Red Cat Holdings, Inc. (RCAT) FY 2023 MD&A

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The
following discussion should be read in conjunction with our audited consolidated financial statements and related notes and other financial
data included elsewhere in this Annual Report on Form 10-K.

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 providing products, services and solutions to the drone industry. 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 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

Corporate
developments during the two years ended April 31, 2023 include:

Capital
Transactions

S-1
Offering

On
May 4, 2021, the Company closed a firm commitment underwritten public offering (the "S-1 Offering") for the sale of 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 to an underwriting agreement with Think Equity. The shares
were sold 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 S-1 offering generated
gross proceeds of $16 million and net proceeds of approximately $14.6 million.

S-3
Offering

On
July 21, 2021 the Company closed a firm commitment underwritten public offering (the "S-3 Offering") for the sale of 13,333,334
shares of common stock at a purchase price of $4.50 per share to ThinkEquity. The shares were sold 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 a registration statement filed with the SEC on July 19, 2021. The S-3 offering generated
gross proceeds of $60 million and net proceeds of approximately $55.5 million.

Plan
of Operations

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 expanded the scope of its drone products and
services through four acquisitions, including:

Following
the Teal acquisition, we focused on integrating and organizing these businesses. Effective May 1, 2022, we established the Enterprise
and Consumer segments in order to sharpen our focus on the unique opportunities in each sector. Enterprise's initial strategy was to
provide UAV's, primarily drones, to commercial enterprises, including the military, to navigate dangerous military environments and confined
industrial and commercial interior spaces. Subsequently, Enterprise narrowed its near term focus on the military and other government
agencies. Skypersonic's technology has been re-focused on military applications and its operations consolidated into Teal. The Consumer
segment, which includes Fat Shark and Rotor Riot, is focused on hobbyists and enthusiasts which are expected to increase as drones become
more visible in our daily lives.

In
November 2022, we entered into an agreement to sell our Consumer segment to Unusual Machines. The adjusted sale price is $20 million,
including $3 million in cash, at closing, and $17 million in securities of Unusual Machines. The agreement reflects the Company's decision
to focus its efforts and capital on military and defense where it believes that there are more opportunities to create long term shareholder
value. The closing of the transaction is contingent upon Unusual Machines completing (i) an initial public offering that raises sufficient
capital to close the transaction, and (ii) a listing on a public stock exchange such as the NYSE or Nasdaq.

Results
of Operations

The
analysis of the Company's results of operations for the year ended April 30, 2023 ("Fiscal 2023") compared to the year ended
April 30, 2022 ("Fiscal 2022") includes its wholly owned subsidiaries including Teal Drones, Rotor Riot, Fat Shark, and Skypersonic.
The results for both periods is significantly impacted by the acquisition of Teal Drones on August 31, 2021. Teal is the Company’s
largest operating subsidiary, and its operating results include 8 months for Fiscal 2022 and 12 months for Fiscal 2023. Since acquiring
Teal, the Company has more than tripled the number of Teal employees and significantly expanded its facilities. As a result, the comparison
of the year ended April 30, 2023 to the year ended April 30, 2022 yields more significant changes than might normally occur.

At
the end of Fiscal 2023, the Company recognized an impairment loss of $2,826,918 related to Skypersonic goodwill which was written down
to zero. In addition, its operations were consolidated into Teal. Skypersonic's operating results represented 2% and 4% of consolidated
revenues and operating loss for Fiscal 2023. Based on its immateriality, Skypersonic is not included in the operating analysis set forth
below.

A summary comparison
of Fiscal 2023 operating results compared to Fiscal 2022 is as follows:

Discussion
and Analysis of Fiscal 2023 compared to Fiscal 2022

Revenues

Consolidated revenues totaled
$9,911,780 during the year ended April 30, 2023 ("Fiscal 2023") compared to $6,428,963 during the year ended April 30, 2022
("Fiscal 2022") representing an increase of $3,482,817, or 54%. Revenue growth for Teal and Rotor Riot represented $2,854,413
and $1,345,972 of the dollar increase, or 82% and 39%, of the percentage increase, respectively, which was partially offset by Fat Shark’s
decrease of $606,006 or 17%. Revenue growth for Teal benefitted from a full year of operations in Fiscal 2023 compared to only eight
months in Fiscal 2023. Higher revenues for Rotor Riot were generated by a significant increase in digital marketing spending. Lower revenues
for Fat Shark related to its newest product, the Dominator, which was launched at the beginning of Fiscal 2023, and while it generated
strong initial sales in the first quarter, sales declined significantly over the remaining quarters in Fiscal 2023.

