NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
January 31, 2020 and 2019
(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 Form 8-K/A filed with the Securities and
Exchange Commission (“SEC”) on July 31, 2019.
Note 1 - The Business
The Company was originally incorporated in
February 1984.
Following the acquisition of Rotor Riot, we remain focused on providing products and solutions to the drone industry.
We believe that Rotor Riot’s visibility and presence in the drone marketplace will foster growth in sales through its e*commerce
platform and provide an initial target base of customers for the launch of “Dronebox”. We are targeting the second
half of 2020 for the release of Dronebox although no assurances can be provided regarding the actual release date. Dronebox is
being designed to provide distributed data storage, analytics and related services to the drone industry. The Company plans to
utilize blockchain based technologies and offer its solutions as a Software-as-a-Service platform. Potential customers include
regulators to track and review flight data, insurance companies for coverage and claims administration, and pilots to maintain
compliance with regulations.
In July 2019, we changed our name from TimeFire
VR Inc. to Red Cat Holdings, Inc.
In August 2019, we changed our fiscal year
to April 30 which was the historical fiscal year of Red Cat.
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 Quarterly Report to shares of the Company’s common stock, including prices per share
of its common stock, reflect the Reverse Stock Split.
In January 2020, we consummated a merger
agreement with Rotor Riot, LLC (“Rotor Riot”), a seller of commercial products in the drone marketplace, primarily
focused on FPV (“first person view”). Rotor Riot primarily sells its products through an e*commerce site located at
www.rotorriot.com.
Recent corporate developments include:
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A.
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The Share Exchange Agreement
|
Effective May 15, 2019, we closed a Share Exchange
Agreement (the “SEA”) with TimeFireVR, Inc., (“TimeFire”), a Nevada corporation. Under the SEA, we acquired
approximately 83.33% of TimeFire’s outstanding share capital on a fully-diluted basis. We issued: (i) 196,667 shares of our
common stock, (ii) 2,169,068 shares of our newly-designated Series A Preferred Stock, and (iii) 4,212,645 shares of our newly-designated
Series B Preferred Stock.
Our Series A Preferred Stock is convertible
to common stock at a ratio of 8.33 shares of common stock for each share of preferred stock held, and votes together with the common
stock on an as-converted basis. The new Series A Preferred Stock converted automatically to common stock upon the effectiveness
of the reverse split of our common stock in August 2019. This common stock and Series A Preferred Stock issued under the SEA constituted
approximately 83.33% of our issued and outstanding share capital on a fully-diluted basis on the date of issuance.
Our Series B Preferred Stock is convertible
to common stock at a ratio of 0.83 shares of common stock for each share of preferred stock held, and votes together with the common
stock on an as-converted basis. This Series B Preferred Stock issued under the SEA constituted approximately 15.64% of our issued
and outstanding share capital on a fully-diluted basis on the date of issuance.
In total, the common stock, Series A Preferred
Stock, and Series B Preferred Stock issued under the SEA were valued at $117,754.
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B.
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Red Cat Propware, Inc.
|
On May 15, 2019, we acquired TimeFireVR, Inc.,
in a $117,754 stock transaction classified as a reverse-merger transaction. The acquisition will provide access to the public markets
and support the development of our product platform. In this reverse merger, the financial results of Red Cat Propware, Inc., (the
accounting acquirer), have been presented as the continuing operations of the Company since inception. The transaction was accounted
for as follows:
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Cash
|
|
|
$
|
24,704
|
|
|
Goodwill
|
|
|
|
93,050
|
|
|
Total
|
|
|
$
|
117,754
|
|
The
goodwill recognized in connection with the acquisition is primarily attributable to anticipated synergies and benefits from the
combination of the two companies, including access to the public markets to raise capital, and is expected to be deductible for
tax purposes.
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C.
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Merger
Agreement with Rotor Riot, LLC
|
On
December 31, 2019, the Company entered into an Agreement of Merger (the “Merger Agreement”) with Rotor Riot and the
three members of Rotor Riot. On January 23, 2020, the Merger was consummated under which Rotor Riot Acquisition Corp, a
wholly owned Delaware subsidiary of the Company, merged with and into Rotor Riot, with Rotor Riot continuing as the surviving
entity and a wholly owned subsidiary of Red Cat Holdings.
