UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 20-F
☐ REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR 12(g) OF THE SECURITIES EXCHANGE ACT OF 1934
OR
☒ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended September 30, 2023
OR
☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____________________ to ____________________
OR
☐ SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission file number: 001-39389
KWESST Micro Systems Inc.
(Exact name of Registrant as specified in its charter)
British Columbia
(Jurisdiction of incorporation or organization)
155 Terence Matthews Crescent, Unit #1, Ottawa, Ontario, Canada, K2M 2A8
(Address of principal executive offices)
Kris Denis, (613) 250-9752, denis@kwesst.com
155 Terence Matthews Crescent, Unit #1, Ottawa, Ontario, Canada, K2M 2A8
(Name, Telephone, E-Mail and/or Facsimile number and Address of Company Contact Person)
Securities registered or to be registered pursuant to Section 12(b) of the Act:
| Title of each class | Trading Symbol | Name of each exchange on which registered |
| Common Shares, no par value | KWE | Nasdaq Capital Market |
| Warrants | KWESW | Nasdaq Capital Market |
Securities registered or to be registered pursuant to Section 12(g) of the Act: N/A
Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act: None
Indicate the number of outstanding shares of each of the issuer's classes of capital or common stock as of the close of the period covered by the annual report: 5,616,782 Common Shares
Indicate by check mark if the Company is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐ No þ
If this report is an annual or transition report, indicate by check mark if the Company is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. Yes ☐ No ☒
Indicate by check mark whether the Company (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 such shorter period that the Company 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 Company 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 Company was required to submit and post such files). Yes ☒ No ☐
Indicate by check mark whether the Company is a large accelerated filer, an accelerated filer, a non-accelerated filer or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
| Large accelerated filer ☐ | Accelerated filer ☐ |
| Non-accelerated filer ☒ | Emerging growth company ☒ |
If an emerging growth company that prepares its financial statements in accordance with U.S. GAAP, 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 has filed a report on and attestation to its management's assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☐
Indicate by check mark which basis of accounting the Company has used to prepare the financial statements included in this filing:
| U.S. GAAP ☐ | International Financial Reporting Standards as issued By the International Accounting Standards Board ☐ | Other ☐ |
If "Other" has been checked in response to previous question, indicate by check mark which financial statement item the Company has elected to follow. Item 17☐ Item 18☐
If this is an annual report, indicate by check mark whether the Company is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ☐ No ☒
TABLE OF CONTENTS
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INTRODUCTION
In this Annual Report on Form 20-F (the "Annual Report"), "KWESST," "Company," "we," "us" and "our" refer to KWESST Micro Systems Inc. and its consolidated subsidiaries.
Information contained in this Annual Report is given as of September 30, 2023, the fiscal year end of Company, unless otherwise specifically stated.
Market and industry data used throughout this Annual Report was obtained from various publicly available sources. Although the Company believes that these independent sources are generally reliable, the accuracy and completeness of such information are not guaranteed and have not been verified due to limits on the availability and reliability of raw data, the voluntary nature of the data gathering process and the limitations and uncertainty inherent in any statistical survey of market size, conditions and prospects.
Statements made in this Annual Report concerning the contents of any contract, agreement or other document are summaries of such contracts, agreements or documents and are not complete descriptions of all of their terms. If we file any of these documents as an exhibit to this Annual Report, you may read the document itself for a complete description of its terms.
Unless otherwise indicated, all references in this Annual Report to "dollars" or "CAD" or "$" are to Canadian dollars and all references to "USD" or "USD$" are to United States dollars.
The following table sets forth the rate of exchange for the Canadian dollar, expressed in United States dollars in effect at various times.
| Canadian Dollars to U.S. Dollars | Year Ended September 30, 2023 | Year Ended September 30, 2022 | ||
| High for period | 0.7617 | 0.8111 | ||
| Low for period | 0.7217 | 0.7285 | ||
| Average rate for period | 0.7416 | 0.7832 | ||
| Rate at end of period | 0.7396 | 0.7296 |
The daily average exchange rate on January 17, 2024 as reported by the Bank of Canada for the conversion of USD into CAD was USD$1.00 equals CAD$ 1.3522.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Annual Report contains "forward-looking statements" and "forward-looking information" within the meaning of United States and Canadian securities laws (collectively, "forward-looking statements"). Such forward-looking statements include, but are not limited to, information with respect to our objectives and our strategies to achieve these objectives, as well as statements with respect to our beliefs, plans, expectations, anticipations, estimates and intentions. These forward-looking statements may be identified by the use of terms and phrases such as "may", "would", "should", "could", "expect", "intend", "estimate", "anticipate", "plan", "foresee", "believe", or "continue", the negative of these terms and similar terminology, including references to assumptions, although not all forward-looking statements contain these terms and phrases. Forward-looking statements are provided for the purposes of assisting the reader in understanding us, our business, operations, prospects and risks at a point in time in the context of historical and possible future developments and therefore the reader is cautioned that such information may not be appropriate for other purposes.
Forward-looking statements relating to us include, among other things, statements relating to:
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Forward-looking statements are based upon a number of assumptions and are subject to a number of risks and uncertainties, many of which are beyond our control, which could cause actual results to differ materially from those that are disclosed in or implied by such forward-looking statements. These risks and uncertainties include, but are not limited to, the following risk factors:
Although the forward-looking statements contained in this Annual Report are based upon what we believe are reasonable assumptions, investors are cautioned against placing undue reliance on this information since actual results may vary from the forward-looking statements. Certain assumptions were made in preparing the forward-looking statements concerning availability of capital resources, business performance, market conditions and customer demand.
Consequently, all of the forward-looking statements contained herein are qualified by the foregoing cautionary statements, and there can be no guarantee that the results or developments that we anticipate will be realized or, even if substantially realized, that they will have the expected consequences or effects on our business, financial condition or results of operation. Unless otherwise noted or the context otherwise indicates, the forward-looking statements contained herein are provided as of the date hereof, and we do not undertake to update or amend such forward-looking statements whether as a result of new information, future events or otherwise, except as may be required by applicable law.
STATUS AS AN EMERGING GROWTH COMPANY
We are an "emerging growth company" as defined in Section 3(a) of the United States Securities Exchange Act of 1934, as amended (the "Exchange Act") by the Jumpstart Our Business Startups Act of 2012 (the "JOBS Act"), and we may take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not emerging growth companies. We will continue to qualify as an "emerging growth company" until the earliest to occur of: (a) the last day of the fiscal year during which we had total annual gross revenues of USD$1,235,000,000 (as such amount is indexed for inflation every 5 years by the United States Securities and Exchange Commission ("SEC")) or more; (b) the last day of our fiscal year following the fifth anniversary of the date of the first sale of equity securities pursuant to an effective registration statement under the United States Securities Act of 1933, as amended (the "Securities Act"); (c) the date on which we have, during the previous 3-year period, issued more than USD$1,000,000,000 in non-convertible debt; or (d) the date on which we are deemed to be a "large accelerated filer", as defined in Exchange Act Rule 12b-2. We expect to continue to be an emerging growth company for the immediate future.
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Generally, a registrant that registers any class of its securities under Section 12 of the Exchange Act is required to include in the second and all subsequent annual reports filed by it under the Exchange Act a management report on internal control over financial reporting and, subject to an exemption available to registrants that are neither an "accelerated filer" or a "large accelerated filer" (as those terms are defined in Exchange Act Rule 12b-2), an auditor attestation report on management's assessment of internal control over financial reporting. However, for so long as we continue to qualify as an emerging growth company, we will be exempt from the requirement to include an auditor attestation report on management's assessment of internal controls over financial reporting in its annual reports filed under the Exchange Act, even if we were to qualify as an "accelerated filer" or a "large accelerated filer". In addition, Section 103(a)(3) of the Sarbanes-Oxley Act of 2002 (the "SOX") has been amended by the JOBS Act to provide that, among other things, auditors of an emerging growth company are exempt from any rules of the Public Company Accounting Oversight Board requiring a supplement to the auditor's report in which the auditor would be required to provide additional information about the audit and the financial statements of the company.
FOREIGN PRIVATE ISSUER FILINGS
We are considered a "foreign private issuer" pursuant to Rule 405 promulgated under the Securities Act. In our capacity as a foreign private issuer, we are exempt from certain rules under the Exchange Act that impose certain disclosure obligations and procedural requirements for proxy solicitations under Section 14 of the Exchange Act. In addition, our officers, directors and principal shareholders are exempt from the reporting and "short-swing" profit recovery provisions of Section 16 of the Exchange Act and the rules under the Exchange Act with respect to their purchases and sales of our shares. Moreover, we are not required to file periodic reports and financial statements with the SEC as frequently or as promptly as United States companies whose securities are registered under the Exchange Act. In addition, we are not required to comply with Regulation FD, which restricts the selective disclosure of material information. For as long as we are a "foreign private issuer" we intend to file our annual financial statements on Form 20-F and furnish our quarterly financial statements on Form 6-K to the SEC for so long as we are subject to the reporting requirements of Section 13(g) or 15(d) of the Exchange Act. However, the information we file or furnish may not be the same as the information that is required in annual and quarterly reports on Form 10-K or Form 10-Q for United States domestic issuers. Accordingly, there may be less information publicly available concerning us than there is for a company that files as a domestic issuer.
We may take advantage of these exemptions until such time as we are no longer a foreign private issuer. We are required to determine our status as a foreign private issuer on an annual basis at the end of our second fiscal quarter. We would cease to be a foreign private issuer at such time as more than 50% of our outstanding voting securities are held by United States residents and any of the following three circumstances applies: (1) the majority of our executive officers or directors are United States citizens or residents; (2) more than 50% of our assets are located in the United States; or (3) our business is administered principally in the United States. If we lose our "foreign private issuer status" we would be required to comply with Exchange Act reporting and other requirements applicable to United States domestic issuers, which are more detailed and extensive than the requirement for foreign private issuers.
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PART I
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS
Not applicable.
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE
Not applicable.
ITEM 3. KEY INFORMATION
A. Reserved.
B. Capitalization and Indebtedness
Not applicable.
C. Reasons for the Offer and Use of Proceeds
Not applicable.
D. Risk Factors
The Company's operations and financial performance are subject to the normal risks of its industry and are subject to various factors which are beyond the control of the Company. Certain of these risk factors are described below. The risks described below are not the only ones facing the Company. Additional risks not currently known to the Company, or that it currently considers immaterial, may also adversely impact the Company's business, operations, financial results or prospects, should any such other events occur.
Risks Relating to Our Business
We are an early-stage company.
We are an early-stage company and as such, we are subject to many risks including under-capitalization, cash shortages, and limitations with respect to personnel, financial and other resources and the lack of revenue. There is no assurance that we will be successful in achieving a return on shareholders' investment and the likelihood of success must be considered in light of our early stage of operations. Our prospects must be considered speculative in light of the risks, expenses, and difficulties frequently encountered by companies in their early stages of operations, particularly in the highly competitive and rapidly evolving markets in which we operate. To attempt to address these risks, we must, among other things, successfully implement our business plan, marketing, and commercialization strategies, respond to competitive developments, and attract, retain, and motivate qualified personnel. A substantial risk is involved in investing in us because, as a smaller commercial enterprise that has fewer resources than an established company, our management may be more likely to make mistakes, and we may be more vulnerable operationally and financially to any mistakes that may be made, as well as to external factors beyond our control.
We currently have negative operating cash flows.
Since inception, we have generated significant negative cash flow from operations, financed in great part through equity financing. There can be no certainty that we will ever achieve or sustain profitability or positive cash flow from our operating activities. In addition, our working capital and funding needs may vary significantly depending upon a number of factors including, but not limited to:
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There is no guarantee that we will ever become profitable. To date, we have generated limited revenues and a large portion of our expenses are fixed, including expenses related to facilities, equipment, contractual commitments and personnel. With the anticipated commercialization for certain of our product offerings during our fiscal year ending September 30, 2024 ("Fiscal 2024"), we expect our net losses from operations will improve. Our ability to generate additional revenues and potential to become profitable will depend largely on the timely productization of our products, coupled with securing timely, cost-effective outsourced manufacturing arrangements and marketing our products. There can be no assurance that any such events will occur or that we will ever become profitable. Even if we achieve profitability, we cannot predict the level of such profitability. If we sustain losses over an extended period of time, we may be unable to continue our business.
Global inflationary pressure may have an adverse impact on our gross margins and our business.
Since December 31, 2021, we have experienced increases in global inflation, resulting in an increase in cost for some of the raw materials (batons / custom chemicals and casings) that we source to manufacture the ammunition for our ARWEN launchers. However, this increase in cost had a small negative impact to the overall gross margin earned from the sales of ARWEN ammunition.
As we are not yet in the production phase for digitization and counter-threat business lines, we do not currently procure large volume of raw materials and therefore the current inflation is negligible for these business lines except for labor costs relating to research and development ("R&D") activities. During our fiscal year ended September 30, 2023 ("Fiscal 2023"), we incurred significant payroll cost increases for some of our employees in order to retain and hire engineers given the strong local demand for experienced software and hardware engineers. While we believe we will be able to pass on this inflation cost to our prospect military customers, there is no assurance that we will succeed. Accordingly, continued inflationary pressure may have an adverse impact on our gross margins and could have a material adverse effect on our business, financial condition, results of operations or cash flows.
We may not be able to successfully execute our business plan.
The execution of our business plan poses many challenges and is based on a number of assumptions. We may not be able to successfully execute our business plan. If we experience significant cost overruns, or if our business plan is more costly than we anticipate, certain activities may be delayed or eliminated, resulting in changes or delays to our current plans. Also, we may be compelled to secure additional funding (which may or may not be available or available at conditions unfavorable to us) to execute our business plan. We cannot predict with certainty our future revenues or results from our operations. If the assumptions on which our revenues or expenditures forecasts are based change, the benefits of our business plan may change as well. In addition, we may consider expanding our business beyond what is currently contemplated in our business plan. Depending on the financing requirements of a potential business expansion, we may be required to raise additional capital through the issuance of equity or debt. If we are unable to raise additional capital on acceptable terms, we may be unable to pursue a potential business expansion.
A significant portion of our revenues are non-recurring.
A significant portion of our revenue for Fiscal 2023 is prior to commercialization of our significant projects and is considered to be non-recurring. We have significantly reduced our reliance on non-recurring revenues during Fiscal 2023 with the Arwen business line, the hiring of Directorate Land Command Systems Program Management Software Engineering Facility ("DSEF") resources, the ramp up of the Para Ops division and the monthly Ground Search And Rescue services.
There is uncertainty with respect to our revenue growth.
There can be no assurance that we can generate substantial revenue growth, or that any revenue growth that is achieved can be sustained. Revenue growth that we have achieved or may achieve may not be indicative of future operating results. In addition, we may further increase our operating expenses in order to fund higher levels of research and development, increase our sales and marketing efforts and increase our administrative resources in anticipation of future growth. To the extent that increases in such expenses precede or are not subsequently followed by increased revenues, our business, operating results and financial condition will be materially adversely affected.
We may not be able to fully develop our products, which could prevent us from ever becoming profitable.
If we experience difficulties in the development process, such as capacity constraints, quality control problems or other disruptions, we may not be able to fully develop market-ready commercial products at acceptable costs, which would adversely affect our ability to effectively enter the market. A failure by us to achieve a low-cost structure through economies of scale or improvements in manufacturing processes would have a material adverse effect on our commercialization plans and our business, prospects, results of operations and financial condition.
We may experience delays in product sales due to marketing and distribution capabilities.
In order to successfully commercialize our products, we must continue to develop our internal marketing and sales force with technical expertise and with supporting distribution capabilities or arrange for third parties to perform these services. In order to successfully commercialize any of our products, we must have an experienced sales and distribution infrastructure. The continued development of our sales and distribution infrastructure will require substantial resources, which may divert the attention of our management and key personnel and defer our product development and commercialization efforts. To the extent that we enter into marketing and sales arrangements with other companies, our revenues will depend on the efforts of others.
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Additionally, in marketing our products, we would likely compete with companies that currently have extensive and well-funded marketing and sales operations. Despite marketing and sales efforts, we may be unable to compete successfully against these companies. We may not be able to do so on favorable terms.
In the event we fail to develop substantial sales, marketing and distribution channels, or to enter into arrangements with third parties for those purposes, we will experience delays in product sales, which could have a material adverse effect on prospects, results of operations, financial condition and cash flows.
There is no assurance that our products will be accepted in the marketplace or that we will turn a profit or generate immediate revenues.
There is no assurance as to whether our products will be accepted in the marketplace. While we believe our products address customer needs, the acceptance of our products may be delayed or not materialize. We have incurred and anticipate incurring substantial expenses relating to the development of our products, the marketing of our products and initial operations of our business. Our revenues and possible profits will depend upon, among other things, our ability to successfully market our products to customers. There is no assurance that revenues and profits will be generated.
Strategic alliances may not be achieved or achieve their goals.
To achieve a scalable operating model with minimal capital expenditures, we plan to rely upon strategic alliances with original equipment manufacturers ("OEMs") for the manufacturing and distribution of our products. There can be no assurance that such strategic alliances can be achieved or will achieve their goals.
We are dependent on key suppliers for our ARWEN product line.
We are only able to purchase certain key components of our products from a limited number of suppliers for our ARWEN product line within our non-lethal business line. As of the date of this Annual Report, we do not have any commercial or financial contracts with any key suppliers who we have procured raw materials from. Procurement is done in the form of individual, non-related standard purchase orders. As a result, there is no contract in place to ensure sufficient quantities are available timely on favorable terms and consequently this could result in possible lost sales or uncompetitive product pricing.
We may incur higher costs or unavailability of components, materials and accessories.
As we expect to commercialize certain of our product lines in Fiscal 2024, we may depend on certain domestic and international suppliers for the delivery of components and materials used in the assembly of our products and certain accessories including ammunition, used with our products. Further, any reliance on third-party suppliers may create risks related to our potential inability to obtain an adequate supply of components or materials and reduced control over pricing and timing of delivery of components and materials. We currently have no long-term agreements with any of our suppliers and there is no guarantee the supply will not be interrupted.
In light of the current global supply chain challenges caused by Russia's invasion of Ukraine, components used in the manufacture of our products may be delayed, become unavailable or discontinued. Any delays may take weeks or months to resolve. Further, parts obsolescence may require us to redesign our product to ensure quality replacement components. While we have not been impacted significantly from the above events to date, there is no assurance that we will not experience significant setback in operations if the global supply chain challenges worsen or continue to persist for a longer period of time. Accordingly, supply chain delays could cause significant delays in manufacturing and loss of sales, leading to adverse effects significantly impacting our financial condition or results of operations.
Additionally, our shipping costs and the timely delivery of our products could be adversely impacted by a number of factors which could reduce the profitability of our operations, including: higher fuel costs, potential port closures, customs clearance issues, increased government regulation or changes for imports of foreign products into Canada, delays created by terrorist attacks or threats, public health issues and pandemics and epidemics, national disasters or work stoppages, and other matters. Any interruption of supply for any material components of our products could significantly delay the shipment of our products and have a material adverse effect on our revenues, profitability, and financial condition.
We rely upon a limited number of third parties for manufacturing, shipping, transportation, logistics, marketing and sales of our products.
We rely on third parties to ship, transport, and provide logistics for our products. Further, we plan on relying on third parties to manufacture, market and sell our PARA OPS system products. Our dependence on a limited number of third parties for these services leaves us vulnerable due to our need to secure these parties' services on favorable terms. Loss of, or an adverse effect on, any of these relationships or failure of any of these third parties to perform as expected could have a material and adverse effect on our business, sales, results of operations, financial condition, and reputation.
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We may be subject to product liability proceedings or claims.
We may be subject to proceedings or claims that may arise in the ordinary conduct of the business, which could include product and service warranty claims, which could be substantial. Product liability for us is a major risk as some of our products will be used by military personnel in theaters-of-war (for the Tactical and Counter-Threat product offerings) and by consumers and law enforcement (for the non-lethal systems). The occurrence of product defects due to non-compliance of our manufacturing specifications and the inability to correct errors could result in the delay or loss of market acceptance of our products, material warranty expense, diversion of technological and other resources from our product development efforts, and the loss of credibility with customers, manufacturers' representatives, distributors, value-added resellers, systems integrators, original equipment manufacturers and end-users, any of which could have a material adverse effect on our business, operating results and financial conditions. To mitigate product liability risk, our products will be sold with a liability disclaimer for misuse of the product.
If we are unable to successfully design and develop or acquire new products, our business may be harmed.
To maintain and increase sales we must continue to introduce new products and improve or enhance our existing products or new products. The success of our new and enhanced products depends on many factors, including anticipating consumer preferences, finding innovative solutions to consumer problems or acquiring new solutions through mergers and acquisitions, differentiating our products from those of our competitors, and maintaining the strength of our brand. The design and development of our products as well as acquisitions of other businesses.
Our business could be harmed if we are unable to accurately forecast demand for our products or our results of operations.
To ensure adequate inventory supply, we forecast inventory needs and often place orders with our manufacturers before we receive firm orders from our retail partners or customers. If we fail to accurately forecast demand, we may experience excess inventory levels or a shortage of products.
If we underestimate the demand for our products, we or our suppliers may not be able to scale to meet our demand, and this could result in delays in the shipment of our products and our failure to satisfy demand, as well as damage to our reputation and retail partner relationships. If we overestimate the demand for our products, we could face inventory levels in excess of demand, which could result in inventory write-downs or write-offs and the sale of excess inventory at discounted prices, which would harm our gross margins. In addition, failures to accurately predict the level of demand for our products could cause a decline in sales and harm our results of operations and financial condition.
In addition, we may not be able to accurately forecast our results of operations and growth rate. Forecasts may be particularly challenging as we expand into new markets and geographies and develop and market new products for which we have no or limited historical data. Our historical sales, expense levels, and profitability may not be an appropriate basis for forecasting future results. Our lack of historical data related to new products makes it particularly difficult to make forecasts related to such products. These effects are expected to last through the remainder of the pandemic. Pandemic related variances require a very quick pivot and adjustments to the supply chain, production and marketing. If we are unable to make these changes quickly or at all our inventory, production and sales may be materially affected.
Failure to accurately forecast our results of operations and growth rate could cause us to make poor operating decisions that we may not be able to correct in a timely manner. Consequently, actual results could be materially different than anticipated. Even if the markets in which we compete expand, we cannot assure you that our business will grow at similar rates, if at all.
Undetected flaws may be discovered in our products.
There can be no assurance that, despite testing by us, flaws will not be found in our products and services, resulting in loss of, or delay in, market acceptance. We may be unable, for technological or other reasons, to introduce products and services in a timely manner or at all in response to changing customer requirements. In addition, there can be no assurance that while we are attempting to finish the development of our technologies, products and services, a competitor will not introduce similar or superior technologies, products and services, thus diminishing our advantage, rendering our technologies, products and services partially or wholly obsolete, or at least requiring substantial re-engineering in order to become commercially acceptable. Failure by us to maintain technology, product and service introduction schedules, avoid cost overruns and undetected errors, or introduce technologies, products and services that are superior to competing technologies, products and services would have a materially adverse effect on our business, prospects, financial condition, and results of operations.
We will be reliant on information technology systems and may be subject to damaging cyber-attacks.
We use third parties for certain hardware, software, telecommunications and other information technology ("IT") services in connection with our operations. Our operations depend, in part, on how well we and our suppliers protect networks, equipment, IT systems and software against damage from a number of threats, including, but not limited to, cable cuts, damage to physical plants, natural disasters, intentional damage and destruction, fire, power loss, hacking, computer viruses, vandalism and theft. Our operations also depend on the timely maintenance, upgrade and replacement of networks, equipment, IT systems and software, as well as pre-emptive expenses to mitigate the risks of failures. Any of these and other events could result in information system failures, delays and/or increase in capital expenses. The failure of information systems or a component of information systems could, depending on the nature of any such failure, adversely impact our reputation and results of operations. Moreover, failure to meet the minimum cybersecurity requirements for defense contracts may disqualify us from participating in the tendering process. To date, we have not experienced any losses relating to cyber-attacks or other information security breaches, but there can be no assurance that we will not incur such losses in the future. Our risk and exposure to these matters cannot be fully mitigated because of, among other things, the evolving nature of these threats. As a result, cybersecurity and the continued development and enhancement of controls, processes and practices designed to protect systems, computers, software, data and networks from attack, damage or unauthorized access is a priority. As cyber threats continue to evolve, we may be required to expend additional resources to continue to modify or enhance protective measures or to investigate and remediate any security vulnerabilities.
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In certain circumstances, our reputation could be damaged.
Damage to our reputation can be the result of the actual or perceived occurrence of any number of events, and could include any negative publicity, whether true or not. Reputational risk for us is a major risk as some of our products will be used by military personnel in theaters-of-war or by law enforcement personnel. The increased usage of social media and other web-based tools used to generate, publish and discuss user-generated content and to connect with other users has made it increasingly easier for individuals and groups to communicate and share opinions and views regarding us and our activities, whether true or not. Although we believe that we operate in a manner that is respectful to all stakeholders and that we take care in protecting our image and reputation, we do not ultimately have direct control over how we are perceived by others. Reputational loss may result in decreased investor confidence, increased challenges in developing and maintaining community relations and an impediment to our overall ability to advance our projects, thereby having a material adverse impact on financial performance, financial condition, cash flows and growth prospects.
Our results of operations are difficult to predict and depend on a variety of factors.
There is no assurance that the production, technology acquisitions, and the commercialization of proprietary technology for game-changing applications in the military, security forces and personal defense markets will be managed successfully. Any inability to achieve such commercial success could have a material adverse effect on our business, financial condition, operating results, liquidity, and prospects. In addition, the comparability of results may be affected by changes in accounting guidance or changes in our ownership of certain assets. Accordingly, the results of operations from year to year may not be directly comparable to prior reporting periods. As a result of the foregoing and other factors, the results of operations may fluctuate significantly from period to period, and the results of any one period may not be indicative of the results for any future period.
Protecting and defending against intellectual property claims may have a material adverse effect on our business.
Our ability to compete depends, in part, upon successful protection of our intellectual property. While we have some patents and trademarks, we also rely on trade secrets to protect our technology, which is inherently risky. Going forward, we will attempt to protect proprietary and intellectual property rights to our technologies through available copyright and trademark laws, patents and licensing and distribution arrangements with reputable international companies in specific territories and media for limited durations. Despite these precautions, existing copyright, trademark and patent laws afford only limited practical protection in certain countries where we distribute our products. As a result, it may be possible for unauthorized third parties to copy and distribute our products or certain portions or applications of our intended products, which could have a material adverse effect on our business, financial condition, operating results, liquidity, and prospects.
Litigation may also be necessary to enforce our intellectual property rights, to protect our trade secrets, or to determine the validity and scope of the proprietary rights of others or to defend against claims of infringement or invalidity. Any such litigation, infringement or invalidity claims could result in substantial costs and the diversion of resources and could have a material adverse effect on our business, financial condition, operating results, liquidity, and prospects.
We face risks from doing business internationally.
Our commercialization strategies for our products include sales efforts outside Canada and deriving revenues from international sources. As a result, our business is subject to certain risks inherent in international business, many of which are beyond our control.
