UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

☑

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended July 31, 2021

	☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
		For the transition period from ___________ to ___________

Commission File Number: 000-31587

Red Cat Holdings, Inc.

(Exact name of Registrant as specified in its charter)

Nevada	86-0490034
(State or other jurisdiction of	(I.R.S. Employer Identification Number)
incorporation or organization)
370 Harbour Drive
Humacao, Puerto Rico	00791
(Address of principal executive offices)	(Zip Code)

(833) 373-3228

(Registrant's telephone number, including area code)

__________________________________

(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

Securities registered pursuant to Section 12(b) of the Act:

Title of Each Class

Trading

Symbol(s)

Name of each exchange on which registered

Common Stock

RCAT

Nasdaq Capital Market

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☑ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☑ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See definition of "large accelerated filer", "accelerated filer" and "smaller reporting company" and "emerging growth company" in Rule 12b-2 of the Exchange Act.

Large accelerated filer ☐	Accelerated filer ☐
Non-accelerated filer ☐	Smaller reporting company ☑
Emerging growth company ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☑

As of September 16, 2021, there were 53,680,126 shares of the registrant's common stock outstanding.

INDEX TO FORM 10-Q

PART I.	FINANCIAL INFORMATION	Page

Item 1.	Financial Statements:	3

	Unaudited Balance Sheet as of July 31, 2021 and Balance Sheet as of April 30, 2021	3

	Unaudited Statements of Operations for the Three Months Ended July 31, 2021 and 2020	4

	Unaudited Statement of Changes in Shareholders' Equity for the Three Months Ended July 31, 2021 and 2020	5

	Unaudited Statements of Cash Flows for the Three Months Ended July 31, 2021 and 2020	6

	Notes to Financial Statements	7

Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	21

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	26

Item 4.	Controls and Procedures	26

PART II.	OTHER INFORMATION

Item 1.	Legal Proceedings	27

Item 1A.	Risk Factors	27

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	27

Item 3.	Defaults Upon Senior Securities	27

Item 4.	Mine Safety Disclosures	27

Item 5.	Other Information	27

Item 6.	Exhibits	27

SIGNATURES		28


RED CAT HOLDINGS
Consolidated Balance Sheets
(Unaudited)


		July 31,			April 30,
		2021			2021

ASSETS
Current Assets
Cash and cash equivalents	$	66,118,581		$	277,347
Accounts receivable, net		267,813			321,693
Inventory		884,931			362,072
Other		2,456,532			678,898
Total Current Assets		69,727,857			1,640,010

Long Term Assets
Goodwill		11,650,879			8,017,333
Intangible assets, net		2,015,843			2,032,169
Other		3,853			3,853
Total Long Term Assets		13,670,575			10,053,355

TOTAL ASSETS		83,398,432			11,693,365


LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Accounts payable		920,256			541,903
Accrued expenses		637,769			614,050
Notes payable		154,872			269,045
Due to related party		239,954			390,209
Customer deposits		108,888			46,096
Warrant derivative liability		2,495,378			2,812,767
Total Current Liabilities		4,557,117			4,674,070

Note payable to related party		1,620,800			1,753,000
Total Long Term Liabilities		1,620,800			1,753,000
Commitments and contingencies

Stockholders' Equity
Series A Preferred Stock - shares authorized 2,200,000;
outstanding 158,704 and 158,704		1,587			1,587
Series B Preferred Stock - shares authorized 4,300,000;
outstanding 986,676 and 1,968,676		9,867			19,687
Common stock - shares authorized 500,000,000;
outstanding 48,489,085 and 29,431,264		48,489			29,431
Additional paid-in capital		94,527,350			21,025,518
Accumulated deficit		(17,367,700	)		(15,809,928	)
Accumulated other comprehensive income		922			-
Total Stockholders' Equity		77,220,515			5,266,295
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY		83,398,432			11,693,365


See accompanying notes.


