UAV Drone IndustryRED CAT : MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (form 10-Q)

September 20, 2021by helo-10
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The following discussion should be read in conjunction with our unaudited
condensed consolidated financial statements and related notes and other
financial data included elsewhere in this Quarterly Report on Form 10-Q.

The Management’s Discussion and Analysis contains forward-looking statements
that involve risks and uncertainties, such as statements relating to our
liquidity, and our plans for our business focusing on (i) selling drones and
related components, and (ii) cloud-based analytics, storage, and services for
drones. Any statements that are not historical fact are forward-looking
statements. When used, the words “believe,” “plan,” “intend,” “anticipate,”
“target,” “estimate,” “expect,” and the like, and/or future-tense or conditional
constructions (“will,” “may,” “could,” “should,” etc.), or similar expressions,
identify certain of these forward-looking statements. These forward-looking
statements are subject to risks and uncertainties that could cause actual
results or events to differ materially from those expressed or implied by the
forward-looking statements in this Quarterly Report on Form 10-Q. The Company’s
actual results and the timing of events could differ materially from those
anticipated in these forward-looking statements as a result of many factors.
Investors should also review the risk factors in the Company’s Annual Report on
Form 10-K filed with the SEC on August 12, 2021.

All forward-looking statements speak only as of the date on which they are made.
The Company does not undertake any obligation to update such forward-looking
statements to reflect events that occur or circumstances that exist after the
date of this Quarterly Report on Form 10-Q except as required by federal
securities law.



Recent Developments



Acquisition of Fat Shark



On November 2, 2020, the Company acquired 100% of Fat Shark’s outstanding equity
and issued to the Fat Shark’s sole shareholder consideration totaling (i)
5,227,223 shares of our common stock, (ii) a cash payment of $250,000, and (iii)
a promissory note for $1,753,000. The promissory note bears interest at 3%, and
the entire principal and accrued interest is due on November 1, 2023.

Underwritten Firm Commitment Underwritten Public Offering.


S-1 Offering


On May 4, 2021, the Company closed its firm commitment underwritten public
offering (the “S-1 Offering”) in which it sold 4,000,000 shares of its common
stock, at a public offering price of $4.00 per share, to ThinkEquity, a division
of Fordham Financial Management, Inc., as representative of the
underwriters (“ThinkEquity”), pursuant into an underwriting agreement with Think
Equity dated April 29, 2021. The Company also granted the underwriters a 45-day
option to purchase up to an additional 600,000 shares of its common stock to
cover over-allotments in the initial public offering price, less the
underwriting discount. These shares of common stock in the S-1 Offering were
offered and sold by the Company pursuant to a registration statement on
Form S-1, as amended (File No. 333-253491), filed with the SEC, which was
declared effective by the Commission on April 29, 2021 (the “S-1 Registration
Statement”).



S-3 Offering



On July 21, 2021 the Company closed on a firm commitment underwritten public
offering (the “S-3 Offering”) in which it sold an aggregate of 13,333,334 shares
of its Common Stock at a purchase price of $4.50 per share to ThinkEquity,
pursuant to an underwriting agreement dated July 18, 2021. The Company has also
granted the underwriters a 45-day option to purchase up to an additional
2,000,000 shares of its common stock to cover over-allotments, if any. These
shares of common stock in the S-3 Offering were offered and sold by the Company
pursuant to a registration statement on Form S-3, as amended (File
No. 333-256216), filed with the SEC, which was declared effective by the SEC on
June 14, 2021 and a Supplement to the Prospectus contained in this registration
statement filed with the SEC on July 19, 2021.


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Acquisition of Teal Drones


On August 31, 2021, we closed the acquisition of Teal Drones Inc., (“Teal”).
Teal is a leader in commercial and government unmanned aerial vehicle (“UAV”)
technology and manufactures the Golden Eagle drone, approved by the US
Department of Defense
for reconnaissance, public safety, and inspection
applications.

Pursuant to the Merger Agreement, we acquired all of the issued and outstanding
share capital of Teal in exchange for $14,000,000 of our common stock, par value
$0.001 per share (“Common Stock”) at the Volume Weighted Average Price (VWAP) of
our Common Stock on August 31, 2021 of $2.908 per share, reduced by the amount
of Teal debt assumed consisting of approximately $1.67 million payable to
Decathlon Alpha IV, L.P., (“DA4”), approximately $771,000 payable to other
creditors and approximately $686,000 in working capital deficit, for a net
closing date payment of $10,872,753. At closing, we issued 3,738,911 shares of
our Common Stock (the “Merger Consideration”). On August 31, 2021, the Company,
Acquisition, Teal and George Matus, as Shareholder Representative, entered into
an Escrow Agreement with Equity Stock Transfer, LLC. Fifteen (15%) percent of
the Merger Consideration (the “Escrow Shares”) was deposited in an escrow
account as security for working capital adjustments and indemnification
obligations for a period of eighteen (18) months under the Merger Agreement. The
indemnification obligations feature a basket amount of fifty-thousand dollars
($50,000) before any claim can be asserted and is subject to a cap equal to the
value of the Escrow Shares. George Matus, founder of Teal, will continue in the
role of Chief Executive Officer of Teal pursuant to an employment agreement
entered August 31, 2021.