These risks may include:
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Events or developments related to these and other risks associated with international trade could adversely affect our revenues from non-Canadian sources, which could have a material adverse effect on our business, financial condition, operating results, liquidity, and prospects. Protection of electronically stored data is costly and if our data is compromised in spite of this protection, we may incur additional costs, lost opportunities, and damage to our reputation.
We maintain information in digital form as necessary to conduct our business, including confidential and proprietary information and personal information regarding our employees.
Data maintained in digital form is subject to the risk of intrusion, tampering, and theft. We develop and maintain systems to prevent this from occurring, but it is costly and requires ongoing monitoring and updating as technologies change and efforts to overcome security measures become more sophisticated. Moreover, despite our efforts, the possibility of intrusion, tampering, and theft cannot be eliminated entirely, and risks associated with each of these acts remain. In addition, we provide confidential information, digital content and personal information to third parties when it is necessary to pursue business objectives. While we obtain assurances that these third parties will protect this information and, where appropriate, monitor the protections employed by these third parties, there is a risk that data systems of these third parties may be compromised. If our data systems or data systems of these third parties are compromised, our ability to conduct our business may be impaired, we may lose profitable opportunities or the value of those opportunities may be diminished and we may lose revenue as a result of unlicensed use of our intellectual property. A breach of our network security or other theft or misuse of confidential and proprietary information, digital content or personal employee information could subject us to business, regulatory, litigation, and reputation risk, which could have a materially adverse effect on our business, financial condition, and results of operations.
Our success depends on management and key personnel.
Our success depends largely upon the continued services of our executive officers and other key employees. From time to time, there may be changes in our executive management team resulting from the hiring or departure of executives, which could disrupt our business. If we are unable to attract and retain top talent, our ability to compete may be harmed. Our success is also highly dependent on our continuing ability to identify, hire, train, retain and motivate highly qualified personnel. Competition for highly skilled executives and other employees is high in our industry, especially from larger and better capitalized defense and security companies. We may not be successful in attracting and retaining such personnel. Failure to attract and retain qualified executive officers and other key employees could have a material adverse effect on our business, prospects, financial condition, results of operations, and cash flows.
Our directors, officers or members of management may have conflicts of interest.
Certain of our directors, officers, and other members of management serve (and may in the future serve) as directors, officers, and members of management of other companies and therefore, it is possible that a conflict may arise between their duties as one of our directors, officers or members of management and their duties as a director, officer or member of management of such other companies. Our directors and officers are aware of the existence of laws governing accountability of directors and officers for corporate opportunity and requiring disclosures by directors of conflicts of interest and we will rely upon such laws in respect of any directors' and officers' conflicts of interest or in respect of any breaches of duty by any of our directors or officers. All such conflicts will be disclosed by such directors or officers in accordance with the BCBCA and they will govern themselves in respect thereof to the best of their ability in accordance with the obligations imposed upon them by law.
It may not be possible for foreign investors to enforce actions against us, and our directors and officers.
We are a corporation organized under the laws of the Province of British Columbia and our Canadian subsidiaries are organized under the laws of the Province of Ontario and our United States subsidiaries are organized under the laws of Delaware. All of our directors and executive officers reside principally in Canada. Because all or a substantial portion of our assets and the assets of these persons are located in Canada, it may not be possible for foreign investors, including United States investors, to effect service of process from outside of Canada upon us or those persons, or to realize in the United States upon judgments of United States courts predicted upon civil liabilities under the Exchange Act or other United States laws. Furthermore, it may not be possible to enforce against us foreign judgments obtained in courts outside of Canada based upon the civil liability provisions of the securities laws or other laws in those jurisdictions.
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The loss of services of members of our management team may have a material adverse effect on our business, financial condition, and results of operations.
Our success depends in large part upon the continued service of key members of our management team. Because we do not maintain "key person" life insurance on any of our executive officers, employees or consultants, any delay in replacing such persons, or an inability to replace them with persons of similar expertise, may have a material adverse effect on our business, financial condition, and results of operations.
Our internal computer systems are vulnerable to damage and failure.
Despite the implementation of security measures and backup storage, our internal computer systems are vulnerable to damage from computer viruses, unauthorized access, natural disasters, terrorism, war, and telecommunication and electrical failure. Any system failure, accident or security breach that causes interruption in our operations could result in a material disruption of our projects. To the extent that any disruption or security breach results in a loss or damage to our data or applications, or inappropriate disclosure of confidential or proprietary information, we may incur liability as a result. In addition, our technology program may be adversely affected and the further development of our technology may be delayed. We may also incur additional costs to remedy the damages caused by these disruptions or security breaches.
Business interruptions could adversely affect our operations.
Our operations are vulnerable to outages and interruptions due to fire, floods, power loss, telecommunications failures, and similar events beyond our control. Although we have developed certain plans to respond in the event of a disaster, there can be no assurance that they will be effective in the event of a specific disaster. Any losses or damages incurred by us could have a material adverse effect on our business and results of operations.
We are subject to risks associated with possible acquisitions, licensing, business combinations, or joint ventures.
While to date we have mainly focused on developing our own products, from time to time, we could be engaged in discussions and activities with respect to possible business and/or technology acquisitions or licensing, sale of assets, business combinations, or joint ventures with the view of either complementing or expanding our internally developed products. These acquisitions and licensing activities are not crucial to our long-term business success. The anticipated benefit from any of the transactions we may pursue may not be realized as expected. Regardless of whether any such transaction is consummated, the negotiation of a potential transaction and the integration of the acquired business or technology, acquired or licensed, could incur significant costs and cause diversion of management's time and resources. Any such transaction could also result in impairment of goodwill and other intangibles, development write-offs, and other related expenses. Such transactions may pose challenges in the consolidation and integration of information technology, accounting systems, personnel, and operations. We may have difficulty managing the combined entity in the short term if we experience a significant loss of management personnel during the transition period after a significant acquisition. We may also have difficulty managing the product development and commercialization following a technology acquisition or licensing. No assurance can be given that expansion, licensing or acquisition opportunities will be successful, completed on time, or that we will realize expected operating efficiencies, cost savings, revenue enhancements, synergies or other benefits. Any of the foregoing could have a material adverse effect on our business, financial condition, operating results, liquidity, and prospects.
Claims against us relating to any acquisition, licensing or business combination may necessitate seeking claims against the seller for which the seller may not indemnify us or that may exceed the seller's or licensor's indemnification obligations.
There may be liabilities assumed in any technology acquisition or licensing or business combination that we did not discover or that we underestimated in the course of performing our due diligence. Although a seller or licensor generally will have indemnification obligations to us under a licensing, acquisition or merger agreement, these obligations usually will be subject to financial limitations, such as general deductibles and maximum recovery amounts, as well as time limitations. There is no assurance that our right to indemnification from any seller or licensors will be enforceable, collectible or sufficient in amount, scope or duration to fully offset the amount of any undiscovered or underestimated liabilities that we may incur. Any such liabilities could have a material adverse effect on our business, financial condition, operating results, liquidity, and prospects.
Growth may cause pressure on our management and systems.
Our future growth may cause significant pressure on our management, and our operational, financial, and other resources and systems. Our ability to manage our growth effectively will require that we implement and improve our operational, financial, manufacturing, and management information systems, hire new personnel and then train, manage, and motivate these new employees. These demands may require the hiring of additional management personnel and the development of additional expertise within the existing management team. Any increase in resources devoted to production, business development, and distribution efforts without a corresponding increase in our operational, financial, and management information systems could have a material adverse effect on our business, financial condition, and results of operations.
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We may infringe intellectual property rights of third parties.
For certain of our product lines, we have elected to protect our technology and products as trade secrets as opposed to seeking patent protection. We may, in future, elect to seek patent protection for some of our future products. While we believe that our products and other intellectual property do not infringe upon the proprietary rights of third parties, our commercial success depends, in part, upon us not infringing intellectual property rights of others. A number of our competitors and other third parties have been issued or may have filed patent applications or may obtain additional patents and proprietary rights for technologies similar to those utilized by us. Some of these patents may grant very broad protection to the owners of the patents. While we have engaged external intellectual property legal counsels to undertake an extensive review of existing third-party patents and prepare our patent applications for some of our products (see Item 4.B. - Business Overview), there is no assurance that their reviews and conclusion will not prevail if challenged by a third party of an alleged infringement of their intellectual properties. We may become subject to claims by third parties that our technology infringes their intellectual property rights due to the growth of products in our target markets, the overlap in functionality of those products and the prevalence of products. We may become subject to these claims either directly or through indemnities against these claims that we provide to end-users, manufacturer's representatives, distributors, value-added resellers, system integrators and original equipment manufacturers. Litigation may be necessary to determine the scope, enforceability and validity of third-party proprietary rights or to establish our proprietary rights. Some of our competitors have, or are affiliated with companies having, substantially greater resources than we and these competitors may be able to sustain the costs of complex intellectual property litigation to a greater degree and for a longer period of time than us. Regardless of their merit, any such claims could be time consuming to evaluate and defend, result in costly litigation, cause product shipment delays or stoppages, divert management's attention and focus away from the business, subject us to significant liabilities and equitable remedies, including injunctions, require that we enter into costly royalty or licensing agreements and require that we modify or stop using infringing technology.
We may be prohibited from developing or commercializing certain technologies and products unless we obtain a license from a third party. There can be no assurance that we will be able to obtain any such license on commercially favorable terms or at all. If we do not obtain such a license, we could be required to cease the sale of certain of our products.
Risks Relating to Our Industry
The following risks relate specifically to Digitization and Counter-Threat business lines:
We are subject to extensive government regulation in the United States for our products designed for the military market.
Our customers in the United States are global defense contractors and they are subject to various United States government regulations which some may be passed on to us in order for them to be compliant. The most significant regulations and regulatory authorities that may affect our future business include the following:
Our failure to comply with applicable regulations, rules and approvals; changes in the United States government's interpretation of such regulations, rules and approvals as have been and are applied to our contracts, proposals or business or misconduct by any of our employees could result in the imposition of fines and penalties, the loss of security clearances, a decrease in profitability, or the loss of our subcontract contracts with United States defense contractors generally, any of which could harm our business, financial condition and results of operations.
A decline in the United States and other government budgets, changes in spending or budgetary priorities, or delays in contract awards may significantly and adversely affect our future revenue.
Since inception, except for our fiscal year ended September 30, 2022 ("Fiscal 2022"), most of our revenue was driven by contracts from the United States government, through United States prime defense contractors. Our results of operations could be adversely affected by government spending caps or changes in government budgetary priorities, as well by delays in the government budget process, program starts, or the award of contracts or orders under existing contracts. As a result, the market for our military solution may be impacted due to shifts in the political environment and changes in the government and agency leadership positions under the new United States administration. If annual budget appropriations or continuing resolutions are not enacted timely, we could face United States government shutdown, which could adversely impact our business and our ability to receive indirectly timely payment from United States government entities on future contracts.
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United States government contracts are generally not fully funded at inception and contain certain provisions that may be unfavorable to us.
We have entered into defense contracts with United States prime defense contractors, which it in turns transact directly with the United States government.
United States government contracts typically involve long lead times for design and development, and are subject to significant changes in contract scheduling. Congress generally appropriates funds on a fiscal year basis even though a program may continue for several years. Consequently, programs are often only partially funded initially, and additional funds are committed only as Congress makes further appropriations. The termination or reduction of funding for a government program would result in a loss of anticipated future revenue attributable to that program. In addition, United States government contracts generally contain provisions permitting termination, in whole or in part, at the government's convenience or for contractor default.
The actual receipt of revenue on future awards subcontracted to us may never occur or may change because a program schedule could change or the program could be cancelled, or a contract could be reduced, modified or terminated early.
While we had no outstanding United States government contracts (directly or indirectly) as of the date of this Annual Report, we are exposed to the above risk for future United States government related contracts.
We may not be able to comply with changes in government policies and legislation.
The manufacture, sale, purchase, possession and use of weapons, ammunitions, firearms, and explosives are subject to federal, provincial and foreign laws. If such regulation becomes more expansive in the future, it could have a material adverse effect on our business, operating results, financial condition, and cash flows. New legislation, regulations, or changes to or new interpretations of existing regulation could impact our ability to manufacture or sell our products and our projectiles, or limit their market, which could impact our cost of sales and demand for our products. Similarly changes in laws related to the domestic or international use of chemical irritants by civilians or law enforcement could impact both our cost of sales and the size of our reachable market.
We may be subject, both directly and indirectly, to the adverse impact of existing and potential future government regulation of our products, technology, operations, and markets. For example, the development, production, exportation, importation, and transfer of our products and technology is subject to Canadian and provincial laws. Further, as we plan to conduct business in the United States, we will also be subject to United States and foreign export control, sanctions, customs, import and anti-boycott laws and regulations, including the Export Administration Regulations (the "EAR") (collectively, "Trade Control Laws"). If one or more of our products or technology, or the parts and components we buy from others, is or become subject to the International Traffic in Arms Regulations (the "ITAR") or national security controls under the EAR, this could significantly impact our operations, for example by severely limiting our ability to sell, export, or otherwise transfer our products or technology, or to release controlled technology to foreign person employees or others in the United States or abroad. We may not be able to retain licenses and other authorizations required under the applicable Trade Control Laws. The failure to satisfy the requirements under the Trade Control Laws, including the failure or inability to obtain necessary licenses or qualify for license exceptions, could delay or prevent the development, production, export, import, and/or in-country transfer of our products and technology, which could adversely affect our revenues and profitability.
Failure by us, our employees, or others working on our behalf to comply with the applicable government policies and regulations could result in administrative, civil, or criminal liabilities, including fines, suspension, debarment from bidding for or performing government contracts, or suspension of our export privileges, which could have a material adverse effect on us.
The following risk relates specifically to PARA OPS business line:
We will be subject to regulation in the United States for our non-lethal systems.
While our PARA OPS devices are non-lethal (based on the kinetic energy of our projectiles), these are automatically classified as a form of firearm under the United States Bureau of Alcohol, Tobacco and Firearms ("ATF") rules and regulations because we use pyrotechnic based primers in our proprietary ammunition cartridges. We have therefore self-classified our .67 caliber PARA OPS single shot device as not only a firearm, but a "destructive device" in accordance with the ATF regulations. We intend to self-classify our other PARA OPS devices as a form of a firearm under ATF regulations until such time we have found an alternative for primers (i.e., a non-pyrotechnic gas generator) to launch our projectiles, and therefore be subject to ATF regulations. We are currently reviewing an alternative to replace the primer with actuator technology that is in the developmental phase and accordingly, there is no assurance that we will succeed and consequently the replacement of the primer may adversely affect our future revenues and related results of operations, business, prospects, and financial condition. Further, in the event we have implemented an alternative to replace the primer and then self-classify our PARA OPS devices as "non-firearm", there is no assurance that the ATF may not contest our self-classification, which could result in discontinuing sales to consumers with no firearm license where required by state law. Accordingly, this could also adversely affect our future revenues and related results of operations, business, prospects, and financial condition.
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Because our business model relies on outsourced production, we have no plans of becoming a firearm manufacturer in the United States but rather to continue to partner with a federal firearms license ("FFL") manufacturer for the production and distribution of our PARA OPS products. Accordingly, post commercialization in the United States the burden to comply with ATF rules and regulations applicable to the manufacturing and distribution process will be with our FFL business partners. Our primary risk of governmental interruption of manufacturing and distribution therefore lies within the operations and attendant internal control environment of our FFL business partners.
Furthermore, with respect to transfers to end users (government, military, or consumer), the obligation to comply with ATF rules and regulations and any applicable state laws resides with the downstream FFL wholesaler/distributor/retailer and any penalties levied upon such parties do not flow up the distribution chain.
See Item 4.B. - Business Overview - Government Regulation - Non-Lethal for a summary of relevant regulation in the United States for our non-lethal business line.
The following risks apply to all business lines:
Rapid technological development could result in obsolescence or short product life cycles of our products.
The markets for our products are characterized by rapidly changing technology and evolving industry standards, which could result in product obsolescence or short product life cycles. Accordingly, our success is dependent upon our ability to anticipate technological changes in the industries we serve and to successfully identify, obtain, develop and market new products that satisfy evolving industry requirements. There can be no assurance that we will successfully develop new products or enhance and improve our existing products or that any new products and enhanced and improved existing products will achieve market acceptance. Further, there can be no assurance that competitors will not market products that have perceived advantages over our products or which render the products currently sold by us obsolete or less marketable.
We must commit significant resources to developing, testing and demonstrating new products before knowing whether our investments will result in products the market will accept. To remain competitive, we may be required to invest significantly greater resources than currently anticipated in research and development and product enhancement efforts, and result in increased operating expenses.
Our industry is highly competitive.
The industry for military and security forces and personal defense is highly competitive and composed of many domestic and foreign companies. We have experienced and expect to continue to experience, substantial competition from numerous competitors whom we expect to continue to improve their products and technologies. Competitors may announce and introduce new products, services or enhancements that better meet the needs of end-users or changing industry standards, or achieve greater market acceptance due to pricing, sales channels or other factors. With substantially greater financial resources and operating scale than we do currently, certain competitors may be able to respond more quickly than us to changes in end-user requirements and devote greater resources to the enhancement, promotion and sale of their products. Such competition could adversely affect our ability to win new contracts and sales.
Since we operate in evolving markets, our business and future prospects may be difficult to evaluate.
Our technological solutions are in new and rapidly evolving markets. The military, civilian public safety, professional and personal defense markets we target are in early stages of customer adoption. Accordingly, our business and future prospects may be difficult to evaluate. We cannot accurately predict the extent to which demand for our products and services will develop and/or increase, if at all. The challenges, risks and uncertainties frequently encountered by companies in rapidly evolving markets could impact our ability to do the following:
If we fail to address these and other challenges, risks and uncertainties successfully, our business, results of operations and financial condition would be materially harmed.
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Uncertainty related to exportation could limit our operations in the future.
We must comply with Canadian federal and provincial laws regulating the export of our products. In some cases, explicit authorization from the Canadian government is needed to export certain products. The export regulations and the governing policies applicable to our business are subject to change. We cannot provide assurance that such export authorizations will be available for our products in the future. To date, compliance with these laws has not significantly limited our operations, but could significantly limit them in the future. Noncompliance with applicable export regulations could potentially expose us to fines, penalties and sanctions. If we cannot obtain required government approvals under applicable regulations, we may not be able to sell our products in certain international jurisdictions, which could adversely affect our business, prospects, financial condition and results of operations.
Global economic turmoil and regional economic conditions in the United States could adversely affect our business.
Global economic turmoil may cause a general tightening in the credit markets, lower levels of liquidity, increases in the rates of default and bankruptcy, levels of intervention from the United States federal government and other foreign governments, decreased consumer confidence, overall slower economic activity, and extreme volatility in credit, equity, and fixed income markets. A decrease in economic activity in the United States or in other regions of the world in which we do business could adversely affect demand for our products, thus reducing our revenues and earnings. A decline in economic conditions could reduce sales of our products.
Risks Relating to Our Financial Condition
We face substantial capital requirements and financial risk.
To be successful, our business requires a substantial investment of capital. The production, acquisition, and distribution of proprietary technology for game-changing applications in the military and security forces and personal defense markets require substantial capital. A significant amount of time may elapse between our expenditure of funds and the receipt of revenues. This may require a significant portion of funds from equity, credit, and other financing sources to fund the business. There can be no assurance that these arrangements will continue to be successfully implemented or will not be subject to substantial financial risks relating to the production, acquisition, and distribution of proprietary technology for game-changing applications in the military and security forces and personal defense markets. In addition, if demand increases through internal growth or acquisition, there may be an increase to overhead and/or larger up-front payments for production and, consequently, these increases bear greater financial risks. Any of the foregoing could have a material adverse effect on our business, financial condition, operating results, liquidity, and prospects.
We may require additional capital which may result in dilution to existing shareholders.
We may need to engage in additional equity or debt financings to secure additional funds to fund our working capital requirement and business growth. If we raise additional funds through further issuances of equity or convertible debt securities, our existing shareholders could suffer significant dilution, and any new equity securities we issue could have rights, preferences, and privileges superior to those of holders of the Common Shares. Any debt financing secured by us in the future could involve restrictive covenants relating to our capital-raising activities and other financial and operational matters, which might make it more difficult for us to obtain additional capital and to pursue business opportunities.
We can provide no assurance that sufficient debt or equity financing will be available on reasonable terms or at all to support our business growth and to respond to business challenges and failure to obtain sufficient debt or equity financing when required could have a material adverse effect on our business, prospects, financial condition, results of operations, and cash flows.
Over the short-term, we expect to incur operating losses and generate negative cash flow until we can produce sufficient revenues to cover our costs. We may never become profitable. Even if we do achieve profitability, we may be unable to sustain or increase our profitability in the future. There are substantial uncertainties associated with our ability to achieving and sustaining profitability. We expect our current cash position will be reduced due to future operating losses and working capital requirements, and we cannot provide certainty as to how long our cash position will last or that we will be able to access additional capital if and when necessary.
Exercise of options or warrants or vesting of restricted stock units will have a dilutive effect on your percentage ownership and will result in a dilution of your voting power and an increase in the number of Common Shares eligible for future resale in the public market, which may negatively impact the trading price of our Common Shares.
We may need to divest assets if there is insufficient capital.
If sufficient capital is not available, we may be required to delay, reduce the scope of, eliminate or divest one or more of our assets or products, any of which could have a material adverse effect on our business, financial condition, prospects, or results of operations.
We have broad discretion over the use of net proceeds from future capital raises.
We will have broad discretion over the use of the net proceeds from any future capital raises. Because of the number and variability of factors that will determine our use of such proceeds, the ultimate use might vary substantially from the planned use. Investors may not agree with how we allocate or spend the proceeds from future capital raises. We may pursue collaborations that ultimately do not result in an increase in the market value of the Common Shares and that instead increase our losses.
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Currency fluctuations may have a material effect on us.
Fluctuations in the exchange rate between the United States dollar, other currencies and the Canadian dollar may have a material effect on our results of operations. To date, we have not engaged in currency hedging activities. To the extent that we may seek to implement hedging techniques in the future with respect to our foreign currency transactions, there can be no assurance that we will be successful in such hedging activities.
Unavailability of adequate director and officer insurance could make it difficult for us to retain and attract qualified directors and could also impact our liquidity.
We have directors and officers liability ("D&O") insurance we believe to be adequate to cover risk exposure for us and our directors and officers, who we indemnify to the full extent permitted by law, there is no guaranty that such coverage will be adequate in the event of litigation.
Our coverage needs for D&O insurance may change or increase in the future for various reasons including changes in our market capitalization, changes in trading volume or changes in the listing rules of exchanges or marketplaces on which our securities may trade from time to time. There is no guaranty that such coverage will be available or available at reasonable rates. While we have obtained new D&O insurance before completing the Nasdaq listing and may need to increase our D&O coverage as needed in the future, there can be no assurance that we will be able to do so at reasonable rates or at all, or in amounts adequate to cover expenses and liability should litigation occur. Without adequate D&O insurance, the costs of litigation including amounts we would pay to indemnify our officers and directors should they be subject to legal action based on their service to us could have a material adverse effect on our financial condition, results of operations and liquidity. Further, if we are unable to obtain adequate D&O insurance in the future for any reason, we may have difficultly retaining and attracting talented and skilled directors and officers, which could adversely affect our business, and may be unable to list our Common Shares on a national exchange in the United States, which could impact the liquidity and value of our stock.
Our insurance policies may be inadequate to fully protect us from material judgments and expenses.
We require insurance coverage for a number of risks, including business interruption, environmental matters and contamination, personal injury and property damage as well as general aviation liability coverage. Although we maintain insurance policies, we cannot provide assurance that this insurance will be adequate to protect us from all material judgments and expenses related to potential future claims or that these levels of insurance will be available in the future at economical prices or at all. A successful product liability claim could result in substantial cost to us. If insurance coverage is unavailable or insufficient to cover any such claims, our financial resources, results of operations and prospects could be adversely affected.
Even if we are fully insured as it relates to a claim, the claim could nevertheless diminish our brand and divert management's attention and resources, which could have a negative impact on our business, prospects, financial condition and results of operations.
Risks Relating to the Ownership of our Securities
An investment in our securities involves significant risks.
Additional risks and uncertainties not presently known to us or that we currently consider immaterial may also impair our business and operations and cause the trading price of our securities to decline. If any of the following or other risks occur, our business, prospects, financial condition, results of operations and cash flows could be materially adversely impacted. In that event, the trading price of our securities could decline and security holders could lose all or part of their investment. There is no assurance that risk management steps taken will avoid future loss due to the occurrence of the risks described below or other unforeseen risks.
Our Common Shares may experience extreme stock price volatility unrelated to our actual or expected operating performance, financial condition or prospects, making it difficult for prospective investors to assess the rapidly changing value of our common shares.
Recently, there have been instances of extreme stock price run-ups followed by rapid price declines and strong stock price volatility with a number of recent initial public offerings, especially among companies with relatively smaller public floats. As a relatively small-capitalization company with relatively small public float, we may experience greater stock price volatility, extreme price run-ups, lower trading volume and less liquidity than large-capitalization companies. In particular, our Common Shares may be subject to rapid and substantial price volatility, low volumes of trades and large spreads in bid and ask prices. Such volatility, including any stock-run up, may be unrelated to our actual or expected operating performance, financial condition or prospects, making it difficult for prospective investors to assess the rapidly changing value of our Common Shares.
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In addition, if the trading volumes of our Common Shares are low, persons buying or selling in relatively small quantities may easily influence prices of our Common Shares. This low volume of trades could also cause the price of our Common Shares to fluctuate greatly, with large percentage changes in price occurring in any trading day session. Holders of our Common Shares may also not be able to readily liquidate their investment or may be forced to sell at depressed prices due to low volume trading. If high spreads between the bid and ask prices of our Common Shares exist at the time of a purchase, the stock would have to appreciate substantially on a relative percentage basis for an investor to recoup their investment. Broad market fluctuations and general economic and political conditions may also adversely affect the market price of our Common Shares.
As a result of this volatility, investors may experience losses on their investment in our Common Shares. A volatile market price of our Common Shares also could adversely affect our ability to issue additional shares of Common Shares or other securities and our ability to obtain additional financing in the future.
The market price of our securities may be volatile.
The market price for our securities may be volatile and subject to wide fluctuations in response to numerous factors, many of which are beyond our control, including, but not limited to, the following: (i) actual or anticipated fluctuations in our quarterly results of operations; (ii) recommendations by securities research analysts; (iii) changes in the economic performance or market valuations of other issuers that investors deem comparable to us; (iv) departure of executive officers or other key personnel; (v) issuances or anticipated issuances of additional Common Shares; (vi) significant acquisitions or business combinations, strategic partnerships, joint ventures or capital commitments by or involving us or our competitors; and (vii) news reports relating to trends, concerns, technological or competitive developments, regulatory changes and other related issues in our industry or target markets.