RED CAT HOLDINGS
Consolidated Statements Of Operations
(Unaudited)


	Three months ended July 31,
	2021			2020
Revenues	$	1,396,751		$	548,282

Cost of goods sold		1,294,347			446,132

Gross Margin		102,404			102,150

Operating Expenses
Operations		176,863			86,546
Research and development		244,254			87,310
Sales and marketing		100,633			24,136
General and administrative		876,180			180,341
Stock based compensation		384,086			107,061
Total operating expenses		1,782,016			485,394
Operating loss		(1,679,612	)		(383,244	)

Other Income (Expense)
Change in fair value of derivative liability		154,248			-
Interest expense		(17,099	)		-
Other, net		(15,309	)		-
Other Income (Expense)	$	121,840		$	-

Net loss	$	(1,557,772	)	$	(383,244	)

Loss per share - basic and diluted	$	(0.05	)	$	(0.02	)

Weighted average shares outstanding -
basic and diluted		34,074,226			20,011,091


RED CAT HOLDINGS
Consolidated Stockholders' Equity Statements
(Unaudited)

	Series A				Series B						Common Stock				Additional					Accumulated Other
	Preferred Stock				Preferred Stock										Paid-in		Accumulated			Comprehensive		Total
	Shares		Amount		Shares			Amount			Shares		Amount		Capital		Deficit			Income (Loss)		Equity
Balances, April 30, 2020		208,704	$	2,087		3,681,623		$	36,816			20,011,091	$	20,011	$	4,043,837	$	(2,573,753	)		-	$	1,528,998

Stock based compensation																107,061							107,061

Net Loss		-		-		-			-			-		-		-		(383,244	)		-		(383,244	)

Balances, July 31, 2020		208,704	$	2,087		3,681,623		$	36,816			20,011,091	$	20,011	$	4,150,898	$	(2,956,997	)	$	-	$	1,252,815

Balances, April 30, 2021		158,704	$	1,587		1,968,676		$	19,687			29,431,264	$	29,431	$	21,025,518	$	(15,809,928	)	$	-	$	5,266,295

Acquisition of Skypersonic												685,321		685		2,630,955							2,631,640

Public offerings, net of $5,959,800 of issuance costs												17,333,334		17,333		70,022,871							70,040,204

Exercise of warrants												66,666		67		263,073							263,140

Conversion of preferred stock						(982,000	)		(9,820	)		818,333		818		9,002							-

Stock based compensation												62,500		63		384,023							384,086

Shares issued for services												91,667		92		191,908							192,000

Currency translation adjustments																					922		922

Net Loss		-		-		-			-			-		-		-		(1,557,772	)		-		(1,557,772	)

Balances, July 31, 2021		158,704	$	1,587		986,676		$	9,867			48,489,085	$	48,489	$	94,527,350	$	(17,367,700	)	$	922	$	77,220,515


RED CAT HOLDINGS
Consolidated Cash Flows Statements
(Unaudited)


	Three months ended July 31,
	2021			2020
Cash Flows from Operating Activities
Net loss	$	(1,557,772	)	$	(383,244	)
Stock based compensation		384,086			107,061
Common stock issued for services		192,000			-
Amortization of intangible assets		16,326			-
Change in fair value of derivative		(154,248	)		-
Adjustments to reconcile net loss to net cash from operations:
Changes in operating assets and liabilities
Accounts receivable		104,963			-
Inventory		(472,303	)		(54,984	)
Other		(1,996,884	)		3,020
Customer deposits		62,792			38,634
Accounts payable		(130,529	)		46,250
Accrued expenses		(522,395	)		10,441
Net cash used in operating activities		(4,073,964	)		(232,822	)

Cash Flows from Investing Activities
Cash acquired through acquisitions		13,502			-
Net cash provided by investing activities		13,502			-

Cash Flows from Financing Activities
Proceeds from exercise of warrants		99,999			-
Payments under related party obligations		(150,255	)		(480	)
Proceeds from notes payable		-			140,000
Payments under notes payable		(114,173	)		(87,496	)
Proceeds from issuance of common stock, net		70,065,203			-
Net cash provided by financing activities		69,900,774			52,024

Effect of foreign exchange rate changes on cash		922			-

Net increase (decrease) in Cash and cash equivalents		65,841,234			(180,798	)
Cash and cash equivalents, beginning of period		277,347			236,668
Cash and cash equivalents, end of period		66,118,581			55,870

Cash paid for interest		2,024			-
Cash paid for taxes		-			-

Non-cash transactions
Common stock issued for services	$	192,000			-
Fair value of shares issued in acquisitions	$	2,631,640			-
Indirect payment to related party	$	132,200
Conversion of derivative liability	$	163,141			-
Conversion of preferred stock into common stock	$	9,820			-

RED CAT HOLDINGS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

July 31, 2021 and 2020

(unaudited)

Our unaudited interim condensed consolidated financial statements and accompanying notes are prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"). In the opinion of management, the unaudited interim condensed consolidated financial statements reflect all adjustments of a normal recurring nature that are necessary for a fair presentation of the results for the interim periods presented. Interim results are not necessarily indicative of results for a full year. The information included in this Form 10-Q should be read in conjunction with the financial information included in the Annual Report on Form 10-K for the fiscal year ended April 30, 2021 of Red Cat Holdings, Inc. (the "Company"), filed with the Securities and Exchange Commission ("SEC") on August 12, 2021.