Revenues for the Enterprise
Segment totaled $4,620,834 in Fiscal 2023 compared to $1,877,983 for Fiscal 2022, representing an increase of $2,742,851, or greater than
100%. This revenue growth was entirely attributable to Teal which recognized product sales of $3,051,348 in Fiscal 2023 and $904,600 of
revenue under the SRR Tranche II program. Revenues for the Consumer Segment totaled $5,290,946 in Fiscal 2023 compared to $4,550,980 for
Fiscal 2022, representing an increase of $739,966, or 16%. This revenue growth was entirely attributable to Rotor Riot whose revenues
increased by $1,345,972, more than offsetting a $606,006 decrease for Fat Shark.

Gross
Margin

Consolidated
gross margin totaled negative $336,795 during Fiscal 2023 compared to $925,515 during Fiscal 2022 representing a decrease of $1,262,310,
or 136%. Gross margin dollar contribution for Teal, Rotor Riot, and Fat Shark totaled negative $857,721, positive $431,751, and positive
$158,285, respectively. The reported gross margin of negative 19% for Teal was adversely impacted by a charge of $1,405,807 related to
the write off of obsolete inventory related to its legacy drone, the Golden Eagle. Excluding this charge, core gross margin for Teal
was 12% in Fiscal 2023 compared to 19% in Fiscal 2022. The lower core gross margin in Fiscal 2023 reflects a significant investment by
the Company to build and scale a new manufacturing facility in Salt Lake City, Utah. Our manufacturing facility is presently producing
drones at a lower level than it is designed for, and these lower production levels, combined with higher labor and overhead costs, are
adversely impacting core gross margins at Teal. As production levels increase, our fixed overhead costs, including labor, will be allocated
to a greater number of drones which will drive our per-drone production costs lower and increase gross margins. The core operating margin
for Fat Shark was 15% in Fiscal 2023 compared to 2% in Fiscal 2022. The lower gross margin in Fiscal 2022 related to price reductions
of the prior digital goggle as the Company prepared for the launch of the Dominator in early Fiscal 2023. Separately, Fat Shark recorded
a charge of $182,845 related to the write-off of excess quantities of Dominator inventory based on sales volumes during the second half
of Fiscal 2023. This charge reduced gross margin from 15% to 7%. The core operating margin for Rotor Riot was 13% in Fiscal 2023 compared
to 21% in Fiscal 2022. The decrease related to higher product and shipping costs.

Operating
Expenses

Operations
expenses totaled $4,411,685 during the 2023 period compared to $1,353,904 during the 2022 period, resulting in an increase of $3,057,781,
or greater than 100%. Higher costs for Teal represented $2,934,250 or 96% of the percentage increase. Since its acquisition, we have
more than tripled Teal's headcount and doubled the size of its facilities. Approximately 49% of Teal's costs related to payroll, 21%
to employee-related office expenses, and 9% to overhead expenses with the balance spread ratably across numerous categories including
information technology, facilities, professional fees, and travel.

Research
and development expenses totaled $5,248,336 during the year ended April 30, 2023 compared to $2,606,141 during the year ended April 30,
2022, representing an increase of $2,642,195, or approximately 100%. The entire increase can be attributed to Teal, with approximately
43% of its expenses related to payroll, 33% related to office, 21% related to professional fees, and 3% related to information technology.

Sales
and marketing costs totaled $4,028,007 during the 2023 period compared to $1,127,532 during the 2022 period, resulting in an increase
of $2,900,475 or more than 100%. Higher costs for Teal and Rotor Riot represented $2,487,331 and $572,891 of the dollar increase and
86% and 20% of the percentage increase. Payroll costs, related to hiring at Teal, totaled $887,891 in the 2023 period compared to $24,428
during the 2022 period, resulting in an increase of $863,463 which represented 30% of the total increase in sales and marketing costs.
Travel and related costs totaled $567,307 in the 2023 period compared to $22,539 in the 2022 period resulting in an increase of $544,768
which represented 19% of the total increase. In addition, higher advertising and show production costs represented 27% of the increase
while professional fees accounted for 15% of the increase.