Financial markets have historically experienced significant price and volume fluctuations that have particularly affected the market prices of equity securities of public entities and that have, in many cases, been unrelated to the operating performance, underlying asset values or prospects of such entities. Accordingly, the market price of our securities may decline even if our operating results, underlying asset values or prospects have not changed. Additionally, these factors, as well as other related factors, may cause decreases in asset values that are deemed to be other than temporary, which may result in impairment losses. There can be no assurance that continuing fluctuations in price and volume will not occur. If such increased levels of volatility and market turmoil continue for a protracted period of time, the trading price of the Common Shares may be materially adversely affected.
There can be no assurance of active market for the Common Shares.
The Common Shares are listed on the TSX Venture Exchange ("TSXV") since September 22, 2020, Nasdaq since December 7, 2022, and the Frankfurt Stock Exchange since March 29, 2022. Additionally, the warrants issued in the U.S. IPO (the "Warrants") are listed on Nasdaq. There can be no assurance an active and liquid market for the Common Shares or Warrants will be maintained.
If we are unable to satisfy the requirements of Sarbanes-Oxley or our internal controls over financial reporting are not effective, the reliability of our financial statements may be questioned.
We are subject to the requirements of Sarbanes-Oxley. Section 404 of Sarbanes-Oxley ("Section 404") requires companies subject to the reporting requirements of United States securities laws to complete a comprehensive evaluation of their internal controls over financial reporting. To comply with this statute, we will be required to document and test our internal control procedures and our management will be required to assess and issue a report concerning our internal controls over financial reporting. Pursuant to the Jumpstart Our Business Startups Act of 2012, as amended, we are classified as an "emerging growth company." Under the JOBS Act, emerging growth companies are exempt from certain reporting requirements, including the independent auditor attestation requirements of Section 404(b) of Sarbanes-Oxley. Under this exemption, our independent auditor is not be required to attest to and report on management's assessment of our internal controls over financial reporting during a five year transition period, except in the event this is accelerated if we lose our status as an "emerging growth company". We will need to prepare for compliance with Section 404 by strengthening, assessing and testing our system of internal controls to provide the basis for our report. However, the continuous process of strengthening our internal controls and complying with Section 404 is complicated and time-consuming. Furthermore, we believe that our business will grow both domestically and internationally, organically and through acquisitions, in which case our internal controls will become more complex and will require significantly more resources and attention to ensure our internal controls remain effective overall. During the course of our testing, management may identify material weaknesses or significant deficiencies, which may not be remedied in a timely manner to meet the deadline imposed by Sarbanes-Oxley. If management cannot favorably assess the effectiveness of our internal controls over financial reporting, or our independent registered public accounting firm identifies material weaknesses in our internal controls, investor confidence in our financial results may weaken, and the market price of our securities may suffer.
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Risks Related to Our Securities
Our status as a Foreign Private Issuer under United States Securities Laws.
We are a "foreign private issuer", under applicable United States federal securities laws, and are, therefore, not subject to the same requirements that are imposed upon United States domestic issuers by the SEC. Under the Exchange Act, we are subject to reporting obligations that, in certain respects, are less detailed and less frequent than those of United States domestic reporting companies. As a result, we do not file the same reports that a United States domestic issuer would file with the SEC, although we are required to file with or furnish to the SEC the continuous disclosure documents that we are required to file in Canada under Canadian securities laws. In addition, our officers, directors, and principal shareholders are exempt from the reporting and short-swing profit recovery provisions of Section 16 of the Exchange Act. Therefore, our shareholders may not know on as timely a basis when our officers, directors and principal shareholders purchase or sell Common Shares, as the reporting periods under the corresponding Canadian insider reporting requirements are longer.
As a foreign private issuer, we are exempt from the rules and regulations under the Exchange Act related to the furnishing and content of proxy statements. We are also exempt from Regulation FD, which prohibits issuers from making selective disclosures of material non-public information. While we comply with the corresponding requirements relating to proxy statements and disclosure of material non-public information under Canadian securities laws, these requirements differ from those under the Exchange Act and Regulation FD and shareholders should not expect to receive the same information at the same time as such information is provided by United States domestic companies. In addition, we may not be required under the Exchange Act to file annual and quarterly reports with the SEC as promptly as U.S. domestic companies whose securities are registered under the Exchange Act.
In order to maintain our status as a foreign private issuer, a majority of the Common Shares must be either directly or indirectly owned by non-residents of the United States unless we satisfy one of the additional requirements necessary to preserve this status. We may in the future lose our foreign private issuer status if a majority of our Common Shares are held in the United States and if we fail to meet the additional requirements necessary to avoid loss of our foreign private issuer status. The regulatory and compliance costs under United States federal securities laws as a United States domestic issuer may be significantly more than the costs incurred as a Canadian foreign private issuer using the standard foreign form. If we are not a foreign private issuer, we would not be eligible to use the foreign issuer forms and would be required to file periodic and current reports and registration statements on United States domestic issuer forms with the SEC, which are more detailed and extensive than the forms available to a foreign private issuer.
We are an emerging growth company and rely on exemptions from certain disclosure requirements which may make our Common Shares less attractive to investors.
We are an "emerging growth company" as defined in section 3(a) of the Exchange Act (as amended by the JOBS Act, enacted on April 5, 2012), and we will continue to qualify as an emerging growth company until the earliest to occur of: (a) the last day of the fiscal year during which we have total annual gross revenues of USD$1,235,000,000 (as such amount is indexed for inflation every five years by the SEC) or more; (b) the last day of our fiscal year following the fifth anniversary of the date of our first sale of common equity securities pursuant to an effective registration statement under the Securities Act, as amended; (c) the date on which we have, during the previous three year period, issued more than USD$1,000,000,000 in non-convertible debt; and (d) the date on which we are deemed to be a "large accelerated filer", as defined in Rule 12b-2 under the Exchange Act. We will qualify as a large accelerated filer (and would cease to be an emerging growth company) at such time when on the last business day of our second fiscal quarter of such year the aggregate worldwide market value of its common equity held by non-affiliates will be USD$700,000,000 or more.
For so long as we remain an emerging growth company, we are permitted to and intend to rely upon exemptions from certain disclosure requirements that are applicable to other public companies that are not emerging growth companies. These exemptions include not being required to comply with the auditor attestation requirements of Section 404 of SOX. We cannot predict whether investors will find our Common Shares or Warrants less attractive because we rely upon certain of these exemptions. If some investors find our Common Shares or Warrants less attractive as a result, there may be a less active trading market for the Common Shares or Warrants and the price per Common Share and Warrant may be more volatile. On the other hand, if we no longer qualify as an emerging growth company, we would be required to divert additional management time and attention from our development and other business activities and incur increased legal and financial costs to comply with the additional associated reporting requirements, which could negatively impact our business, financial condition and results of operations.
Our failure to meet the continued listing requirements Nasdaq could result in a delisting of our securities.
If we fail to satisfy the continued listing requirements of Nasdaq, such as minimum bid price requirements, Nasdaq may take steps to delist our Common Shares and Warrants. Such a delisting would have a materially adverse effect on the price of our Common Shares and Warrants, impair the ability to sell or purchase our Common Shares and Warrants when persons wish to do so, and materially adversely affect our ability to raise capital or pursue strategic restructuring, refinancing or other transactions on acceptable terms, or at all. Delisting from Nasdaq could also have other negative results, including the potential loss of institutional investor interest and fewer business development opportunities, as well as a limited amount of news and analyst coverage. In the event of a delisting, we would attempt to take actions to restore our compliance with Nasdaq's listing requirements, but we can provide no assurance that any such action taken by us would allow our securities to become listed again, stabilize the market price or improve the liquidity of our securities, prevent our Common Shares from dropping below the Nasdaq minimum bid price requirement or prevent future non-compliance with Nasdaq's listing requirements.
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ITEM 4. INFORMATION ON THE COMPANY
A. History and Development of the Company
Name, Address and Incorporation
KWESST Micro Systems Inc. is a corporation domiciled in Canada and was incorporated under the BCBCA on November 28, 2017. We develop and commercialize next-generation tactical systems for military, security, and personal defense markets. Key market segments and solutions addressed by our proprietary solutions are:
(i) non-lethal products with broad application in the professional and personal defense market,
(ii) modernized digitization of tactical teams for shared real-time situational awareness in the military and civilian markets, and
(iii) counter-measures against threats such as drones, lasers and electronic detection for the military market.
Our business activities are carried on by our wholly-owned subsidiaries, see Item 4.C. - Organizational Structure.
Our registered office is located at 2900 - 550 Burrard Street, Vancouver, British Columbia V6C 0A3 and our principal place of business is located at 155 Terence Matthews Crescent, Unit #1, Ottawa, Ontario, Canada, K2M 2A8.
Our Common Shares are listed and posted for trading on Nasdaq under the symbol "KWE", the TSXV under the trading stock symbol "KWE.V" and the Frankfurt Stock Exchange under the stock symbol of "62U". Our Warrants are listed and posted for trading on Nasdaq under the symbol "KWESW".
Following the closing of the Qualifying Transaction on September 17, 2020 (as defined below) pursuant to the policies of the TSXV, we changed our fiscal year end from December 31st to September 30th.
The SEC maintains an internet site at http://www.sec.gov/edgar that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. Our internet site is https://www.kwesst.com; our telephone number is (613)319-0537.
Events in the Development of the Business
All share-related information presented in this section gives effect to the one for seventy (1-for-70) reverse stock split of our Common Shares that occurred on October 28, 2022 (the "Reverse Split") - see Item 4.A. - History and Development of the Company - Recent Developments.
Inception to 2019 Highlights
KWESST was formed in April 2017 by Jeffrey MacLeod, our President and Chief Executive Officer ("CEO") and director and promoter. KWESST was founded to pursue advanced projects within the defense and security fields. We opened our offices in Ottawa, Ontario in May of 2017 and began development of what would become our core technology, TASCS. Our TASCS consists of a sensor package mounted to a soldier weapon and a display running a user interface program typically known as the Battlefield Management System ("BMS").
Between May and September of 2017, we developed the first-generation prototype of the sensor package forming part of TASCS, combined with a basic BMS system. KWESST started to collaborate with a United States military drone supplier, AeroVironment, Inc. ("AeroVironment").
In March 2018, we successfully integrated AeroVironment's drone data feed into KWESST's TASCS.
From April 20, 2018 to December 14, 2018, KWESST completed several financings (collectively "KWESST 2018 Financing") in the amount of $940,255 by way of revenue sharing agreements, related party loans and 10% convertible debentures to fund our working capital requirements.
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2019 Highlights
On April 12, 2019, we won our first contract with AeroVironment valued at USD$100,000. In August 2019, we were in discussions with AeroVironment for a further contract to integrate our TASCS IFM with AeroVironment's Augmented Weapon Sight technology for the preproduction development of 60mm and 81mm mortar and machine gun mounts. This was delayed to April 2020 due to COVID-19 restrictions.
On October 1, 2019, we entered into an executive service agreement with DEFSEC Corporation ("DEFSEC") in which its CEO, David Luxton, agreed to serve as our Executive Chairman (refer to Compensation for remuneration information).
On October 24, 2019, we completed a private placement of Common Shares for gross proceeds of $1,015,000 at a price of $14 per share, resulting in the issuance of 72,500 Common Shares (the "October 2019 Private Placement").
On October 24, 2019, the revenue sharing agreements and convertible debentures that we issued as part of the KWESST 2018 Financing were settled by the issuance of: (i) 44,350 Common Shares, and (ii) $234,515 in principal amount of convertible notes, bearing interest at a rate of 10% per annum (the "KWESST 2019 Convertible Notes").
On November 18, 2019, we entered into a non-exclusive licensing agreement (the "AerialX Licensing Agreement") with AerialX and licensed a technology required to manufacture, operate and use a drone whose principal function and purpose is to act as a projectile to intercept aerial threats using kinetic force (the "Licensed Technology").
During the quarter ended December 31, 2019, we started developing proprietary laser defense products to protect ground forces from a portable laser attack weapon developed and produced by a foreign adversary.
Fiscal 2020 Highlights
On January 30, 2020, we completed a private placement of 37,500 Common Shares at a price of $28 per Common Share for gross proceeds of $1,050,000.
On March 1, 2020, we entered into a consulting agreement with SageGuild to provide United States business development support to facilitate the integration of our solutions/services into the U.S. Department of Defense markets. The monthly consulting fee comprised of cash and 435 Common Shares at a price of $35 per share. In preparation for a go-public transaction, the Common Shares issuable in satisfaction of the consulting fee were amended to stock options starting from May 31, 2020, in which the exercise price was satisfied by services rendered by SageGuild.
On March 25, 2020, we completed a private placement of 12,082 Common Shares at a price of $35 per Common Shares for gross proceeds of $422,875.
On April 30, 2020, Foremost Ventures Corp. ("Foremost"), together with its wholly owned subsidiary, Subco, entered into an amalgamation agreement ("Amalgamation Agreement") with KWESST Inc. pursuant to which Subco and KWESST Inc. agreed to amalgamate (the "Amalgamation") to complete an arm's length qualifying transaction, in accordance with the policies of the TSXV (the "Qualifying Transaction" or "QT").
On April 25, 2020, AeroVironment issued an additional purchase order valued at USD$635,000 to provide increased capability to the AWS system. This generated approximately $530,000 of revenue in fiscal year 2020.
On May 8, 2020, we issued an aggregate amount of $1,115,034 in convertible notes comprised of (i) $1,081,504 in principal amount of convertible notes convertible at $31.50 per Common Share, bearing interest at a rate of 15% per annum ("KWESST May 2020 Private Placement Convertible Notes") and (ii) a convertible note with a principal amount of $33,530 issued to a third party for services rendered in connection with the private placement, all of which convertible notes (including accrued interest thereon) were automatically converted into 37,275 Common Shares upon closing of the Qualifying Transaction on September 17, 2020. Additionally, as an inducement, the note holders were entitled to receive 25% of the principal amount in the form of Common Shares based on a stock price of $31.50 per share, resulting in the issuance of 8,583 Common Shares concurrently with the above conversion event.
On June 12, 2020, we entered into a technology agreement (the "GhostStep Technology Purchase Agreement") with SageGuild pursuant to which KWESST acquired GhostStep technology. We have since rebranded it as Phantom. The total purchase consideration was valued at approximately $482,000. For further information see Item 4.A. - History and Development of the Company - Principal Capital Expenditures and Divestitures.
On July 9, 2020, KWESST issued 62,994 subscription receipts of KWESST at $49.01 per subscription receipt for aggregate gross proceeds of approximately $3,087,138, before share issuance costs. As part of the Qualifying Transaction, in September 2020, the 62,994 subscription receipts were converted into Common Shares of KWESST, which were subsequently cancelled, and Common Shares were issued in exchange therefore.
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On July 20, 2020, we won a contract with a United States military customer valued at USD$405,000 to integrate our TASCS IFM with a mortar system.
On September 17, 2020, KWESST completed the Qualifying Transaction with Foremost. The Amalgamation was structured as a three-cornered amalgamation and, as a result, the amalgamated corporation, named "KWESST Inc.", became a wholly owned subsidiary of Foremost, which changed its name to "KWESST Micro Systems Inc.". Immediately following the completion of the Amalgamation, there were 589,516 Common Shares outstanding, and the former shareholders of KWESST Inc., along with the holders of the subscription receipts and convertible notes of KWESST Inc., owned approximately 97.8% of the issued and outstanding Common Shares. This constituted a reverse acquisition for accounting purposes under IFRS.
On September 22, 2020, the Common Shares began trading on the TSXV under the stock symbol "KWE".
Fiscal 2021 Highlights
On December 16, 2020, following successful trials, a United States military customer awarded a follow-on order of USD$799,000 with new hardware and software requirements coupled with additional military trials.
On January 14, 2021, we entered into a definitive technology purchase agreement (the "DEFSEC Purchase Agreement") to acquire the Low Energy Cartridge technology from DEFSEC, a proprietary non-lethal cartridge-based firing system (rebranded as the "PARA OPS" system) for a total purchase consideration of approximately $2.9 million, subject to closing conditions. For further information, see Item 4.A. - History and Development of the Company - Principal Capital Expenditures and Divestitures.
On February 4, 2021, the Common Shares commenced quotation on the OTCQB under the stock symbol "KWEMF."
On April 5, 2021, KWESST and AerialX entered into an amended and restated license agreement in which we obtained exclusive rights to gain exclusive rights to manufacture, operate, and use its drone for the C-UAS (Counter Unmanned Aerial Systems) market, for the United States Department of Defense and Canada's Department of National Defense. For further information, see Item 4.A. - History and Development of the Company - Principal Capital Expenditures and Divestitures.
On April 29, 2021, we completed a private placement of 51,087 units at a price of $87.50 per unit for gross proceeds of $4,470,071 (the "April 2021 Private Placement"), as amended in August 2021. Each unit consisted of one Common Share and seventy Common Share purchase warrants, exercisable to acquire 1/70 of a Common Share at a price of $1.75 each (70 warrants for one Common Share) for a period of 24 months. Following this closing, we also closed the acquisition of the PARA OPS system on same day.
On July 9, 2021, we held our first live demonstration of the PARA OPS system in Whistler, British Columbia. Following this successful live demonstration, on July 12, 2021, we announced details of our commercialization road map for the PARA OPS system, including the unveiling our products at the 2022 SHOT Show® in Las Vegas, Nevada to be held on January 18-21, 2022.
On July 21, 2021, we announced that Brandon Tatum agreed to be our strategic advisor and advocate for the LEC System. Mr. Tatum is a former Tucson Police Officer and runs a successful You-Tube channel called "The Officer Tatum", with over 1.9 million subscribers, as well as other social media platforms and a nationally syndicated radio show on the Salem Radio Network.
On August 31, 2021, the Common Share purchase warrants issued in the April 2021 Private Placement were listed for trading on the TSXV under the stock symbol "KWE.WT."
On September 16, 2021, we completed a private placement of 10,714 units at a price of $140 per unit for gross proceeds of $1,500,000 (the "September 2021 Private Placement"). Each unit consisted of one Common Share and seventy Common Share purchase warrants, exercisable at a price of $2.35 for each 1/70 of a Common Share (70 warrants for one Common Share) for a period of 24 months.
On September 28, 2021, we announced our strategic partnership with Stryk Group USA for the commercialization of our PARA OPS system in the United States.
Fiscal 2022 Highlights
On October 4, 2021, we announced the introduction to market of our Phantom electronic battlefield decoy, including advanced negotiation with a global defense contractor to provide Phantom units as part of a contractor tender for armored vehicles to a large North Atlantic Treaty Organization ("NATO") customer. There are only two bidders that have qualified for this opportunity.
On October 13, 2021, we announced that we are accelerating the readiness of deployable and man-wearable BLDS for first deliveries available by end of Q1 Fiscal 2022, following military interest from a number of NATO land and Special Operation Forces at the signature European defense show, DESI, which took place in London, UK, on September 13 to 18, 2021. While no deliveries took place in Fiscal 2022, on November 2, 2022, we won our first customer order of USD$330,000 for an overseas NATO country through a defense trading and consulting agency. These BLDS units are to be mounted and integrated on a new combat patrol vehicle for the end customer. Through this initial order, we are well positioned to supply a higher quantity of BLDS to this customer, who has asked for budgetary pricing on a follow-on quantity of BLDS units.
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Completion of the overseas NATO country contract requires activation of certain capabilities designed into the BLDS system, notably a software bridge from the hardware sensors to a standard threat library of laser signatures, which is underway. A custom threat library may also be required by the customer who has meanwhile asked for budgetary pricing for almost two dozen additional BLDS units subject to satisfactory completion of the existing contract and successful test and evaluation.
Our BLDS technology, as developed, is designed to include a number of capabilities for technology upgrade and insertion into existing systems, in a "system of systems" architecture, for a next-generation advance over legacy laser detection systems.
Activation and/or adaptation of these advanced capabilities may require customization and integration into platforms such as armored vehicles and electro-optical pods.
One developmental variant of our BLDS that the Company is working on is a universal micro sensor that can be soldier worn or mounted on vehicles or other assets. If successful, this would facilitate a mass network of standardized micro laser sensors/detectors in the battlefield in a common platform for manufacturing at scale.
On November 12, 2021, we announced that General Dynamics Land Systems ("GDLS") selected KWESST's Phantom electronic battlefield decoy as part of its ongoing efforts to develop a next generation multi-domain mobile capability at the tactical level. If GDLS wins the contract with their United States military customer, we have estimated the potential value for this contract to KWESST could be more than USD $40 million, depending on the number of Phantom units per military vehicle and final pricing based on volume. Accordingly, there is no assurance that we will be awarded this contract or if we are, what the value of such contract will be to KWESST.
On November 15, 2021, we conducted a live fire demonstration of our initial non-lethal cartridge-based single shot device for investors near Toronto, Ontario, including an opportunity for these investors to use the devices. Further, on January 14, 2022, we announced the unveiling of our non-lethal cartridge-based products under the brand PARA OPS at the 2022 SHOT Show® in Las Vegas held on January 18th to 21st 2022.
On November 23, 2021, in connection with an updated capital markets strategy, we submitted our initial application to list our Common Shares on Nasdaq.
On December 2, 2021, we announced that we engaged the New York-based public relations firm AMW Public Relations to lead our public relations, brand strategy, and media communication initiatives.
On December 8, 2021, our United States military customer accepted the delivery of the final milestone of the US $0.8 million relating to the integration of our TASCS IFM with the 81 mortar system. Final payment was received in January 2022.
On December 14 and 16, 2021, we announced that we signed a Master Services Agreement with GDMS - Canada to support the development of digitization solutions for future Canadian land C4ISR programs. We estimated the contract's value to KWESST to be up to $1.0 million over the next 12 months.
On December 15, 2021, we completed the non-cash acquisition of Police Ordnance Company Inc. ("Police Ordnance") - see Item 4.A. - History and Development of the Company - Principal Capital Expenditures and Divestitures for further details. On January 10, 2022, we announced that Police Ordnance received orders from law enforcement agencies for approximately $0.4 million in ARWEN products, all have since been delivered as of the date of this Annual Report. However, as most of the shipments related to open customer orders at the acquisition date, these were not recorded as revenue during the quarter but rather as a reduction of intangible assets in accordance with IFRS.
From January 18th to 21st 2022, we showcased our initial PARA OPS single shot device at the 2022 SHOT Show® held in Las Vegas. Since this event, we have continued to make further improvements to this device based on positive feedback from the SHOT Show®.
On February 11, 2022, we filed United States patent application No. 17/669,420 claiming priority to a provisional patent application serial 63/148,163 by the USPO for our PARA OPS system.
On March 11, 2022, we closed a non-secured and non-convertible loan financing transaction with a syndicate of lenders for aggregate loan proceeds of $1.8 million and an additional $0.2 million on March 15, 2022, for a gross total of $2.0 million (the "Unsecured Loans"). The Unsecured Loans bear interest at a rate of 9.0% per annum, compounded monthly and not in advance, and have a maturity of thirteen months, with KWESST having the option to repay the whole or any part of the Unsecured Loans, without penalty or premium, at any time prior to the close of business on the maturity date. The principal amount is due only at maturity. As part of the terms of the Unsecured Loans, we issued an aggregate of 14,286 bonus Common Shares to the lenders. These Common Shares were issued pursuant to prospectus exemptions of applicable Canadian securities laws and therefore subject to a four-month plus one day trading restriction.
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On March 29, 2022, the Common Shares commenced trading on the Frankfurt Stock Exchange under the stock symbol "62U."
On April 4, 2022, with the war in Ukraine, we announced that we were auctioning a number of NATO and non-NATO country requests for quotations of our Phantom electronic decoy and laser detection products.
On April 22, 2022, we issued 875 Common Shares to the selling shareholders of Police Ordnance as a result of achieving the performance milestone as defined in the share purchase agreement.
On April 25, 2022, we announced that we engaged RedChip Companies ("RedChip") to lead our investor relations efforts in the United States, in advance of our pending Nasdaq listing. Headquartered in Orlando, Florida, RedChip provides investor relations, financial media, and research for microcap and small-cap stocks.
On July 6, 2022, we won our first CISM related contract and entered into a three-year contract with Counter-Crisis Technology Inc. to design, develop, and implement a significant component of a national Ground Search and Rescue Incident Command System for Public Safety Canada, with the Ontario Provincial Police as technical advisory stakeholder for this project. The total contract value is approximately $0.7 million, net of in-kind contributions of $76,000, over three years of services commencing in late July 2022. Either party may, at any time and for any reason, terminate the contract for convenience upon at least 30 business days' notice. In the event of termination for convenience, we may recover only the actual cost of work completed to the date of termination in approved units of work or percentage of completion.
On July 14, 2022, we closed a non-brokered private placement, resulting in the issuance of 22,857 units of KWESST, at a price of $15.05 per unit, for aggregate gross proceeds of $0.34 million. Each unit consisted of one Common Share and seventy one-half Common Share purchase warrants, exercisable at a price of $0.285 each per share for a period of 24 months. Each Warrant converts into 0.01428571 Common Shares or 70 warrants for one Common Share. Certain of our directors and officers participated in the amount of $87,500.
On August 16, 2022, we announced that we publicly filed a registration statement on Form F-1 with the SEC relating to a proposed public offering in the United States of common units (the "U.S. Common Units"), consisting of one Common Share and a warrant to purchase one Common Share, and pre-funded units, consisting of a pre-funded warrant to purchase one Common Share and a warrant to purchase one Common Share (the "U.S. IPO").
On August 29, 2022, we announced that we closed two non-secured loans in the amount of USD$200,000 per loan with a third party lender for an aggregate amount of USD$400,000. The first non-secured loan of USD$200,000 bears interest of 6% per annum and will mature on August 31, 2023. In connection with the first non-secured loan, we issued 4,239 bonus shares to the lender. The second non-secured loan of USD$200,000 (the "Second Loan") bears interest of 6% per annum and will mature on August 31, 2023. For both loans, the repayment will be 110% of its principal and both loans are senior to our other unsecured indebtedness. The Second Loan contains certain provisions allowing us to apply to the TSXV to repay the principal amount by issuing Common Shares in accordance with the rules and regulations of the TSXV.
On September 13, 2022, we announced the commencement of an underwritten public offering in Canada of units (the "Canadian Units") consisting of one Common Share and one Common Share purchase warrant for gross proceeds of approximately USD$3 million (the "Canadian Offering") following the filing of a preliminary short form base PREP prospectus with the securities regulatory authorities in each of the provinces of Canada, except Québec.
Fiscal 2023 Highlights
On October 28, 2022, in advance of the Nasdaq listing, we effected the Reverse Split of our common shares (the "Common Shares") to meet Nasdaq's initial listing requirements. All information respecting outstanding Common Shares and other securities of KWESST, including net loss per share, in the current and comparative periods presented in this Annual Report give effect to the Reverse Split.
On November 2, 2022, we won our first customer order from an overseas NATO country for our BLDS product (see Item 4.B. - Business Overview - Principal Products and Services). These BLDS are for Special Forces who will be battle-testing the system in operational conditions. Subject to successful testing, we expect follow-on requirements, though there is no assurance there will be any follow-on orders.
On December 6, 2022, our Common Shares and the Warrants offered in the U.S. IPO were approved for trading on Nasdaq under the symbols "KWE" and "KWESW", respectively, and commenced trading on December 7, 2022. The SEC declared our Form F-1 Registration Statement effective on December 6, 2022.