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 of the Merger Agreement,
the former members of Rotor Riot owned approximately 10.4% of the Company. In addition, management of Red Cat Holdings controls
the operating decisions of the combined company. Accordingly, we have accounted for the transaction as an acquisition of Rotor
Riot by Red Cat. Based on purchase price accounting, we have 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 Company’s
estimates of the acquisition date values of the purchase consideration, assets acquired, and liabilities assumed. The shares issued
were valued at $1,820,113 (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).
Shares issued
|
|
$
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1,820,114
|
|
Promissory note issued
|
|
$
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175,000
|
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Total Purchase Price
|
|
$
|
1,995,114
|
|
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II.
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Purchase
Price Allocation
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Assets Acquired
|
|
|
Cash
|
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$
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21,623
|
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Accounts receivable
|
|
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28,500
|
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Other assets
|
|
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3,853
|
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Inventory
|
|
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127,411
|
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Trademark
|
|
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20,000
|
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Goodwill
|
|
|
2,375,852
|
|
Total assets acquired
|
|
|
2,577,239
|
|
|
|
|
|
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Liabilities Assumed
|
|
|
|
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Accounts Payable and accrued expenses
|
|
$
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171,651
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Notes payable
|
|
$
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216,099
|
|
Due to Related Party
|
|
$
|
194,375
|
|
Total liabilities assumed
|
|
$
|
582,125
|
|
Net assets acquired
|
|
$
|
1,995,114
|
|
The foregoing amounts reflect our preliminary
estimates of fair value as of the January 23, 2020 acquisition date. The Company expects to recognize fair values associated with
the customer relationships acquired, as well as the Rotor Riot 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.
Note 2 - Going Concern
The financial statements have been prepared
on a going concern basis which contemplates the realization of assets and the settlement of liabilities and commitments in the
normal course of business. As reflected in our accompanying financial statements, we have generated less than $50,000 in revenues since our inception
and have accumulated losses totaling approximately $2 million through January 31, 2020. Management recognizes that these operating
results and our financial position raise substantial doubt about our ability to continue as a going concern. The financial statements
do not include any adjustments related to the recoverability and classification of recorded asset amounts and the classification
of liabilities that might be necessary should we be unable to continue as a going concern.
We are presently seeking to address these
going concern doubts through a number of actions including efforts to (a) raise capital through the public markets, (b) release
additional commercial products and (c) pursue acquisitions of complementary, revenue generating companies which are accretive to
our operating results. We can provide no assurance that any of these efforts will be successful or, that even if successful, that
they will alleviate doubts about our ability to continue as a going concern.
Note 3 - Summary of Significant Accounting
Policies
Basis of Accounting - The financial
statements and accompanying notes are prepared in accordance with GAAP.
Principles of Consolidation –
Our condensed consolidated financial statements include the accounts of our subsidiaries, Red Cat Propware, Inc. and Rotor
Riot, LLC. 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 and
(ii) complete purchase price accounting for acquisitions.
Cash – At January 31, 2020,
we held cash of $442,863 with three commercial banks. We have not experienced any loss on these accounts and believe they are not
exposed to any significant credit risk.
Leases –
Leases at January 31, 2020 are short term in nature and do not require accounting under the lease accounting standards.
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 plan to 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.
Common Stock – Our common
stock has a par value of $0.001 per share.
Warrants – In connection
with our Series B Preferred Stock Issuance, we issued warrants to purchase shares of our common stock. Outstanding warrants are
standalone instruments that are not puttable or mandatorily redeemable by the holder and are classified as equity. We measured
the fair value of the warrants using the Black-Scholes option pricing model.
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 received.
Customers pay at the time they order and the Company recognizes revenue upon shipment which occurs quickly after the order is
received.
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 and nine months ended January 31, 2020 and 2019, there were no differences between net loss and comprehensive loss. Therefore,
the consolidated statements of comprehensive loss have been omitted.
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 plan to estimate the forfeiture rate based on our historical experience but have made no such allowance to date as
our first issuances of stock based awards occurred during the three months ended October 31, 2019. 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 12.
Note
4 – Notes Payable
In
connection with the merger agreement with Rotor Riot, the Company agreed to assume certain financial obligations of Rotor Riot
totaling $216,099 in the aggregate. A summary of these obligations is as follows:
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A.
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Note
Payable to PayPal
|
In
November 2019, Rotor Riot entered into an agreement with PayPal under which it borrowed $100,000. 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 note is being repaid through 52 weekly payments of $2,056 ending in November
2020, resulting in an effective interest rate of 16%. The balance outstanding at January 31, 2020 was $88,398.
