Unusual Machines, Inc.: Form 10-Q for the period ended Sep 30, 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/A for the year ended December 31, 2023, which was filed with the SEC on August 9, 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 final prospectus filed with the SEC on October 25, 2024, 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

Private Placement

On October 29, 2024 (the “Closing Date”), we entered into Securities Purchase Agreements (the "SPA”) with accredited investors (each, an "Investor” and together the "Investors”) for a private placement offering ("Private Placement”), for aggregate gross proceeds of $1.95 million before deducting fees to the placement agent and other expenses payable by us in connection with the Private Placement. We intend to use the net proceeds of the Offering for working capital and general corporate purposes. As part of the Private Placement, we issued an aggregate of 1,286,184 units at a per unit purchase price of $1.52 per unit. Each unit consisted of one share of common stock, par value $0.01 per share (the "Common Stock”) and one warrant to purchase one share of the Company’s Common Stock (each an "Investor Warrant”) and collectively, the Investor Warrants”). The Investor Warrants have a term of five and a half years from the Closing Date and may not be exercised for 180 days after the Closing Date and are exercisable at $1.99 per share, subject to certain limitations and adjustments set forth in the Investor Warrants.

Results of Operations – Three Months Ended September 30, 2024 compared to the Three Months Ended September 30, 2023

Revenue

During the three months ended September 30, 2024 we generated revenues totaling $1,531,264 compared to $0 during the three months ended September 30, 2023, representing an increase of $1,531,264 or 100%. We did not generate any revenues until the closing of the acquisitions of Fat Shark Holdings Ltd. (“Fat Shark”) and Rotor Riot LLC (“Rotor Riot”) on February 16, 2024. The majority of our revenue during the quarter relates 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 September 30, 2024, we incurred cost of goods sold of $1,131,777 compared to $0 during the three months ended September 30, 2023, resulting in an increase of $1,131,777 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 September 30, 2024, our gross margin was $399,487 compared to $0 during the three months ended September 30, 2023, resulting in an increase of $399,487 or 100%. Our gross margin, as a percentage of sales, totaled 26% during the three months ended September 30, 2024, compared to 0% during the three months ended September 30, 2023. We anticipate our gross margin to fluctuate period to period depending on certain promotions and products that are sold during the period and the margins we generated during the quarter are in line with our expectations and normal operating margins.

Operating Expenses

During the three months ended September 30, 2024, operations expenses totaled $218,126 compared to $0 during the three months ended September 30, 2023, resulting in an increase of $218,126 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 September 30, 2024, research and development expenses was $15,000 compared to $0 for the three months ended September 30, 2023, resulting in an increase of $15,000. 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 as we continue to partner with manufacturers to bring drone component manufacturing to the United States.

During the three months ended September 30, 2024, sales and marketing expenses totaled $252,253 compared to $0 for the three months ended September 30, 2023, resulting in an increase of $252,253 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 September 30, 2024, general and administrative expenses totaling $1,374,989 compared to $353,029 for the three months ended September 30, 2023, resulting in an increase of $1,021,960 or 289%. The increase primarily relates to stock compensation expense during quarter that we did not have in the previous year, an increase in 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 September 30, 2024, totaled $2,144,250 compared to $353,674 for the three months ended September 30, 2023, resulting in an increase in net loss of $1,790,576 or 506%. The increase in net loss primarily relates to stock compensation expense taken during the period, the $685,151 loss on debt extinguishment, of which $663,250 was non-cash, in connection with the $1.0 million debt exchange for Series C preferred shares. In addition, the increase in general and administrative expenses related to closing the initial public offering (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. In the fourth quarter of 2024 we expect to complete our valuation and identification of any intangible assets related to the acquisitions of Fat Shark and Rotor Riot. For any identified intangibles, we will begin to amortize during the fourth quarter which will result in a non-cash charge going forward. However, and until we complete our valuation on intangibles, the amount is uncertain, and the future amortization may or may not be material. After the identification and valuation of intangibles is complete, we will complete our impairment analysis on goodwill and the identified intangibles during the fourth quarter. While the amount is uncertain, we expect that our goodwill impairment could be material.

Results of Operations – Nine months Ended September 30, 2024 compared to the Nine months Ended September 30, 2023

Revenue

During the nine months ended September 30, 2024 we generated revenues totaling $3,561,303 compared to $0 during the nine months ended September 30, 2023, representing an increase of $3,561,303 or 100%. We did not generate any revenues until the closing of the acquisitions of Fat Shark and Rotor Riot on February 16, 2024. Accordingly, our revenues for the nine months ending September 30, 2024 are affected by not having any revenues for half of the first quarter. 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 nine months ended September 30, 2024, we incurred cost of goods sold of $2,569,209 compared to $0 during the nine months ended September 30, 2023, resulting in an increase of $2,569,209 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 nine months ended September 30, 2024, our gross margin was $992,094 compared to $0 during the nine months ended September 30, 2023, resulting in an increase of $992,094 or 100%. Our gross margin, as a percentage of sales, totaled 28% during the nine months ended September 30, 2024, compared to 0% during the nine months ended September 30, 2023. We anticipate our gross margin to fluctuate period to period depending on certain promotions and products that are sold during the period and the margins we generated during the quarter are in line with our expectations and normal operating margins.