On December 9, 2022, we announced the closing of the U.S. IPO and Canadian Offering, for aggregate gross proceeds of USD$14.1 million. In the U.S. IPO, we sold 2,500,000 U.S. Common Units at a public offering price of USD$4.13 per unit. Each Common Unit consisted of one Common Share and one Warrant. The Warrants sold in the U.S. IPO have a per share exercise price of USD$5.00, can be exercised immediately, and expire five years from the date of issuance. These Warrants are listed on the Nasdaq under the symbol "KWESW". In connection with the closing of the U.S. IPO, the underwriter partially exercised its over-allotment option to purchase an additional 199,000 pre-funded common share purchase warrants and 375,000 Warrants. In the Canadian Offering, we sold 726,392 Canadian Units at a price to the public of USD$4.13 per unit. The Canadian Warrants have a per Common Share exercise price of USD$5.00, are exercisable immediately and expire five years from the date of issuance. The Canadian Warrants are not listed on any exchange.
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On January 30, 2023, we announced the highlights of the 2023 SHOT SHOW where the Company's new PARA OPS products and its ARWEN non-lethal launcher were showcased, in Las Vegas. The Company was invited to demonstrate and brief its ARWEN 37mm launcher system two symposiums in 2023 to highlight the effectiveness of the ARWEN platform for crowd control and for SWAT teams conducting high-risk arrests.
On February 14, 2023, we announced that the Company was showcasing its products at IDEX in Abu Dhabi, United Arab Emirates, and to exhibit and speak at Future Soldier 2023 Technology Conference in London, United Kingdom, as part of our international market development program.
On February 27, 2023, we announced the key business pursuits arising from IDEX in Abu Dhabi, United Arab Emirates including: (i) a digitization project to provide first responders with shared, real-time situational awareness in critical incident response; (ii) a digitization project to feed video footage directly to shipborne and ground personnel from airborne platforms conducting maritime patrol operations in the Gulf; (iii) equipping police and security forces in the MENA region with the Company's new PARA OPS non-lethal system through distributors the Company met with; and (iv) potential co-ventures with UAE defense technology agencies and financial partners, arranged through the Company's investment bankers, Think Equity, New York.
On March 1, 2023, we announced that Steven Archambault stepped down as Chief Financial Officer ("CFO") of the Company to pursue a new opportunity overseas.
On March 17, 2023, we announced the prospect of new European opportunities with military and major defense industry suppliers arising from our presentation at the Future Soldier Technology conference and its subsequent meetings in the United Kingdom.
On March 24, 2023, we announced that a G7 capital police force had adopted the Company's new Overwatch Commander system for critical incident management.
On April 3, 2023, we announced that David Luxton assumed the role of Interim CFO in addition to his role as Executive Chairman.
On May 2, 2023, we announced that the Company received notice of a contract award under a joint venture with two other defence industry partners, to perform software systems engineering work for the Canadian Department of National Defence for approximately $20 million over a span of five years.
On May 29, 2023, we announced that at CANSEC 2023, the Company planned to feature its capability to rapidly integrate and exploit digital information for the dismounted and mounted soldier to more than thirty visiting countries, including Team Awareness Kit integration, Tactical Digital Fires System and Command and Control On The Move, all vital aspects of soldier modernization for survivability.
On May 30, 2023, we announced the appointment of Sean Homuth as CFO and Chief Compliance Officer, effective June 12, 2023.
On July 19, 2023, we announced that we had entered into definitive agreements with a group of accredited and institutional investors for the issuance and sale of the Company's common shares (or common share equivalents) on a brokered private placement basis, for aggregate gross proceeds of approximately US$5.6 million (the "July 2023 Private Placement"). On July 21, 2023, we announced the closing of the offering and the issuance and sale of 2,472,742 common shares (or common share equivalents), for aggregate gross proceeds of US$5,588,396.92. As a part of the offering, the Company issued 1,542,194 common shares at a price of US$2.26 per common share and 930,548 pre-funded warrants at a price of US$2.259 per pre-funded warrant, with each common share and pre-funded warrant being bundled with one common share purchase warrant of the Company. As compensation for services rendered, the Company paid to ThinkEquity LLC ("ThinkEquity") a cash fee of $475,013.14 representing 8.5% of the aggregate gross proceeds of the offering and issued 123,637 warrants to purchase a number of common shares.
On July 25, 2023, we announced that we had filed a U.S. patent application for the core module of our next-generation Battlefield Laser Detection System branded "BlaDE", and that we will make the BlaDE module available as a plug-and-play offering to third-party OEMs for incorporation into their new and legacy electro-optical systems on armored vehicles.
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Recent Developments
On October 18, 2023, we announced that we are developing a patent-pending SaaS product for public safety agencies to enable "lightning fast" real-time shared situational awareness among front-line responders during critical incidents. Built using the "TAK" - the U.S. government Team Awareness Kit software at the foundation, the solution addresses the issues of scalability, interoperability, and time to engagement while customizing the user experience to meet the demands of the specific mission sets that responders encounter.
On October 24, 2023, we announced that we received Notice of Allowance for the Luxton Low Energy Cartridge (LEC) patent from USPTO and notification that the USPTO will issue the patent October 31, 2023.
On October 31, 2023, we announced that our intention to issue 46,706 common shares at a deemed price per share of $2.09 in settlement of a debt in an amount of approximately $97,615. The debt resulted in a tail obligation relating to services rendered by a third-party consultant, which the Company has elected to pay in common shares.
On October 31, 2023, Jeff MacLeod retired from his position as President and CEO of the Company.
On November 6, 2023, we announced that we expect the DSEF program to begin contributing revenue for the Company in the first quarter of Fiscal 2024.
On November 13, 2023, we announced the reorganization of our cross-border U.S.-Canada facilities, and our plans to expand the ARWEN business, including the introduction of a new 40mm cartridge for third-party riot control launchers used when public protests turn violent.
On November 27, 2023, we announced our Board of Directors (the "Board") had appointed Sean Homuth as President and CEO and Kris Denis as interim CFO.
On December 6, 2023, we announced that General (Retired) Rick Hillier was appointed to the Board.
On December 13, 2023, we announced that the non-lethal PARA OPS and Arwen products will be available for law enforcement to purchase online.
Principal Capital Expenditures and Divestitures
We made the following capital expenditures over the last three financial years.
Fiscal 2023
Fiscal 2022
Fiscal 2021:
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B. Business Overview
Principal Products and Services
KWESST Micro Systems Inc. is an early-stage technology company that develops and commercializes next-generation tactical systems for military and security forces and public safety markets.
As an early-stage technology company, we develop and commercialize next-generation technology solutions that deliver a tactical advantage for military, public safety agencies and personal defense markets. Our product development has focused on three niche market segments as follows:
Our core mission is to protect and save lives. At Fiscal 2023 year-end we began to group our offerings for commercialization purposes into Military and Public Safety missions.
KWESST's Military offerings are comprised of:
Digitization: real-time data sharing at the tactical level, including integration with Battlefield Management Applications (BMS) including ATAK and TAK.
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Digitized firing platforms ("Digital Fires" or "Joint Fires").
Battlefield Laser Detection Systems ("BLDS").
Digitized Electro Magnetic Spectrum Operations ("Phantom").
KWESST's Public Safety offerings are comprised of:
KWESST Lightning: leverages the Company's military digitization technology to provide responders to any type of incident with instant onboarding to the mission and TAK-enabled real-time situational awareness software as a service ("SaaS").
Non-Lethal Munitions Systems
PARA OPS, a next-generation non-lethal system just being introduced to market now.
ARWEN 37mm system, plus a new 40mm munition
Strategy
Our strategy is to pursue and win large defense contracts with prime defense contractors for programmatic revenue visibility several years out, while at the same time exploiting book-and-ship business in the public safety market where it is possible to drive sales and where the sales cycle is typically shorter.
The following is a summary of our main product and service categories for each business line:
| Non-Lethal | Digitization | Counter-Threat | ||
| PARA OPS products: Non-reciprocating devices:
Reciprocating devices
| Products:
| Products:
|
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Non-Lethal Products
Non-reciprocating PARA OPS devices
We are in the LRIP phase for the .67 caliber single shot and multi-shot devices. We expect to complete our sales, marketing and distribution plan and begin the higher volume production phase for these devices during our second quarter of Fiscal 2024, which ends March 31, 2024. Both will be offered to the public safety market, including our proprietary projectiles for these devices.
 |  | |
| (Single shot) | (Pro 5 Magnum) |
(Proprietary cartridge and projectile)
We plan to offer three types of payload for projectiles based on customer needs:
Reciprocating PARA OPS devices
We plan to begin the design and prototype of PARA OPS high-capacity automatic pistols and carbines (referred as reciprocating devices) for non-lethal operations and force-on-force training in Q2 of Fiscal 2024.
See below for further details of our projected product development cycle and estimated additional investment to reach full commercialization for our PARA OPS devices.
ARWEN launchers
As a result of the Police Ordinance Acquisition, we are currently selling the following ARWEN products and related ammunition to law enforcement agencies:
 |  |
| (Multi-shot launcher) | (Single-shot launcher) |
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Digitization
For the Digitization business line, our products share the same core technology platforms and leverage our domain knowledge, proprietary sensor-software integration, algorithms and electronic circuity in order to develop and deliver integrated solutions to our clients who operate in the primarily dismounted domain (i.e., away from supporting platforms such as vehicles, aircraft and armored vehicles):
The following is a summary of our Digitization main products that became ready for commercialization in Fiscal 2023, subject to customer orders and primarily through OEM partnerships involving Digital Fires or Joint Fires.
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 | TASCS Indirect Fire Module • The TASCS IFM equips existing direct and indirect weapons systems with a sensor pack, that accurately locates the weapon on the battlefield and provides a high-resolution bearing line indicating the direction in which the weapon is pointed. When connected to a display, and combined with our ballistic algorithm built into ATAK, the operator can engage targets in less time and with greater accuracy. When networked across an ATAK-based network, targeting information can be received from and on any source of the network, and once a weapon is activated in the integrated fires modules systems mode, the impact point of the ammunition is displayed on all systems, giving friendly forces the ability to know if they are inadvertently being targeted and to take appropriate action. It also enables all networked systems to see where potential targets are and who is engaging them. The TASCS IFM is utilized primarily on systems that ordinarily require the user to have direct line of sight to the target, leaving them exposed. With TASCS IFM, they can engage from positions of cover and at longer distances, improving safety and survivability of the user. • TASCS IFM can be developed for any weapon type; particualrly crew served direct and indirect firing systems such as Artillery, Mortars, Anti-Armour, Heavy and Medium Machine Guns, Sniper Systems, etc. |
 | TASCS Networked Observation and Reconnaissance System ("TASCS NORS") • The TASCS NORS consists of a sensor package mounted to a soldier weapon and a display running a user interface program typically known as battlefield management system. The TASCS equips sniper weapons and spotters’ stations with sensor packages that allow them to be accurately located on the battlefield. TASCS NORS is equipped with cameras that allows viewing through the snipers’ sight or the spotters’ scope on the display device provided. The systems are networked through the user’s communication network to allow the sharing of target information and imagery. Target information can be shared between the sniper and the spotter, and to all TASCS equipped systems in the network. With the TASCS system, target information can readily be passed, including a picture of the target, helping reduce incidents of friendly fire and collateral damage. |
 | Critical Incident Management System Comprehensive Critical Incident Management System architecture and Solution: Native Cloud-based Microsoft environment (MS Azure) with Team Awareness Kit (TAK) Seamless INTEGRATION and FUSION of crucial real-time position location, imagery, and targeted time-sensitive emergency services data and information for the effective and coordinated delivery of emergency services Supporting stakeholders from Emergency Operations Centres (EOC), Incident Command Post (ICP), Incident Commanders, and all first responders whether mobile or dismounted Data managed and stored in compliance with NFPA 1600 |
Counter Threats
We offer the following proprietary next-generation counter-threat solution to protect against hostile enemy lasers, electronic detection, and drones.
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 | Phantom • Our Phantom is a compact portable multi-function device that includes the ability to emulate the electronic communications of any NATO country in order to spoof adversaries as to the location of NATO forces. • Our Phantom is a patented version of much larger vehicle-mounted Electronic Warfare systems. Its small size means it can be deployed at the tactical level by ground personnel or by drones or mounted on light tactical vehicles. |
 | Battlefield Laser Defense System • BLDS is a unique, proprietary system that detects and can locate lasers and alert ground personnel with KWESST’s networked Digitization applications. • We have three variant o BLDS: individual personnel-worn, squad version, and vehicle mounted for mobile operations. |
Other products under development
In Q4 Fiscal 2021, we partnered with Alare in the United States to establish the technical feasibility of a kinetic system to neutralize small Unmanned Aircraft Systems ("UAS") and loitering munitions without collateral damage. The nature of our contract with Alare is of a short-term consulting agreement in which we agree to pay for engineering services as rendered. This drone project, referred to as GhostNet, is currently paused while we assess market interest and focus on the commercialization of PARA OPS and pursue other Digitization sales opportunities for near-term revenue generation. We discontinued further investment in another drone project under development, referred as GreyGhost, which was a licensed technology with AerialX Drone Solutions Inc. ("AerialX") providing a kinetic interceptor that could use multiple methods to engage target drones. To date, AerialX has not successfully delivered a functioning prototype.
We have also started the development of Shot Counter which is largely based on the same sensor technology as the TASCS, and which can be incorporated into a firearm in order to count the number of rounds fired by the weapon. It is a small device that fits inside the pistol grip of most weapons, and functions with no user input for up to ten years on a single battery. Today we have reached the proof-of-concept design; but, have not yet built a prototype. This project is on hold due to other priority projects.
Over the last three financial years we have made significant investment to further advance our product development and position ourselves with OEM partners for expected commercialization during Fiscal 2023. We also concluded two acquisitions, the PARA OPS and Phantom solutions. At the moment, only the ARWEN product line is considered to be in full production.
The following table provides an update of our current product development cycle by product line and estimated timeline by quarter (fiscal year ended September 30th) to reach production:
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| Concept & Design | Prototype(1) | Market Testing(2) | LRIP Production(3) | Higher Volume Production(4) | |
| PARA OPS– single shot device (5) | Completed | Completed | Q3 FY23 – Ongoing  | Q4 FY23 – Q1 FY24  | Q1-Q2 FY24 |
| PARA OPS– Pro 5 Magnum (5) | Completed | Completed | Q3 FY23 – Ongoing | Q4 FY23 – Q2 FY24 | Q3-Q4 FY24 |
| | ||||
| PARA OPS – reciprocating devices | Q2 FY24 | Q3 FY24 | Q3FY24 | Q4 FY24 | Q1 FY25 |
| | | | ||
| TASCS IFM | Completed | Completed | Ongoing | Ongoing | Underway |
| BLDS | Completed | Completed | Ongoing | Ongoing | Underway |
Notes:
(1) Includes prototype Version 1 (V1), integration, and testing.
(2) Includes field testing and prototype V2.
(3) "Low Rate Initial Production". Includes final product development, LRIP, and sales demonstration units. A product is not ready for pre-production until it reaches Technology Readiness Level (TRL) of 5 to 6.
(4)Actual volumes subject to market demand for KWESST's product.
(5) Includes the cartridges for the devices.
We consider a product to have reached the commercialization phase when we have begun LRIP and we have a sales, marketing, and distribution plan for the product.
Principal Markets
Our total revenues by category of activity and geographic market for each of the last three financial years were as follows:
| Year ended | Year ended | Year ended | |||||||
| September 30, | September 30, | September 30, | |||||||
| 2023 | 2022 | 2021 | |||||||
| Major products / service lines | |||||||||
| Digitization | $ | 819,604 | $ | 354,620 | $ | 1,255,982 | |||
| Non-Lethal | 411,758 | 330,658 | - | ||||||
| Training and services | - | 34,590 | - | ||||||
| Other | 3,088 | 1,651 | 19,822 | ||||||
| $ | 1,234,450 | $ | 721,519 | $ | 1,275,804 | ||||
| Primary geographical markets | |||||||||
| United States | $ | 819,604 | $ | 389,210 | $ | 1,238,063 | |||
| Canada | 414,846 | 332,309 | 37,741 | ||||||
| $ | 1,234,450 | $ | 721,519 | $ | 1,275,804 |
Market Opportunities
Non-Lethal
According to Fact.MR: Non-Lethal Weapons Market, April 2023, the global non-lethal weapons market was approximately USD$4.95 billion in 2023 and is projected to reach USD$7.6 billion in 2028 (a 4.3% compound annual growth rate). We plan to target the following two markets, with an initial focus in the United States:
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Our main focus in the short-term is the professional market in the United States and overseas as these represent a major opportunity for our non-lethal security products. According to the U.S. Bureau of Labor Statistics, in the United States there are nearly 917,000 police officers, detectives and criminal investigators. Cases involving police shootings and deaths related to the use of conductive energy devices have increased in the United States. According to The Washington Post, there have been over 6,300 shootings in the United States since 2017 involving police.
A Reuters report estimates that at least 1,000 people have died as a result of being stunned by conductive energy devices in the United States. In over 150 of those deaths, the conductive energy device was determined to be a cause or a contributing factor.
There are several other security-related occupations which we believe are potential customers for our non-lethal products. These include 800,000 private security guards, 346,000 corrections officers and 90,000 private detectives, according to the U.S. Bureau of Labor Statistics. We believe that our PARA OPS products could play a meaningful role in addressing the tragic increase in school shooting events. According to the Naval Postgraduate School's Center for Homeland Defense and Security, there have been approximately 460 shooting events in K-12 schools during the last five years. We believe our non-lethal security products offer school personnel important options to create a tactical advantage in school shootings without using lethal firearms.
According to the U.S. Department of Education, there are over 132,000 elementary and secondary schools and nearly 6,000 colleges and universities in the United States. We believe there is an opportunity to utilize our products to enhance school safety.
Other public spaces such as grocery stores, houses of worship, bars and nightclubs, concert venues, sporting arenas and public transportation centers are also confronted with increased security challenges. Each of these locations represents an opportunity for us as they could improve security without introducing lethal firearms into crowded civilian environments by equipping their employees and security personnel with our non-lethal products.
Other market opportunities that we intend to further explore include the international professional market, realistic force-on-force training for military and police, realistic high-action gaming and animal control, both in the United States and internationally.
The principal market for the ARWEN product line of non-lethal systems is law enforcement, primarily in Canada and United States.
According to Gallup and the United States Census Bureau, as at January 2022, there are approximately 82 million gun owners in the United States. We believe our PARA OPS devices will offer gun owners and members of their households a safer, personal defense option, without the risk of loss of human life.
In addition to personal defense, we believe we have an opportunity to disrupt the recreational market - specifically for paintball guns, which are air-based devices rather than cartridge-based (see Item 4.B. - Business Overview - Competitive Conditions). According to market research by Statista, the paintball gun market size in the United States was $1.3 billion in 2020.
Digitization
The principal market for our digitization business lines is primarily among military and public safety agencies in countries that are members of NATO, as well as Australia and New Zealand. As the largest purchaser and user of military and public safety products, the United States is our primary focus, followed by the other NATO member countries, and to a lesser extent, the Middle and Asia.
In addition to increased military spending in the United States and other members of NATO, another important trend that we have observed is an increase in funding within the military for projects related to precision munitions for weapons already in use by the military (legacy weapons) to further enhance survivability of soldiers and their operational effectiveness. Our TASCS Integrated Fires Module (IFM) products are expected to benefit from these trends by transforming "dumb" legacy weapons into "smart" weapons (with better accuracy) and integration into military "Joint Fires" systems.
For our CIMS offering, our principal market is public safety agencies, primarily in Canada and United States. Public safety agencies across the United States are seeking to implement digital solutions that can improve responder safety and incident management. According to Accenture, digital transformation presents one of the biggest challenges for public safety agencies. Globally, the public safety and security market was USD$435 billion in 2021 and is expected to reach USD$868 billion by 2028, growing at a CAGR of 10.4%, according to Fortune Business Insights. We have evolved a CIMS system under a SaaS model, branded "KWESST Lightning" to appeal to public safety agencies who may find it attractive to adopt this as a service rather than purchase hardware and software.
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The major factors fueling the public safety market include rising instances of mass shooting, natural disasters, terrorist activities and security breaches as well as increasing law enforcement requirements for public safety and investments in public safety measures for smart cities.
Counter Threat
Our BLDS product was developed expressly to address the health and safety threats from weaponized and/or targeting laser devices utilized by adversaries in the field and to aid in the prevention of friendly fire incidents.
Our Phantom product was developed to provide additional protection to friendly forces by confusing adversaries' Electronic Warfare operators, preventing them from targeting our forces.
We are also exploring the counter unmanned aircraft system ("C-UAS") market including loitering munitions. The proliferation of small hostile drones continues to be a growing worldwide problem for military forces, sensitive facilities, and public security agencies. Most counter-drone systems are electronic, designed to detect, identify, track and, if possible, disrupt the communications protocols of drones to prevent completion of their mission. Increasingly, however, drones are being developed by adversaries that are difficult or impossible to disrupt electronically. Military and Homeland Security agencies are therefore seeking alternatives for stopping drones kinetically but without collateral damage. We have been conferring with various C-UAS vendor regarding a system for the domestic market that can be made interoperable with our digitization offerings to provide public safety agency a full solution.
Competitive Conditions
Non-lethal
We expect our competition for non-lethal PARA OPS products will primarily be manufacturers of:
Our competitive advantage is principally our proprietary system consisting of:
Our Executive Chairman was the inventor of PARA OPS. He was previously the founder of SimunitionTM, a manufacturer of non-lethal training ammunition, since sold to General Dynamics. Further, he was also the CEO and Executive Chairman of United Tactical Systems, LLC, a company offering public-safety products for law enforcement, military and personal defense (owns the PepperBallTM brand). Accordingly, he brings a wealth of market knowledge to us. Additionally, our former President and CEO has almost 20 years of firearms manufacturing experience. He was previously the General Manager of Colt Canada (the Canadian division of the American firearms manufacturer). In August 2021, we also hired a senior Technical Manager with over 17 years of firearms manufacturing, he previously held senior roles at Colt Canada including most recently R&D Manager and Product Support Engineering. While we do not build lethal firearms, this experience is very relevant for building our PARA OPS business.
Many air-powered (CO2-powered) devices are complex and less reliable, specifically:
Our patent application with the U.S. Patent and Trademark Office ("USPO") for our proprietary cartridge-based firing system was approved and the patent issued effective October 31, 2023.
For the ARWEN's product line, our primary competitors are the following:
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A further market advantage is the access to the law enforcement market through our ownership of ARWEN, and the strength of its brand, which has been selling non-lethal systems to law enforcement agencies internationally for over 30 years. As a result of our acquisition of Police Ordnance, we believe there are synergies between our PARA OPS and ARWEN products such as access to law enforcement market for PARA OPS, providing a low-energy cartridge for ARWEN launchers and combining facilities and engineering.
We have developed a 40mm ARWEN baton cartridge which we believe has the superior performance of the 37 mm cartridge and is designed to work in most third-party 40mm launchers. We plan to offer this to the law enforcement tactical community and OEMs in Fiscal Q2 of 2024.
Digitization and Counter-Threat
Our competition for digitization and counter threat business lines is primarily:
We are currently not aware of any major direct competitors for our BLDS technology apart from legacy detection systems that provide very basic detection.
Our competitive advantage is the significant experience that our team of engineers and technicians have in soldier systems (which we consider to be any device that a soldier carries onto the battlefield, ranging from a communications device to a sensor), weapons, and sensor fields. Our expertise in the field of networked weapons has been recognized by the United States military who requested that we participate in the NATO working group tasked with developing standards and requirements for these types of networked weapons.
We are also not aware of any major direct competitors for our CIMS.
Seasonality
We do not expect our non-lethal business line will be exposed to seasonality. While our Digitization and Counter-Threat business lines may be affected by national military budgetary cycles, as well as federal, state and local government spending, we expect the various customers having different spending cycles will mitigate our potential cyclicality exposure.
Manufacturing and Availability of Raw Materials
Non-lethal
We have currently outsourced the engineering work for the PARA OPS devices to a third party, with oversight by us. Additionally, we plan to rely upon strategic alliances with OEMs for the manufacturing and distribution of our PARA OPS products.
For the ARWEN launchers, components are outsourced to various suppliers and assembled by an outsourced manufacturer.
Today, we are not aware of material sourcing issues or pricing volatility of raw materials, except for price volatility for certain components to manufacture ARWEN ammunition that will be required for our non-lethal business line (see Item 3.D. - "Risk Factors - We Are Dependent on Key Suppliers for our ARWEN Product Line").
Digitization and Counter-Threat
Today we have assembled a team of engineers, technicians and advisors that have significant experience in soldier systems (which we consider to be any device that a soldier carries onto the battlefield, ranging from a communications device to a sensor), weapons, and sensor fields. It is this combination of disparate knowledge sets that enables us to integrate and develop innovative solutions. We leverage from this same pool of talent to deploy CIMS solutions for the public safety market.
All current product development is done at our facility in Ottawa (see Item 4.D. - "Property, Plants and Equipment"). For as long as market demand justifies a low rate of production quantities, we will internally produce these products. Once demand reaches quantities necessitating commercial-level production quantities, we will outsource our production to companies specifically suited to producing each particular product. We are not aware of any material regulatory approvals that are required for us to outsource production.
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Marketing Plans and Strategies
Non-lethal
Initially we plan to sell our PARA OPS to the professional market which includes law enforcement agencies and then to the consumer market through an e-commerce store and a network of distributors. We plan to hire sales and marketing resources during Q2 Fiscal 2023 for the commercialization of PARA OPS.
For the ARWEN launchers, we plan to continue direct sales to law enforcement agencies, with marketing via tradeshows and social media/web-based.
As part of our marketing efforts, we are planning to attend the following tradeshows to promote all KWESST products and services:
| Tradeshow | Location | Date of Event |
| SHOT Show ATLAS Special Units CANSEC | Las Vegas, USA Marseilles, France Ottawa, Ontario | January 23-26, 2024 April 2024 May 2024 |
| Modern Day Marine | Washington, D.C., USA | April 30-May 2, 2024 |
| EUROSATORY | Paris, France | June 17-21, 2024 |
| AUSA | Washington, D.C., USA | October 2024 |
| International Association of Chiefs of Police | Boston, USA | October 2024 |
Proprietary Protection
Non-lethal
On February 11, 2022, we filed United States patent application No. 17/669,420 claiming priority to a provisional patent application serial 63/148,163 by the USPO for our PARA OPS system. On October 18, 2022, we were advised by USPO that a notice of publication of application had been issued in relation to our patent application. We subsequently received notification that the patent had issued effective October 31, 2023.
Additionally, we filed patent applications for our PARA OPS system with the Canadian Intellectual Property Office (Filing Certification pending) on October 24, 2022 and with the Australian Patent Office (Serial No. 2022259822) on October 27, 2022.
