Red Cat Holdings, Inc. (RCAT) FY 2022 MD&A

ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Management's Discussion and Analysis contains forward-looking
statements that involve risks and uncertainties, such as statements relating to our business plan to provide products, services and solutions
to the drone industry. Any statements that are not statements of 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 Annual Report on Form 10-K. 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.

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 Annual Report on Form 10-K except as required by federal securities law.

Recent Developments

Red Cat Holdings has recently completed a series
of acquisitions and financings which have broadened the scope of its activities in the drone industry. These developments include:

Business Strategy

Red Cat remains focused
on building a portfolio of complementary products and services to support the continued growth and maturation of the drone industry in
both the enterprise and consumer market segments. Our disciplined acquisition strategy targets companies with advanced product offerings
and unique drone platforms and intellectual property. After the integration of Teal Drones, we would expect government customers including
defense, public safety, and infrastructure to be our most significant revenue drivers in the fiscal year ending April 30, 2023.

During the second
half of the fiscal year ending on April 30, 2022, the Company focused on integrating and organizing its acquired businesses. These efforts
including refining the establishment of Enterprise and Consumer segments in order to sharpen the Company's focus on the unique opportunities
in each sector of the drone industry. The Enterprise segment is focused on opportunities in the commercial sector, including the military.
Enterprise is building the infrastructure to manage drone fleets, fly and provide services remotely, and navigate confined interior spaces
and dangerous military environments. The Consumer segment is focused on enthusiasts and hobbyists which are expected to increase as drones
become more visible in our daily lives. Consumer provides a growing revenue base, strong brand visibility for the Company, and is an
excellent source of professional pilots.

Results of Operations

When evaluating its operating results, the Company categorizes its functional
expenses into sub-categories that capture the essence of the hundreds of general ledger accounts that it maintains.  The Company
believes this process enables a more insightful understanding of changes in its operating expenses.  Cost of Goods is categorized
into (i) materials, (ii) labor, (iii) overhead, and (iv) freight.  Operations includes (i) payroll and (ii) overhead.  Research
and development is categorized into (i) payroll, (ii) materials, and (iii) overhead.  Sales and marketing includes (i) payroll,
(ii) advertising programs, and (iii) third party services.  General and administrative is categorized into (i) payroll, (ii) facilities,
(iii) professional services, (iv) public company, (v) office, and (vi) insurance and related.

During the fiscal year ended April 30, 2022 (“Fiscal 2022”),
the Company completed the acquisitions of Teal Drones and Skypersonic which effectively doubled the number of operating subsidiaries.
These transactions were the primary reason that the Company’s operating expenses increased to $13,927,801 in Fiscal 2022 compared
to $5,946,295 in Fiscal 2021 (the fiscal year ending April 30, 2021) representing an increase of $7,981,506, or 134%. During Fiscal 2022,
employee headcount increased from 16 at the beginning of the year to 62 on April 30, 2022. This increase includes the addition of 15 and
10 employees from Teal and Skypersonic, respectively, that now work for the Company. Since acquiring Teal, its headcount has doubled from
15 to 30 in connection with its expanded operations. In addition, we have hired 6 employees to form an internal sales team primarily focused
on our Enterprise segment.

Year Ended April 30, 2022 and April 30, 2021

Revenue

During the year ended April 30, 2022 (or the “2022
period”), we generated revenues totaling $6,428,963 compared to revenues totaling $4,999,517 during the year ended April 30, 2021
(or the “2021 period”) representing an increase of $1,429,446 or 29%. Rotor Riot and Fat Shark revenues comprise the entire
amount for the 2021 period. During fiscal year 2022, we acquired two additional drone technology companies: Skypersonic and Teal. The
increase in revenue during the 2022 period is directly related to the acquisitions. The increase is partially offset by a decrease in
both Rotor Riot and Fat Shark revenues of 8% and 9%, respectively. The decreased sales for Fat Shark primarily related to its primary
product being at the end of its sales cycle. Fat Shark released its next generation product in June 2022.

Cost of Goods Sold

During the year ended
April 30, 2022, we incurred cost of goods sold of $5,503,448 compared to $3,929,832 during the year ended April 30, 2021 resulting in
an increase of $1,573,616 or 40%. The higher dollar amount relates to the increase in revenues, primarily related to the acquisitions
of Skypersonic and Teal.

