Red Cat Holdings, Inc. annual report, FY2018

Filing identity and reporting period

Important entity mismatch: The supplied filing is TimefireVR Inc.’s Form 10-K for the fiscal year ended December 31, 2018, filed April 1, 2019. It is not a Red Cat Holdings, Inc. filing. It reports annual results, not standalone 2018 Q4 results.

Business context

TimefireVR sold its virtual-reality subsidiary, Timefire LLC (TLLC), on January 3, 2018, and shifted to cryptocurrency mining. The mining business generated limited revenue and was unprofitable; the company sold approximately 80% of its mining capacity late in 2018 to raise cash and reduce losses. The filing says its remaining miners continued operating through a co-location provider.

Financial performance and position

• 2018 other expense was $1,233,030, including a $522,917 equipment-disposal loss, $500,182 interest expense, a $100,000 allowance against the TLLC note receivable, and cryptocurrency and mining-equipment impairment/disposition losses. 2017 results included a $4,193,081 noncash gain from changes in derivative fair value.
• At December 31, 2018, cash was $5,787, cryptocurrencies were $32,925, total current assets were $170,711, and total current liabilities were $2,690,481. Total liabilities were $2,769,569, against total assets of $262,387.
• Convertible notes payable, net, were $1,966,571 at year-end; accrued interest was $494,956. Management later reported approximately $2.7 million of indebtedness due April 15, 2019, plus a smaller note in default.
• Management reported approximately $30,000 in cash and Bitcoin as of March 29, 2019 and said it could not pay its obligations when due. The filing states substantial doubt exists about the company’s ability to continue as a going concern. The auditor’s opinion was unqualified and also highlighted the going-concern uncertainty.

Material changes versus 2017

• Revenue began in 2018 from cryptocurrency mining, but cost of revenue exceeded revenue by $246,714.
• Operating expenses rose by about $742,000, including increased officer compensation and costs associated with mining.
• Net results swung from 2017 income to a 2018 loss; the comparison is affected by the large 2017 noncash derivative gain and the 2018 TLLC-sale gain.
• Cash fell from $558,732 at December 31, 2017 to $5,787 at December 31, 2018. Operating cash use improved year over year, but investing outflows and inadequate financing left very little cash.
• The company issued substantial equity and convertible securities. Common shares outstanding increased from 47,269,804 at year-end 2017 to 235,460,470 at year-end 2018. Series E preferred stock outstanding could convert into 122,190,000 common shares; the filing also reports 49,887,720 warrants outstanding at year-end.

Outlook, risks and unusual items

• Liquidity and survival: The company said it had no working capital and no financing commitment, and would likely cease operations if it could not complete a transaction and obtain financing.
• Proposed acquisition: Management described only an oral understanding to acquire a Puerto Rico-based drone and blockchain company; no written term sheet or definitive agreement existed as of the filing. Completion and financing were uncertain. Under the contemplated terms, target owners would hold approximately 83.3% of the company on a fully diluted basis, and the company would need to address existing debt and payables.
• Mining economics: Cryptocurrency price declines, mining competition, equipment and electricity costs, and limited operating expertise constrain the business. The filing says the mining business was not feasible for a public company with the company’s overhead at then-current market prices.
• Debt and dilution: Several notes carried elevated maturity repayment terms, conversion rights, security interests, or were in default. Further conversions, warrants, and financings could materially dilute existing shareholders.
• TLLC sale: The sale generated a reported gain of $670,428, including liabilities assumed by the buyers. The $120,000 secured note was in default; after a $20,000 partial payment, the company reserved the remaining $100,000 as likely uncollectible. The buyers included former owners and former company officers/directors; shareholders ratified the sale in November 2018.
• Controls and governance: Management concluded internal control over financial reporting was ineffective and disclosed three material weaknesses: lack of a functioning audit committee and sufficient independent oversight, inadequate segregation of duties, and ineffective period-end financial reporting controls. The company said it had not devoted material resources to remediation.
• Other risks: The filing highlights evolving cryptocurrency regulation, potential licensing or investment-company requirements, security and custody risks, cryptocurrency price volatility, and the possibility of losing access to cryptocurrency. No quantitative financial guidance was provided.

Important facts for investors to verify

1. Confirm the issuer: this document identifies TimefireVR Inc., not Red Cat Holdings, Inc.
2. Verify current cash, cryptocurrency holdings, debt balances, defaults, maturity obligations, and any financing or restructuring since the filing.
3. Check whether the proposed acquisition was documented, financed, approved, or completed, and review its final ownership and dilution terms.
4. Reconcile the mining-equipment sale disclosures: the filing describes equipment sold for $150,000, while the cash-flow statement reports $50,000 of proceeds from equipment sales.
5. Review the collectability and status of the TLLC note, the effectiveness of any collateral, and the related-party sale disclosures.
6. Assess the fully diluted share count, Series E conversion terms, outstanding warrants, and subsequent issuances.
7. Review subsequent control-remediation disclosures and whether the going-concern uncertainty was resolved.