We have the following registered trademarks:
| Trademark | Country | Application # / Registration # | Status / Registration Date |
| ARWEN | Canada | TMA657,575 | January 31, 2006 |
| ARWEN | Great Britain | UK00001247086 | July 27, 1985 |
| ARWEN | Singapore | T9105613J | June 8, 1991 |
| ARWEN | United States | 1,404,833 | August 12, 1986 |
We have the following trademark and design mark pending applications:
| Trademark | Country | File Date for Pending | Application # / Registration # | Status / Registration Date |
| PARA OPS | United States | February 2, 2022 | 97/248,319 | Pending |
| EVERYONE GOES HOME ALIVE | Canada | August 10, 2022 | 2,203,009 | Pending |
| EVERYONE GOES HOME ALIVE | United States | September 16, 2022 | 97/594,701 | Pending |
 | Canada | November 5, 2021 | 2,145,500 | Pending |
We have the following patent pending or issued applications:
| Product line | Country | File Date for Pending | Application # / Registration # | Status / Registration Date |
| LOW ENERGY CARTRIDGE (PARA OPS) | Canada | October 25, 2022 | 3,179,723 | Pending |
| LOW ENERGY CARTRIDGE (PARA OPS) | Australia | October 27, 2022 | 2022259822 | Pending |
| LOW ENERGY CARTRIDGE (PARA OPS) | United States | November 2, 2022 | 17/669,420 | Issued October 31, 2023 |
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Digitization
While we rely significantly on trade secrets to protect our internally developed technologies, we currently have the following patent pending applications regarding our digitization business lines:
| Product line | Country | Application # | File Date | Title | Status |
| TASCS IFM | International | PCT/CA2021/050993 | Filed on July 19, 2021 which claims the benefit of 63/054,435 | Methods and Systems for Digital Image-Referenced Indirect Target Aiming | Published as W02022/016260 Pending Applicant is KWESST Inc. |
| TASCS IFM | Canada | 3,186,490 | Filed on July 19, 2021 | Methods and Systems for Digital Image-Referenced Indirect Target Aiming | Pending Applicant is KWESST Inc. |
| TASCS IFM | Australia | 2021312552 | Filed on July 19, 2021 | Methods and Systems for Digital Image-Referenced Indirect Target Aiming | Pending Applicant is KWESST Inc. |
| TASCS IFM | Europe | 21845180.5 | Filed on July 19, 2021 | Methods and Systems for Digital Image-Referenced Indirect Target Aiming | Pending Applicant is KWESST Inc. |
| TASCS IFM | Israel | 300031 | Filed on July 19, 2021 | Methods and Systems for Digital Image-Referenced Indirect Target Aiming | Pending Applicant is KWESST Inc. |
| TASCS IFM | India | 202327004493 | Filed on July 19, 2021 | Methods and Systems for Digital Image-Referenced Indirect Target Aiming | Pending Applicant is KWESST Inc. |
| TASCS IFM | Jordan | PCT/JO/2023/14 | Filed on July 19, 2021 | Methods and Systems for Digital Image-Referenced Indirect Target Aiming | Pending Applicant is KWESST Inc. |
| TASCS IFM | Japan | 2023-504725 | Filed on July 19, 2021 | Methods and Systems for Digital Image-Referenced Indirect Target Aiming | Pending Applicant is KWESST Inc. |
| TASCS IFM | South Korea | 10-2023-7005420 | Filed on July 19, 2021 | Methods and Systems for Digital Image-Referenced Indirect Target Aiming | Pending Applicant is KWESST Inc. |
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| TASCS IFM | New Zealand | NZ796573 | Filed on July 19, 2021 | Methods and Systems for Digital Image-Referenced Indirect Target Aiming | Pending Applicant is KWESST Inc. |
| TASCS IFM | Saudi Arabia | 523442231 | Filed on July 19, 2021 | Methods and Systems for Digital Image-Referenced Indirect Target Aiming | Pending Applicant is KWESST Inc. |
| TASCS IFM | Singapore | 11202300411W | Filed on July 19, 2021 | Methods and Systems for Digital Image-Referenced Indirect Target Aiming | Pending Applicant is KWESST Inc. |
| TASCS IFM | United States | 18/006,055 | Filed on July 19, 2021 | Methods and Systems for Digital Image-Referenced Indirect Target Aiming | Pending Applicant is KWESST Inc. |
| TASCS IFM | South Africa | 2023/00978 | Filed on July 19, 2021 | Methods and Systems for Digital Image-Referenced Indirect Target Aiming | Pending Applicant is KWESST Inc. |
| |
Counter Threat While we rely significantly on trade secrets to protect our internally developed technologies, we currently have the following patent and pending patent applications regarding our counter-threat business lines: |
| Product line | Country | Application # | File Date | Title | Status |
| Phantom | United States | 16/686,095 | Filed on November | Programmable Multi-Waveform RF Generator for Use as Battlefield Decoy | Issued as Patent No. 10,969,467 (assigned to KWESST Inc.) |
| Phantom | United States | 16/116,914 | Filed on August 30, 2018 which claims the benefit of 62/657,706 | Programmable Multi-Waveform RF Generator for Use as Battlefield Decoy | Issued as Patent No. 11,096,243 (assigned to KWESST Inc.) |
| Phantom | United States | 17/163,546 | Filed on January 31, 2021 which claims benefit of 16/116,914 | Programmable Multi-Waveform RF Generator for Use as Battlefield Decoy | Pending |
| Phantom | United States | 17/405,021 | Filed on August 17, 2021 which claims the benefit of 16/116,914 | Programmable Multi-Waveform RF Generator for Use as Battlefield Decoy | Pending |
| Phantom | United States | 18/138,071 | Filed on April 22, 2023 which claims the benefit of 17/163,546 | Programmable Multi-Waveform RF Generator for Use as Battlefield Decoy | Pending |
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| Phantom | International | PCT/CA2021/050038 | Filed on January 15, 2021 | Programmable Multi-Waveform RF Generator for Use as Battlefield Decoy | Published as W02022/150901 Pending Applicant is KWESST Inc. |
| Phantom | Canada | 3,106,716 | Filed on January 21, 2021 | Programmable Multi-Waveform RF Generator for Use as Battlefield Decoy | Pending (assigned to KWESST Inc.) |
| Phantom | Australia | 2021200556 | Filed on January 29, 2021 | Programmable Multi-Waveform RF Generator for Use as Battlefield Decoy | Pending (assigned to KWESST Inc.) |
| BLDS | United States | 63/523,726 | Filed on June 28, 2023 | Battlefield Laser Detection Equipment Module and System Comprising the Same | Pending |
We have the following pending trademark applications:
| Trademark | Country | Application # | File Date | Status |
| Phantom | Canada | 2,047,424 | August 24, 2020 | Pending |
| Phantom | United States | 90/135,612 | August 25, 2020 | Pending |
We also have the following corporate pending trademark applications:
| Trademark | Country | Application # | File Date | Status |
 | Canada | 2,063,763 | November 12, 2020 | Pending |
| United States | 90/518,212 | February 8, 2021 | Pending |
Government Regulations
Non-lethal
United States
In February 2022, we retained the services of Orchid Advisors to assist us with the classification and ATF compliance for our PARA OPS devices. Orchid Advisors is an FFL compliance solutions firm headquartered in Hartford, Connecticut.
Based on Orchid Advisor's interpretation of the ATF rules and regulations, we have self-classified the .67 caliber version of the PARA OPS devices as a "destructive device," providing us with the ability to go to market much sooner than waiting for ATF classification ruling. Under the ATF rules, a manufacturer must determine whether the device is a firearm and therefore be subject to ATF regulation and if it is a firearm whether it is subject to National Firearms Act of 1934 ("NFA") regulations.
To be considered a regulated firearm in the United States, the device must be: (i) a weapon that (ii) will or is designed to expel a projectile (iii) by the action of an explosive. Although primers in ammunition cartridges are exempt from control under the explosives regulations as administered by ATF, they are still considered an "explosive" for the purposes of the firearm definition. Because we use primers in the ammunition cartridges for our PARA OPS devices, we have decided to self-classify our PARA OPS devices as a form of firearm in the United States pending any different eventual classification by the ATF.
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As the PARA OPS product line is identified as a firearm in the United States, it must be determined whether an additional level of control is imposed by the NFA. Under NFA regulations, there are only two possible types of NFA firearm that PARA OPS could be defined as: (1) a "any other weapon" ("AOW") or (2) a "destructive device". Sale of either of these to consumers is permissible but requires a lengthy approval process conducted by the ATF (the background check process on the consumer); whereas sale to law enforcement agencies, military bodies, or government agencies is a more expedient approval process (usually less than 7 days). Further, the AOW classification requires only a $5 transfer tax to consumers whereas a destructive device classification results in a $200 transfer tax to consumers (such tax being borne by the consumer). While our PARA OPS is non-lethal (the kinetic energy of our projectile is well below lethal threshold), we have determined that the current version of our PARA OPS devices are "destructive devices" because the measurement of the bore of our device is currently in excess of the one-half inch in diameter, the maximum size for AOW.
As a result, initial sales of our PARA OPS devices in the United States are expected to come primarily from law enforcement agencies until we reduce the bore diameter of our device to less than one-half inch in diameter for the consumer market. In July 2022, we entered into a consulting agreement with an FFL engineering firm, Bachstein Consulting LLC, in the United States to finalize the prototype for the PARA OPS single and multi-shot devices, including LRIP during Q1 Fiscal 2023. We are currently pursuing development through Fiscal 2023 and the first half of Fiscal 2024 of a non-pyrotechnic energy actuator for PARA OPS in conjunction with a smaller diameter cartridge and projectile which, together, we expect would result in a next-generation version of PARA OPS products that would be considered non-firearms in most jurisdictions. The distribution of our PARA OPS in the United States will be done directly with FFL distributors/firearm dealers for civilian sales. Today, all 50 states of the United States allow civilians to own a firearm subject to the firearm laws of the state (which vary by state). We expect the sales of our PARA OPS devices will position us well for significant recurring revenues through the sale of subsequent ammunition over the next 12 months (see Item 3.D. - "Risk Factors - We have Significant Non-Recurring Revenue").
For the non-lethal ARWEN products, we maintain a firearm business license (the "Firearm Business License") issued by the Chief Firearms Office of the Ontario Ministry of the Solicitor General and we are also registered under the Controlled Goods Program in Canada. For further information, see Item 4.B. - "Digitization and Counter Threat". Additionally, we maintain a Federal Explosives License/Permit for the manufacturing of explosives and a FFL for manufacturer and sale of destructive devices, both issued by the ATF in the United States. These are currently under renewal. All sales of our ARWEN launchers are made directly to law enforcement agencies.
Rest of the World
As our current focus is commercializing PARA OPS in the United States, we have not begun analyzing the related government regulations for the rest of the world.
Digitization and Counter-Threat
Firearm Business License
In Canada, we maintain a Firearm Business License with the Chief Firearms Officer of the Ontario Ministry of Solicitor General for our following business activities:
The Firearm Business License is delivered for the purposes of: (i) the performance of a contract entered into by the Government of Canada, the government of a province, the government of a municipality acting on behalf of a police force, or a police force, or by a person acting on behalf of such a government or a police force; and (ii) the development, modification or testing of a prohibited firearm, prohibited weapon, prohibited device or prohibited ammunition, or any component or part thereof, for the purpose of training, or supplying goods or training materials used in the training of, a public officer as defined in subsection 117.07(2) of the Criminal Code (Canada), who is acting in the course of his or her duties or employment.
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As of the date of this Annual Report, we believe to be fully compliant with all the conditions under which the Firearm Business License is delivered and maintained.
We have applied for and received a Firearms Business License that covers off any potential scenario that we may from time to time be involved in which such a license would be required. We are currently not in the retail or consignment sale of firearms and do not expect to be in this type of business.
For greater clarity, we use real firearms in the development and testing of our products as well as in training users on their use. Any device such as the TASCS IFM or TASCS NORS must be developed and tested on the weapon platforms for which it is designed. The Shot Counter is designed to work on automatic weapons in military and police inventories. These types of weapons are classified as prohibited and are solely utilized in the development and testing of the product. Replica systems are utilized for static demonstration, trade shows and other non-firing events.
We procure ammunition such as those required for mortars, grenade launchers and others weapon types to conduct testing and evaluation. On occasion, we may need to export ammunition in support of demonstrations.
Controlled Goods Program
In Canada, an individual or organization must register in the Controlled Goods Program with the Public Services and Procurement Canada if they need to:
We are registered in the Controlled Goods Program and believe we are in compliance as of the date of this Annual Report.
Economic Dependence
As an early-stage company, the revenue stream in Fiscal 2021 for the TASCS system was concentrated on one United States military customer. We recognized 98.3% of the total revenue (US $0.8 million) for this United States military customer during Fiscal 2021 (see Item 5.E. - "Critical Accounting Estimates"). We have delivered the remaining milestone and recognized the remaining 2.7% of the total revenue during the first quarter of Fiscal 2022. While we expect follow-on orders for our TASCS IFM 81mm mortar system they are likely to be under multi-year Joint Fires programs beginning in Fiscal 2024, and there is no assurance of such orders in Fiscal 2023.
Since September 30, 2021, we have further diversified our revenue base as a result of the Police Ordnance Acquisition. Additionally, on December 1, 2021, we entered into a master professional services agreement (the "MPSA") with GDMS to support the development of digitization solutions for future Canadian land C41SR programs under Strong, Secure, Engaged: Canada's Defence Policy. This includes TAK integration and other digitization services over 12 months. The MPSA serves as the master agreement and governs the basic terms and conditions for all future statements of work ("SOW") but does not in itself give rise to financial rights or obligations for either GDMS or us nor does it ensure that a future SOW will be awarded. Accordingly, there are no material terms in the MPSA except for the termination provision. At its sole discretion, GDMS may terminate the MPSA and/or a SOW by written notice to us. Under such event, GDMS will be liable for work rendered or expenses incurred prior to the effective date of such termination for which payment has not been made to us. GDMS may also terminate the MPSA immediately in the event of default (as defined in the GDMS). Concurrently with entering in the MPSA, we entered into a SOW with GDMS for the first phase of the project which was delivered by the end of Q3 Fiscal 2022 and fully collected. GDMS accounted for 41% of our Fiscal 2022 consolidated revenue. During Q1 Fiscal 2023 we entered into another SOW with GDMS for USD$0.1 million, which we delivered by the end of the quarter. With the anticipated commercial launch of PARA OPS product line in Fiscal 2023 and continued product sales from the ARWEN launchers, we anticipate our total consolidated revenue will continue to diversify with various customers, resulting in less dependence on limited customers to drive positive cash flows and profitability.
Foreign Operations
We established office space in Stafford, Virginia to conduct United States business development activities and anticipated light assembly and distribution for our non-lethal, Digitization, and Counter-Threat business lines. We released this space in the summer of 2023 and rented alternative space in the premises of our outsourced PARA OPS devices manufacturer in North Carolina for greater economy and convenience.
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C. Organizational Structure
The following chart illustrates our wholly-owned subsidiaries:
KWESST U.S. Holdings Inc.
On May 2, 2022, we incorporated a wholly-owned United States holding subsidiary in Delaware (United States).
KWESST Public Safety Systems U.S. Inc.
On May 2, 2022, we incorporated a wholly-owned United States subsidiary in Delaware (United States), for the PARA OPS product line in the United States (see Item 4.B. - Business Overview).
KWESST Defense Systems U.S. Inc. (formerly KWESST U.S., Inc.)
On January 28, 2021, we incorporated a wholly-owned United States subsidiary in Delaware (United States), named KWESST U.S., Inc., and established an office in Stafford, Virginia (United States) to further pursue Digitization and Counter-Threat business opportunities in the United States. On June 3, 2022, we amended the certificate of incorporation of the subsidiary to change the name to KWESST Defense Systems U.S. Inc.
KWESST Public Safety Systems Canada Inc.
On April 6, 2022, we incorporated a wholly-owned subsidiary in Ontario (Canada), for the PARA OPS business line in Canada (see Item 4.B. - Business Overview).
2720178 Ontario Inc. and Police Ordnance Company Inc.
On December 15, 2021, we acquired 2720178 Ontario Inc., which owns all of the issued and outstanding shares of Police Ordnance, a company incorporated in Ontario (Canada) (see Item 4.A. - History and Development of the Company - Principal Capital Expenditures and Divestitures). These are wholly-owned subsidiaries of KWESST.
KWESST Inc.
On April 24, 2017, we incorporated a company in Ontario (Canada) named KWESST Inc. for the Digitization and Counter-Threat business lines.
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On September 17, 2020, pursuant to the Qualifying Transaction (as defined below), KWESST Inc. amalgamated with 2751530 Ontario Ltd. ("Subco"), with the amalgamated company retaining the name of "KWESST Inc."
D. Property, Plants and Equipment
We do not own any real estate property. We operate from leased premises in three different locations, as detailed in the following table:
| Location | Area | Premise Use | Expiry Date |
(approx.) | |||
| 155 Terence Matthews, Unit#1, Ottawa, Ontario, Canada | 7,200 sq. ft. | Corporate offices and administration, R&D | April 30, 2026 |
(renewal extension of 5 years) | |||
| 557 Massey Road, Guelph, Ontario, Canada | 5,500 sq. ft. | Storage, distribution, and training of non-lethal ARWEN products, Para Ops engineering and sales | July 30, 2026 (renewal |
extension of 2 years to 2028) | |||
| 70 Mosswood BVLD, Suite 100 Youngsville, NC 27596
| 1,500 sq. ft | Address and US facility of ATF/Federal Firearms license for Para Ops, ARWEN and KWESST serialized products. Also used for product testing and sales demonstrations, product development and support. | June 2026 |
At September 30, 2023, the carrying value of our total tangible fixed assets was approximately $0.4 held in Ottawa, Ontario, Canada.
ITEM 4A. UNRESOLVED STAFF COMMENTS
Not applicable.
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS
The following Operating and Financial Review and Prospects section is intended to help the reader understand the factors that have affected the Company's financial condition and results of operations for the historical period covered by the financial statements and management's assessment of factors and trends which are anticipated to have a material effect on the Company's financial condition and results in future periods. This section is provided as a supplement to, and should be read in conjunction with, our Consolidated Financial Statements and the other financial information contained elsewhere in this document. Our Consolidated Financial Statements have been prepared in accordance with International Reporting Standards as issued by the International Accounting Standards Board ("IFRS"). Our discussion contains forward-looking statements based on current expectations that involve risks and uncertainties, such as our plans, objectives and intentions. Our actual results may differ from those indicated in such forward-looking statements.
A. Operating Results
Overview
During Fiscal 2023, we had some significant highlights to our operating results:
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Additionally, we completed our cross-border listing on Nasdaq and our Common Shares began trading on December 7, 2022, under the stock symbol "KWE" and certain of our outstanding warrants under the symbol "KWESW" on the same day. On December 9, 2022, we closed our U.S. IPO and the Canadian Offering for aggregate gross proceeds of USD$14.1 million, before deducting underwriting and offering costs (see Item 5.B - Liquidity and Capital Resources for further details). In advance of the Nasdaq listing, on October 28, 2022, we effected the Reverse Split of our Common Shares to meet Nasdaq's initial listing requirements. All information respecting to outstanding Common Shares and other securities of KWESST, including net loss per share, in the current and comparative periods presented herein give effect to the Reverse Split.
Results of Operations
The following selected financial data has been extracted from the audited Fiscal 2023 financial statements.
| Change | Change | ||||||||||||||
| 2023 vs | 2022 vs | ||||||||||||||
| 2022 | 2021 | ||||||||||||||
| 2023 | 2022 | 2021 | % | % | |||||||||||
| Revenue | $ | 1,234,450 | $ | 721,519 | $ | 1,275,804 | 71% | -43% | |||||||
| Cost of sales | (1,425,828 | ) | (536,735 | ) | (798,888 | ) | 166% | -33% | |||||||
| Gross profit (loss) | (191,378 | ) | 184,784 | 476,916 | -204% | -61% | |||||||||
| Gross margin % | -15.5% | 25.6% | 37.4% | ||||||||||||
| Operating Expenses | |||||||||||||||
| General and administrative | 7,244,762 | 4,915,263 | 4,057,167 | 47% | 21% | ||||||||||
| Selling and marketing | 3,024,283 | 3,296,373 | 3,484,159 | -8% | -5% | ||||||||||
| R&D | 1,644,565 | 2,064,493 | 2,138,138 | -20% | -3% | ||||||||||
| Total operating expenses | 11,913,610 | 10,276,129 | 9,679,464 | 16% | 6% | ||||||||||
| Operating loss | (12,104,988 | ) | (10,091,345 | ) | (9,202,548 | ) | 20% | 10% | |||||||
| Other income (expenses) | |||||||||||||||
| Share issuance costs | (1,985,074 | ) | - | - | N/A | N/A | |||||||||
| Net finance costs | (668,034 | ) | (506,002 | ) | (107,751 | ) | 32% | 370% | |||||||
| Foreign exchange gain (loss) | (98,275 | ) | 28,780 | (3,742 | ) | -441% | -869% | ||||||||
| Change in fair value of warrant liabilities | 5,841,192 | - | - | N/A | N/A | ||||||||||
| Loss on disposals | (291,181 | ) | (1,165 | ) | (1,331 | ) | N/A | N/A | |||||||
| Total other income (expenses), net | 2,798,628 | (478,387 | ) | (112,824 | ) | -685% | 324% | ||||||||
| Loss before income taxes | (9,306,360 | ) | (10,569,732 | ) | (9,315,372 | ) | -12% | 13% | |||||||
| Deferred tax recovery | - | 49,442 | - | N/A | N/A | ||||||||||
| Net loss | $ | (9,306,360 | ) | $ | (10,520,290 | ) | $ | (9,315,372 | ) | -12% | 13% | ||||
| EBITDA loss | $ | (7,685,818 | ) | $ | (9,737,239 | ) | $ | (9,066,631 | ) | -21% | 7% | ||||
| Adjusted EBITDA loss(1) | $ | (10,778,926 | ) | $ | (7,304,670 | ) | $ | (6,599,351 | ) | 48% | 11% | ||||
| Loss per share - basic and diluted | $ | (2.28 | ) | $ | (14.41 | ) | $ | (14.72 | ) | -84% | -2% | ||||
| Weighted average common shares - basic | 4,082,275 | 730,302 | 632,721 | 459% | 15% |
(1) EBITDA and Adjusted EBITDA are non-IFRS measures. See "Non-IFRS Measures".
In the following table, we have reconciled the EBITDA and Adjusted EBITDA to the most comparable IFRS financial measure.
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| Nine months | |||||||||
| Year ended | Year ended | ended | |||||||
| September 30, | September 30, | September 30, | |||||||
| 2023 | 2022 | 2021 | |||||||
| Net loss as reported under IFRS | $ | (9,306,360 | ) | $ | (10,520,290 | ) | $ | (9,315,372 | ) |
| Net finance costs | 668,034 | 506,002 | 107,751 | ||||||
| Depreciation and amortization | 952,508 | 326,491 | 140,990 | ||||||
| Deferred tax recovery | - | (49,442 | ) | - | |||||
| EBITDA loss | (7,685,818 | ) | (9,737,239 | ) | (9,066,631 | ) | |||
| Other adjustments: | |||||||||
| Stock-based compensation | 373,554 | 1,960,072 | 2,462,207 | ||||||
| Share issuance costs | 1,985,074 | - | - | ||||||
| Professional fees relating to financings | - | 500,112 | - | ||||||
| Fair value adjustment on derivatives | (5,841,192 | ) | - | - | |||||
| Foreign exchange loss (gain) | 98,275 | (28,780 | ) | 3,742 | |||||
| Loss on disposals | 291,181 | 1,165 | 1,331 | ||||||
| Adjusted EBITDA loss | $ | (10,778,926 | ) | $ | (7,304,670 | ) | $ | (6,599,351 | ) |
Current Year Variance Analysis (2023 vs. 2022)
For Fiscal 2023, KWESST's net loss was $9.3 million. Fiscal 2023 adjusted EBITDA loss was $10.8 million, an increase of 48% compared to the prior year, mainly due to increased operating expenses driven by increased personnel costs, consulting costs, professional fees, insurance costs, regulatory and compliance costs, and tradeshows. The adjustments to EBITDA loss for Fiscal 2023 included share insurance costs relating to warrant liabilities, and the change in fair value of derivative liabilities, all of which are related to the warrants issued in the U.S. IPO and Canadian Offering and the July 2023 Private Placement (see Notes 15 and 16 of the Fiscal 2023 financial statements). There has been a lower volume of stock-based grants in the last 12 months resulting in a material reduction in stock-based compensation expense in the current year compared to Fiscal 2022.
Revenue
Total revenue increased by $0.5 million in the year compared Fiscal 2022, mainly due to an additional $0.4 million generated from our digitization business line and $0.1 million from our non-lethal business line (driven from sale of ARWEN products).
We expect revenue to increase as we have formally received work tasks under the recently announced Canadian Government Contract amongst Modis Canada Inc., Thales Canada Inc., KWESST Inc. and the Canadian DND, dated May 1, 2023 (the "Canadian Government Contract") and we have commenced hiring and staffing those requirements. We continue to work towards a commercial launch of our PARA OPS, which we now expect to be in 1H Fiscal 2024.
Gross Profit
Our gross profit was a negative $0.2 million in the year compared to a positive gross profit of $0.2 million in Fiscal 2022. The decrease is due mainly to onerous contracts and consultant fees that have since been eliminated. As we are in the pre-revenue stage for most product lines, we expect continued fluctuation in gross profit / margin during Fiscal 2024 as we ramp up anticipated revenue in the year.
Operating Expenses ("OPEX")
Total OPEX was $11.9 million for YTD Fiscal 2023 compared to $10.3 million in YTD Fiscal 2022 for a total increase of $1.6M. Excluding share-based compensation, total OPEX was $11.5 million compared to $8.3 million, a 39% increase over the comparable prior year due to the following factors:
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Other income (expenses), net
For Fiscal 2023, our total other income was $2.8 million, compared to total other expenses of $0.5 million. The change in other income (expenses), net was driven mainly by the $5.8 million favorable change in fair value of warrant liabilities as a result of the remeasurement of the warrant liabilities at September 30, 2023, driven by a decrease in the underlying common share price on September 30, 2023. Under IFRS, we are required to remeasure the warrant liabilities at each reporting date until they are exercised or expired. This was partially offset by:
Prior Year Variance Analysis (2022 vs. 2021)
Revenue
We generated $0.7 million in revenue for Fiscal 2022, a decrease of 43% over last year's revenue. The decline in revenue was driven mainly due to the timing of expected contracts and a smaller contract awarded by GDMS-C and CC-T during the current year compared to the USD$0.8 million contract awarded by a United States military customer in Fiscal 2021. This was partially offset by $0.3 million from the ARWEN product line as a result of the Police Ordnance acquisition made in late Q1 Fiscal 2022. The ARWEN revenue excludes $0.4 million for deliveries in relation to open customer orders at the closing of the Police Ordnance acquisition which were recognized as a reduction of intangible assets.
We expect revenue to ramp up during Fiscal 2023 with new anticipated military contracts, coupled with the pending commercial launch of our PARA OPS, scheduled for Q2 Fiscal 2023, and full year revenue results from the ARWEN product line.