The consideration payable under the Merger Agreement may be increased upon the
achievement of certain milestones set forth in the Merger Agreement (the
“Earn-Out Consideration”). Additional shares of Common Stock may become issuable
by the Company in the event that within twenty-four (24) months following
closing of the Merger, Teal realizes certain revenue targets. A total of Sixteen
Million Dollars
($16,000,000) in additional shares of Common Stock may become
issuable in the event that sales and services of Teal’s Golden Eagle drones
shall have equaled at least Thirty-six Million Dollars ($36,000,000). A total of
Ten Million Dollars ($10,000,000) in additional shares of Common Stock may
become issuable in the event that sales and services of Teal’s Golden Eagle drones shall have equaled at least $24 million ($24,000,000) but less than $36
million
($36,000,000). A total of Four Million Dollars ($4,000,000) in
additional shares of Common Stock may become issuable in the event that sales
and services of Teal’s Golden Eagle drones shall have equaled at least Eighteen
Million Dollars
($18,000,000) but less than Twenty-Four Million Dollars
($24,000,000). Additional Share Consideration, if earned, is issuable at the
VWAP of the Company within thirty (30) days of the determination that Earn-Out
Consideration is payable.

On August 31, 2021, Teal entered into an Amended and Restated Loan and Security
Agreement with DA4 (the “Loan Agreement”) in the amount of $1,670,294 (the
“Loan”), representing the outstanding principal amount previously due and owing
by Teal to DA4. Interest on the Loan accrues at a rate of ten (10%) percent per
annum. Principal and interest under the term Loan is payable monthly in an
amount equal to $49,275 until maturity on December 31, 2024. Teal may prepay the
loan at any time, subject to a prepayment premium of $300,705, less the amount
of any prior payments of interest. Under the Loan Agreement, Teal granted DA4 a
continuing security interest in substantially all of the assets of Teal. In the
event of a default under the loan DA4 may declare the full amount of the Loan
immediately due and payable as a secured lender and take additional actions as a
secured lender including seeking to foreclose on collateral pledged under the
Loan Agreement. The Company agreed to guaranty the obligations of Teal under the
Loan pursuant to a Joinder Agreement dated August 31, 2021.

Plan of Operations

Red Cat Holdings (“Red Cat” or the “Company”) was originally incorporated in
February 1984. Since April 2016, the Company’s primary business has been to
provide products, services and solutions to the drone industry which it
presently does through its four wholly owned subsidiaries. Beginning in January
2020
, the Company has expanded the scope of its drone products and services
through a number of acquisitions. Fat Shark Holdings is a provider of First
Person View (FPV) video goggles to the drone industry. Rotor Riot sells FPV
drones and equipment, primarily to the consumer marketplace through its digital
storefront located at www.rotorriot.com. Skypersonic provides software and
hardware solutions that enable drones to complete inspection services in
locations where GPS (global positioning systems) are not available, yet still
record and transmit data even while being operated from thousands of miles away.
Red Cat Propware is developing drone flight data analytics and storage
solutions, as well as diagnostic products and services. On August 31, 2021, the
Company acquired Teal Drones, a leader in commercial and government UAV
technology.


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Results of Operations



Three Months Ended July 31, 2021 and July 31, 2020


Revenue


During the three months ended July 31, 2021 (or the “2021 period”), we generated
revenues totaling $1,396,751 compared to $548,282 during the three months ended
July 31, 2020 (or the “2020 period”), representing an increase of $848,469, or
155%. The increase in revenues related to acquisitions completed after the end
of the 2020 period. In November 2020, we acquired Fat Shark which contributed
$948,417, or 68%, of our revenues in the 2021 period.


Cost of Goods Sold


During the three months ended July 31, 2021, we incurred cost of goods sold of
$1,294,347 compared to $446,132 during the three months ended July 31, 2020,
representing an increase of $848,215 or greater than 100%. The increase related
to the acquisitions of Fat Shark and Skypersonic which were completed after the
end of the 2020 period.


Gross Margin


During the three months ended July 31, 2021, gross margin was $102,404 compared
to $102,150 during the three months ended July 31, 2020, representing an
increase of $254 or 0.3%. Gross margin, as a percentage of revenue, decreased
from 19% during the 2020 period to 7% during the 2021 period. The lower gross
margin during the 2021 period reflects higher product and shipping costs,
resulting from the impact of COVID-19 on business operations.