Operating Expenses

During the nine months ended September 30, 2024, operations expenses totaled $544,220 compared to $0 during the nine months ended September 30, 2023, resulting in an increase of $544,220 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 nine months ended September 30, 2024, research and development expenses totaled $42,078 compared to $0 for the nine months ended September 30, 2023, resulting in an increase of $42,078 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 as we continue to partner with manufacturers to bring drone component manufacturing to the United States.

During the nine months ended September 30, 2024, sales and marketing expenses totaled $795,643 compared to $0 for the nine months ended September 30, 2023, resulting in an increase of $795,643 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 nine months ended September 30, 2024, general and administrative expenses totaling $3,728,749 compared to $1,965,469 for the nine months ended September 30, 2023, resulting in an increase of $1,763,280 or 90%. 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 nine months ended September 30, 2024, totaled $4,862,490 compared to $1,966,876 for the nine months ended September 30, 2023, resulting in an increase in net loss of $2,895,614 or 147%. The increase in net loss primarily relates the increase in general and administrative expenses related to closing the IPO with additional increase in expenses for operations, sales and marketing expenses we incurred since the acquisition from Fat Shark and Rotor Riot, and other expenses of $743,381 related to interest expense and a large non-cash loss on debt extinguishment during the period. 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. In the fourth quarter of 2024 we expect to complete our valuation and identification of any intangible assets related to the acquisitions of Fat Shark and Rotor Riot. For any identified intangibles, we will begin to amortize during the fourth quarter which will result in a non-cash charge going forward. However, and until we complete our valuation on intangibles, the amount is uncertain, and the future amortization may or may not be material. After the identification and valuation of intangibles is complete, we will complete our impairment analysis on goodwill and the identified intangibles during the fourth quarter. While the amount is uncertain, we expect that our goodwill impairment could be material.

Cash Flow Analysis

Prior to the closing of our IPO and the acquisitions of Fat Shark and Rotor Riot, we did not have any cash inflows from operations and all cash outflows related to our activities related to 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 $2,718,513 during the nine months ended September 30, 2024, compared to net cash used in operating activities of $1,382,538 during the nine months ended September 30, 2023, representing an increase of $1,335,975 or 97%. This increase in net cash used primarily resulted from our increase in net loss of $2,895,614 and an increase in prepaid expenses of $319,532, accounts receivable of $73,109, other assets of $62,850, offset by a decrease in inventory of $337,562, an increase in accounts payable and accrued expenses of $681,414, other liabilities of $153,020 and non-cash expenses of $1,378,790.

Investing Activities

Net cash used in investing activities was $852,801 during the nine months ended September 30, 2024 compared to net cash used in investing activities of $3,164 during the nine months ended September 30, 2023, representing an increase of $849,637. This increase in net cash used related to the $1,000,000 we paid to purchase Fat Shark and Rotor Riot, offset by $147,199 in cash acquired as compared to $3,164 used for purchase of computer equipment during 2023.

Financing Activities

Net cash provided by financing activities totaled $4,362,313 during the nine months ended September 30, 2024, compared to net cash used in financing activities of $376,702 during the nine months ended September 30, 2023, resulting in an increase in net cash provided by financing activities of $4,739,015. The increase primarily relates to proceeds received from our IPO of $5,000,000, offset by change in deferred offering costs and other IPO related expenses of $260,985.

Liquidity and Capital Resources

As of September 30, 2024, we had current assets totaling $4,517,325 primarily consisting of cash balances of $1,685,772, inventory of $1,453,042 and prepaid deposits for inventory of $1,140,511. Our current liabilities as of September 30, 2024 totaled $2,018,255, primarily consisting of accounts payable and accrued expenses of $1,032,637 and customer deposits and other current liabilities of $985,618. Our net working capital as of September 30, 2024 was $2,499,070.

On October 29, 2024, we completed a private placement offering for the sale of 1,286,184 shares of common stock at a price of $1.52 per share for aggregate gross proceeds of $1.95 million before deducting fees to the placement agent and other expenses payable by us in connection with the private placement. We retained approximately $1.7 million in net proceeds.

