Unusual Machines, Inc.: Form 10-Q for the period ended Mar 31, 2024

The following discussion and analysis should be read in conjunction with the unaudited condensed financial statements and related notes included elsewhere in this Quarterly Report and our audited financial statements and related notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2023, which was filed with the SEC on March 22, 2024. The following discussion contains forward-looking statements that are subject to risks and uncertainties. See “Special Note Regarding Forward-Looking Statements” for a discussion of the uncertainties, risks, and assumptions associated with those statements. Actual results could differ materially from those discussed in or implied by forward-looking statements as a result of various factors, including those discussed below and elsewhere in this Quarterly Report and of our Annual Report on Form 10-K for the year ended December 31, 2023, particularly in the section entitled “Risk Factors.” Unless we state otherwise or the context otherwise requires, the terms “we,” “us,” “our” and the “Company” refer to Unusual Machines, Inc. and its subsidiaries. All amounts presented in tables, other than per share amounts, are in thousands unless otherwise noted.

Recent Developments

Initial Public Offering

On February 16, 2024, we closed our initial public offering (“IPO”) for the sale of 1,250,000 shares of common stock, at a public offering price of $4.00 per share. The IPO generated gross proceeds of $5.0 million and net proceeds of approximately $4.5 million. We incurred and paid additional direct offering costs prior to the close of the IPO of $0.1 million during the three months ended March 31, 2024, and $0.5 million during the year ended December 31, 2023. We used $1.0 million of proceeds to pay for the acquisition of Fat Shark and Rotor Riot as discussed below.

Acquisition of Fat Shark and Rotor Riot

On November 21, 2022, we entered into the Purchase Agreement with Red Cat Holdings, Inc. (“Red Cat”) and Jeffrey Thompson, the founder and Chief Executive Officer of Red Cat and also director of our Company, pursuant to which we agreed to purchase Red Cat’s consumer business consisting of Fat Shark Holdings Ltd. (“Fat Shark”) and Rotor Riot LLC (“Rotor Riot”). Fat Shark and Rotor Riot are in the business of designing and marketing consumer drones and FPV goggles. Rotor Riot is also a licensed authorized reseller of consumer drones manufactured by third-parties.

Under the terms of the Purchase Agreement, as amended, the Company purchased from Red Cat its Rotor Riot and Fat Shark subsidiaries for $20.1 million comprised of (i) $1.1 million in cash, (ii) a $2.0 million promissory note issued by the Company to Red Cat, and (iii) $17.0 million of the Company’s common stock or 4,250,000 shares of common stock.

Simultaneous with the closing of our IPO, on February 16, 2024, we closed the acquisitions of Fat Shark and Rotor Riot.

We agreed to a working capital adjustment with Red Cat related to the acquisitions of Fat Shark and Rotor Riot. We are uncertain as to how much this adjustment will be. However, between the fair value of Fat Shark inventory, Rotor Riot inventory, cash and prepaid assets, offset by accounts payable and other accrued expenses, we expect the adjustment to Red Cat for working capital will be material. The adjustment to working capital could be settled in cash, an adjustment to the convertible note, or a combination thereof. We and Red Cat agreed to have a preliminary calculation of the working capital adjustment by May 17, 2024, however, with the determination of fair value of assets acquired and liabilities assumed still be determined, this calculation may be deferred.

Nevada Reincorporation

On April 22, 2024, we completed the change of incorporation from a Puerto Rico Corporation to a Nevada Corporation.

Results of operations

Revenue

During the three months ended March 31, 2024 we generated revenues totaling $618,915 compared to $0 during the three months ended March 31, 2023, representing an increase of $618,915 or 100%. We did not generate any revenues until the closing of the acquisitions of Fat Shark and Rotor Riot on February 16, 2024. Revenues relate to completed and fulfilled product sales during the period through our Rotor Riot retail channel and from our B2B wholesale through Fat Shark.

Cost of Goods Sold

During the three months ended March 31, 2024, we incurred cost of goods sold of $414,748 compared to $0 during the three months ended March 31, 2023, resulting in an increase of $414,748 or 100%. Similar to revenues, we did not incur any cost of goods sold until the closing of the acquisitions on February 16, 2024. Cost of goods sold primarily relate to product costs from our sales, but also include certain shipping and other direct product costs.

