 3,500 NDAA-compliance motors produced at our new U.S. based manufacturing facility. The motors will support the Division’s deployment of the new Attritable Battlefield Enabler V1.01 drones. The Army has also indicated plans to expand procurement, targeting an additional order of 20,000 components including motors from us in 2026. On October 3, 2025, we secured an $800,000 purchase order for high-performance drone components from Red Cat. The order includes several of our Blue UAS products and motors that will be integrated into Red Cat’s FANG™ drones, supporting ongoing demand for U.S. made, NDAA compliant systems in defense, public safety, and other government agency applications. Recent Investments During the first quarter of 2026, we have entered into and made several key investments with three different private drone related companies. We invested a total $17.5 million between the three different companies, all of which will include registration rights upon completion of their initial public offering or merger with a publicly traded company. These investments are ancillary to our core drone components business and were made because we believe the investments will provide future drone related revenues. In all cases, we also believed that apart from the future sales benefits, each investment potential outweighed the risks. Recent Hires On February 2, 2026, we appointed Chadd Cole as Vice President of FP&A. Mr. Cole has more than 12 years of experience in financial planning and analysis roles at Verizon, Electronic Arts (EA) and most recently was the Director of FP&A at Carrier. Mr. Cole led the financial planning and analysis function including budgeting, planning and financial reporting through automation and technology. On January 1, 2026, we promoted Stacy Wright to Chief Revenue Officer. Ms. Wright joined Rotor Riot in 2020 as Vice President and was promoted to President in 2024 following its acquisition by Unusual Machines. She has been instrumental in scaling operations evolve the business from a community-driven e-commerce platform into a diversified revenue operation service enterprise and defense customers. Results of Operations We acquired Fat Shark and Rotor Riot on February 16, 2024 and generated no revenue from January 1, 2024 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, 2024, See Note 3 to our Consolidated Financial Statements. 36 Years Ended December 31, 2025 and 2024 Revenue During the year ended December 31, 2025 we generated revenues totaling $11,199,217 compared to $5,565,319 during the year ended December 31, 2024, representing an increase of $5,633,898 or 101%. Our revenues during 2024 consisted primarily of retail revenue in our B2C business line. The increase in revenue during 2025 primarily relates to the increase and establishment of our B2B business and revenue related to our NDAA and Blue UAS products. During the fourth quarter of 2025, we started manufacturing production on certain products including drone motors and we continue to see increased interest and demand in our manufactured products heading into 2026. We expect our revenue to continue to grow quarterly in 2026 as we continue to build out our capacity including our manufacturing facilities and products as well increasing our staffing to handle additional demand from the market. Cost of Goods Sold During the year ended December 31, 2025, we incurred cost of goods sold of $7,292,370 compared to $4,019,068 during the year ended December 31, 2024, resulting in an increase of $3,273,302 or 81%. Cost of goods sold primarily relate to product costs from our sales, but also include certain shipping and other direct product costs including tariffs. During the fourth quarter of 2025, cost of goods sold also include direct payroll costs, a portion of rent expense and depreciation expense related to our manufactured products. The increase in cost of goods sold is primarily driven by the increase in our revenue and growth in B2B sales along with the increase in tariffs during 2025. We expect our total cost of goods sold to increase in 2026 in conjunction with our revenue increases as we sell additional product. Gross Margin During the year ended December 31, 2025, our gross profit was $3,906,847 compared to $1,546,251 during the year ended December 31, 2024, resulting in an increase of $2,360,596 or 153%. Our gross margin, as a percentage of sales, totaled 35% during the year ended December 31, 2025, compared to 28% during the year ended December 31, 2024. We anticipate our gross margin to fluctuate period to period depending on certain promotions and products that are sold during the year including the mix between retail and enterprise sales. The increase in gross margin during the year was based on our larger mix of enterprise orders during 2025. While the margins we generated during the year are in line with our expectations and normal operating margins, we do anticipate continued fluctuations in our manufactured products into 2026 as we continue to improve our manufacturing process and become more efficient. We anticipate our gross margins to have fluctuations in 2026 as we start scaling our manufacturing process. We anticipate our gross margins will have a decline in the first two quarters of 2026 as we bring on and train our staff, work to scale production, increase to multiple shifts, and build out efficiencies. We anticipate our margins will improve in the second half of 2026 as we have more trained staff and efficient processes and as we bring on our highly-automated production line for motors. Operating Expenses During the year ended December 31, 2025, operations expenses totaled $3,234,706 compared to $959,740 during the year ended December 31, 2024, resulting in an increase of $2,274,966 or 237%. Operations expenses primarily relate to our direct operations including our warehouse personnel and warehouse expenses. In addition, we have started incurring additional operations related expenses as we start incurring non-product costs related to our motor production and headset facilities. We expect our operations expense to increase as we continue to hire additional staff to support our operations including engineering staff to help improve process and gain efficiencies. We are also setting up our headset factory and anticipate building out a battery facility and camera facility in the second half of 2026. During the year ended December 31, 2025, research and development expenses totaled $202,585 compared to $90,584 for the year ended December 31, 2024, resulting in an increase of $112,001 or 124%. 