Note 1 - The Business

Red Cat Holdings ("Red Cat" or the "Company") was originally incorporated in February 1984. 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. Fat Shark Holdings is a provider of First Person View (FPV) video goggles to the drone industry. Rotor Riot sells FPV drones and equipment, primarily to the consumer marketplace through its digital storefront located at www.rotorriot.com. Skypersonic provides software and hardware solutions that enable drones to complete inspection services in locations where GPS (global positioning systems) are not available, yet still record and transmit data even while being operated from thousands of miles away. Red Cat Propware is developing drone flight data analytics and storage solutions, as well as diagnostic products and services.

Corporate developments during the two years ended July 31, 2021 include:

Organizational

In August 2019, we effected a reverse stock split (the "Reverse Stock Split") of our outstanding shares of common stock at a ratio of one-for-twelve hundred (1 for 1,200). All references in this report to shares of the Company's common stock, including prices per share of its common stock, reflect the Reverse Stock Split.

Merger Agreement with Rotor Riot, LLC

In January 2020, the Company consummated a Merger Agreement under which Rotor Riot Acquisition Corp, a wholly owned subsidiary of the Company, merged with and into Rotor Riot, with Rotor Riot continuing as the surviving entity and a wholly owned subsidiary of the Company. Under the Merger Agreement, each member of Rotor Riot received its pro rata portion of the total number of shares of the Company's common stock issued based on (A)(i) $3,700,000 minus (ii) $915,563 (which included certain debt and other obligations of Rotor Riot and its Chief Executive Officer that the Company agreed to assume (the "Assumed Obligations") divided by (B) the volume weighted average price ("VWAP") of the Company's common stock for the twenty trading days prior to the closing of the Merger. Based on a share issuance value of $2,784,437 and a VWAP of $1.25445, the Company issued an aggregate of 2,219,650 shares of common stock to the members of Rotor Riot.

Following the closing, the Company's management controlled the operating decisions of the combined company. Accordingly, we accounted for the transaction as an acquisition of Rotor Riot by the Company. Based on purchase price accounting, we recognized the assets and liabilities of Rotor Riot at fair value with the excess of the purchase price over the net assets acquired recognized as goodwill. The table below reflects the acquisition date values of the purchase consideration, assets acquired, and liabilities assumed. The shares issued were valued at $1,820,114 (2,219,650 shares issued times $0.82 per share which equaled the closing price of the Company's common stock on the date that the merger agreement was consummated). A summary of the purchase price and its related allocation is as follows:

Purchase Price

Shares issued	$	1,820,114
Promissory note issued		175,000
Total Purchase Price	$	1,995,114

II.

Purchase Price Allocation

*Assets Acquired*
Cash	$	21,623
Accounts receivable		28,500
Other assets		3,853
Inventory		127,411
Trademark		20,000
Brand name		578,000
Customer relationships		39,000
Goodwill		1,756,023
Total assets acquired	$	2,574,410

*Liabilities Assumed*
Accounts payable and accrued expenses	$	171,651
Notes payable		209,799
Due to related party		197,846
Total liabilities assumed		579,296
Net assets acquired	$	1,995,114

The final purchase price allocation was determined by an independent valuation services firm. Customer Relationships with a value of $39,000 are being amortized over 7 years. The carrying value of Brand Name is not being amortized but will be reviewed quarterly and formally evaluated at the end of each fiscal year.

Fat Shark Acquisition

In November 2020, the Company closed a share purchase agreement ("Share Purchase Agreement") with the sole shareholder of Fat Shark Holdings ("Fat Shark"), to acquire all of the issued and outstanding shares of Fat Shark and its subsidiaries. The transaction was valued at $8,354,076 based on (i) the issuance of 5,227,273 shares of common stock with a value of $6,351,076 on the date of closing (ii) a senior secured promissory note in the original principal amount of $1,753,000 which matures on November 1, 2023, and (iii) a cash payment of $250,000. The Share Purchase Agreement includes indemnification provisions, a two year non-compete agreement, and registration rights for the shares issued in the transaction. A summary of the purchase price and its related allocation is as follows:

Purchase Price

Shares issued	$	6,351,076
Promissory note issued		1,753,000
Cash		250,000
Total Purchase Price	$	8,354,076

II.