As of November 13, 2024, we have approximately $2.4 million in cash. We believe that the net proceeds from our 2024 financings and revenues, October 2024 private placement 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. We do not anticipate any significant cost increases post the Fat Shark and Rotor Riot acquisitions and with consideration of the combined companies’ net low and cash position, we expect we will have sufficient working capital to support our operations for at least 12 months.

As described in Note 8 of our financial statements, we issued the August Notes following our agreement with Red Cat on the Working Capital Adjustment. Once the August Notes mature in November 2025, we will need to either (a) raise additional capital, (b) refinance the August Notes, (c) seek an extension of the maturity date of the Notes, or (d) explore the conversion or exchange of the New Notes into equity, which will result in dilution to our shareholders, if the August Notes have not been converted or paid in full prior to the maturity date. If we are unable to raise capital or explore such other options when needed or on acceptable terms, we may default under the obligation pursuant to the New Notes, or be forced to delay, reduce or eliminate certain operational efforts.

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.

Fair value of assets acquired and liabilities assumed in business combination

The Fat Shark and Rotor Riot acquisitions are accounted for as a business combination under ASC 805. We recognized the assets acquired and liabilities assumed at fair value as of the date of acquisition. We have not yet completed our evaluation of the fair value for determining the unallocated purchase price between goodwill and other intangible assets. Such amounts are subject to adjustment during the one-year measurement period. The fair value will be determined based on assumptions used in valuations and estimates determined by management, which are subjective.

Impairment of 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. Goodwill represents costs in excess of fair values assigned to the underlying identifiable net assets of acquired businesses. Intangible assets from acquired business are recognized at fair value on the acquisition date. We are continuing our evaluation of the fair value of the assets acquired and liabilities assumed from the Fat Shark and Rotor Riot acquisition, and we have not yet determined the unallocated purchase price between goodwill and other intangible assets. 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.

Valuation of Inventory

Our policy for valuation of inventory requires us to evaluate the net realizable value of our inventory using various reference measures including current product selling prices, as well as evaluating for excess quantities and obsolescence. We may be required to record inventory write-downs if actual inventory values are less favorable than those estimates by management.

Stock Based Compensation

Certain employees and directors have received grants of restricted common shares in our company. Other employees received grants of stock options in our Company. These awards are accounted for in accordance with guidance prescribed for accounting for equity-based compensation. Based on this guidance and the terms of the awards, the awards are equity classified.

The fair value of restricted stock awards is based on the fair value of the Company’s common stock on the date of grant and expensed over the vesting period.

The fair value of each stock option award is determined using the Black-Scholes option-pricing model which values options based on the stock price at the grant date, the expected life of the option, the estimated volatility of the stock, and the risk-free interest rate over the expected life of the option. The expected volatility was determined considering comparable companies historical stock prices as a peer group for the fiscal year the grant occurred and prior fiscal years for a period equal to the expected life of the option. The risk-free interest rate was the rate available from the St. Louis Federal Reserve Bank with a term equal to the expected life of the option. The expected life of the option was estimated based on a mid-point method calculation.

In addition, the Company issued shares of our common stock in 2023 to consultants for services performed. Prior to our IPO in February 2024, we were a private company with no active public market for our common stock. Therefore, we have periodically determined the overall value of our company and the estimated per share fair value of our common equity at their various dates and valuations based on a per share valuation using the private funding transactions as an estimate. These values and estimates are subjective.

Warrant Classification and Fair Value

The Company classifies warrants issued for the purchase of shares of its common stock as either equity or liability instruments based on an assessment of the specific terms and conditions of each respective contract. The assessment considers whether the warrants are freestanding financial instruments or embedded in a host instrument, whether the warrants meet the definition of a liability pursuant to ASC 480, whether the warrants meet the definition of a derivative under ASC 815, and whether the warrants meet all of the requirements for equity classification under ASC 815. This assessment, which requires the use of professional judgment, is conducted at the time of warrant issuance and as of each subsequent quarterly period end date while the warrants are outstanding.

For issued or modified warrants that meet all of the criteria for equity classification, the warrants are required to be recorded as a component of equity at the time of issuance. For issued or modified warrants that do not meet all the criteria for equity classification, the warrants are required to be recorded as liabilities at their fair value. The fair value of the warrant liability is determined using the binomial option pricing model the binomial option pricing model which values the liability on the stock price at the grant date, the estimate volatility of the stock, the expected term until exercise, the risk-free interest rate over the expected term, certain estimates and probabilities of different outcomes.

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 September 30, 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 nine months ended September 30, 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;
• Implemented the initial phase of an ERP and financial accounting system and added additional systematic internal controls and timely recording of transactions. We will continue to build out and expand the functionality of our ERP system and build in additional automation and controls.

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 nine months ended September 30, 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.