Gross Margin

During the three months ended March 31, 2024, our gross margin was $204,167 compared to $0 during the three months ended March 31, 2023, resulting in an increase of $204,167 or 100%. Our gross margin, as a percentage of sales, totaled 33.0% during the three months ended March 31, 2024, compared to 0.0% during the three months ended March 31, 2023. We anticipate our gross margin to fluctuate period to period depending on certain promotions and products that are sold during the period.

Operating Expenses

During the three months ended March 31, 2024, operations expenses totaled $112,322 compared to $0 during the three months ended March 31, 2023, resulting in an increase of $112,322 or 100%. Prior to the closing of the acquisitions in February 2024, we did not have any operations expenses. Operations expenses primarily relate to our direct operations including our warehouse personnel and warehouse expenses.

During the three months ended March 31, 2024, research and development expenses totaled $16,796 compared to $0 for the three months ended March 31, 2023, resulting in an increase of $16,796 or 100%. Prior to the closing of the acquisitions in February 2024, we did not have any research and development expenses during 2023. Research and development expense primarily relates to new product development.

During the three months ended March 31, 2024, sales and marketing expenses totaled $157,058 compared to $0 for the three months ended March 31, 2023, resulting in an increase of $157,058 or 100%. Prior to the closing of the acquisitions in February 2024, we did not have any sales and marketing expenses. Sales and marketing expenses primarily relate to advertising spend related to Rotor Riot and payroll expenses.

During the three months ended March 31, 2024, general and administrative expenses totaling $998,874 compared to $588,516 for the three months ended March 31, 2023, resulting in an increase of $410,358 or 69.7%. The increase relates to increased expenses related to closing the IPO including legal and accounting fees, additional transition and integration related expenses, and the costs related to operating Fat Shark and Rotor Riot.

Net Loss

Our net loss for the three months ended March 31, 2024, totaled $1,106,001 compared to $588,897 for the three months ended March 31, 2023, resulting in an increase in net loss of $517,104 or 87.8%. This increase in net loss relates to the increase in general and administrative expenses related to closing the IPO and the increased operations and sales and marketing expenses we incurred since the acquisition from Fat Shark and Rotor Riot. This was partially offset by generating gross margin related to the revenue and cost of goods sold from sales for Fat Shark and Rotor Riot.

Cash Flow Analysis

Prior to the closing of our IPO and the acquisitions of Fat Shark and Rotor Riot, we did not have any cashflow from normal operations and we only had cash used from operating activities preparing for our IPO. Our future cash flows from operating activities will be significantly impacted by revenues received, our investment in sales and marketing to drive growth, and general and administrative expenses related to operating a public company. Our ability to meet future liquidity needs will be driven by our operating performance and the extent of continued investment in our operations. Failure to generate sufficient revenues and related cash flows could have a material adverse effect on our ability to meet our liquidity needs and achieve our business objectives.

Operating Activities

Net cash used in operating activities was $1,195,604 during the three months ended March 31, 2024, compared to net cash used in operating activities of $542,448 during the three months ended March 31, 2023, representing an increase of $653,156 or 120.4%. This increase in net cash used primarily resulted from our increase in net loss of $517,104 and an increase in prepaid expenses of $377,144, offset by decrease in inventory of $148,765, change in working capital of $22,894 offset by non-cash expenses of $69,433.

Investing Activities

Net cash used in investing activities was $852,876 during the three months ended March 31, 2024 compared to net cash used in operating activities of $0 during the three months ended March 31, 2023, representing an increase of $852,876 or 100%. This increase in net cash used related to the $1,000,000 of cash used in the Purchase Agreement related to Fat Shark and Rotor Riot, offset by $147,124 in cash acquired.

Financing Activities

Net cash provided by financing activities totaled $4,362,313 during the three months ended March 31, 2024, compared to $0 during the three months ended March 31, 2023, resulting in an increase in net cash provided by financing activities of $4,362,313 or 100%. The increase is entirely related to proceeds received from our IPO of $5,000,000, offset by deferred offering costs and other IPO related expenses of $637,687.