Purchase Price Allocation

*Assets Acquired*
Cash	$	201,632
Accounts receivable		249,159
Other assets		384,232
Inventory		223,380
Brand name		1,144,000
Proprietary technology		272,000
Non-compete agreement		16,000
Goodwill		6,168,260
Total assets acquired	$	8,658,663

*Liabilities Assumed*
Accounts payable and accrued expenses	$	279,393
Customer deposits		25,194
Total liabilities assumed		304,587
Net assets acquired	$	8,354,076

The final purchase price allocation was determined by an independent valuation services firm. Intangible assets included proprietary technology and non-compete agreement which are being amortized over 5 and 3 years, respectively. The carrying value of Brand Name is not being amortized but will be reviewed quarterly and formally evaluated at the end of each fiscal year.

Skypersonic Acquisition

In February 2021, the Company entered into Share Purchase and Liquidity Event Agreements (the "Skypersonic Agreements") with the founder and majority shareholder of Skypersonic, Inc., ("Skypersonic") and the holders of common stock and equity based agreements representing 97.46% of Skypersonic (the "Sellers"), pursuant to which, subject to the satisfaction of certain closing conditions, the Company would acquire all of the issued and outstanding share capital of Skypersonic for an aggregate of $3,000,000 in shares (the "Share Consideration") of the Company's common stock, based upon the VWAP of the Company's common stock at closing of the transaction (the "Skypersonic Transaction"). Prior to the closing, the Company provided $75,000 to fund operating costs of Skypersonic. This amount was capitalized as part of the purchase price. The transaction closed on May 7, 2021 and was paid through the issuance of 857,124 shares of common stock which had a fair market value of $3,291,356. Fifty (50%) percent of the Share Consideration (the "Escrow Shares") was deposited in an escrow account for a period of twelve (12) months as security for indemnification obligations and any purchase price adjustments due to working capital deficiencies and any other claims or expenses arising under the Skypersonic Agreements. Under the Skypersonic Agreements, closing date working capital deficits in excess of $300,000 shall result in a reduction of the Share Consideration on a dollar of dollar basis. As of July 31, 2021, the Company has completed a preliminary determination of the working capital deficit to be $989,848 which would result in a reduction in the purchase price of $689,848. The Company has reflected the required adjustments in the financial statements as of July 31, 2021 and for the three months then ended, including a 171,801 reduction in the number of shares to be issued. The Company and the Sellers have agreed to finalize the calculation by the end of September 2021. A preliminary summary of the purchase price and its related allocation is as follows:

Purchase Price

Shares issued	$	2,631,640
Cash		75,000
Total Purchase Price	$	2,706,640

II.

Purchase Price Allocation

*Assets Acquired*
Cash	$	13,502
Accounts receivable		51,083
Other assets		12,950
Inventory		50,556
Goodwill		3,633,546
Total assets acquired	$	3,761,637

*Liabilities Assumed*
Accounts payable and accrued expenses	$	1,054,997
Total liabilities assumed		1,054,997
Net assets acquired	$	2,706,640

The foregoing amounts reflect our current estimates of fair value as of the May 7, 2021 acquisition date. The Company expects to recognize fair values associated with the customer relationships acquired, as well as the Skypersonic brand name, but has not yet accumulated sufficient information to assign such values. As additional information becomes known regarding the acquired assets and assumed liabilities, management may make adjustments to the opening balance sheet of the acquired company up to the end of the measurement period, which is a one-year period following the acquisition date. The determination of the fair values of the acquired assets and liabilities assumed (and the related determination of estimated lives of depreciable tangible and intangible assets) requires significant judgement.

Signing of Teal Drones Acquisition

On July 13, 2021, the Company and Teal Acquisition I Corp., ("Acquisition"), a wholly-owned subsidiary, entered into an Agreement and Plan of Merger (the "Agreement") with Teal Drones, Inc. ("Teal"). Under the terms of the Agreement, subject to the satisfaction of certain closing conditions, Acquisition will acquire Teal by merger of Acquisition with and into Teal, with Teal as the surviving corporation (the "Merger"). At the Effective Time of the Merger. all of the issued and outstanding share capital of Teal will be exchanged for an aggregate of Fourteen Million Dollars ($14,000,000) of Company common stock, (the "Common Stock") and Series C Convertible Preferred Stock, (the "Series C Preferred", and together with the Common Stock, the "Share Consideration"). The Company will at closing issue such number of shares equal to the Share Consideration divided by the VWAP of the Company (the "Closing Date VWAP") which shall be equal to the average of the Daily VWAP for the twenty (20) trading days ending on and including the Closing Date. "Daily VWAP" means, for any trading day, the per share volume-weighted average price of the Company's Common Stock as reported by Nasdaq. Fifteen (15%) percent of the Share Consideration (the "Escrow Shares") shall be held in an escrow account for a period of eighteen (18) months as security for indemnification obligations and any purchase price adjustments due to working capital deficiencies and any other claims or expenses arising under the Agreement.