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B.
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Note
Payable to Shopify Capital
|
In
August 2019, Rotor Riot entered into an agreement with Shopify Capital under which it sold $176,000 of “Purchased Receivables”
for total consideration of $160,000. Shopify Capital is an affiliate of Shopify, Inc. which provides sales software and services
to the Company. The Company processes customer transactions ordered on its e-commerce site through Shopify which will retain 14%
of daily receipts until a total of $176,000 is retained. The balance outstanding at January 31, 2020 was $64,487.
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C.
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Note Payable to Race Day Quads
|
During 2019, Rotor Riot purchased inventory
from Race Day Quads (“RDQ”), an online retailer of drone racing parts. The owner of Race Day Quads acquired
a Membership Interest in Rotor Riot in March 2019. In October 2019, RDQ agreed to allow Rotor Riot to pay for $82,141 of inventory
purchases on an installment basis through June 2020. The balance outstanding at January 31, 2020 was $58,724.
Note 5 – Due to Related Party
BRIT, LLC, formally known as Brains Riding
in Tanks, LLC, was the largest shareholder of Rotor Riot. Following the Merger, BRIT is a significant shareholder in the Company.
The controlling shareholder of BRIT is now employed in a management role with the Company.
|
A.
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Note Payable to BRIT, LLC
|
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 and requires $3,500 of the principal amount to be paid monthly. The outstanding principal amount
and all accrued interest is due on the earlier of (a) January 23, 2021 or (b) the closing of an equity offering by the
Company of at least $3,500,000. The balance outstanding at January 31, 2020 totaled $175,182, reflecting the addition of
accrued interest from the date of issuance through January 31, 2020.
|
B.
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Obligations of BRIT, LLC
|
BRIT incurred certain financial obligations
in support of the operations of Rotor Riot which the Company has agreed to assume responsibility to pay. The total amount assumed
was $167,939 which equals the balance outstanding at January 31, 2020. These obligations bear interest at annual rates ranging
from 7.5% to 21.74%.
Note 6 – Convertible Debentures
In November 2019 we issued a convertible note
in the principal amount of $300,000 to one accredited investor and in December 2019 we 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 “Notes”). The Notes have a term of 2 years and bear interest at a rate of 12% which accrues and is payable in
full when the Notes mature. Interest on the Notes may be paid in cash or in shares of common stock of the Company at the Conversion
Price (as defined below).The Notes are convertible into shares of common stock at the holder’s sole discretion as follows:
(A) prior to consummating an equity financing which generates gross proceeds of not less than $3,000,000 (a “Qualified Offering”),
then at the 30 day volume weighted average of the closing price of a share of our common stock as listed or quoted on the market
in which the shares are then traded or listed, or (B) after we have consummated a Qualified Offering, at 40% of the price per
share of common stock sold in the Qualified Offering (the “Conversion Price”) . We may, upon 10 business days advance
notice, elect to pre-pay the Note, including all accrued interest, in whole or in part, provided that any such prepayment prior
to the one-year anniversary of the Note issuance shall be at a price equal to 112% of the then outstanding original principal
amount. Upon an event of default, as described in the Notes, the outstanding principal and interest shall become immediately due
and payable. Additionally, under the Note, unless waived by the holder, the holder shall not be entitled to convert the Note if
such conversion would result in beneficial ownership by the holder and its affiliates of more than 9.99% of the outstanding shares
of common stock of the Company on such date. Based on the Company’s results since inception, both on an operating and capital
raising basis, we believe that it is more likely than not that the Company will not be able to complete an equity financing of
at least $3,000,000 during the term of the Notes. In addition, we do not believe that the Company will be able to pre-pay the
Notes prior to the one year anniversary of their issuance. Based on these conclusions, the Company
has not recognized a beneficial conversion feature or a derivative liability in connection with the convertible debentures.
Note 7 - Income Taxes
Our operating subsidiary 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 January 31, 2020 and April 30, 2019,
we had accumulated deficits of approximately $1,948,000 and $972,000, respectively. Deferred tax assets related to the future
benefit of these net operating losses for tax purposes totaled approximately $78,000 and $39,000, 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 January 31, 2020 and April 30, 2019.
Note 8 – Common Stock
We are authorized to issue 500,000,000 shares
of common stock. Each share of common stock is entitled to one vote.