Liquidity and capital resources

As of March 31, 2024, we had current assets totaling $6,128,890 primarily consisting of cash balances of $3,208,606, inventory of $1,641,839 and prepaid expenses and deposits for inventory of $998,254. Our current liabilities as of March 31, 2024 totaled $691,978, primarily consisting of accounts payable and accrued expenses of $455,764 and customer deposits and other current liabilities of $176,268. Our net working capital as of March 31, 2024 was $5,436,912.

On February 16, 2024, we completed our IPO for the sale of 1,250,000 shares of common stock at a public offering price of $4.00 per share for gross proceeds of $5.0 million. After paying certain underwriting discounts and commissions, business combination cash payment and other expenses related to the IPO, we retained approximately $2.9 million in net proceeds. Our cash balance as of the date of this Report was approximately $2.6 million.

Prior to our IPO in February 2024, our operations were funded exclusively by exempt private offerings of our common stock. In September 2021, we closed a private offering of 4,552,000 shares of common stock at a price of $0.50 per share for total proceeds of $2,276,000. On December 31, 2021, we closed an additional private offering of 482,500 shares of common stock at a price of $4.00 per share for total gross proceeds of $1,930,000, of which we received net proceeds of $1,842,000 after fees and other expenses. On July 25, 2022, we closed an additional private offering of 150,000 shares of common stock at a price of $4.00 per share for total proceeds of $600,000.

We believe that the net proceeds from our February 2024 IPO and existing cash balances will be sufficient to fund our current operating plans through at least the next 12 months. We have based these estimates, however, on assumptions that may prove to be wrong, and we could spend our available financial resources much faster than we currently expect and need to raise additional funds sooner than we anticipate. If we are unable to raise capital when needed or on acceptable terms, we may be forced to delay, reduce or eliminate certain operational efforts. We do not anticipate any significant cost increases post the Fat Shark and Rotor Riot acquisitions and with consideration of the combined companies’ net loss and cash position, we expect we will have sufficient working capital to support our operations for at least 12 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.

Significant estimates reflected in these financial statements include those used to (i) purchase price accounting for acquisitions and (ii) reserves and fair value related to inventory.

Goodwill

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 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.

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.

We are a smaller reporting company as defined by Rule 12b-2 of the Exchange Act and are not required to provide the information required under this item.

Evaluation of Disclosure Controls and Procedures

We carried out an evaluation, under the supervision and with the participation of our management, including our Principal Executive Officer and Principal Financial Officer, of the effectiveness of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934 (the “Exchange Act”) as of the end of the period covered by this report. Based on that evaluation, our Principal Executive Officer and Principal Financial Officer have concluded that our disclosure controls and procedures as of March 31, 2024, were not effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms because of a material weakness in the Company’s internal control over financial reporting. Specifically, the Company did not maintain effective controls, segregation of duties, and procedures to support the identification of, accounting for, and the evaluation and disclosure of certain transactions, as limited individuals, either the Principal Executive Officer or Principal Financial Officer, initiates all transactions and they also review, evaluate, and approve these same transactions.

Changes in Internal Control Over Financial Reporting

During the three months ended March 31, 2024, we have:

• Continued to strengthen our internal policies, processes, and reviews, including drafting of related documentation thereof;
• Engaged outside consultants to ensure that appropriate level of knowledge and experience is applied based on the risk and complexity of the transactions and tasks under review;
• Hired additional accounting staff to provide additional segregation of duties within accounting functions;
• Started internal control documentation along with the engagement of outside consultants to assist in the design, implementation, and documentation of internal controls to address relevant risks;
• Executed an agreement to implement an ERP and financial accounting system which will provide additional internal controls and appropriate recording of transactions.

The process of implementing an effective financial reporting system is a continuous effort that requires us to anticipate and react to changes in our business and the economic and regulatory environments and to expend significant resources to maintain a financial reporting system that is adequate to satisfy our reporting obligations. As we continue to evaluate and take actions to improve our internal control over financial reporting, we may take additional actions to address control deficiencies or modify certain of the remediation measures described above.

While progress has been made to enhance our internal control over financial reporting, we are still in the process of implementing these processes, procedures and controls. Additional time is required to complete implementation and to assess and ensure the sustainability of these procedures. There have been no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) during the three months ended March 31, 2024 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting, other than the activities described above.

In addition to the information set forth in this Form 10-Q, you should carefully consider the risk factors disclosed under the heading “Risk Factors” in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2023.