In addition, the Share Consideration may be increased upon the achievement of certain milestones (the "Earn-Out Consideration"). A total of $16 million in Earn Out Consideration will be issued if sales and services of Teal's Golden Eagle drones ("Teal Sales") total $36 million during the 24 month period following the Closing (the "Earn-Out Period"). A total of $10 million in Earn Out Consideration will be issued if Teal Sales total at least $24 million but less than $36 million during the Earn-Out Period. A total of $4 million in Earn Out Consideration will be issued if Teal Sales total at least $18 million but less than $24 million. Additional Share Consideration, if earned, is issuable at the VWAP of the Company within thirty (30) days of the determination that Earn-Out Consideration is payable.

Under the Agreement, the Share Consideration to be paid on the Closing Date shall be reduced by any indebtedness of Teal, including up to $2 million of senior secured debt to be assumed by the Company (the "Assumed Debt") and any working capital deficit, on a dollar of dollar basis. In addition, it is anticipated that $1 million of the Share Consideration payable to the shareholders of Teal in connection with the Merger, has been agreed to be paid to the Assumed Debt holder to secure consent to the Merger and the transactions contemplated thereby.

Note 2 - Summary of Significant Accounting Policies

Basis of Accounting - The financial statements and accompanying notes are prepared in accordance with accounting principles generally accepted in the United States ("GAAP").

Principles of Consolidation - Our condensed consolidated financial statements include the accounts of our operating subsidiaries, Red Cat Propware, Inc., Rotor Riot, Fat Sharking Holdings and Skypersonic. Intercompany transactions and balances have been eliminated.

Use of Estimates - The preparation of financial statements in accordance 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 revenue and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates reflected in these financial statements include those used to (i) determine stock based compensation, (ii) complete purchase price accounting for acquisitions, and (iii) the accounting for derivatives.

Cash and Cash Equivalents - At July 31, 2021, we had cash of $66,118,581 in multiple commercial banks and financial services companies. We have not experienced any loss on these accounts and believe they are not exposed to any significant credit risk.

Accounts Receivable, net - Accounts receivable are recorded at the invoiced amount less allowances for doubtful accounts. The Company's estimate of the allowance for doubtful accounts is based on a percentage of sales. Accounts receivable balances are written off against the allowance when it is probable that the receivable will not be collected.

Inventory - Inventory is stated at the lower of cost or estimated net realizable value with cost determined under the first-in first-out method.

Goodwill - Goodwill represents the excess of the purchase price of an acquisition over the estimated fair value of identifiable net assets acquired. The measurement periods for the valuation of assets acquired and liabilities assumed ends as soon as information on the facts and circumstances that existed as of the acquisition date becomes known, not to exceed 12 months. Adjustments in a purchase price allocation may require a change in the amounts allocated to goodwill during the periods in which the adjustments are determined.

We perform an impairment test at the end of each fiscal year, or more frequently if indications of impairment arise. We have a single reporting unit, and consequently, evaluate goodwill for impairment based on an evaluation of the fair value of the Company as a whole.

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 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 levels of the fair value hierarchy are described below:

•

Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access.

•

Level 2 inputs utilize other than quoted prices included in Level 1 that are observable for the asset, either directly or indirectly, for substantially the full term of the asset. Level 2 inputs include quoted prices for similar assets in active markets, quoted prices for identical or similar assets in markets that are not active and inputs other than quoted prices that are observable in the marketplace for the asset. The observable inputs are used in valuation models to calculate the fair value for the asset.

•

Level 3 inputs are unobservable but are significant to the fair value measurement for the asset, and include situations where there is little, if any, market activity for the asset. These inputs reflect management's own assumptions about the assumptions a market participant would use in pricing the asset.

A review of fair value hierarchy classifications is conducted on a quarterly basis. Changes in the observability of valuation inputs may result in a reclassification of levels for certain securities within the fair value hierarchy.