Gross Margin

During the year ended April 30, 2022, gross margin was $925,515 compared to $1,069,685 during the year ended April 30, 2021, resulting
in a decrease of $144,170 or 13%. Gross margin, as a percentage of sales, totaled 14% in Fiscal 2022 compared to 21% in Fiscal 2021.
The lower level of gross margin was primarily related to Teal whose gross margin of 19% was lower than the consolidated gross margin.
In addition, the gross margin of Fat Shark decreased from 18% to 2% due to pricing discounts associated with the sales of products at
the end of their life cycles.

Operating Expenses

Operations expenses totaled $1,353,904 during Fiscal
2022 compared to $590,342 during Fiscal 2021, representing an increase of $763,562, or 129%. Payroll costs increased to $911,358 in Fiscal
2022 compared to $219,396 in Fiscal 2021, representing an increase of $691,962, or more than 100%. Higher payroll costs represented 91%
of the total increase in Operations expense.

During the year ended April 30, 2022, we incurred
research and development expenses totaling $2,606,141 compared to $516,084 for the year ended April 30, 2021 resulting in an increase
of $2,090,057, or greater than 100%. Payroll costs totaled $2,211,909 in Fiscal 2022 compared to $510,084 in Fiscal 2021, representing
an increase of $1,701,825, or more than 100%. Higher payroll costs represented 81% of the total increase in Research and Development expense.
In addition, materials costs totaled $350,372 in Fiscal 2022 compared to $1,449 in Fiscal Year 2021 representing an increase of $348,923.
Higher material costs represented 17% of the year-over-year increase.

During the year ended April 30, 2022, sales and marketing
expenses totaled $1,127,532 compared to $172,182 during the year ended April 30, 2021, resulting in an increase of $955,350 or greater
than 100%. Payroll costs totaled $764,404 in Fiscal 2022 compared to $90,363 in Fiscal 2021, representing an increase of $674,041, or
more than 100%. Higher payroll costs represented 71% of the total increase in sales and marketing expense. In addition, advertising program
costs totaled $256,895 in Fiscal 2022 compared to $61,228 in Fiscal Year 2021 representing an increase of $195,667. Higher advertising
program costs represented 20% of the year-over-year increase.

During the year ended April 30, 2022, we incurred
general and administrative expenses totaling $5,548,589 compared to $1,279,471 for the year ended April 30, 2021, resulting in an increase
of $4,269,118, or greater than 100%. Payroll costs totaled $1,536,126 in Fiscal 2022 compared to $297,909 in Fiscal 2021, representing
an increase of $1,238,217, or more than 100%. Higher payroll costs represented 29% of the total increase in general and administrative
expense. In addition, professional services costs totaled $1,004,785 in Fiscal 2022 compared to $418,340 in Fiscal Year 2021 representing
an increase of $586,445, or 140 percent. Higher professional services costs represented 14% of the year-over-year increase in general
administrative expenses. Finally, public company costs, including insurance, totaled $1,456,413 in Fiscal 2022 compared to $339,428 in
Fiscal Year 2021 representing an increase of $1,116,985, or more than 100 percent. Higher public company costs represented 26% of the
year-over-year increase in general and administrative expenses. The Company uplisted to Nasdaq Capital Market in April 2021 which has
resulted in higher public company costs. The remaining 30% of the increase in general and administrative expenses occurred across all
functional areas including facilities and office.

Other Expense

Other income totaled $1,313,158 during the year ended
April 30, 2022, compared to other expense of $8,359,565 during the year ended April 30, 2021, resulting in a change that is not comparable.
During Fiscal 2021, the Company recognized $7,123,182 of expenses associated with derivative liabilities related to the issuance of convertible
debentures and warrants in October 2020 and January 2021. During Fiscal 2022, the Company recognized a benefit of $1,042,129 as a decrease
in the Company’s stock price caused the derivative liability to decrease. Amounts related to derivatives comprised 85% of the net
expense recognized in Fiscal 2021 and 79% of the net benefit recognized in Fiscal 2022.