Gross Profit
Our gross profit was $0.2 million for Fiscal 2022, or gross margin of 25.6%, compared to $0.5 million in Fiscal 2021 with gross margin of 37.4%. The fluctuation in gross profit / margin is primarily due to our pre-commercialization phase.
Operating Expenses
Total operating expenses were $10.3 million for Fiscal 2022, a 6% increase over the prior year. Excluding share-based compensation (non-cash item), total OPEX was $8.3 million compared to $7.2 million over the prior year. This represents a 15% increase which was driven mostly by accrued bonuses to our employees and management (none in the prior year) for their significant contributions in positioning KWESST for future success, coupled with higher professional fees incurred relating to a brokered private placement financing effort during the Spring 2022 that did not close due to very challenging global equity market conditions where S&P 500 index and Nasdaq index declined by approximately 20.6% and 29.5%, respectively from January 1, 2022, to June 30, 2022. We subsequently completed a successful cross-border listing on Nasdaq with a U.S. IPO and concurrent Canadian Offering, which both closed in December 2022. Professional fees relating to this effort were capitalized and reported as deferred share offering costs in our consolidated statements of financial position at September 30, 2022.
The above increase was partially offset by lower spend on advertising and promotion as well as no royalty and license costs in the current year compared to the previous year.
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Our R&D expenses during Fiscal 2022 comprised of costs incurred in performing R&D activities, including new product development, continued product enhancement, materials and supplies, salaries and benefits (including share-based compensation), engineering consulting costs, patent procurement costs, and estimated R&D-related facility costs. Where we qualify for Canadian investment tax credits for qualified scientific research and experimental development expenditures, we record this income as a reduction of R&D expenses. Additionally, in accordance with IFRS, we capitalize development costs only if development costs can be measured reliably, the product or process is technically or commercially feasible, future economic benefits are probable, and we have the intention and sufficient resources to complete the development and to use or sell the asset. Accordingly, we capitalized $1.2 million of development costs during Fiscal 2022 for PARA OPS and Phantom, compared to $83 thousand for Phantom during Fiscal 2021. See Note 9 of the audited consolidated financial statements for Fiscal 2022.
Finance Costs
Net finance costs were $0.5 million for Fiscal 2022, a 370% increase over Fiscal 2021 driven mainly by an increase in borrowings during Fiscal 2022 and full year accretion cost on the accrued royalties liability relating to the acquisition of the PARA OPS system.
Net Loss and Adjusted EBITDA Loss
We incurred a net loss of $10.5 million or $14.41 per basic share for Fiscal 2022, compared to the net loss of $9.3 million or $14.72 per basic share for Fiscal 2021. After adjusting for share-based compensation and other items (see table above), our Adjusted EBITDA loss was $7.3 million, compared to Adjusted EBITDA loss of $6.6 million in Fiscal 2021.
The increase in net loss and Adjusted EBITDA loss was primarily due to lower revenue and higher OPEX as noted above.
Selected Annual and Quarterly Information
The following selected financial information is taken from the audited financial statements for the years ended September 30, 2023, 2022 and 2021.
| Year ended | Year ended | Nine months ended | |||||||
| September 30, | September 30, | September 30, | |||||||
| 2023 | 2022 | 2021 | |||||||
| Statement of Operations data: | |||||||||
| Revenue | $ | 1,234,450 | $ | 721,519 | $ | 1,275,804 | |||
| Gross profit | $ | (191,378 | ) | $ | 184,785 | $ | 476,916 | ||
| Gross margin % | -15.5% | 25.6% | 37.4% | ||||||
| Operating loss | $ | (12,104,988 | ) | $ | (10,091,345 | ) | $ | (9,202,548 | ) |
| Net loss | $ | (9,306,360 | ) | $ | (10,520,290 | ) | $ | (9,315,372 | ) |
| Loss per share - basic and diluted | $ | (2.28 | ) | $ | (14.41 | ) | $ | (14.72 | ) |
| September 30, | September 30, | September 30, | |||||||
| 2023 | 2022 | 2021 | |||||||
| Financial Position data: | |||||||||
| Cash | $ | 5,407,009 | $ | 170,545 | $ | 2,688,105 | |||
| Total assets | $ | 11,758,832 | $ | 11,758,832 | $ | 8,717,846 | |||
| Total non-current liabilities | $ | 1,439,577 | $ | 1,434,628 | $ | 1,434,628 | |||
| Total shareholders' equity (deficit) | $ | 3,935,620 | $ | 6,123,728 | $ | 6,123,728 |
See Item 4.A - Operating Results - Results of Operations for additional details and for the comparison discussion between the periods presented above.
Summary of Quarterly Results
The following table summarizes selected results for the eight most recent completed quarters to September 30, 2023.
| 2023 | 2022 | |||||||||||||||||||||||
| ($ in thousands) | Q4 | Q3 | Q2 | Q1 | Q4 | Q3 | Q2 | Q1 | ||||||||||||||||
| Revenue | 606 | 150 | 161 | 317 | 255 | 282 | 166 | 17 | ||||||||||||||||
| Net loss | (2,419 | ) | (3,452 | ) | (1,227 | ) | (2,208 | ) | (2,345 | ) | (2,600 | ) | (2,290 | ) | (2,290 | ) | ||||||||
Quarterly Results Trend Analysis
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We experienced volatility with our quarterly revenue during Fiscal 2023 due to ramp up of new military contracts, which is expected to continue into Fiscal 2024 as we launch PARA OPS coupled with an increase in operating expenses as highlighted in the Results of Operations. Additionally, we expect further volatility with our quarterly net loss due to the remeasurement of warrant liabilities at each reporting period, with the change in fair value recorded through P&L.
Fourth Quarter Fiscal 2023
The following table summarizes our results of operations for the respective periods:
| Three months ended September 30, | ||||||
| 2023 | 2022 | |||||
| Revenue | $ | 605,445 | $ | 255,371 | ||
| Operating Expenses | ||||||
| General and administrative | 2,798,250 | 1,504,376 | ||||
| Selling and marketing | 685,637 | 364,913 | ||||
| R&D | 618,028 | 454,048 | ||||
| Total operating expenses | 4,101,915 | 2,323,337 | ||||
| Net loss | $ | (5,854,335 | ) | $ | (2,344,944 | ) |
Revenue
Total revenue increased by $0.3 million in Q4 ended September 30, 2023 compared to Q4 of Fiscal 2022, mainly due to an additional $0.4 million generated from our digitization business line offset by a $0.1 million decrease from our non-lethal business line (driven from sale of ARWEN products).
Operating Expenses
Total OPEX was $4.1 million for Q4 FY2023 compared to $2.3 million in Q4 of Fiscal 2022 for a total increase of $1.8M, a 77% increase over the comparable prior year quarter due to the following factors:
Net Loss
As a result of the above, our net loss was $5.9 million for the quarter ended September 30, 2023, a $3.5 million increase from the Q4 period in Fiscal 2022; however, the Company has made significant efforts to reduce S&M and R&D costs throughout remaining quarters in Fiscal 2023.
B. Liquidity and Capital Resources
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Financial Condition
The following table summarizes our financial position:
| September 30, | September 30, | September 30, | |||||||
| 2023 | 2022 | 2021 | |||||||
| Assets | |||||||||
| Current | $ | 6,842,074 | $ | 1,516,393 | $ | 4,055,697 | |||
| Non-current | 4,916,758 | 5,807,070 | 4,662,149 | ||||||
| Total assets | $ | 11,758,832 | $ | 7,323,463 | $ | 8,717,846 | |||
| Liabilities | |||||||||
| Current | $ | 6,383,635 | $ | 6,925,880 | $ | 1,159,490 | |||
| Non-current | 1,439,577 | 1,400,474 | 1,434,628 | ||||||
| Total liabilities | 7,823,212 | 8,326,354 | 2,594,118 | ||||||
| Net assets | $ | 3,935,620 | $ | (1,002,891 | ) | $ | 6,123,728 | ||
| Working capital (1) | $ | 458,439 | $ | (5,409,487 | ) | $ | 2,896,207 | ||
(1) Working capital is calculated as current assets less current liabilities.
Our working capital was positive $0.5 million at September 30, 2023, an increase of $5.9 million from September 30, 2022. The increase was primarily due to net proceeds from the U.S. IPO and Canadian Offering and the July 2023 Private Placement, offset partially by an increase to inventory and prepaid expenses, repayment of all outstanding loans, payments of overdue accounts payables and certain accrued liabilities, and net operating loss for Fiscal 2023. Current liabilities include warrant liabilities, a non-cash liability item (see Note 15 of Fiscal 2023 financial statements). Excluding warrant liabilities, working capital would be $6.8 million. These warrant liabilities will be extinguished when the warrants are exercised or expired. If exercised, the proceeds will provide us with additional capital to fund our future working capital requirements. There is no assurance that any warrants will be exercised.
Total assets increased by $4.4 million from September 30, 2022, mainly due to an increase of $5.3 million in currents assets made up mostly of net proceeds of the U.S. IPO and Canadian Offering and the July 2023 Private Placement, offset partially by inventory and prepaid expenses, repayment of all outstanding loans, payments of overdue accounts payables and certain accrued liabilities.
Total liabilities decreased by $0.5 million from September 30, 2022, to $7.8 million at September 30, 2023, mainly due to a reduction in current liabilities from having paid aged accounts payable subsequent to the closing of our NASDAQ IPO. While we have significantly paid the outstanding accounts payable and fully repaid all outstanding loans during the current year, these were offset by the recognition of warrant liabilities at fair value as noted above. As at September 30, 2023, we had $4.3 million of warrant liabilities.
Available Liquidity
Our approach to managing liquidity is to ensure, to the extent possible, that we always have sufficient liquidity to meet our liabilities as they come due. We regularly perform cash flow forecasts to ensure that we have sufficient cash to meet our operational needs while maintaining sufficient liquidity. At this time, we do not use any derivative financial instruments to hedge our currency risk.
On July 21, 2023, we closed the July 2023 Private Placement pursuant to which we received aggregate gross proceeds of USD$5.59 million (or CAD$7.4 million), before underwriting and offering costs (see below, Capital Resources, for further details including our expected use of proceeds). On December 9, 2022, we closed both the U.S. IPO and Canadian Offering pursuant to which we received aggregate gross proceeds of USD$14.1 million (or CAD$19.4 million), before underwriting and offering costs (see below, Capital Resources, for further details including our expected use of proceeds).
At September 30, 2023, our cash position was $5.4 million, an increase of $5.2 million since September 30, 2022 primarily due to net proceeds from the U.S. IPO and Canadian Offering and the July 2023 Private Placement, offset partially by repayment of all outstanding loans, payments of overdue accounts payables and certain accrued liabilities, and net operating loss for Fiscal 2023.
As an early-stage company, we have not yet reached commercial production for most of our other products and have incurred significant losses and negative operating cash flows from inception that have primarily been funded from financing activities. Our ability to continue as a going concern and realize our assets and discharge our liabilities in the normal course of business is dependent upon closing timely additional sales orders, timely commercial launch of new products, and the ability to raise additional debt or equity financing, when required. There are various risks and uncertainties affecting our future financial position and our performance. However, we may require additional capital in the event we fail to implement our business plan, which could have a material adverse effect on our financial condition and/or financial performance. There is no assurance that we will be able to raise additional capital as they are required in the future. Potential sources of capital may include additional equity and/or debt financings. In our view, the availability of capital will be affected by, among other things, capital market conditions, the success of our PARA OPS system commercialization efforts, timing for winning new customer contracts, potential acquisitions, and other relevant considerations (see Risk Factors). In the event we raise additional funds by issuing equity securities, our existing shareholders will likely experience dilution, and any additional incurrence of indebtedness would result in increased debt service obligations and could require us to agree to operational and financial covenants that could further restrict our operations. Any failure to raise additional funds on terms favorable to us or at all may require us to significantly change or curtail our current or planned operations in order to conserve cash until such time, if ever, that sufficient proceeds from operations are generated, and could result in us not being in a position to advance our commercialization strategy or take advantage of business opportunities.
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Consolidated Statements of Cash Flows
The following table summarizes our consolidated statements of cash flows for the respective periods:
| September 30, | September 30, | September 30, | |||||||
| 2023 | 2022 | 2021 | |||||||
| Total cash provided by (used in): | |||||||||
| Operating activities | $ | (14,078,630 | ) | $ | (4,256,596 | ) | $ | (6,255,213 | ) |
| Investing activities | (1,440,733 | ) | (1,113,793 | ) | (1,073,192 | ) | |||
| Financing acitivities | 20,755,827 | 2,852,829 | 6,942,750 | ||||||
| Net cash outflows | $ | 5,236,464 | $ | (2,517,560 | ) | $ | (385,655 | ) | |
| Cash, beginning of period | 170,545 | 2,688,105 | 3,073,760 | ||||||
| Cash, end of period | $ | 5,407,009 | $ | 170,545 | $ | 2,688,105 | |||
Cash used by operating activities
Cash flow used in operating activities increased by $9.8 million to $14.1 million for the year ended September 30, 2023 primarily due to payments on overdue payables as well as unpaid voluntary deferred wages, consulting fees, and bonuses until we closed the U.S. IPO and Canadian Offering, coupled with significant prepaid expenses during the year ended September 30, 2023. Prepaid expenses increased by $0.4 million mainly due to the renewal of D&O and commercial insurance coverage, capital market advisory services, and retention bonus for our head of PARA OPS (refundable in the event he voluntarily terminates prior to a specified date as set by us).
Cash used by investing activities
Cash flow used in investing activities was $1.4 million for the year ended September 30, 2023, an increase of $0.3 million from the comparable period, mainly due to additional investment in the product development of our PARA OPS, coupled with additional low-rate initial production equipment for PARA OPS.
Cash provided by financing activities
Cash flow provided by financing activities was $20.8 million in Fiscal 2023 compared to $2.9 million in Fiscal 2022 primarily due to net proceeds generated from the U.S. IPO and Canadian Offering and the July 2023 Private Placement, partially offset by repayment of all outstanding borrowings during the year ended September 30, 2023.
Capital Resources
Our objective in managing our capital is to safeguard our ability to continue as a going concern and to sustain future development of the business. Our senior management is responsible for managing the capital through regular review of financial information to ensure sufficient resources are available to meet operating requirements and investments to support its growth strategy. Our Board is responsible for overseeing this process. From time to time, we could issue new Common Shares or debt to maintain or adjust our capital structure. We are not subject to any externally imposed capital requirements.
Our primary sources of capital to date have been borrowings, security offerings, exercise of stock options and warrants, and, to a lesser extent, pre-commercial revenue. The following is a breakdown of our capital:
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| September 30, | September 30, | September 30, | |||||||
| 2023 | 2022 | 2021 | |||||||
| Debt: | |||||||||
| Lease obligations | $ | 429,523 | $ | 275,621 | $ | 307,909 | |||
| Related party loans | - | - | - | ||||||
| Borrowings | - | 2,278,774 | 53,251 | ||||||
| Warrant liabilities | 4,335,673 | - | - | ||||||
| Equity: | |||||||||
| Share capital | 33,379,110 | 19,496,640 | 17,215,068 | ||||||
| Warrants | 1,042,657 | 1,959,796 | 1,848,389 | ||||||
| Contributed surplus | 4,769,115 | 3,551,330 | 2,458,211 | ||||||
| Accumulated other comprehensive loss | (39,663 | ) | (101,418 | ) | (8,991 | ) | |||
| Accumulated deficit | (35,215,599 | ) | (25,909,239 | ) | (15,388,949 | ) | |||
| Total capital | $ | 8,700,816 | $ | 1,551,504 | $ | 6,484,888 | |||
During Fiscal 2023, we fully repaid all outstanding loans following the closing of the U.S. IPO and Canadian Offering.
Contractual Obligations and Commitments
At September 30, 2023, our contractual obligations and commitments were as follows:
| 5 years and | |||||||||||||||
| Payment due: | Total | Within 1 Year | 1 to 3 years | 3 to 5 years | beyond | ||||||||||
| Minimum royalty commitments | $ | 2,350,000 | $ | 150,000 | $ | 400,000 | $ | 500,000 | $ | 1,300,000 | |||||
| Accounts payable and accrued liabilities | 1,649,876 | 1,649,876 | - | - | - | ||||||||||
| Lease obligations | 558,755 | 197,367 | 355,430 | 5,958 | - | ||||||||||
| Total contractual obligations | $ | 4,558,631 | $ | 1,997,243 | $ | 755,430 | $ | 505,958 | $ | 1,300,000 | |||||
Shares Outstanding
At September 30, 2023, our authorized capital consists of an unlimited number of Common Shares with no stated par value.
The following table shows the outstanding Common Shares and dilutive securities at September 30, 2023:
| Average | |||||||||
September 30, | price | Proceeds if | |||||||
2023(1) | (CAD $) | Exercised | |||||||
| Common shares | 5,616,782 | ||||||||
| Founders' warrants | 106,000 | $ | 14.00 | $ | 1,484,000 | ||||
| Warrants | 21,429 | $ | 0.61 | $ | 13,072 | ||||
| Pre-funded warrants | 1,129,548 | $ | 0.01 | $ | 11,295 | ||||
| Warrant liabilities | 4,824,727 | $ | 5.63 | $ | 27,163,213 | ||||
| Over-allotment warrants | 375,000 | $ | 6.63 | $ | 2,486,250 | ||||
| U.S. Underwriter warrants | 258,587 | $ | 5.14 | $ | 1,329,137 | ||||
| Stock options | 389,907 | $ | 2.72 | $ | 1,060,480 | ||||
| Restricted stock units (RSUs) | 1,071 | $ | - | $ | - | ||||
| Agents' compensation options: | |||||||||
| Common shares | 50,848 | $ | 5.47 | $ | 278,253 | ||||
| Warrants | 50,848 | $ | 6.63 | $ | 336,868 | ||||
| Total common shares and dilutive securities | 12,824,747 | $ | 34,162,568 |
(1) Represents the number of shares to be issued upon exercise.
U.S. IPO and Canadian Offering
On December 9, 2022, we closed the U.S. IPO and Canadian Offering. In the U.S. IPO, we sold 2.5 million U.S. Common Units at a public offering price of US$4.13 per unit, consisting of one Common Share and one Warrant. The Warrants have a per share exercise price of US$5.00, could be exercised immediately, and expire five years from the date of issuance. In connection with the closing of the U.S. IPO, the underwriter partially exercised its over-allotment option to purchase an additional 199,000 pre-funded common share purchase warrants and 375,000 warrants to purchase Common Shares. All these warrants will expire on December 8, 2027.
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In the Canadian Offering, we sold 726,392 units, each consisting of one Common Share and one warrant to purchase one Common Share, at a price to the public of US$4.13 per unit. The warrants will have a per Common Share exercise price of US$5.00, are exercisable immediately and expire five years from the date of issuance.
The closing of the U.S. IPO and Canadian Offering resulted in aggregate gross proceeds of US$14.1 million (CAD $19.4 million). After underwriting discounts and offering expenses, the net proceeds were US$11 million (CAD $15 million). See Note 16(a) of Fiscal 2023 financial statements for further details.
Use of Proceeds
As of September 30, 2023, the Company has used all of the US $11M of the net proceeds as outlined below:
| Expected Use | Expected Use of | Actual Expenditures | ||||||||
| of Proceeds In | Proceeds In | to Sep 30, 2023 In | ||||||||
| Use of Net Proceeds from the US IPO (1) | U.S . Dollars | CAD Dollars | CAD Dollars (8) | |||||||
| Repayment of non-secured borrowings: | ||||||||||
| Issued in March 2022 (2) | $ | 1,460,000 | $ | 2,000,200 | $ | 2,027,517 | ||||
| Issued in August 2022 (3) | $ | 220,000 | $ | 301,400 | $ | 338,976 | ||||
| CEBA loans (4) | $ | 51,000 | $ | 69,870 | $ | 70,000 | ||||
| Product development (5) | $ | 529,000 | $ | 724,730 | $ | 683,450 | ||||
| Corporate, general & administration, and working capital: | ||||||||||
| General and administrative (6) | $ | 2,469,000 | $ | 3,382,530 | $ | 4,128,985 | ||||
| Selling and marketing | $ | 1,355,000 | $ | 1,856,350 | $ | 2,447,930 | ||||
| Research and development, net | $ | 296,000 | $ | 405,520 | $ | 1,287,581 | ||||
| Negative working capital at September 30, 2022 (excluding above loans) | $ | 2,286,226 | $ | 3,132,130 | $ | 3,132,130 | ||||
| Unallocated working capital (7) | $ | 2,297,213 | $ | 3,147,182 | $ | 903,342 | ||||
| Total use of net proceeds | $ | 10,963,439 | $ | 15,019,911 | $ | 15,019,911 |
(1) For Canadian dollars denominated expenses, the amounts were converted at a rate of $1.37 to USD$1.00 on as reported by the Bank of Canada on December 16, 2022.
(2) The net proceeds were used to fund the Corporation's working capital.
(3) On December 13, 2022, one of the two non-secured loans issued in August 2022 was settled for KWESST Units (same terms as those Units offered in the Canadian Offering).
(4) This is net of $23,077 forgivable amount as we have repaid the CEBA loans due to the Canadian Government the repayment deadline for the forgivable amount.
(5) Estimate of Product development costs subsequent to IPO.
(6) Includes litigation settlement for two cases: $27,179 for an ex-employee & $141,123 for an ex-consultant. Excludes non-cash items such as depreciation, share-based costs & impairment costs
(7) Remaining unallocated costs incurred to PP&E additions, inventory additions and FX.
(8) Use of proceeds calculated on a first in, first out basis.
Shares for Debt Settlement
On December 13, 2022, we issued 56,141 units to settle $12,000 of the Unsecured Loans and USD$223,321 of the Secured Loan, including unpaid accrued interest and 10% premium at maturity. See Note 13(a) of Q2 Fiscal 2023 for further details.
Private Placement
On July 21, 2023, we closed the July 2023 Private Placement, resulting in the issuance of 1,542,194 Common Shares, for aggregate gross proceeds of USD$5,588,397 (approximately CAD$7.4M).
As a part of the July 2023 Private Placement, the Company issued 1,542,194 Common Shares at a price of US$2.26 (CAD$2.98) per Common Share and 930,548 pre-funded warrants at a price of US$2.259 (CAD$2.979) per pre-funded warrant (each a "Pre-funded Warrant"), with each Common Share and Pre-funded Warrant being bundled with one common share purchase warrant of the Company (each a "Common Warrant"). Each Pre-Funded Warrant entitles the holder to acquire one Common Share at an exercise price of US$0.001 per Common Share, and each Common Warrant is immediately exercisable and entitles the holder to acquire one Common Share at an exercise price of US$2.66 (CAD$3.50) per Common Share for a period of 60 months following the closing of the July 2023 Offering. Although the Common Shares and Pre-funded Warrants are each bundled with a Common Warrant, each security is issued separately. See Note 16(a) of Fiscal 2023 financial statements for further details.
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Use of Proceeds
As of September 30, 2023, the Company has used $0.9M of the $6.3M net proceeds from the July 2023 Private Placement for general working capital purposes. Use of proceeds is estimated on a first in, first out basis.
Use of Proceeds from Prior Financings
The following table provides an approximate breakdown on the initial allocation of the use of funds for the 2021 brokered private placement and the actual use of proceeds:
| 2021 Financing | |||||||||
Estimated and | |||||||||
Unaudited Actual |
| ||||||||
Expected | Use of Funds from | Proceeds | |||||||
Allocation of | April 29, 2021 to | Unspent as at | |||||||
Net Proceeds | September 30, | September 30, | |||||||
| Use of Proceeds (1) | 2022 | 2022 | |||||||
| Products development: (2) | |||||||||
| TASCS IFM (3) | $ | 400,000 | $ | 314,087 | $ | 85,913 | |||
| BLDS | 200,000 | 305,788 | (105,788 | ) | |||||
| Phantom | 500,000 | 793,852 | (293,852 | ) | |||||
| GreyGhost | 200,000 | 15,840 | 184,160 | ||||||
| ATAK | 500,000 | 304,162 | 195,838 | ||||||
| LEC | 500,000 | 761,943 | (261,943 | ) | |||||
| Total products development | 2,300,000 | 2,495,672 | (195,672 | ) | |||||
| Other specific allocations: | |||||||||
| Repayment of CEO and employee loans | 191,600 | 191,600 | - | ||||||
| Repayment of unsecured borrowings | 310,527 | 310,527 | - | ||||||
| Prepaid royalties to DEFSEC (4) | 150,000 | 150,000 | - | ||||||
| Total allocated proceeds | 2,952,127 | 3,147,799 | (195,672 | ) | |||||
| Unallocated proceeds for working capital | 2,516,366 | 2,320,694 | 195,672 | ||||||
| Transferred from 2020 Financing | 235,345 | 235,345 | - | ||||||
| Total use of proceeds | $ | 5,703,838 | $ | 5,703,838 | $ | - | |||
Notes:
(1) Excludes non-cash transactions settled in Common Shares.
(2) Includes concept & design, initial prototype, market testing, and pre-production including a few demo units. Costs includes internal labor costs, outsourced engineering costs, and materials (no overhead allocation).
(3) Net of customer funding of $1.0 million.
(4) In connection with the PARA OPS System acquisition.
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements that have or are reasonably likely to have, a current or future effect on our results of operations, financial condition, revenues or expenses, liquidity, capital expenditures or capital resources.
C. Research and Development, Patents and Licences, etc.
See Item 5.A. - Operating Results - Results of Operations for a description of our research and development activities during the last three fiscal years.
See Item 4.B. - Business Overview - Proprietary Protection for a listing of patents and product development in progress.
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D. Trend Information
See Item 5.A. - Operating Results - Results of Operations and Item 5.B. - Liquidity and Capital Resources for trend information.
E. Critical Accounting Estimates.
The following is a summary of critical accounting policies, requiring management to make significant estimates and assumptions:
Revenue
Revenue is recognized upon transfer of control of products or services to customers at an amount that reflects the transaction price we expect to receive in exchange for the products or services. Our contracts with customers may include the delivery of multiple products and services, which are generally capable of being distinct and accounted for as separate performance obligations. The accounting for a contract or contracts with a customer that contain multiple performance obligations requires us to allocate the contract or contracts transaction price to the identified distinct performance obligations.
Revenue from contracts with customers is recognized, for each performance obligation, either over a period of time or at a point in time, depending on which method reflects the transfer of control of the goods or services underlying the particular obligation to the customer.
For performance obligations satisfied over time, we recognize revenue over time using an input method, based on costs incurred to date relative to total estimated costs at completion, to measure progress toward satisfying such performance obligation (for non-recurring engineering services, the input method is based on hours). Under this method, costs that do not contribute to our performance in transferring control of goods or services to the customer are excluded from the measurement of progress toward satisfying the performance obligation. In certain other situations, we might recognize revenue at a point in time, when the criteria to recognize revenue over time are not met. In any event, when the total anticipated costs exceed the total anticipated revenues on a contract, such loss is recognized in its entirety in the period it becomes known. Refer to Note 18 of Fiscal 2023 financial statements for timing of revenue recognition.