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

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

Convertible Securities and Derivatives

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

Derivative Liabilities

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

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

Revenue Recognition - The Company recognizes revenue in accordance with ASC 606, "Revenue from Contracts with Customers", issued by the Financial Accounting Standards Board ("FASB"). This standard includes a comprehensive evaluation of factors to be considered regarding revenue recognition including (i) identifying the promised goods, (ii) evaluating performance obligations, (iii) measuring the transaction price, (iv) allocating the transaction price to the performance obligations if there are multiple components, and (v) recognizing revenue as each obligation is satisfied. The Company's revenue transactions include a single component, specifically, the shipment of goods to customers as orders are fulfilled. Customers pay at the time they order and the Company recognizes revenue upon shipment. The timing of the shipment of orders can vary considerably depending upon whether an order is for an item normally maintained in inventory or an order that requires assembly or unique parts. Customer deposits totaled $108,888 and $46,096 at July 31, 2021 and April 30, 2021, respectively.

Research and Development - Research and development expenses include payroll, employee benefits, and other headcount-related expenses associated with product development. Research and development expenses also include third-party development and programming costs, as well as a proportionate share of overhead costs such as rent. Costs related to software development are included in research and development expense until technological feasibility is reached, which for our software products, is generally shortly before the products are released to production. Once technological feasibility is reached, such costs are capitalized and amortized as a cost of revenue over the estimated lives of the products.

Income Taxes - Deferred taxes are provided on the liability method, whereby deferred tax assets are recognized for deductible temporary differences and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.

Recent Accounting Pronouncements - Management does not believe that recently issued, but not yet effective accounting pronouncements, if adopted, would have a material effect on the accompanying condensed consolidated financial statements.

Comprehensive Loss -During the three months ended July 31, 2021, differences between net loss and comprehensive loss totaled $922 relating to foreign currency translation adjustments. During the three months ended July 31, 2020, there were no differences between net loss and comprehensive loss.

Stock-Based Compensation - We use the estimated grant-date fair value method of accounting in accordance with ASC Topic 718, Compensation - Stock Compensation. Fair value is determined using the Black-Scholes Model using inputs reflecting our estimates of expected volatility, term and future dividends. We recognize forfeitures as they occur. We recognize compensation costs on a straight line basis over the service period which is generally the vesting term.

Basic and Diluted Net Loss per Share - Basic and diluted net loss per share has been calculated by dividing net loss by the weighted average number of shares of common stock outstanding during the period. Common stock equivalents were excluded from the computation of diluted net loss per share of common stock because they were anti-dilutive. The exercise of these common stock equivalents would dilute earnings per share if we become profitable in the future.

Related Parties - Parties are considered to be related to us if they have control or significant influence, directly or indirectly, over us, including key management personnel and members of the Board of Directors. Related Party transactions are disclosed in Note 13.

Note 3 - Other Current Assets

Other current assets as of July 31, 2021 and April 30, 2021 included:

	July 2021		April 2021
Prepaid inventory	$	1,998,537	$	478,939
Prepaid insurance		420,546		-
Prepaid expenses		18,023		115,587
Security deposits		19,426		9,372
Due from related party		-		75,000
Total	$	2,456,532	$	678,898

Note 4 - Notes Payable

PayPal

PayPal is an electronic commerce company that facilitates payments between parties through online funds transfers. The Company processes certain customer payments ordered on its e-commerce site through PayPal. The Company has entered into multiple agreements under which PayPal provides an advance on customer payments, and then retains a portion of customer payments until the advance is repaid. PayPal charges a fee which the Company recognizes in full upon entering an agreement. A November 2019 agreement under which PayPal advanced $100,000 and charged a transaction fee of $6,900 was completed in January 2021. A January 2021 agreement under which PayPal advanced $75,444 and charged a transaction fee of $2,444 had a remaining balance of $569 at July 31, 2021.

Shopify Capital

Shopify Capital is an affiliate of Shopify, Inc. which provides sales software and services to the Company. The Company processes customer transactions ordered on the e-commerce site for Rotor Riot through Shopify. Shopify Capital has entered into multiple agreements with the Company in which it has "purchased receivables" at a discount. Shopify retains a portion of the Company's daily receipts until the purchased receivables have been paid. The Company recognizes the discount as a transaction fee, in full, in the month in which the agreement is executed. The Company assumed an existing agreement when it acquired Rotor Riot in January 2020. This agreement was repaid in May 2020. Since then, the Company has entered into the following agreements with Shopify:

Date of Transaction	Purchased Receivables	Payment to Company	Transaction Fees	Withholding Rate	Balance at July 31, 2021
May 2020	$158,200	$140,000	$18,200	17%	Completed - October 2020
September 2020	$209,050	$185,000	$24,050	17%	Completed - May 2021
April 2021	$236,500	$215,000	$21,500	17%	$154,303

Note 5 - Due to Related Party

Short Term

Note Payable to BRIT, LLC

BRIT, LLC, formally known as Brains Riding in Tanks, LLC, was the largest shareholder of Rotor Riot. Following the Merger Agreement, BRIT is a significant shareholder in the Company. The controlling shareholder of BRIT is now employed with the Company. Under the terms of the Merger Agreement, the Company issued a promissory note to BRIT, LLC in the principal amount of $175,000. The promissory note bears interest at 4.75% annually. The balance outstanding, including accrued interest, totaled $103,992 and $159,679 at July 31, 2021 and April 30, 2021, respectively. The Company is making monthly payments of $3,500.