General
and administrative expenses totaled $6,618,596 during the year ended April 30, 2023 compared to $5,548,589 during the year ended April
30, 2022, representing an increase of $1,070,007 or 19%. Higher costs at the Corporate level essentially represented 100% of the increase.
Corporate includes executive compensation and other administrative costs associated with operating a publicly traded company including
departments such as finance, human resources, and administration. Other significant costs include professional services fees (legal,
audit, and board compensation), Nasdaq listing fees and filing costs, and corporate insurance. Specific increases in costs included payroll
which totaled $2,283,639 in the 2023 period compared to $1,536,125 in the 2022 period resulting in an increase of $747,514 or 70% of
the total increase in general and administrative expenses. Legal and lobbying services costs totaled $928,621 in Fiscal 2023 compared
to $312,367, representing an increase of $616,254, or 58% of the total increase. These higher costs were partially offset by decreases
in facilities costs of $140,634 and travel costs of $139,778.

During
the year ended April 30, 2023, we incurred stock-based compensation costs of $3,656,724 compared to $3,291,635 in the 2022 period, resulting
in an increase of $365,089 or 11%. During the 2023 period, the Company issued 1,503,500 additional options which resulted in incremental
stock-based compensation costs of $322,215.

Other
Income

Other
income totaled $39,324 during the 2023 period compared to $1,313,158 during the 2022 period, representing a decrease of $1,273,834. This
decrease in other income was principally related to higher depreciation and amortization expense which totaled $966,072 during the 2023
period compared to $264,803 during the 2022 period resulting in an increase of $701,269 and representing 55% of the total decrease in
other income. Higher depreciation expense related to approximately $2.5 million in capital expenditures in Fiscal 2023, primarily related
to the construction of the new manufacturing facility in Salt Lake City, Utah. Higher amortization expense related to a full year of
amortization of intangible assets acquired through acquisitions, especially Teal.

Net
Loss

Net
Loss totaled $27,087,737 during the year ended April 30, 2023, compared to $11,689,128 during the year ended April 30, 2022, representing
an increase of $15,398,609, or greater than 100%. Net Loss for Teal, Rotor Riot and Fat Shark totaled $12,554,652, $1,204,175, and $526,211,
or 46%, 4%, and 2% of the consolidated net loss. The acquisition of Teal Drones in August 2021 accounted for most of the increase. Since
acquiring Teal, we have more than tripled its headcount and significantly expanded its facilities. Net loss for Teal during the 2023
period totaled $12,554,652 compared to $2,198,232 for the 2022 period, representing an increase of $10,356,420, or almost 5 times. The
higher net loss for Teal represented 67% of the increase in the consolidated net loss. Corporate costs totaled $11,747,049 in the
2023 period compared to $6,978,663 in the 2022 period resulting in an increase of $4,768,386 or 68%. The increase represented 31%
of the increase in the consolidated loss.

Cash
Flows

Operating
Activities

Net
cash used in operating activities was $29,199,420 during the year ended April 30, 2023, compared to net cash used in operating activities
of $16,019,320 during the year ended April 30, 2022, representing an increase of $13,180,100 or 82%. Net cash used in operations, net
of non-cash expenses, totaled $20,322,665 during the year ended April 30, 2023, compared to 8,924,419 during the year ended April 30,
2022, resulting in an increase of $11,398,246, or greater than 100%. The higher use of cash primarily related to the acquisition of Teal
Drones in August 2021, and the subsequent expansion of its operations, as well the inclusion of a full year of operations in the 2023
period compared to eight months of operations in the 2022 period. Net cash used related to changes in operating assets and liabilities
totaled $8,876,755 during the year ended April 30, 2023, compared to $7,094,901 during the year ended April 30, 2022, representing an
increase of $1,781,854 or 25%. 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. Net inventory purchases, including
deposits, totaled $8,805,110 and $3,457,633 in fiscal 2023 and fiscal 2022, respectively.

Investing
Activities

Net
cash provided by investing activities was $29,590,235 during the year ended April 30, 2023, compared to net cash used in investing activities
of $46,603,486 during the year ended April 30, 2022 resulting in a decrease of $76,193,721 or greater than 100%. During the 2023 period,
net proceeds of $32,290,448 from the maturities of marketable securities were used to fund operations, and $2,450,213 was used to purchase
property and equipment, primarily related to the expansion of the manufacturing facilities for Teal. During the 2022 period, purchases
of marketable securities, net of proceeds from sales of marketable securities, totaled $46,264,663. During Fiscal 2023, the Company was
spending the proceeds from the Fiscal 2022 stock offerings to support operations for the full year, whereas in Fiscal 2022 the proceeds
from the stock offerings were invested in marketable securities and also used to support operations for the second half of Fiscal 2022.