We may enter into contractual arrangements with a customer to deliver services on one project with respect to more than one performance obligation, such as non-recurring engineering, procurement, and training. When entering into such arrangements, we allocate the transaction price by reference to the stand-alone selling price of each performance obligation. Accordingly, when such arrangements exist on the same project, the value of each performance obligation is based on its stand-alone price and recognized according to the respective revenue recognition methods described above. For example, for non-recurring engineering services rendered over a contract period the revenue is recognized using the percentage of completion method; whereas for training services the revenue is recognized after the training is delivered (i.e. point in time).
We account for a contract modification, which consists of a change in the scope or price (or both) of a contract, as a separate contract when the remaining goods or services to be delivered after the modification are distinct from those delivered prior to the modification and the price of the contract increases by an amount of consideration that reflects our stand-alone selling price of the additional promised goods or services. When the contract modification is not accounted for as a separate contract, we recognize an adjustment to revenue on a cumulative catch-up basis at the date of contract modification. There was no contract modification in the fiscal years ended September 30, 2023, 2022, and 2021.
The timing of revenue recognition often differs from performance payment schedules, resulting in revenue that has been earned but not billed. These amounts are included in unbilled receivables. At September 30, 2023, and 2022, we had an immaterial amount of unbilled receivable. Amounts billed in accordance with customer contracts, but not yet earned, are recorded and presented as part of contract liabilities. At September 30, 2023 there was $121 thousand of contract liabilities (2022 - $47 thousand).
When a contract includes a significant financing component, the value of such component is excluded from the transaction price and is recognized separately as finance income or expense, as applicable.
Accounting for acquisitions and contingent consideration
During Fiscal 2022, we acquired Police Ordnance and accounted for it pursuant to IFRS 3, Business Combinations. Areas of significant estimation in connection with the accounting of this transaction included:
During Fiscal 2021, we acquired the PARA OPS system and accounted for it pursuant to IFRS 2, Share-Based Payment. Areas of significant estimation in connection with the acquisition of the PARA OPS system included:
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For further details on the above acquisitions, refer to Note 4 of the Fiscal 2023 financial statements.
Impairment of long-lived assets
We review property and equipment for impairment whenever events or changes in circumstances indicate the carrying amount may not be recoverable. An impairment loss is recognized the carrying value of an asset exceeds its recoverable amount. The recoverable amount is the higher of an asset's fair value less costs to sell and value in use. For the purpose of assessing impairment, assets are grouped at the lowest levels for which there are separately identifiable cash flows, referred as the cash generating unit ("CGU").
In accordance with IFRS, if the sum of the undiscounted expected future cash flows from a long-lived asset is less than the carrying value of that asset, then we recognize an asset impairment charge. The impairment charge is determined based on the excess of the asset's carrying value over its fair value, which generally represents the discounted future cash flows from that asset.
Because we are an early-commercial stage technology company, management exercises significant judgment in establishing key assumptions and estimates to determine the recoverable amount of our CGU, including future cash flows based on historical and budgeting operating results, growth rates, tax rates, and appropriate after-tax discount rates. The actual results may vary and may cause significant adjustments in future periods.
Impairment of non-financial assets
We review non-financial assets for impairment whenever events or changes in circumstances indicate the carrying amount of the assets may be impaired. If the recoverable amount of the respective non-financial asset is less than our carrying amount, it is considered to be impaired. Management exercises significant judgement in estimating the recoverable amount for non-financial assets (see Item 5.E - Critical Accounting Estimates - Impairment of long-lived assets).
Accounting for share-based compensation
We measure share-based compensation at fair value. Key inputs in the Black Scholes option model is the volatility assumption, forfeiture rate, and expected life of our Common Shares. Due to our limited trading history, management has established a relevant peer group of listed companies and selected the weighted average of their volatilities over a period of three to five years, where available. Starting in Fiscal 2021, we have commenced to incorporate a percentage of our stock volatility in the overall calculation of the volatility assumption. We rely on our stock volatility to estimate the fair value of share-based compensation as well as for warrants. As a result of our limited trading history, we have assumed a forfeiture rate of 0%, which will be reassessed annually. The expected life is estimated based on our trading history.
Accounting for Unsecured Loans
Due to the issuance of bonus Common Shares as part of the unsecured loans transactions during Fiscal 2022, we are required to allocate a percentage of the gross proceeds between the bonus Common Shares and the debt component based on their relative fair value. To measure the fair value of the unsecured loans, we used the income approach and estimated a market discount rate ranging from 22% - 24% to discount the future cash flows of the unsecured loans. Management selected a discount rate based on review of the debt cost for comparable public companies.
For further information on the unsecured loans, see Note 12 of the Fiscal 2022 financial statements.
Broker compensation options
As a result of the private placement in April 2021, we issued broker compensation options. To measure the fair value of the broker compensation options, we used the Monte Carlo valuation model and exercised judgment in estimating the life, risk free rate, and volatility.
For further information on the broker compensation options see Note 16(c) of the Fiscal 2023 financial statements.
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ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
A. Directors and Senior Management
The following table sets forth the name of each of our directors and executive officers, as well as such individual's place of residence, position with us, principal business activities performed outside those with us and period of service as a director (if applicable).
Directors and Executive Officers
| Name | Position With | Age | Principal Business Activity | Director/Officer Since | |
KWESST Micro | Outside KWESST Micro | ||||
| David Luxton | Executive Chairman and Director | 71 | N/A | October 24, 2019(1) | |
Ontario, Canada
| |||||
| Sean Homuth | President, CEO(6) | 45 | N/A | June 12, 2023(2) | |
Ontario, Canada
| |||||
Paul Mangano (3) Maine, United States | Director | 65 | Founder and Owner, Surculus Advisors LLC and General Manager, Steiner Optics Inc. (up to April 2022), CEO of OnPoint Systems, Inc. since August 2022 | September 17, 2020 | |
| Paul Fortin (3) Ontario, Canada | Director | 55 | Senior Associate, David Pratt & Associates and Independent Advisor | September 17, 2020 | |
| John McCoach (3) British Columbia, Canada | Director | 66 | Director and Chairman of the Audit Committee, Xybion Digital Inc.; Vice Chairman, Royal Canadian Marine Search and Rescue | November 28, 2017(4) | |
| Kris Denis Ontario, Canada | Interim Chief Financial Officer and Chief Compliance Officer | 42 | N/A | November 27, 2023(5) | |
| Rick Hillier Ontario, Canada | Director | 68 | Consultant | December 6, 2023(7) | |
Notes:
(1) Date on which Mr. Luxton became a director of KWESST.
(2) Mr. Homuth became CEO of KWESST on November 27, 2023. From June 12, 2023 to November 26, 2023, Mr. McLeod served as President and CEO of KWESST.
(3) A member of the Audit Committee. Mr. McCoach is Chair of the Audit Committee.
(4) Date on which Mr. McCoach became a director of Foremost.
(5) Date on which Mr. Denis became interim Chief Financial Officer of KWESST
(6) As at September 30, 2023, Mr. Jeffrey McLeod held the office of Director, President and Chief Executive Officer of the Company, until his resignation on October 31, 2023.
(7) Mr. Hillier was appointed to the Board of December 6, 2023.
The following are brief biographies of our directors and executive officers.
David Luxton, Executive Chairman and Director
David Luxton is an entrepreneur in the defense and security industry. He is a former Canadian infantry officer, and former senior official with the Canadian and British governments. In 1990 he founded Simunition, a business that develops and sells simulated munitions for realistic close quarters combat training for military and law enforcement. Between 2003 and 2009, he led the expansion of the Allen-Vanguard Corporation, a company in the IED countermeasures business, from approximately $3,000,000 to a run rate of approximately $300,000,000 in annual revenues, then served as Chairman from 2010 to October 2021. Between 2015 and 2018, he was the Executive Chairman of United Tactical Systems, LLC, a company offering non-lethal products for law enforcement, military and personal defense. From 2003 to the date of this Annual Report, he has been President & Owner of DEFSEC, a company that specializes in strategic transactions in the defense and security industry. Furthermore, from 2016 to 2020, he was a Senior Strategic Advisor to the University of Ottawa. Since 2019, he has been the Executive Chairman of KWESST. He holds a SMDP postgraduate studies from the University of Oxford. He entered into a confidentiality and non-disclosure agreement through his consulting agreement with us on October 1, 2019.
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Sean Homuth, President and Chief Executive Officer
Mr. Homuth is a senior financial executive with more than 20 years of experience working with both Canadian and U.S. public companies across a broad range of industries. He has experience with a variety of financing (equity, debt, royalty) and M&A transactions. Since 2008, he has spent the majority of his time in various senior executive roles with emerging companies. Mr. Homuth is a Chartered Professional Accountant (CPA, CA Ontario) and a Certified Public Accountant (Illinois).
Paul Mangano - Director
Prior to being invited to join our Board, Mr. Mangano founded and owned Surculus Advisors LLC since 2016, a boutique management consulting firm providing advice, leadership, specialized expertise and transaction consultation services to the industrial and high-tech sectors including aerospace, defense and security. Further, since August 2022, he is the CEO of Onpoint Systems, Inc. From August 2020 to April 2022, he was the General Manager of Steiner Optics Inc., a division of Beretta. Prior to forming Surculus Advisors LLC, from 2006 to 2015, he served as the President of L-3 Communication's Public Safety & Sporting business unit. Mr. Mangano graduated with a BA in Economics from Harvard University and an MBA in High Technology from Northeastern University.
Paul Fortin - Director
Prior to being invited to join our Board, Paul Fortin was the director of international business development at Borden Ladner Gervais LLP, a full-service law firm, from 2011 to 2019. Since March 2020, he has been working with David Pratt & Associates as a Senior Associate and is an independent advisor within the defense and security industry. Mr. Fortin graduated from Carleton University with a Bachelor's degree in Political Science and from Algonquin College with a specialization in Product Marketing Management.
John McCoach - Director
Prior to being invited to join our Board, John McCoach held multiple senior positions in various companies, including seven years as the President of the TSXV. John McCoach was a member of the Capital Markets Authority Implementation Organization Board of Directors from 2016 to 2021. Mr. McCoach is an independent director and the current Audit Committee Chairman of Xybion Digital Inc. since November 2021. He also served as Interim CEO and as a director of Foremost Ventures Corp., a position he held from 2018 until the Qualifying Transaction with KWESST Inc. Finally, Mr. McCoach is an active crew member, and Vice Chairman of, Royal Canadian Marine Search and Rescue.
Kris Denis - Interim Chief Financial Officer and Chief Compliance Officer
Mr. Denis has 20 years' experience in all aspects of financial management with private and public companies, large and small, across a wide range of industries. Mr. Denis has spent the majority of his career in increasingly senior positions with publicly traded companies. Mr. Denis is a Chartered Professional Accountant (CPA, CA Ontario).
Rick Hillier - Director
General (Retired) Rick Hillier served over 35 years in the Canadian Armed Forces, culminating his career as the Chief of Defence Staff from 2005-2008. His leadership, geopolitical knowledge and experience on multinational operations, at the tactical, operational and strategic levels, prepares him to help position the Company for success and navigate the Company through its next stages of growth.
Board Diversity Matrix
| Board Diversity Matrix (As of January 17, 2024) | ||||
| Country of Principal Executive Offices: | Canada | |||
| Foreign Private Issuer | Yes | |||
| Disclosure Prohibited under Home Country Law | No | |||
| Total Number of Directors | 5 | |||
| Female | Male | Non-Binary | Did Not Disclose Gender | |
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| Part I: Gender Identity | ||||
| Directors | 0 | 5 | - | - |
| Part II: Demographic Background | ||||
| Under-represented person in Home Country | 0 | |||
| LGBTQ+ | 0 | |||
| White | 5 | |||
On August 6, 2021, the SEC approved Nasdaq Listing Rule 5605(f) regarding board diversity. Under the rule, NASDAQ-listed companies, that are also foreign issuers, are required to include, or explain why it has not included (as the case may be), at least one "Diverse" director prior to December 31, 2023 and at least two "Diverse" directors by December 31, 2025. Under Nasdaq Listing Rule 5605(f)(2)(D), boards of directors composed of five or fewer members must have one director who is "Diverse."
The composition of our Board does not currently include an individual who is "Diverse" under the Nasdaq Listing Rule 5605(f), as presented in the above Board Diversity Matrix. We are mindful of the benefit that diversity can provide in maximizing the effectiveness and decision-making abilities of our Board. In this regard, we are committed to increasing diversity on our Board and moving forward, in our searches for new director candidates, we will consider the level of diversity, including representation of underrepresented individuals and female representation, on the Board, which will be one of several factors used in the search process.
B. Compensation
Compensation for Fiscal 2023
The aggregate amount of compensation paid during the year ended September 30, 2023 (including accrued amount at September 30, 2023), directly and indirectly, including directors' fees, to our named executive officers and directors in their capacity as such, was $1.5 million (Fiscal 2022: $1.2 million).
This discussion describes our compensation program for each person who acted as President and CEO, CFO and the three most highly-compensated executive officers (or three most highly-compensated individuals acting in a similar capacity), other than the CEO and the CFO, whose total compensation was more than $150,000 in our last fiscal year and who was performing a policy-making function in respect of the Company (each a "NEO" and collectively the "NEOs"). This section addresses our philosophy and objectives and provides a review of the process that the Board follows in deciding how to compensate the NEOs. This section also provides discussion and analysis of the Board's specific decisions about the compensation of the NEOs for the fiscal year ended September 30, 2023. We had five (6) NEOs during the fiscal year ended September 30, 2023, namely: David Luxton, Executive Chairman and Director, Sean Homuth, CFO and CCO, Jeffery MacLeod, former President and CEO, Steven Archambault, former CFO, VP, Corporate Services & Compliance, and interim Corporate Secretary, Harry Webster, Genreal Manager and Richard Bowes, VP, Operations of Digitzation & Tactical Products.
Compensation Philosophy and Objectives
Our current executive compensation program is designed to provide short and long-term rewards to our executives that are consistent with individual and corporate performance and their contribution to our short and long-term objectives. Our objectives with respect to compensation of executive officers are to provide compensation levels necessary to attract and retain high quality executives, and to motivate key executives to contribute to our interests. These objectives are to be met by the principal components of our executive compensation program, which has been focused on a combination of base compensation, cash bonus remuneration, and long-term incentives in the form of stock options or other security-based compensation.
The executive compensation program adopted by us and applied to our executive officers is designed to:
(a) attract and retain qualified and experienced executives who will contribute to our growth and success;
(b) ensure that the compensation of our executive officers provides a competitive base compensation package and a strong link between corporate performance and compensation; and
(c) motivate executive officers to enhance long-term shareholder value, with current compensation being weighted toward at-risk long-term incentives in the form of options and other security-based incentives so as to foster alignment with the interests of our shareholders and stakeholders.
We do not believe that our compensation programs encourage excessive or inappropriate risk taking because: (i) our employees receive both fixed and variable compensation, and the fixed portion (salary) provides a steady income regardless of Common Share value, which allows employees to focus on our business; and (ii) our LTIP encourages a long-term perspective due to the vesting provisions, which is generally at least over two (2) years. We believe that our compensation program is appropriately structured and balanced to motivate our employees and reward the achievement of annual performance goals, as well as the achievement of long-term growth in shareholder value.
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Compensation Governance and Process
We have relied on the experience of our Board in setting our executive compensation philosophy and appropriate levels of compensation for our NEOs.
Today, we do not have a separate Compensation Committee. Our Board assumes responsibility as a whole for the oversight over the compensation of directors and executives, including:
While David Luxton works with our Board in making recommendations regarding our overall compensation policies and plan as well as specific level of compensation for the other NEOs, they are recused from any Board deliberations and decisions in respect to their own personal compensation. Their respective current fixed compensation was set prior to going public in Canada.
For Fiscal 2023, we retained an independent consulting firm to conduct a peer review and recommend to the Board competitive compensation plans (short and long-term) for our NEOs and independent directors. Accordingly, this may lead to significant changes to our compensation policies and practices.
Elements of Compensation
Our executive compensation program consists of three principal components: base salaries, annual incentive compensation and benefits, and long-term compensation.
Base Salaries
Base salaries are intended to reflect an executive officer's position within our corporate structure, his or her years of experience and level of responsibility, and salary norms in the sector and general marketplace We have not formally conducted benchmarking against our peer group. Further, as an early-stage company, we believe we have set the base salaries for the NEOs below current market to conserve cash in return for higher stock-based compensation awards. As previously noted, for Fiscal 2023 we retained an independent consultant firm to formalize this process. Accordingly, decisions with respect to base salary levels for executive officers are not based on objective identifiable performance measures but for the most part are determined by reference to competitive market information for similar roles and levels of responsibility, coupled with subjective performance factors such as leadership, commitment, accountability, industry experience, and contributions. Our view is that a competitive base salary is a necessary element for retaining qualified executive officers, as it creates a meaningful incentive for individuals to remain with us and not be unreasonably susceptible to recruiting efforts by our competitors.
In determining the base salary compensation of each NEO, the Board considers: (i) recruiting and retaining executives critical to our success and the enhancement of shareholder value; (ii) providing fair and competitive compensation; (iii) balancing the interests of management and our shareholders; and (iv) rewarding performance, both on an individual basis and with respect to operations in general.
Annual Incentive Compensation and Benefits
Our Board will consider whether it is appropriate and in our best interests to award discretionary cash bonus to the NEOs for the most recently completed fiscal year and, if so, the amount. Discretionary cash bonuses are awarded to recognize the achievement of annual corporate objectives and to recognize contributions that enhance our intrinsic value.
The following is a summary of the maximum annual incentive compensation as a percentage of base salary / annual consulting fee, for the NEOs based on their respective employment / consulting agreements, at the sole discretion of the Board:
| Position | Maximum Annual Incentive Compensation (Percentage of Base Salary) | |
| Executive Chairman | 75% | |
| President and CEO | 75% | |
| CFO, General Manager | 40% |
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We have not established explicit goals / milestones for our NEOs for Fiscal 2023 for the annual cash incentive compensation.
Long-Term Compensation
The long-term component of compensation for our NEOs, consists of (i) stock options ("Options"), (ii) RSUs, (iii) deferred share units ("DSUs"), (iv) SARs and/or (v) PSUs (collectively the "Security-Based Compensation Awards"). This component of compensation is intended to reinforce management's commitment to long-term improvements in our performance.
Our Board believes that incentive compensation in the form of Security-Based Compensation Awards which vest over time, is and has been beneficial and necessary to attract and retain NEOs. Furthermore, the Board believes Security-Based Compensation Awards are an effective long-term incentive vehicle because they are directly tied to our share price over a longer period and therefore motivates NEOs to deliver sustained long-term performance and increase shareholder value, and have a time horizon that aligns with long-term corporate goals. As such, our Board does not grant Security-Based Compensation Awards in excessively dilutive numbers or at exercise prices not reflective of the Company's underlying value.
In determining individual equity-based grants, the Board considers the experience, responsibilities and performance of each recipient of an award under the LTIP. Previous grants are also taken into consideration during the grant process.
Benefits Plans
The NEOs are entitled to life insurance, health and dental benefits.
We do not maintain a pension plan or retirement benefit plan for the NEOs.
External Compensation Consultants
For Fiscal 2023, we retained an independent consulting firm to conduct a peer review and recommend to the Board competitive compensation plans (short and long-term) for our NEOs and independent directors. Accordingly, this may lead to significant changes to our compensation policies and practices.
Assessment of Risks Associated with Our Compensation Policies and Practices
Our Board has assessed the compensation plans and programs for our executive officers to ensure alignment with our business plan and to evaluate the potential risks associated with those plans and programs. Our Board has concluded that the compensation policies and practices do not create any risks that are reasonably likely to have a material adverse effect on the Company.
Our Board considers the risks associated with executive compensation and corporate incentive plans when designing and reviewing such plans and programs. We have not adopted a policy restricting our NEOs or directors from purchasing financial instruments that are designated to hedge or offset a decrease in market value of equity securities granted as compensation or held, directly or indirectly, by its NEOs or directors. To our knowledge, none of the NEOs or directors has purchased such financial instruments.
Performance Graph
The following graph illustrates the cumulative return to our shareholders based on a $100 investment in the Common Shares from September 22, 2020, the date we went public in Canada, to September 30, 2023, as compared to the cumulative total return on the Standard & Poor's / TSXV Composite Index for the same period, assuming the reinvestment of cash distributions and/or dividends:
The trend in the above performance graph does not correlate to the trend of the compensation paid to the NEOs. As described under "Elements of Compensation", based salaries reflect each NEO's primary duties and responsibilities and are set at levels based on responsibility, experience and expertise as well as subjective factors such as leadership. We believe that management must be compensated a minimum base salary for the value of the services provided, irrespective of our Common Share price performance. Pursuant to our LTIP, we have granted Options, RSUs, and PSUs to our NEOs, each form a significant portion of compensation, and therefore the total compensation for the NEOs is directly affected by decreases or increases in the price of our Common Shares as the value of such Options, RSUs, and PSUs changes as our Common Share price changes.
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Summary Compensation Table
The following table provides information concerning the total compensation paid to the NEOs for the years ended September 30, 2023, 2022, and 2021.
| Non-equity incentive plan compensation | |||||||||||||||||||||||||||
| Name | Fiscal Year | Fee / Salary | Share-based Awards (1) | Option-based Awards (2) | Annual Incentive Plans (3) (10) | Long-term Incentive Plans | Pension Value (4) | All Other Compensation | Total Compensation | ||||||||||||||||||
| David Luxton (5) Executive Chairman and Director | 2023 | $ | 315,000 | $ | - | $ | 178,500 | $ | - | $ | - | $ | - | $ | - | $ | 493,500 | ||||||||||
| 2022 | $ | 180,000 | $ | - | $ | - | $ | 308,408 | $ | - | $ | - | $ | - | $ | 488,408 | |||||||||||
| 2021 | $ | 180,000 | $ | 237,300 | $ | 58,000 | $ | - | $ | - | $ | - | $ | - | $ | 475,300 | |||||||||||
| Sean Homuth (6) CFO and CCO | 2023 | $ | 92,308 | $ | - | $ | 140,250 | $ | - | $ | - | $ | - | $ | 2,000 | $ | 234,558 | ||||||||||
| 2022 | $ | - | $ | - | $ | - | $ | - | $ | - | $ | - | $ | - | $ | - | |||||||||||
| 2021 | $ | - | $ | - | $ | - | $ | - | $ | - | $ | - | $ | - | $ | - | |||||||||||
| Jeffrey MacLeod (7) President & CEO and Director | 2023 | $ | 160,000 | $ | - | $ | 25,500 | $ | - | $ | - | $ | - | $ | - | $ | 185,500 | ||||||||||
| 2022 | $ | 160,000 | $ | - | $ | - | $ | - | $ | - | $ | - | $ | - | $ | 160,000 | |||||||||||
| 2021 | $ | 160,000 | $ | 237,300 | $ | 58,000 | $ | - | $ | - | $ | - | $ | - | $ | 455,300 | |||||||||||
| Steven Archambault (8) CFO and VP, Corporate Services & Compliance | 2023 | $ | 111,462 | $ | - | $ | - | $ | - | $ | - | $ | - | $ | 127,930 | $ | 239,392 | ||||||||||
| 2022 | $ | 155,000 | $ | 115,660 | $ | 12,334 | $ | 171,338 | $ | - | $ | - | $ | - | $ | 454,332 | |||||||||||
| 2021 | $ | 192,733 | $ | 24,999 | $ | 301,000 | $ | - | $ | - | $ | - | $ | - | $ | 518,732 | |||||||||||
| Harry Webster General Manager | 2023 | $ | 23,077 | $ | - | $ | - | $ | - | $ | - | $ | - | $ | - | $ | 23,077 | ||||||||||
| 2022 | $ | - | $ | - | $ | - | $ | - | $ | - | $ | - | $ | - | $ | - | |||||||||||
| 2021 | $ | - | $ | - | $ | - | $ | - | $ | - | $ | - | $ | - | $ | - | |||||||||||
| Richard Bowes (9) VP, Operations of Digitization & Tactical Products | 2023 | $ | 206,471 | $ | - | $ | - | $ | 130,000 | $ | - | $ | - | $ | - | $ | 336,471 | ||||||||||
| 2022 | $ | 155,000 | $ | 25,648 | $ | 12,334 | $ | - | $ | - | $ | - | $ | - | $ | 192,982 | |||||||||||
| 2021 | $ | 78,419 | $ | 24,999 | $ | 301,000 | $ | - | $ | - | $ | - | $ | - | $ | 404,418 | |||||||||||
(1) Represents the grant value of RSU awards, based the closing price of the Common Shares on the TSXV on the grant date.
(2) Represents the grant value of the option awards, using the Black-Scholes option model. The Black-Scholes option model was selected by us as it is the most widely adopted and used option-valuation method. For the key inputs used in this valuation mode, refer to Note 16 (c) of the audited financial statements for Fiscal 2023.
(3) In December 2022, the Board awarded a cash bonus of USD$225,000 to David Luxton and USD$125,000 to Steven Archambault in respect to their performance during Fiscal 2022, paid only after the closing of the U.S. IPO and Canadian Offering. For the above table, these amounts were converted to CAD using the daily average exchange rate on September 30, 2022, as reported by the Bank of Canada for the conversion of USD into CAD was USD$1.00 equals CAD$1.3707.
(4) The Company does not have a retirement plan.
(5) Effective October 1, 2019, we entered into a professional services agreement with DEFSEC Corporation, a private company owned by Mr. Luxton. The compensation payable to Mr. Luxton is paid to his private company, DEFSEC Corporation.
(6)Mr. Homuth served as CFO of KWESST from June 12, 2023 to November 26, 2023. On November 27, 2023, Mr. Homuth was appointed as President and CEO of KWESST.
(7) Mr. MacLeod retired from his positions as President, CEO and Director of KWESST on October 31, 2023. As part of his departure, the Company is continuing to pay his base salary and provide benefits for a period of one year with no incentive pay. While this arrangement was verbally agreed to, it continues to be subject to formal agreement with Mr. Macleod.
(8) Mr. Archambault joined as our CFO on a part-time basis on October 1, 2020, and transitioned to full-time on April 1, 2021. He also took on the role of VP, Corporate Services and Compliance in October 2021 and Interim Corporate Secretary in May 2022. He resigned from his positions with KWESST on June 12, 2023.
(9) From January 25, 2021 to April 12, 2021, the Company entered into a consulting agreement with Mr. Bowes' private company, Cardinal Defence. Effectively April 12, 2022 Mr. Bowes joined KWESST as a full-time employee until February 28, 2023. From March 1, 2023 to November 15, 2023, the Company entered into a consulting agreement once again with Mr. Bowes' private company, Cardinal Defence.
(10) As part of his 2023 consulting agreement, Mr. Bowes was entitled to a $15K quarterly incentive bonus. He was also awarded a $100K contract awared bonus as part of the successful DSEF contract negotiations.
Employment and Consulting Agreements
The following summarizes the key salient terms of the employment agreements between us and our NEOs in force as of September 30, 2023.