II.

Obligations of BRIT, LLC

BRIT incurred certain financial obligations in support of the operations of Rotor Riot which the Company assumed responsibility to pay at the effective time of the Merger. These obligations bear interest at annual rates ranging from 5.5% to 11.99%. The outstanding balance totaled $141,330 and $166,529 at July 31, 2021 and April 30, 2021, respectively.

III.

Payable to Aerocarve

In 2020, the Company received advances totaling $79,000 from Aerocarve, which is controlled by the Company's Chief Executive Officer. The parties agreed that the funds would bear interest at 5% annually until repaid. The balance owed at April 30, 2021 was $74,000. The balance was repaid in full in May 2021.

Note Payable to Related Party

In connection with the acquisition of Fat Shark in November 2020, the Company issued a secured promissory note in the amount of $1,753,000 to the seller who is now an employee. The note bears interest at 3% annually and matures in full in November 2023. In May 2021, we directed a refund of $132,200 related to prepaid inventory in China to the seller who is also based in China, resulting in a balance outstanding of $1,620,800 at July 31, 2021. Accrued interest totaled $39,046 and $25,791 at July 31, 2021 and April 30, 2021, respectively.

Note 6 - Convertible Notes

In November 2019, the Company issued a convertible note in the principal amount of $300,000 to one accredited investor and in December 2019, the Company issued a convertible note in the principal amount of $125,000 to a director and a convertible note in the principal amount of $25,000 to our chief executive officer (collectively, the "2019 Notes"). The Notes had a term of 2 years and accrued interest at an annual rate of 12% through the date of conversion. In September and October 2020, the entire $450,000 of 2019 Notes, plus accrued interest totaling $45,204, was converted into 710,444 shares of common stock.

October 2020 Financing

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

The Company determined that the provision associated with a potential reduction in the conversion price of the notes and the exercise price of the warrant represented an embedded derivative financial liability. The derivative liability was initially valued at $728,587, of which $580,000 was applied as a debt discount to reduce the initial carrying value of the notes to zero with the remaining $20,000 applied against transaction fees. The derivative liability was valued using a multinomial lattice model with $460,588 and $267,999 related to the derivate features of the notes and warrants, respectively.

As of July 31, 2021, (a) the entire $600,000 of 2020 Notes have been converted into common stock and the related derivative liability eliminated, and (b) 266,666 of the warrants were outstanding with a derivative liability of $822,936.

January 2021 Financing

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

The Company determined that the provision associated with a potential reduction in the conversion price of the notes and the exercise price of the warrant represented an embedded derivative financial liability. The derivative liability was initially valued at $4,981,701, of which $500,000 was applied as a debt discount to reduce the initial carrying value of the notes to zero. The derivative liability was valued using a multinomial lattice model with $2,111,035 and $2,870,666 related to the derivate features of the notes and warrants, respectively.

As of July 31, 2021, (a) the entire $500,000 of 2021 Notes have been converted into common stock and the related derivative liability eliminated, and (b) 540,000 of the warrants were outstanding with a derivative liability of $1,672,442.

Note 7 - Income Taxes

Our operating subsidiary, Red Cat Propware, Inc., is incorporated and based in Puerto Rico which is a commonwealth of the United States. We are not subject to taxation by the United States as Puerto Rico has its own taxing authority which passed the Export Services Act, also known as Act 20, in 2012. Under Act 20, eligible businesses are subject to a special corporate tax rate of 4%. Since inception, we have incurred net losses in each year of operations. Our current provision for the reporting periods presented in these financial statements consisted of a tax benefit against which we applied a full valuation allowance, resulting in no current provision for income taxes. In addition, there was no deferred provision for any of these reporting periods.

