# Red Cat Holdings, Inc. (RCAT) FY 2024 MD&A Verbatim Item 7 Management's Discussion and Analysis from Red Cat Holdings, Inc.'s 10-K for fiscal year 2024. SEC filing source: https://www.sec.gov/Archives/edgar/data/748268/000155479524000195/rcat0808form10k.htm Accession: 0001554795-24-000195 Filing date: 2024-08-08 Report date: 2024-04-30 Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary. Confidence: high Company profile: /company/RCAT/ All MD&A years: /company/RCAT/mda/ Previous year: /company/RCAT/mda/fy2023/ (FY 2023) Next year: /company/RCAT/mda/fy2025/ (FY 2025) ITEM 7. 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. In addition to our historical consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates, and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. For more information regarding forward-looking statements, please refer to the discussion above under the heading “Forward-Looking Statements.” Recent Developments Corporate developments during the two years ended April 30, 2024 include: Capital Transactions During the first quarter of fiscal 2022, the Company completed two firm commitment underwritten public offerings with ThinkEquity, a division of Fordham Financial Management. The first offering, in May 2021, generated gross and net proceeds of $16 and $14.6 million, respectively. The second offering, in July 2021, generated gross and net proceeds of $60 and $55.5 million, respectively. On December 11, 2023, the Company completed a firm commitment underwritten public offering with ThinkEquity of 18,400,000 shares of common stock which generated gross and net proceeds of $9.2 and $8.4 million, respectively. 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: [[GREPCENT_TABLE]] [["","A.","In January 2020, the Company acquired Rotor Riot, a provider of First Person View (FPV) drones and equipment, primarily to the consumer marketplace. The purchase price was $1,995,114."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["","B.","In November 2020, the Company acquired Fat Shark Holdings, a provider of FPV video goggles to the drone industry. The purchase price was $8,354,076."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["","C.","In May 2021, the Company acquired Skypersonic which provides hardware and software solutions that enable drones to complete inspection services in locations where GPS is not available, yet still record and transmit data even while being operated from thousands of miles away. The purchase price was $2,791,012."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["","D.","In August 2021, the Company acquired Teal Drones, a leader in commercial and government UAV (Unmanned Aerial Vehicles) technology. The purchase price was $10,011,279."]] [[/GREPCENT_TABLE]] Following the Teal acquisition in August 2021, we concentrated on integrating and organizing these businesses. Effective May 1, 2022, we established the Enterprise segment and the Consumer segment to focus on the unique opportunities in each sector. The Enterprise segment’s initial strategy was to provide UAVs to commercial enterprises, and the military, to navigate dangerous military environments and confined industrial and commercial interior spaces. Subsequently, the segment narrowed its near-term attention on the military and other government agencies. Skypersonic's technology has been redirected to military applications and its operations consolidated into Teal. [[GREPCENT_TABLE]] [["","30"]] [[/GREPCENT_TABLE]] The Enterprise segment’s current business strategy is focused on providing integrated robotic hardware and software for use across a variety of applications. Its solutions provide critical situational awareness and actionable intelligence to on-the-ground warfighters and battlefield commanders as well as firefighters and public safety officials. Our Enterprise segment’s efforts are centered on developing and scaling an American made family of systems. We have since completed construction of a manufacturing facility in Salt Lake City and believe that an increased focus by the United States government and American businesses on purchasing products that are “Made in America” provide our Enterprise segment with a competitive advantage. On February 16, 2024, we closed the sale of our Consumer segment, consisting of Rotor Riot and Fat Shark, to Unusual Machines. The sale reflects our decision to focus our efforts and capital on defense where we believe there are more opportunities to create long term shareholder value. Results of Operations The analysis of the Company's results of operations for the year ended April 30, 2024 ("Fiscal 2024") compared to the year ended April 30, 2023 ("Fiscal 2023") includes only the Company’s Enterprise segment as our Consumer segment was divested in February 2024. 