Operating Expenses


During the three months ended July 31, 2021, we incurred operations expense of
$176,863 compared to $86,546 during the 2020 period, resulting in an increase of
$90,317 or 104%. This increase is directly related to our expanded operations
following the acquisitions of Fat Shark in November 2020 and Skypersonic in May
2021
. Operations expense for Fat Shark totaled $72,868 in the 2021 period which
represented approximately 80% of the increase.

During the three months ended July 31, 2021, we incurred research and
development expenses totaling $244,254 compared to $87,310 for the three months
ended July 31, 2020 resulting in an increase of $156,944, or 180%. This increase
is directly related to our expanded operations following the acquisitions of Fat
Shark and Skypersonic. Research and development expense for Fat Shark and
Skypersonic totaled $107,153 and $31,689, respectively, collectively
representing 88% of the increase.

During the three months ended July 31, 2021, we incurred sales and marketing
expenses of $100,633 compared to $24,136 during the three months ended July 31,
2020
, resulting in an increase of $76,497 or greater than 100%. This increase is
primarily related to higher payroll costs and marketing events that did not
occur in the 2020 period. In addition, we incurred $17,204 of expenses related
to Fat Shark which was included in the 2021 period.

During the three months ended July 31, 2021, we reported general and
administrative expenses of $876,180 compared to $180,341 for the three months
ended July 30, 2020, representing an increase of $695,839, or more than 100%.
This increase is primarily related to investor relations expenses, director and
officer insurance, increased payroll costs including the hiring of a new
employee, and increased public company expenses. In addition, we incurred
$179,068 of expenses in connection with the Fat Shark and Skypersonic
acquisitions completed after the 2020 period.

During the three months ended July 31, 2021, we incurred stock based
compensation costs of $384,086 compared to $107,061 in the 2020 period,
resulting in an increase of $277,025 or greater than 100%.


Other Income


Other income totaled $121,840 during the three months ended July 31, 2021,
compared to zero during the three months ended July 31, 2020. This income
primarily related to changes in the fair value of the warrant derivative
liability which was favorably impacted by a decrease in our stock price during
the 2021 period. The derivative liability is valued using a multinomial lattice
model which utilizes the Company’s stock price in its calculation.


  23




Net Loss


Net Loss during the three months ended July 31, 2021 totaled $1,557,772 compared
to a Net Loss of $383,244 during the three months ended July 31, 2020,
representing an increase of $1,174,528, or greater than 100%. This increase is
primarily related to higher operating expenses which increased to $1,782,016 in
the 2021 period as compared to $485,394 in the 2020 period, representing an
increase of $1,296,622. Approximately $436,000 of the increase, or 34%, related
to the Fat Shark and Skypersonic acquisitions completed during the 2021 period.
Higher general and administrative expenses primarily accounted for the balance
of the increase.


Cash Flows



Operating Activities



Net cash used in operating activities was $4,073,964 during the three months
ended July 31, 2021 compared to net cash used in operating activities of
$232,822 during the three months ended July 31, 2020 representing an increase of
$3,841,142, or greater than 100%. Net cash used in operations, net of non-cash
expenses totaling $438,164, equaled $1,119,608 in the 2021 period compared to
$276,183 in the 2020 period, resulting in an increase of $843,425, or greater
than 100%. The higher operating use of cash in the 2021 period reflected the
acquisitions of Fat Shark and Skypersonic. Net cash used related to changes in
operating assets and liabilities totaled $2,954,356 during the three months
ended July 31, 2021 compared to net cash provided through changes in operating
assets and liabilities of $43,361 during the three months ended July 31, 2020,
representing an increase of $2,997,717, or greater than 100%. Approximately $2
million
, or 66%, of the increase related to inventory, both higher balances on
hand as well as prepaid purchases not yet delivered. Changes in operating assets
and liabilities can fluctuate significantly from period to period depending upon
the timing and level of multiple factors, including inventory purchases and
vendor payments.



Investing Activities



Net cash provided by investing activities was $13,502 during the three months
ended July 31, 2021 compared to zero during the three months ended July 31,
2020
. The Company acquired $13,502 of cash in connection with an acquisition
completed in the 2021 period.


Financing Activities


Net cash used provided by financing activities totaled $69,900,774 during the
three months ended July 31, 2021 compared to $52,024 during the three months
ended July 31, 2020. Financing activities can vary from period to period
depending upon market conditions, both at a macro-level and specific to the
Company. During the 2021 period, the Company received net proceeds of
approximately $70 million in connection with two offerings of common stock.