At July 31, 2021 and April 30, 2021, we had accumulated deficits of approximately $17,400,000 and $15,800,000, respectively. Deferred tax assets related to the future benefit of these net operating losses for tax purposes totaled approximately $696,000 and $632,000, respectively, based on the Act 20 rate of 4%. Currently, we focus on projected future taxable income in evaluating whether it is more likely than not that these deferred assets will be realized. Based on the fact that we have not generated an operating profit since inception, we have applied a full valuation allowance against our deferred tax assets at July 31, 2021 and April 30, 2021.

Note 8 - Common Stock

Our common stock has a par value of $0.001 per share. We are authorized to issue 500,000,000 shares of common stock. Each share of common stock is entitled to one vote.

On May 4, 2021, the Company closed an offering of 4 million shares of common stock which generated gross proceeds of $16 million and net proceeds of approximately $14.6 million.

On May 4, 2021, the Company issued 50,000 shares of common stock for investor relations services rendered.

On July 21, 2021, the Company closed an offering of 13,333,334 shares of common stock which generated gross proceeds of $60 million and net proceeds of approximately $55.5 million.

During the three months ended July 31, 2021, 62,500 shares of common stock were issued under the terms of a restricted stock agreement with an officer.

Note 9 - Preferred Stock

Series A Preferred Stock ("Series A Stock") is convertible to common stock at a ratio of 8.33 shares of common stock for each share of Series A Stock, and votes together with the common stock on an as-if-converted basis. The Series A Stock was automatically converted into shares of common stock upon the effectiveness of our reverse stock split in August 2019, except for 208,704 shares which were subject to a limitation on the number of shares of common stock that can be held by the holder of those shares of Series A Stock. Shares outstanding totaled 158,704 at July 31, 2021, and were converted into 1,321,996 shares of common stock on August 10, 2021.

Series B Preferred Stock ("Series B Stock") is convertible into common stock at a ratio of 0.8334 shares of common stock for each share of Series B Stock held and votes together with the common stock on an as-if-converted basis. Shares outstanding at July 31, 2021 totaled 986,676 which are convertible into 822,230 shares of common stock.

Note 10 - Warrants

In October 2020, the Company issued five-year warrants to purchase a total of 399,998 shares in connection with the issuance of $600,000 of convertible notes. The warrants have an initial exercise price of $1.50 which may be reduced to (i) a 25% discount of the price per share of Common Stock offered in a future qualified offering. The warrants were valued at $267,999 using the multinomial lattice model and are considered derivative liabilities under ASC 815-40.

In January 2021, the Company issued five-year warrants to purchase a total of 675,000 shares in connection with the issuance of $500,000 of convertible notes. The warrants have an initial exercise price of $1.50 which may be reduced to (i) a 25% discount of the price per share of Common Stock offered in a future qualified offering and also include a ratchet provision. The warrants were valued at $2,870,666 using the multinomial lattice model and are considered derivative liabilities under ASC 815-40.

In March and April 2021, we received $201,249 in connection with the exercise of 201,666 warrants which had been issued in October 2020 and January 2021 as part of the convertible note financings described in note 7. Since these exercises resulted in the elimination of the derivative liability in the warrants, the derivative liability was reduced by $694,305 with a corresponding increase in additional paid in capital.

In May 2021, the Company issued warrants to purchase 200,000 shares of common stock to the placement agent of its common stock offering. The warrants have a five year term, an exercise price of $5.00 and were valued at $826,740 using the Black Scholes model.

In June 2021, we received $99,999 in connection with the exercise of 66,666 warrants which had been issued in October 2020 as part of the convertible note financings described in Note 6. Since these exercises resulted in the elimination of the derivative liability in the warrants, the derivative liability was reduced by $163,141 with a corresponding increase in additional paid in capital.

In July 2021, the Company issued warrants to purchase 533,333 shares of common stock to the placement agent of its common stock offering. The warrants have a five year term, an exercise price of $5.625 and were valued at $2,154,423 using the Black Scholes model.

The following table presents the assumptions used to estimate the fair values of the stock warrants granted during the three months ended July 31, 2021:

	July 31, 2021
Expected volatility		211 - 223	%
Expected dividends		0	%
Expected term (years)		4.17 - 5.00
Risk-free interest rate		0.52 - 0.85	%

The following table summarizes the changes in warrants outstanding since April 30, 2020.

	Number of Shares		Weighted-average Exercise Price per Share		Weighted-average Remaining Contractual Term (in years)		Aggregate Intrinsic Value
Balance as of April 30, 2020	-			-		-		-
Granted	1,074,998		$	1.50
Exercised	(201,666	)		1.50
Outstanding as of April 30, 2021

SEC Form 10-Q filed by Red Cat Holdings Inc.