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 0% and 2% of consolidated revenues and operating loss for Fiscal 2024. Based on its immateriality, Skypersonic is not included in the operating analysis set forth below. Discussion and Analysis of Fiscal 2024 compared to Fiscal 2023 Revenues Consolidated revenues totaled $17,836,382 during the year ended April 30, 2024 (or the "2024 period") compared to $4,620,834 during the year ended April 30, 2023 (or the "2023 period") representing an increase of $13,215,548, or 286%. The increase primarily related to higher product revenue related to the launch of the Teal 2 in April 2023. Product revenue totaled $13,588,372 during the year ended April 30, 2024 compared to $3,012,470 during the year ended April 30, 2023 representing an increase of $10,575,902, or 351%. The increase in revenue also partially related to increased contract revenues during the 2024 period. Contract revenues totaled $4,173,005 during the 2024 period compared to $1,312,427 during the 2023 period, representing an increase of $2,860,578, or 218%. Contract revenues are primarily sourced through government agencies and can fluctuate from period to period based on the timing of award deliverables and amendments. Gross Profit Consolidated gross profit totaled $3,680,546 during the 2024 period compared to negative $834,311 during the 2023 period representing an increase of $4,514,857, or 541%. On a percentage basis, gross profit was 21% during the 2024 period compared to negative 18% during the 2023 period. The percentage basis increase in gross profit in the 2024 period primarily related to obsolete inventory write-offs that occurred during the 2023 period. Additionally, lower manufacturing levels in the 2023 period resulted in higher relative overhead costs compared to the 2024 period. Our manufacturing facility is presently producing drones at a lower level than it is designed for, and these lower production levels, combined with higher overhead costs, continue to result in lower than targeted gross profits. As production levels increase, our fixed overhead costs, including labor, are expected to be allocated to a greater number of drones which is expected to drive our per-drone production costs lower and increase gross profits. Operating Expenses Research and development expenses totaled $5,896,037 during the 2024 period compared to $5,595,281 during the 2023 period, representing an increase of $300,756, or 5%. Supplies and materials expense totaled $2,017,979 in the 2024 period compared to $1,444,051 in the 2023 period. This increase of $573,928, or 40%, primarily related to increased efforts in developing new products and represented substantially all of the total increase in research and development costs. Sales and marketing costs totaled $4,568,617 during the 2024 period compared to $3,731,776 during the 2023 period, representing an increase of $836,841 or 22%. The increase was driven by higher payroll expenses to support increased sales efforts of the Teal 2. [[GREPCENT_TABLE]] [["","31"]] [[/GREPCENT_TABLE]] General and administrative expenses totaled $10,679,105 during the 2024 period compared to $12,383,470 during the 2023 period, representing a decrease of $1,704,365 or 14%. The decrease primarily related to lower professional fees. During the 2024 period, we incurred stock-based compensation costs of $3,609,267 compared to $3,656,724 in the 2023 period, resulting in a decrease of $47,457 or 1%. Other Income Other expense totaled $3,650,484 during the 2024 period compared to $1,004,887 during the 2023 period, representing a decrease of $2,645,597 or 263%. During the 2024 period, the divestiture of the Consumer segment resulted in a gain of $9,642,427, impairment of $11,353,875, and an equity method loss of $503,625. Additionally, during the 2024 period, the Company was awarded a manufacturing modernization grant from the State of Utah for $750,000 of which $675,000 is attributable to the 2024 period. Net Loss from Continuing Operations Net loss from continuing operations totaled $21,526,696 for the 2024 period compared to $26,376,643 for the 2023 period, resulting in a decrease of $4,849,947 or 18%. Total operating expenses totaled $21,556,758 for the 2024 period compared to $24,537,445 for the 2023 period. The decrease in operating expenses was offset by the increase in other expense. Higher gross profit is attributable to the decrease in net loss from continuing operations. Results of Discontinued Operations Net loss from discontinued operations totaled $2,525,933 for the 2024 period compared to $1,730,386 for the 2023 period, representing an increase of $795,547, or 46%. Net loss for Fat Shark totaled $1,365,707 for