Net Loss

Net Loss for the year ended April 30, 2022, totaled
$11,689,128 compared to $13,236,175 for the year ended April 30, 2021 resulting in a decrease of $1,547,047, or 12%. Higher operating
expenses in Fiscal 2022, primarily related to the 2 acquisitions and a 288% percent increase in headcount, resulted in an operating loss
of $13,002,286 in Fiscal 2022 compared to $4,876,610 in Fiscal 2021, representing an increase of $8,125,676, or 167%. This increase was
partially offset by a change in the impact of derivative accounting which resulted in a net benefit of $1,042,129 in Fiscal 2022 compared
to a net expense of $7,123,182 in Fiscal 2021 resulting in a net difference of $8,165,401.

Cash Flows

Operating Activities

Net cash used in operating activities was $16,019,320
during the year ended April 30, 2022 compared to net cash used in operating activities of $1,399,001 during the year ended April 30, 2021
representing an increase of $14,620,319, or greater than 100%. Net cash used in operations, net of non-cash expenses, totaled $8,924,419
in the year ended April 30, 2022 compared to $1,587,946 in the year ended April 30, 2021, resulting an increase of $7,336,473, or greater
than 100%. The increase primarily related to higher operating costs associated with the acquisitions of Teal Drones and Skypersonic. Net
cash used related to changes in operating assets and liabilities totaled $7,094,901 during the year ended April 30, 2022 compared to net
cash provided by changes in operating assets and liabilities of $188,945 during the year ended April 30, 2021, representing a net increase
in cash used of $7,283,846, or greater than 100%. Changes in operating assets and liabilities can fluctuate significantly from year to
year depending upon the timing and level of multiple factors, including inventory purchases and vendor payments. During Fiscal 2022, the
Company spent almost $4 million to increase inventory levels, including pre-payments, to minimize the impact of global supply chain issues,
including a shortage of computer chips, on the Company’s operations.

Investing Activities

Net cash used in investing activities was $46,603,486
during the year ended April 30, 2022 compared to net cash provided by investing activities of $48,368 during the year ended April 30,
2021. The increase in net cash used in investing activities primarily related to the purchase of marketable securities, partially offset
by proceeds from maturities during the year ended April 30, 2022. The Company received proceeds of approximately $70 million from the
issuance of common stock in Fiscal 2022, with a portion of those proceeds invested in a portfolio of marketable securities.

Financing Activities

Net cash provided by financing activities totaled
$66,430,274 during the year ended April 30, 2022 compared to $1,488,048 during the year ended April 30, 2021, representing an increase
of $64,942,226, or greater than 100%. Financing activities can vary, in nature and amount, from period to period. During the year ended
April 30, 2022, net proceeds of $70,065,203 were received through the issuance of common stock compared to zero during the year ended
April 30, 2021.

Liquidity and Capital Resources

At April 30, 2022, the Company reported current assets
totaling $55,653,297, current liabilities totaling $5,439,421 and net working capital of $50,213,876. Cash and marketable securities totaled
$48,875,184 at April 30, 2022 and related to issuances of common stock in 2022 which generated net proceeds of more than $70 million.
As of April 30, 2022, we had inventory related balances, including pre-paid inventory, totaling $5,602,955. The higher-than-normal inventory
balances related to actions taken to address the global supply chain issues, including a chip shortage. At April 30, 2022, the Company
was in a strong liquidity and capital position relative to its recent annual operating results.

We have only recently begun generating revenues
and have reported net losses since our inception. Through fiscal year 2022, we have funded our operations through private and public
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.

2020 Convertible Note Offering

In October 2020, the Company closed a private offering
of convertible promissory notes (the "2020 Notes") in the aggregate principal amount of $600,000. The 2020 Notes accrued interest
at 12% annually, had a two-year term, and were convertible into common stock at the lower of $1.00 or a 25% discount of the price per
share of Common Stock offered in a future, qualified offering. The financing also included the issuance of warrants to purchase 399,998
shares of common stock. The Warrants are exercisable for a period of five years at a price equal to the lower of (1) $1.50 per share,
or (2) at a price equal to 75% of the price per share of the common stock offered in a future, qualified offering.

As of April 30, 2022, (a) the 2020 Notes were fully
converted into common stock and the related derivative liability eliminated, and (b) 266,666 of the warrants were outstanding with a derivative
liability of $529,383.