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. We expect our research and development expenses to increase some as we continue to build out our products, however, we do not anticipate a significant growth as compared to revenue and other costs. During the year ended December 31, 2025, sales and marketing expenses totaled $1,581,716 compared to $1,091,268 for the year ended December 31, 2024, resulting in an increase of $490,448 or 45%. Sales and marketing expenses primarily relate to advertising spend related to Rotor Riot, marketing events and payroll expenses for our sales and marketing team. The increase relates mainly to adding additional staffing to our sales and marketing team. We anticipate our sales and marketing costs to increase in 2026 related to building out our enterprise sales team, however, we expect these increases to be at a lower rate than our revenue and other expenses as our enterprise sales are more dedicated efforts, while our retail revenue is driven off of advertising sales. 37 During the year ended December 31, 2025, general and administrative expenses totaling $23,898,633 compared to $6,250,939 for the year ended December 31, 2024, resulting in an increase of $17,647,694 or 282%. General and administrative expenses incurred during 2025 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. We’ve also increased our headcount to support our growth which includes building out our accounting, HR, and facilities staff. The above amount includes $15,619,929 in non-cash stock compensation expense during 2025 as compared to $2,309,531 during 2024. We expect our general and administrative expenses to increase during 2026 as we continue to build out our infrastructure with additional hires and systems. We also anticipate things like professional fees and other expenses related to being a public company to increase. In addition, we anticipate our non-cash stock compensation expense to be higher in 2026. We do not anticipate the increase in our general and administrative expenses to increase at the same rate as our revenue as we start to gain operational efficiencies at scale. During the year ended December 31, 2025, we recognized a loss on impairment of goodwill of $0 compared to $10,073,326 for the year ended December 31, 2024, resulting in a decrease of $10,073,326 or 100%. The loss on goodwill impairment in 2024 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 December 31, 2024. We did not have any goodwill impairment in 2025. Other Income (Expense) During the year ended December 31, 2025, other income and expense totaled $5,922,191 compared to ($15,002,061) during the year ended December 31, 2024. During 2025, we generated $1,830,944 in interest income from our preferred savings account related to our cash balances. We also generated $1,623,317 in realized gains from our investments and an additional $2,469,908 in unrealized gains from our investments in the drone industry. During 2024, other income and expenses mostly consisted 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 was 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. Net Loss Our net loss for the year ended December 31, 2025, totaled $19,193,617. This compared to $31,980,468 for the year ended December 31, 2024, resulting in a decrease in net loss of $12,786,851. The change in net loss primarily consists of an increase in our revenue, offset by a large increase in G&A expenses, mainly from non-cash stock compensation expense of $15.6 million and the net change in other income and expense during the year based on our interest income and realized and unrealized gains from investments during the year. We anticipate our net loss position to improve during 2026 as we start scaling our revenue and gain some operational efficiencies on the general and administrative expenses. This will partially be offset by anticipated fluctuations in our margins during the first half of the year. Cash Flows Operating Activities Net cash used in operating activities was $21,177,620 during the year ended December 31, 2025, compared to net cash used in operating activities of $3,966,368 during the year ended December 31, 2024, representing an increase of $17,181,252 or 433%. This change in net cash used in operating activities includes a net impact of non-cash adjustments to reconcile our net loss to net cash used in operating activities of $15,666,817 primarily driven by not having an impairment charge on goodwill and change in fair value of derivatives during 2025 and offset by the increase in stock based compensation expense during the year. The net impact of non-cash activities was offset by an increase in our net loss this year of $12,786,852. Our change in assets and liabilities was the other primary driver of the change in net cash used in operating activities with the primarily impact being a result from an increase in prepaid inventory of $8,760,006, inventory of $4,399,358, and accounts receivable of $1,538,774. This was offset by an increase in operating lease liabilities of $2,288,458 with the addition of our additional facilities and increase in our accounts payable and accrued expenses of $479,259. 