Note 9 – Preferred Stock
Our 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-converted basis. The Series A Preferred Stock was originally issued under the Securities
Exchange Agreement, as further described in Note 1. 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.
Our 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-converted basis. The Series B Preferred Stock was originally issued under
the Exchange Agreement, as further described in Note 1. Conversions of Series B Stock into Common Stock are as follows:
Date
|
|
Series B
|
|
Common Stock
|
July 2019
|
|
240,000
|
|
200,000
|
November 2019
|
|
60,000
|
|
50,000
|
December 2019
|
|
231,022
|
|
192,519
|
Note 10 - Warrants
In May 2019, as part of the Share Exchange
Agreement, we issued warrants to purchase 469,874 shares of common stock at an exercise price of $0.324 per share of common stock.
The value of these warrants was considered to be a nominal amount at the time of issuance. In September 2019, we received $152,239
in connection with the exercise of these warrants. We also assumed a fully vested, restricted stock unit agreement requiring the
issuance of 41,667 shares of common stock in May 2021, as well as a warrant to purchase 5,556 shares of common stock at an exercise
price of $60.00 per share. This warrant expires in March 2021.
Note 11 – Share Based Awards
Effective August 2019, shareholders approved
the 2019 Equity Incentive Plan (the “Plan”) which allows us to incentivize key employees, consultants, and directors
with long term compensation awards such as stock options, restricted stock, and restricted stock units (collectively, the “Awards”).
The number of shares issuable in connection with Awards under the Plan may not exceed 8,750,000.
|
A.
|
October 2019 Issuances
|
In October 2019, we issued options to purchase
350,000 shares of common stock valued at $477,500. Options to purchase 200,000 shares vest ratably over a 2 year period and expire
in October 2029. Options to purchase 150,000 shares vest ratably over a 3 year period and expire in October 2024. All of the options
were issued at an exercise price of $2.10 which equaled the stock price on the date of issuance. We used the Black-Scholes Model
to estimate the fair value of the stock options issued using the following assumptions: (i) expected volatility – 75%, (ii)
risk free interest rate – 1.59% or 1.74%, (iii) expected life – 5 or 10 years, and (iv) expected dividend yield of
0%.
|
B.
|
January 2020 Issuances
|
In January 2020, we issued options to purchase
1,100,000 shares of common stock exercisable at $0.82 vesting quarterly over a 3 year period. These options were valued at $707,300.
We also issued options to purchase 147,475 shares of common stock exercisable at $0.82. These options were valued at $94,826 and
were vested in full upon issuance. All of these options were issued at an exercise price which equaled the stock price on the date
of issuance. We used the Black-Scholes Model to estimate the fair value of the stock options issued using the following assumptions:
(i) expected volatility – 75%, (ii) risk free interest rate – 1.74%, (iii) expected life – 10 years, and (iv)
expected dividend yield of zero.
|
C.
|
Summary for three and nine months ended January 31, 2020
|
Compensation expense recognized in the three
months ended January 31, 2020 was $149,462, of which $105,976 was included in general and administrative expenses and $43,486 was
included in research and development expenses. Compensation expense recognized in the nine months ended January 31, 2020 was $161,529,
of which $114,791 was included in general and administrative expenses and $46,738 was included in research and development expenses.
There was no compensation expense recognized in the nine months ended January 31, 2019.
Options exercisable as of January 31, 2020
totaled $147,475. The remaining weighted average contractual term of the options outstanding at October 31, 2019 was 9.47 years.
The aggregate intrinsic value of outstanding options, representing the excess of the stock price at January 31, 2020 of $1.74
over the exercise price of each option, was $1,147,677 at January 31, 2020.
Note 12 - Related-Party Transactions
Shares Issued for
Services – In May 2019, we issued 1,570 shares of common stock valued at $70,000 to a shareholder for legal services
provided to us.
Office Lease – We rented
space from our Chief Executive Officer during the fiscal year ended April 30, 2019 and made payments totaling $8,100.
Convertible Note Financing –
In December 2019, we completed a convertible note financing with a member of the Board of Directors for $125,000 and with our
Chief Executive Officer for $25,000. See Note 6 for details on the terms of the transaction.
Note 13 - Commitments and Contingencies
Office Lease – In December
2018, we entered into a one year lease arrangement for office space in San Juan, Puerto Rico, for $26,638 annually. There are no
renewal terms.
Note 14 - Subsequent Events
Subsequent
events have been evaluated through the date of this filing and there are no subsequent events which require disclosure.