Financing
Activities

Net
cash used in financing activities totaled $1,215,325 during the year ended April 30, 2023, compared to net cash provided by financing
activities of $66,430,274 during the year ended April 30, 2022. Financing activities can vary from period to period depending upon market
conditions, both at a macro-level and specific to the Company. During the 2022 period, the Company received net proceeds of approximately
$70 million in connection with two offerings of common stock and made payments under debt obligations totaling $2,900,709. Debt payments
totaled $646,954 during the 2023 period.

Liquidity
and Capital Resources

At
April 30, 2023, the Company reported current assets totaling $32,175,012, current liabilities totaling $4,760,616 and net working capital
of $27,414,396. Cash and marketable securities totaled $16,074,343 at April 30, 2023. Inventory related balances, including pre-paid
inventory, totaled $14,408,065. We continue to maintain higher-than-normal inventory balances related to the global supply chain issues,
including chip shortages, which continue to impact the timing of our purchase decisions.

Going
Concern

The
Company has never been profitable, and its net losses have been increasing related to acquisitions, as well as costs incurred to pursue
its long-term growth strategy. During the year ended April 30, 2023, the Company incurred a net loss of $27,087,737 and used cash
in operating activities of $29,199,420. As of April 30, 2023, the Company has working capital of $27,414,396. While the Company has historically
been successful in raising capital to meet its working capital requirements, the ability to continue raising such capital to enable the
Company to continue its growth is not guaranteed. Therefore, there is substantial doubt about the Company’s ability to continue
as a going concern as the Company will require additional liquidity to continue its operations and meet its financial obligations for
twelve months from the date these consolidated financial statements are issued. The Company is evaluating strategies to obtain
the required funding and exploring opportunities to reduce expenses.

If
the Company is unable to raise additional capital, there is a risk that the Company could default on its financial obligations and could
be required to discontinue or significantly reduce the scope of its operations. The consolidated financial statements do not include
any adjustments relating to the recoverability and classification of recorded asset amounts, or the amount and classification of liabilities
or any other adjustment that might be necessary should the Company be unable to continue as a going concern.

Critical
Accounting Policies and Estimates

Our
financial statements and accompanying notes have been prepared in accordance with GAAP applied on a consistent basis. The preparation
of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts
of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting periods.

We
regularly evaluate the accounting policies and estimates that we use to prepare our financial statements. A complete summary of these
policies is included in the notes to our financial statements. In general, management's estimates are based on historical experience,
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, (iii)
accounting for derivatives, (iv) reserves and allowances related to accounts receivable and inventory, and (v) the evaluation of long
term assets, including goodwill, for impairment.

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. We test goodwill for impairment in accordance with the provisions of ASC
350, Intangibles – Goodwill and Other, (“ASC 350”). 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. ASC 350 provides that
an entity has the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a
determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing
the totality of events or circumstances, an entity determines it is not more likely than not that the fair value of a reporting unit
is less than its carrying amount, then additional impairment testing is not required. However, if an entity concludes otherwise, then
it is required to perform an impairment test. The impairment test involves comparing the estimated fair value of a reporting unit with
its book value, including goodwill. If the estimated fair value exceeds book value, goodwill is considered not to be impaired. If, however,
the fair value of the reporting unit is less than book value, then an impairment loss is recognized in an amount equal to the amount
that the book value of the reporting unit exceeds its fair value, not to exceed the total amount of goodwill allocated to the reporting
unit.

The
estimate of fair value of a reporting unit is computed using either an income approach, a market approach, or a combination of both.
Under the income approach, we utilize the discounted cash flow method to estimate the fair value of a reporting unit. Significant assumptions
inherent in estimating the fair values include the estimated future cash flows, growth assumptions for future revenues (including gross
margin, operating expenses, and capital expenditures), and a rate used to discount estimated future cash flow projections to their present
value based on estimated weighted average cost of capital (i.e., the selected discount rate). Our assumptions our based on historical
data, supplemented by current and anticipated market conditions, estimated growth rates, and management’s plans. Under the market
approach, fair value is derived from metrics of publicly traded companies or historically completed transactions of comparable businesses.
The selection of comparable businesses is based on the markets in which the reporting units operate and consider risk profiles, size,
geography, and diversity of products and services.

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.

Financial
Instruments

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.

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 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. The valuation is updated each reporting
date with the change in the liability reflected as a 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.