Liquidity and Capital Resources

As of July 31, 2021, we had current assets totaling $69,727,857, including cash
of $66,118,581, inventory of $884,931, accounts receivable of $267,813, and
other current assets of $2,456,532. Current liabilities as of July 31, 2021
totaled $4,557,117, including derivative liability of $2,495,378, accounts
payable of $920,256, accrued expenses of $637,769, notes payable of $154,872,
amounts due to related party of $239,954, and customer deposits of $108,888. Our
net working capital as of July 31, 2021 was $65,170,740.

We have reported net losses since inception and only began generating revenues
in January 2020. To date, we have primarily funded our operations through
offerings of common stock. In May 2021, we completed an offering of common stock
which raised gross proceeds of $16 million. In July 2021, we completed an
offering of common stock which raised gross proceeds of $60 million.


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2021 Underwritten Public Offerings


S-1 Offering


On May 4, 2021, the Company closed its firm commitment underwritten public
offering (the “S-1 Offering”) in which it sold 4,000,000 shares of its common
stock, at a public offering price of $4.00 per share, to ThinkEquity, a division
of Fordham Financial Management, Inc., as representative of the
underwriters (“ThinkEquity”), pursuant into an underwriting agreement with Think
Equity dated April 29, 2021. The Company also granted the underwriters a 45-day
option to purchase up to an additional 600,000 shares of its common stock to
cover over-allotments in the initial public offering price, less the
underwriting discount. These shares of common stock in the S-1 Offering were
offered and sold by the Company pursuant to a registration statement on
Form S-1, as amended (File No. 333-253491), filed with the SEC, which was
declared effective by the Commission on April 29, 2021 (the “S-1 Registration
Statement”).

The net proceeds to the Company from the Offering, after deducting the
underwriting discount, the underwriters’ fees and expenses and the Company’s
estimated Offering expenses, were approximately $14.6 million . The Company
anticipates using the net proceeds from the Offering to provide funding for
service, sales, and marketing efforts for its Red Cat Drone Services, strategic
acquisitions and related expenses, and general working capital.


S-3 Offering


On July 21, 2021 the Company closed on a firm commitment underwritten public
offering (the “S-3 Offering”) in which it sold an aggregate of 13,333,334 shares
of its Common Stock at a purchase price of $4.50 per share to ThinkEquity,
pursuant to an underwriting agreement dated July 18, 2021. The Company has also
granted the underwriters a 45-day option to purchase up to an additional
2,000,000 shares of its common stock to cover over-allotments, if any. These
shares of common stock in the S-3 Offering were offered and sold by the Company
pursuant to a registration statement on Form S-3, as amended (File
No. 333-256216), filed with the SEC, which was declared effective by the SEC on
June 14, 2021 and a Supplement to the Prospectus contained in this registration
statement filed with the SEC on July 19, 2021.

The net proceeds to the Company from the S-3 Offering, after deducting the
underwriting discount, the underwriters’ fees and expenses and the Company’s
estimated expenses related to this S-3 Offering, were approximately $55.5
million
,. The Company anticipates using the net proceeds from the S-3 Offering
to provide funding for services, sales, and marketing efforts for its Red Cat
Drone
services, strategic acquisitions and related expenses, and general working
capital.

Until we are able to sustain operations through the sale of products and
services, we will continue to fund operations through equity and/or debt
transactions. We can provide no assurance that the financing described above
will be sufficient to fund our operations until we are able to sustain
operations through the sale of products and services. In addition, there can be
no assurance that such additional financing, if required, will be available to
us on acceptable terms, or at all.


Going Concern


We only began generating revenues in January 2020 and have reported net losses
since our inception. We expect to report net losses for at least the next twelve
months. The success of our business plan during the next 12 months and beyond
will be contingent upon generating sufficient revenue to cover our operating
costs and/or upon obtaining additional financing. The report from our
independent registered public accounting firm for the fiscal year ended April
30, 2021
includes an explanatory paragraph stating the Company has recurring net
losses from operations, negative operating cash flows, and will need additional
working capital for ongoing operations. These factors, among others, raise
substantial doubt about the Company’s ability to continue as a going concern. If
we are unable to obtain sufficient funding, our business, prospects, financial
condition and results of operations will be materially and adversely affected
and we may be unable to continue as a going concern.

As reflected in our accompanying financial statements, we have accumulated
losses totaling approximately $17.4 million through July 31, 2021. Management
recognizes that these operating results and our financial position raise
substantial doubt about our ability to continue as a going concern.


  25



We are presently seeking to address these going concern doubts through a number
of actions including efforts to (a) raise capital through the public markets,
(b) release additional commercial products and (c) pursue acquisitions of
complementary, revenue generating companies which are accretive to our operating
results. In May 2021, we completed an offering of common stock which raised
gross proceeds of $16 million and in July 2021, we completed an offering of
common stock which raised gross proceeds of $60 million. We can provide no
assurance that any of these efforts will be successful or, that even if
successful, that they will alleviate doubts about our ability to continue as a
going concern form more than the next twelve months.

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.

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.

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