38 Investing Activities Net cash used in investing activities was $37,090,810 during the year ended December 31, 2025 compared to net cash used in investing activities of $852,801 during the year ended December 31, 2024, representing an increase of $36,238,009. This change in net cash used in investing activities is related to the $38,550,000 used for short-term investments in other drone related companies during the year and $2,062,181 related to purchase of property and equipment for our motor and headset factories which was offset by proceeds from the sale of short-term investments of $3,428,317. Financing Activities Net cash provided by financing activities totaled $157,769,034 during the year ended December 31, 2025, compared to net cash provided by financing activities of $7,711,718 during the year ended December 31, 2024, resulting in an increase in net cash provided by financing activities of $150,057,316. The change relates to proceeds received from multiple financings during 2025 including our confidentially marketed public offering of $40,000,000 in May 2025, our registered direct offering of $48,500,000 in July 2025, and our at-the-market offering of $72,145,636 in October 2025. We received $5,000,000 related to our IPO in 2024 and an additional $2,047,105 from a private placement in October 2024. We also had $5,744,927 related to cash proceeds received during 2025 for warrant exercises as compared to $1,523,700 during 2024. This was all offset by fees related to our financings of $9,268,101 in 2025 and $859,087 in 2024. Liquidity and Capital Resources As of December 31, 2025, we had current assets totaling $159,511,482 primarily consisting of cash balances of $103,261,397, trading security investments of $39,214,909, accounts receivable of $1,779,423, inventory of $5,316,648 and prepaid deposits for inventory of $9,748,483, and other current assets of $190,622. Our current liabilities as of December 31, 2025 totaled $2,601,347, primarily consisting of accounts payable and accrued expenses of $1,506,793, operating lease liabilities of $456,429 and customer deposits of $638,125. Our net working capital as of December 31, 2025 was $156,910,135. 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 $3.0 million 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 approximately $1.5 million. 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 approximately $2.4 million. On May 7, 2025, we completed a confidentially marketed public offering in which we sold 8,000,000 shares of our common stock at $5.00 per share and after deducting underwriting discounts and expenses, we received approximately $36.5 million in net cash proceeds. On July 14, 2025, we entered into a Securities Purchase Agreement with certain investors for the purchase and sale of 5,000,000 shares of common stock in a registered direct offering at a public offering price of $9.70 per share. We received net cash proceeds of approximately $44.9 million. During the month of October 2025, we sold a total of 4,666,600 shares of common stock at an average price of $15.46 per share under our Sales Agreement and after deducting fees and other expenses, we received approximately $69.9 million in net cash proceeds. 39 On November 5, 2025, warrant holders exercised 640,000 warrants at $5.00 per warrant in connection with the May 2025 confidentially marketed public offering and the Company issued 640,000 shares of Common Stock. The Company received cash proceeds of $3.2 million in relation to the exercise. As of March 6, 2026, we have approximately $90 million in cash and $27 million in inventory and prepaid inventory. We believe that the net proceeds from our 2025 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. Business Combinations The Fat Shark, Rotor Riot, and Rotor Lab acquisitions were 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. The Rotor Lab acquisition included a contingent consideration of up to $3.0 million based on the Company producing and recognizing revenue, dollar for dollar related to internally manufactured motors during the first two years after the acquisition closing date. The fair value of contingent consideration is determined using the Monte-Carlo variable scenario model which values the liability at the measurement date using certain assumptions including the expected revenue over the calculation period, a discount rate related to revenue projections, the risk-free interest rate over the earnout period and certain estimates and probabilities of different outcomes. 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. 40 Revenue Recognition We receive revenues from the sale of drone and drone parts from enterprise customers and distributers (enterprise revenue) and individual consumers (retail revenue). 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. Investments We have several short-term investments in other publicly traded drone and drone related companies. Since the investments are not part of the company’s primary business, the Investments are valued under ASC 820 – Fair Value Measurement. Common stock, preferred stock and warrants are both measured at Fair Value each quarter, with changes recognized through net income each reporting period. We value the fair value of preferred stock based on the conversion calculation of preferred shares into common shares outlined in the certificate of designation into a common stock equivalent multiplied by the quoted trading price of the common stock as of the close of market on the reporting period. Due to the warrants being non-tradable, we estimate fair value using a Black-Scholes model based on the current stock price, the exercise price of the warrant, the estimated volatility of the stock, the risk-free interest rate, and the expected life of the warrant. 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. 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. 41 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.