2021 Convertible Note Offering

In January 2021, the Company closed a private offering
of convertible promissory notes (the "2021 Notes") in the aggregate principal amount of $500,000. The 2021 Notes accrued interest
at 12% annually, had a two-year term, and were convertible into shares of the Company's common stock at the lower of $1.00 or a 25% discount
of the price per share of Common Stock offered in a future, qualified offering. The financing also included the issuance of warrants to
purchase 675,000 shares of common stock. The Warrants are exercisable for a period of five years at a price equal to the lower of (i)
$1.50 per share, or (ii) a 25% discount to the price per share of common stock offered in a future qualified offering.

As of April 30, 2022, (a) the 2021 Notes were fully
converted into common stock and the related derivative liability eliminated, and (b) 540,000 of the warrants were outstanding with a derivative
liability of $1,078,113.

Underwritten Public
Offerings

S-1 Offering

On May 4, 2021, the Company
closed a firm commitment underwritten public offering (the "S-1 Offering") in which it sold 4,000,000 shares of 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 an underwriting agreement dated April 29, 2021. These shares of common stock
were offered to 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, after deducting the underwriting discount, the underwriters’ fees and expenses and the Company’s
estimated expenses, were approximately $14.6 million.

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 Common Stock at a purchase price of $4.50 per share to ThinkEquity, pursuant to an underwriting agreement dated July 18, 2021. These
shares of common stock 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, after deducting the underwriting discount, the underwriters’
fees and expenses, and the Company’s estimated expenses were approximately $55.5 million.

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 financings 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.

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.  Significant estimates reflected in these financial statements include those used to (i) determine
stock based compensation, (ii) complete purchase price accounting for acquisitions, and (iii) accounting for derivatives

Goodwill – 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.

Fair Values, Inputs and Valuation Techniques for
Financial Assets and Liabilities and Related Disclosures

The fair value measurements and disclosure guidance
defines fair value and establishes a framework for measuring fair value. Fair value is defined as the price that would be received to
sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the measurement
date. In accordance with this guidance, the Company has categorized its recurring basis financial assets and liabilities into a three-level
fair value hierarchy based on the priority of the inputs to the valuation technique.

The fair value hierarchy gives the highest priority
to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level
3). The inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the
fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level input
that is significant to the fair value measurement in its entirety. The Company's assessment of the significance of a particular input
to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability.

The guidance establishes three levels of the fair
value hierarchy as follows:

Level 1:
Inputs are unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date;

Level 2:
Inputs are observable, unadjusted quoted prices in active markets for similar assets or liabilities, unadjusted quoted prices for identical
or similar assets or liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable
market data for substantially the full term of the related assets or liabilities; and

Level 3:
Unobservable inputs that are significant to the measurement of the fair value of the assets or liabilities that are supported by
little or no market data.

Disclosures for Non-Financial Assets Measured at
Fair Value on a Non-Recurring Basis

The Company's financial instruments mainly consist
of cash, receivables, current assets, accounts payable, accrued expenses and debt. The carrying amounts of cash, receivables, current
assets, accounts payable, accrued expenses and current debt approximates fair value due to the short-term nature of these instruments.

Convertible Securities and Derivatives

When the Company issues convertible debt or equity
instruments that contain embedded derivative instruments that are to be bifurcated and accounted for as liabilities, the total proceeds
from the convertible host instruments are first allocated to the bifurcated derivative instruments.  The remaining proceeds,
if any, are then allocated to the convertible instruments themselves, resulting in those instruments being recorded at a discount from
their face value but no lower than zero. Any excess amount is recognized as a derivative expense.

Derivative Liabilities

The Company has financial instruments that are considered
derivatives or contain embedded features subject to derivative accounting. Embedded derivatives are valued separately from the host instrument
and are recognized as derivative liabilities on the Company's balance sheet. The Company measures these instruments at their estimated
fair value and recognizes changes in their estimated fair value in results of operations during the period of change.

In October 2020 and January 2021, the Company entered
into convertible note agreements which included provisions under which the conversion price was equal to the lesser of an initial stated
amount or the conversion price of a future offering. This variable conversion feature was recognized as a derivative. Both financings
included the issuance of warrants which contained similar variable conversion features. The Company values these convertible notes and
warrants using the multinomial lattice method that values the derivative liability based on a probability weighted discounted cash flow
model. The resulting liability is valued at each reporting date and the change in the liability is reflected as change in derivative liability
in the statement of operations.

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.