the 2024 period, compared to $543,962 for the 2023 period, representing an increase of $821,745 or 151%, and represents 103% of the total increase in net loss from discontinued operations. Fat Shark’s results were adversely impacted by a charge of $1,244,920 during the 2024 period related to the write-off of excess quantities of Dominator inventory based on sales volumes. Net loss for Rotor Riot totaled $1,160,226 for the 2024 period compared to $1,186,424 for the 2023 period, representing a decrease of $26,198 or 2%. Cash Flows Operating Activities Net cash used in operating activities was $17,687,063 during the 2024 period compared to net cash used in operating activities of $24,313,674 during the 2023 period, representing a decrease of $6,626,611 or 27%. The decreased use of cash primarily related to timing of accounts receivable receipts for government customers. Net cash used in operations, net of non-cash expenses, totaled $8,512,449 during the 2024 period, compared to $7,784,364 during the 2023 period, resulting in an increase of $728,085, or 9%. Net cash used related to changes in operating assets and liabilities totaled $4,672,816 during the 2024 period, compared to $5,721,395 during the 2023 period, representing a decrease of $1,048,579 or 18%. 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, vendor payments, and customer collections. Investing Activities Net cash provided by investing activities was $13,567,078 during the 2024 period compared to net cash provided by investing activities of $29,590,235 during the 2023 period, resulting in a decrease of $16,023,157 or 54%. Proceeds of $12,826,217 and $32,290,448 from the sale of marketable securities were used to fund operations during the 2024 period and the 2023 period, respectively. Financing Activities Net cash provided by financing activities totaled $7,802,076 during the 2024 period compared to net cash used in financing activities of $1,215,325 during the 2023 period. Financing activities can vary from period to period depending upon market conditions, both at a macro-level and specific to the Company. During the fiscal 2024 period, the company received net proceeds from issuance of common stock of $8,395,600. [[GREPCENT_TABLE]] [["","32"]] [[/GREPCENT_TABLE]] Liquidity and Capital Resources At April 30, 2024, the Company reported current assets totaling $22,397,549, current liabilities totaling $3,651,130 and net working capital of $18,746,419. Cash totaled $6,067,169 at April 30, 2024. Inventory related balances, including pre-paid inventory, totaled $8,610,125. Going Concern The Company has never been profitable and has incurred net losses related to acquisitions, as well as costs incurred to pursue its long-term growth strategy. During the year ended April 30, 2024, the Company incurred a net loss from continuing operations of $21,526,696 and used cash in operating activities of continuing operations of $17,687,063. As of April 30, 2024, working capital for continuing operations totaled $18,746,419. These financial results and our financial position at April 30, 2024 raise substantial doubt about our ability to continue as a going concern. However, the Company has recently taken actions to strengthen its liquidity. On December 11, 2023, we completed a public offering of 18,400,000 shares of common stock which generated net proceeds of approximately $8,400,000. Subsequent to year end, the Company sold its equity method investment for $4,400,000. In addition, the Company’s operating plan for the next twelve months has been updated to reflect recent operating improvements.  Revenues have accelerated and are expected to continue growing. The Company’s manufacturing facility is scaling production and gross profits are projected to increase. If necessary, the Company will seek to obtain additional debt financing for which there can be no guarantee. Management has concluded that these recent positive developments alleviate any substantial doubt about the Company’s ability to continue its operations, and meet its financial obligations, for twelve months from the date these consolidated financial statements are issued. 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) complete purchase price accounting for acquisitions, (ii) the evaluation of long-term assets, including goodwill, for impairment, and (iii) the evaluation of other-than-temporary-impairment of equity method investments. 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. [[GREPCENT_TABLE]] [["","33"]] [[/GREPCENT_TABLE]] 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 profit, 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 are 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. 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.