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David Luxton
On October 1, 2019, we entered into a professional services agreement with DEFSEC Corporation, a private holding company owned by Mr. Luxton, in which he agreed to serve as our Executive Chairman for an annual fee of $120,000 per year and raising to $150,000 per year upon a going public transaction. This agreement was amended effective August 1, 2020, whereby the annual fee was adjusted to $180,000 per year. Mr. Luxton is entitled to an annual incentive bonus up to 200% of his annual fee at the Board's sole discretion. This agreement expired on December 31, 2022. Subsequent to December 31, 2022, Mr. Luxton's compensation was amended to $360,000 per year with entitlement to an annual incentive bonus of up to 75% effective January 1, 2023. We have the right to terminate his consulting agreement with twelve (12) month notice period, subject to termination benefits (see Item 5.B. - Potential Termination and Change of Control Benefits). The notice period increases to 18 months in the event of a change of control.
Sean Homuth
On July 31, 2023, we entered into an amended and restated employment agreement, with effective date of June 12, 2023, with Mr. Homuth to serve as Chief Financial Officer and Chief Compliance Officer. Mr. Homuth receives an annual base salary of CAD$300,000 with an annual incentive bonus of up to 50% of his annual base salary at the Board's sole discretion and four weeks of vacation per year. Mr. Homuth will also receive an initial stock option grant with amount determined at the Board's discretion and vesting in accordance with the terms of the Company's LTIP plan. We may terminate Mr. Homuth's employment upon payment of a lump sum equal to 26 weeks' salary plus accrued bonus. This lump sum is increased by one week per completed year of service following the first anniversary of his employment with the Company to a maximum of 38 weeks. In the event of a change of control, the forgoing is changed from 26 weeks to 52 weeks with the maximum changing from 38 weeks to 64 weeks. On November 27, 2023, Mr. Homuth was appointed President and CEO and his employment agreement was amended and restated. Mr. Homuth's salary was increased to $360,000, the annual incentive bonus was increased up to 75% of his annual salary, his employment may be terminated upon payment of a lump sum equal to 52 weeks salary plus accrued bonus, this lump sum is increased by one week per completed year of service to a maximum of 78 weeks and in the event of a change in control, the foregoing is changed from 52 weeks to 78 weeks.
Jeffrey MacLeod
On October 1, 2019, we entered into an employment agreement with Mr. MacLeod to serve as our President and CEO with an initial base salary of $140,000 per year and raising to $160,000 upon a going public transaction. Because Mr. MacLeod's principal residence is based in West Montrose, Ontario, his employment agreement includes a $1,000 per month housing allowance for accommodations in Ottawa, Ontario while working at our corporate office. For Fiscal 2019, Mr. MacLeod collected a lower base salary to help us conserve cash to fund our working capital requirements. Further, he did not receive any housing allowance in the last three financial years. Mr. MacLeod is entitled to an annual incentive bonus at the Board's sole discretion and five weeks of vacation per year. His employment agreement will expire on September 30, 2022. We have the right to terminate his consulting agreement with twelve (12) month notice period, subject to termination benefits (see Item 5.B. - Potential Termination and Change of Control Benefits). The notice period increases to 18 months in the event of a change of control. Mr. MacLeod retired on October 31, 2023.
Steven Archambault
On October 1, 2020, we entered into a part-time employment agreement with Mr. Archambault to serve as our part-time CFO for a monthly salary of $9,950 based on two business days per week, subject to adjustment for extra business days as defined in the agreement. On April 1, 2021, we amended his employment agreement to serve as our full-time CFO with an annual base salary of $180,000, of which $25,000 is to be in the form of RSUs and $155,000 in cash. These RSUs will be granted each year on April 1st, vesting over the next 12 months. Mr. Archambault is entitled to an annual incentive bonus up to 50% of his annual base salary at the Board's sole discretion and four weeks of vacation per year. Mr. Archambault also assumed the role of Vice President, Corporate Services and Compliance starting in October 2021. We have the right to terminate his employment agreement with 30 days' notice, subject to termination benefits (see Item 5.B. - Potential Termination and Change of Control Benefits). Mr. Archambault stepped down as CFO of the Company on March 1, 2023, to pursue a new opportunity overseas.
Harry Webster
On August 28, 2023, we entered into a full-time employment agreement with Mr. Webster to serve as our General Manager. Mr. Webster receives an annual base salary of $240,000. Subsequent to September 30, 2023, the board approved a change in his entitlement annual incentive bonus to up to 40% of his annual base salary at the Board's sole discretion and four weeks of vacation per year. We may terminate Mr. Webster's employment upon payment of the greater of 12 weeks' salary or his minimum entitlements under the ESA.
Outstanding Equity Awards at September 30, 2023
The following table sets forth information concerning all the outstanding equity awards held by each NEO as at September 30, 2023.
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| Option-based awards | Share-based awards | ||||||||||||||||||||
| Number of securities underlying unexercised options | Option exercise price | Option expiration date | Value of unexercised in the- money options(1) | Number of shares or units of shares that have not vested | Market or payout value of share-based awards that have not vested (2) | Market or payout value of vested share-based awards not paid out or distributed | |||||||||||||||
| David Luxton (3) | 1,429 | $ | 87.50 | 2026-07-02 | $ | - | - | $ | - | $ | 3,001 | ||||||||||
| 70,000 | $ | 2.55 | 2026-08-16 | $ | - | - | $ | - | $ | - | |||||||||||
| Sean Homuth (4) | 55,000 | $ | 2.55 | 2026-08-16 | $ | - | - | $ | - | $ | - | ||||||||||
| Jeff MacLeod (5) | 1,429 | $ | 87.50 | 2026-07-02 | $ | - | 3,000 | $ | - | $ | 9,301 | ||||||||||
| 10,000 | $ | 2.55 | 2026-08-16 | $ | - | - | $ | - | $ | - | |||||||||||
| Steven Archambault (6) | 1,429 | $ | 14.70 | 2027-07-24 | $ | - | - | $ | - | $ | 3,001 | ||||||||||
| 2,857 | $ | 136.50 | 2026-08-25 | $ | - | - | $ | - | $ | 6,000 | |||||||||||
| 714 | $ | 49.00 | 2025-11-20 | $ | - | - | $ | - | $ | 1,499 | |||||||||||
| 3,571 | $ | 52.50 | 2025-10-01 | $ | - | - | $ | - | $ | 7,499 | |||||||||||
| Harry Webster | - | $ | - | n/a | $ | - | - | $ | - | $ | - | ||||||||||
| Richard Bowes (7) | 1,429 | $ | 14.70 | 2027-07-24 | $ | - | - | $ | - | $ | 3,001 | ||||||||||
| 1,428 | $ | 136.50 | 2026-08-25 | $ | - | - | $ | - | $ | 2,999 | |||||||||||
| 4,285 | $ | 90.30 | 2026-04-29 | $ | - | - | $ | - | $ | 8,999 | |||||||||||
| 1,428 | $ | 120.40 | 2021-01-25 | $ | - | - | $ | - | $ | 2,999 | |||||||||||
| Total | 154,999 | $ | - | 3,000 | $ | - | $ | 48,298 | |||||||||||||
(1) Based on the difference between the exercise price of the Option and $2.10, the closing price of the Common Shares on the TSXV on September 30, 2023.
(2) Based on $2.10, the closing price of the Common Shares on the TSXV on September 30, 2023.
(3) The grants were made to Mr. Luxton's private company, DEFSEC Corporation. His 2021 Option grant will vest over two (2) years and his RSU grant will vest over one (1) year.
(4) Mr. Homuth served as CFO of KWESST from June 12, 2023 to November 26, 2023. On November 27, 2023, Mr. Homuth was appointed as President and CEO of KWESST.
(5) Mr. MacLeod's 2021 Option grant will vest over two (2) years and his RSU grant will vest over one (1) year. Mr. MacLeod retired from his positions as President, CEO and Director of KWESST on October 31, 2023.
(6) Mr. Archambault joined as our CFO on a part-time basis on October 1, 2020, and transitioned to full-time on April 1, 2021. He also took on the role of VP, Corporate Services and Compliance in October 2021 and Interim Corporate Secretary in May 2022. He resigned from his positions with KWESST on June 12, 2023.
(7) From January 25, 2021 to April 12, 2021, the Company entered into a consulting agreement with Mr. Bowes' private company, Cardinal Defence. Effectively April 12, 2022, Mr. Bowes joined KWESST as a full-time employee until February 28, 2023. From March 1, 2023 to November 15, 2023, the Company entered into a consulting agreement once again with Mr. Bowes' private company, Cardinal Defence.
There was no exercise of stock options during Fiscal 2023.
Value Vested or Earned During the Year
The following table sets forth, for each NEO, the value of option-based awards and share-based awards which vested during the fiscal year ended September 30, 2023 and the value of non-equity incentive plan compensation earned during the fiscal year ended during the year ended September 30, 2023.
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| Option-based | Share-based | Non-equity incentive | |||||||
| awards - value | awards - value | plan compensation - | |||||||
| vested during | vested during | value earned during | |||||||
| Name | Fiscal 2023 (1) | Fiscal 2023 (2) | Fiscal 2023 | ||||||
| David Luxton | $ | 2,631 | $ | - | $ | - | |||
| Sean Homuth (3) | $ | - | $ | - | $ | - | |||
| Jeff MacLeod (4) | $ | 2,631 | $ | - | $ | - | |||
| Steven Archambault (5) | $ | 10,260 | $ | 4,830 | $ | - | |||
| Harry Webster | $ | - | $ | - | $ | - | |||
| Richard Bowes (6) | $ | 14,883 | $ | 1,649 | $ | 130,000 |
(1) Amounts represent the difference between the exercise price of the Options and the closing price of the Common Shares on the TSXV on the vesting date.
(2) Amounts represent the number of vested Share Units (as defined below) multiplied by the closing price of the Common Shares on the TSXV on the vesting date.
(3) Mr. Homuth served as CFO of KWESST from June 12, 2023 to November 26, 2023. On November 27, 2023, Mr. Homuth was appointed as President and CEO of KWESST.
(4) Mr. MacLeod retired from his positions as President, CEO and Director of KWESST on October 31, 2023.
(5) Mr. Archambault joined as our CFO on a part-time basis on October 1, 2020, and transitioned to full-time on April 1, 2021. He also took on the role of VP, Corporate Services and Compliance in October 2021 and Interim Corporate Secretary in May 2022. He resigned from his positions with KWESST on June 12, 2023.
(6) From January 25, 2021 to April 12, 2021, the Company entered into a consulting agreement with Mr. Bowes' private company, Cardinal Defence. Effectively April 12, 2022, Mr. Bowes joined KWESST as a full-time employee until February 28, 2023. From March 1, 2023 to November 15, 2023, the Company entered into a consulting agreement once again with Mr. Bowes' private company, Cardinal Defence.
Potential Termination and Change of Control Benefits
All outstanding equity compensation is forfeited / cancelled if we terminate a NEO's employment / consulting agreement for cause. Further, in the event a NEO voluntarily resigns from his employment / consulting with us, any unpaid annual incentive and unvested equity compensation are forfeited in accordance with our LTIP.
We have agreements with the NEOs that set out the terms of their employment / consulting and what they are entitled to in connection with a termination of employment or change of control. These agreements include non-solicitation, confidentiality, and ownership of intellectual property provisions to protect our interests.
The table below sets out the amount that would have been payable to each NEO that was employed by the Company on September 30, 2023 if had there been a change of control of the Company resulting in termination on September 30, 2023:
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| Termination | |||||||||
Notice | Termination | Without Cause in | |||||||
Period | Without Cause (pre- | Connection with | |||||||
(months) | Change of Control) | Change of Control | |||||||
| David Luxton | |||||||||
| Base fee | 12 | $ | 630,000 | $ | 945,000 | ||||
| Value of unvested options | $ | - | $ | - | |||||
| Value of unvested RSUs | $ | - | $ | - | |||||
| Value of vested RSUs not yet issued | $ | 3,001 | $ | 3,001 | |||||
| TOTAL | $ | 633,001 | $ | 948,001 | |||||
| Sean Homuth | |||||||||
| Base pay | 12 | $ | 630,000 | $ | 945,000 | ||||
| Value of unvested options | $ | - | $ | - | |||||
| Value of unvested RSUs | $ | - | $ | - | |||||
| Value of vested RSUs not yet issued | $ | - | $ | - | |||||
| TOTAL | $ | 630,000 | $ | 945,000 | |||||
| Jeffrey MacLeod | |||||||||
| Base pay | 12 | $ | 160,000 | $ | 240,000 | ||||
| Value of unvested options | $ | - | $ | - | |||||
| Value of unvested RSUs | $ | - | $ | - | |||||
| Value of vested RSUs not yet issued | $ | 9,301 | $ | 9,301 | |||||
| TOTAL | $ | 169,301 | $ | 249,301 | |||||
| Harry Webster | |||||||||
| Base pay | 3 | $ | 84,000 | $ | 84,000 | ||||
| Value of unvested options | $ | - | $ | - | |||||
| Value of unvested RSUs | $ | - | $ | - | |||||
| Value of vested RSUs not yet issued | $ | - | $ | - | |||||
| TOTAL | $ | 84,000 | $ | 84,000 |
(1) Mr. Homuth served as CFO of KWESST from June 12, 2023 to November 26, 2023. On November 27, 2023, Mr. Homuth was appointed as President and CEO of KWESST. Amounts represent his most recent employment agreement.
(2) Mr. MacLeod retired from his positions as President, CEO and Director of KWESST on October 31, 2023. As part of his departure, the Company is continuing to pay his base salary and provide benefits for a period of one year with no incentive pay. While this arrangement was verbally agreed to, it continues to be subject to formal agreement with Mr. Macleod.
A change of control is commonly defined in each of the respective agreements as:
a) the sale of all or substantially all of our outstanding Common Shares for cash or securities of an entity not managed by our management team and that are determined by our Board to be liquid for all of our shareholders ("Liquid Unrelated Issuer");
b) a merger, amalgamation, arrangement or other similar transaction involving us where the holders of our Common Shares receive cash or securities of a Liquid Unrelated Issuer, but do not immediately thereafter own securities of the successor corporation which entitle them to cash more than 50% of the votes attaching to all shares in the capital of the successor corporation;
c) the sale of all or substantially all of our assets followed by a liquidating distribution to the holders of our Common Shares of cash or securities of a Liquid Unrelated Issuer;
provided that our Board shall have the right, in its absolute discretion, to deem any transaction not enumerated above to be a change of control. For greater clarity, a sale or transfer of founders shares between related parties, and/or an initial going public transaction of any kind shall not constitute a change of control.
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Compensation of Independent Directors
In July 2023, our Board approved the following cash compensation for the independent directors retroactive October 1, 2022:
Prior to December 2020, we made no cash compensation to the directors.
The following table sets out the total compensation for our independent directors who served at any time during the year ended September 30, 2023.
| Stock | Non-equity | ||||||||||||||||||||
| Fees | Awards | Option | Incentive Plan | Pension | All Other | Total | |||||||||||||||
| Name | Earned | (1) | Awards (2) | Compensation | Value (3) | Compensation | Compensation | ||||||||||||||
| John McCoach | $ | 50,000 | $ | - | $ | 25,500 | $ | - | $ | - | $ | - | $ | 75,500 | |||||||
| Paul Fortin | $ | 40,000 | $ | - | $ | 25,500 | $ | - | $ | - | $ | - | $ | 65,500 | |||||||
| Paul Mangano | $ | 40,000 | $ | - | $ | 25,500 | $ | - | $ | - | $ | - | $ | 65,500 | |||||||
(1) Represents the grant value of RSU awards, based on the closing price of the Common Shares on the TSXV on the grant date.
(2) Represents the grant value of the option awards, using the Black-Scholes option model. The Black-Scholes option model was selected by the Company as it is the most widely adopted and used option-valuation method. For the key inputs used in this valuation mode, refer to Note 16 (c) of the Fiscal 2023 financial statements.
(3) The Company does not have a pension plan.
Outstanding Equity Awards at September 30, 2023
In August 2023, there were 30,000 stock options granted to the independent directors.
The following table sets forth information concerning all the outstanding equity awards held by each of our independent director as at September 30, 2023.
| Option-based awards | Share-based awards | ||||||||||||||||||||
| Number of | Value of | Market or | Market or payout | ||||||||||||||||||
| securities | unexercised | Number of | payout value of | value of vested | |||||||||||||||||
| underlying | Option | Option | in the- | shares or units | share-based | share-based | |||||||||||||||
| unexercised | exercise | expiration | money | of shares that | awards that have | awards not paid | |||||||||||||||
| options (1) | price | date | options(2) | have not vested | not vested (3) | out or distributed | |||||||||||||||
| John McCoach | 3,571 | $ | 67.90 | 2025-12-15 | $ | - | - | $ | - | $ | 7,499 | ||||||||||
| 306 | $ | 32.90 | 2023-06-15 | $ | - | - | $ | - | $ | 643 | |||||||||||
| 10,000 | $ | 2.55 | 2026-08-16 | $ | - | - | $ | - | $ | - | |||||||||||
| Paul Fortin | 3,571 | $ | 67.90 | 2025-12-15 | $ | - | - | $ | - | $ | 7,499 | ||||||||||
| 10,000 | $ | 2.55 | 2026-08-16 | $ | - | - | $ | - | $ | - | |||||||||||
| Paul Mangano | 3,571 | $ | 67.90 | 2025-12-15 | $ | - | - | $ | - | $ | 7,499 | ||||||||||
| 10,000 | $ | 2.55 | 2026-08-16 | $ | - | - | $ | - | $ | - | |||||||||||
| Total | 41,019 | $ | - | - | $ | - | $ | 23,140 | |||||||||||||
(1) The 2023 Option grants to the directors vest over two (2) years. The 2021 Option grants to the directors vest over two (2) years. The 2018 Option granted to Mr. McCoach has fully vested.
(2) Based on the difference between the exercise price of the Option and $2.10, the closing price of the Common Shares on the TSXV on September 30, 2023.
(3) Based on $2.10, the closing price of the Common Shares on the TSXV on September 30, 2023.
There was no exercise of options during Fiscal 2023.
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Value Vested or Earned During the Year
The following table sets forth, for each independent director, the value of option-based awards and share-based awards which vested during the fiscal year ended September 30, 2023 and the value of non-equity incentive plan compensation earned during the fiscal year ended during the year ended September 30, 2023. No share-based awards have been granted to our directors since inception.
| Option-based | Share-based | Non-equity incentive | |||||||
| awards - value | awards - value | plan compensation - | |||||||
| vested during | vested during | value earned during | |||||||
| Name | Fiscal 2023 (1) | Fiscal 2023 (2) | Fiscal 2023 | ||||||
| John McCoach | $ | - | $ | - | $ | - | |||
| Paul Fortin | $ | - | $ | - | $ | - | |||
| Paul Mangano | $ | - | $ | - | $ | - |
(1) Amounts represent the difference between the exercise price of the Options and the closing price of the Common Shares on the TSXV on the vesting date.
(2) Amounts represent the number of vested Share Units (as defined below) multiplied by the closing price of the Common Shares on the TSXV on the vesting date.
Equity Compensation Plans
On February 10, 2021, our Board adopted a new LTIP, which was approved by our shareholders on March 31, 2021 and on April 9, 2021 by the TSXV. Our LTIP was subsequently amended to conform with the new TSXV policy issued on November 24, 2021 in relation to security based compensation. Our shareholders approved this amended LTIP on March 31, 2022, which was subsequently approved by the TSXV on April 14, 2022.
The maximum number of Common Shares issuable under our LTIP for stock options is 10% of our issued and outstanding Common Shares, subject to adjustment or increase pursuant to the terms of the LTIP. Any stock options that have been cancelled, repurchased, expired, or exercised will again be available under the LTIP. At September 30, 2023, we had 389,907 outstanding stock options, leaving 171,771 stock options available for future grants.
Additionally, the maximum number of Common Shares issuable under our LTIP in respect of RSUs, DSUs, SARs, and PSUs (collectively "Share Units") is 407,274. At September 30, 2023, we had 401,060 Share Units available for future grants.
The following is a summary of the salient terms of the equity-based awards available under our amended LTIP. For a more fulsome disclosure of our LTIP, a copy of our amended LTIP is available on SEDAR+ website at www.sedarplus.com.
Stock Options
Key Employees, Directors, Consultants and Persons performing Investor Relations Services (as such terms are defined in the LTIP) are eligible to receive grants of stock options to acquire Common Shares at the time of employment or contract, if applicable, and thereafter as determined by the Board.
Restricted Share Units
Key Employees, Directors and Consultants, are eligible to receive grants of RSUs, entitling the holder to receive one Common Share for each RSU, subject to restrictions as the Board may, in its sole discretion, establish in the applicable award agreement. The Board believes the granting of RSUs creates long-term incentive, a sense of ownership and an alignment of the recipients' interests with those of our shareholders and stakeholders. The granting of RSUs is intended to reward those executives who are responsible for our management and growth and to encourage such executives to develop a long-term vision for us to operate in a manner to maximize shareholder value. By using vesting periods for RSUs in addition to other restrictions, this compensation element is also designed to support long term retention of valuable Key Employees and Directors as well as provide an incentive for the achievement of specific milestones, if applicable.
Performance Share Units
Key Employees, Directors, and Consultants are eligible to receive grants of PSUs, entitling the holder to receive one Common Share for each PSU, subject to the achievement or attainment of specific performance criteria ("Performance Criteria") within a specific period ("Performance Cycle"). The number of PSUs and the Performance Criteria which must be satisfied in order for the PSUs to vest and the Performance Cycle in respect of such PSUs shall be specified in the applicable award agreement. The Board believes the granting of the PSUs incentivizes the attainment of specific goals which support our overall strategies and creates a sense of ownership and an alignment of the recipients' interests with those of our shareholders and stakeholders. The granting of PSUs is intended to reward those executives who are responsible for our management and growth and to encourage such executives to develop a long-term vision for us to operate in a manner to maximize shareholder value. By using vesting periods for PSUs in addition to other restrictions, this compensation element is also designed to support long-term retention of valuable employees as well as provide an incentive for the achievement of specific milestones, if applicable.
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Deferred Share Units
Key Employees and Directors are eligible to receive grants of DSUs. Directors may elect to receive any part or all of their fees payable in respective of their position as a director as DSUs. Each holder of a DSU is entitled to receive one Common Share for each DSU. The Board believes the granting of DSUs creates long-term incentive, a sense of ownership and an alignment of the recipients' interests with those of our shareholders and Stakeholders. The granting of DSUs is intended to reward directors who are responsible for oversight of our management and growth and to encourage such directors to maintain a long-term vision for us to operate in a manner to maximize shareholder value.
Stock Appreciation Rights
Key Employees, Directors, and Consultants are eligible to receive grants of SARs, entitling the recipient to receive a payment in Common Shares equal to the current market price less the grant price of the SAR as determined by the Board at the time of the grant for each SAR. Notwithstanding the foregoing, the Board may, in its sole discretion, satisfy payment of the entitlement in cash rather than in Common Shares. The granting of SARs is intended to reward those executives who are responsible for our management and growth and to encourage such executives to develop a long-term vision for us to operate in a manner to maximize shareholder value. By using vesting periods for SARs, this compensation element is also designed to support long-term retention of valuable employees as well as provide an incentive for the achievement of specific milestones, if applicable.
Vesting Provision
No award issued under the LTIP, other than Options, may vest before the date that is one year following the date it is granted or issued. Notwithstanding this provision, vesting may be accelerated for a Participant who dies or who ceases to be an eligible Participant under the LTIP in connection with a change of control, takeover bid, RTO, or other similar transaction.
For Options grants to Investor Relations service providers, vesting must be over a period of not less than one year, with no more than 25% of such options vesting in any three months.
Modification of an Award
Any adjustment, other than as noted in section 4.3 Anti-Dilution of the LTIP, to award granted or issued under our LTIP must be subject to the prior acceptance of the TSXV, including adjustments related to an amalgamation, merger, arrangement, reorganization, spin-off, dividend, or recapitalization.
Further, any decrease in the exercise price of or extension to stock options granted to individuals that are Insiders at the time of the proposed amendment is subject to disinterested shareholder approval.
Securities Authorized for Issuance Under Equity Compensation Plans
The following table sets forth the details as at September 30, 2023, the end of our most recently-completed fiscal year, with respect to compensation plans pursuant to which equity securities of the Company are authorized for issuance under our LTIP.
| Equity Compensation Plans Information | |||
| Plan Category | Number of securities to be issued upon exercise of outstanding options, warrants and rights | Weighted average exercise price of outstanding options, warrants and rights | Number of securities remaining available for future issuance under Equity Compensation Plans (excluding securities listed in column (a)) |
| (a) | (b) | (c) | |
| Equity Compensation Plans approved by shareholders - LTIP | Share Units: 6,214 | Share Units: $nil | Share Units: 401,060 |
| Options: 389,907 | Options: $2.8 | Options: 171,771 | |
| Equity Compensation Plans not approved by shareholders | n/a | n/a | n/a |
C. Board Practices
Each of our directors will hold office until the next annual general meeting of our shareholders or until his or her office is earlier vacated, in accordance with our Articles of Incorporation (the "Articles") and the BCBCA. Each of our officers serves at the pleasure of our Board. Please also refer to Directors and Senior Management above for further details regarding the periods of service of each of our current directors and officers.
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As of September 30, 2023, we did not have any service contracts with any of our independent directors.
Board Nomination
The identification of potential candidates for nomination as our directors is carried out by all directors, who are encouraged to participate in the identification and recruitment of new directors. Potential candidates are primarily identified through referrals and business contacts.
Cease Trade Orders, Bankruptcies, Penalties or Sanctions
Corporate Cease Trade Orders
As at the date of this document, no current director or executive officer of the Company is, or within the ten years prior to the date of this document has been, a director, chief executive officer or chief financial officer of any company (including the Company), that:
(a) was subject to a cease trade order (including any management cease trade order which applied to directors or executive officers of a company, whether or not the person is named in the order), an order similar to a cease trade order, or an order that denied the relevant company access to any exemption under securities legislation, that was in effect for a period of more than 30 consecutive days (an "Order") while that person was acting in that capacity; or
(b) was subject to an Order that was issued after the current director or executive officer ceased to be a director, chief executive officer or chief financial officer and which resulted from an event that occurred while that person was acting in the capacity as director, chief executive officer or chief financial officer
except in the following cases:
Mr. Sean Homuth previously served as the Chief Financial Officer of North Bud Farms Inc. ("North Bud") from October 2019 to December 2019. Subsequently, Mr. Sean Homuth was appointed as the Chief Executive Officer of North Bud in January 2020. On March 31, 2020, a management cease trade order was issued by the Ontario Securities Commission against Mr. Homuth in respect of North Bud. On June 3, 2023, the Ontario Securities Commission issued a cease trade order in connection with North Bud's failure to file financial statements, management's discussion and analysis and officer's certifications. At of the date hereof, the cease trade order has not yet been revoked.
Furthermore, on January 2, 2024, a management cease trade order was issued by the Ontario Securities Commission against Mr. Homuth in connection with the Company's failure to file financial statements, annual information form, management's discussion and analysis and officer's certifications for the year ended September 30, 2023.
On January 2, 2024, a management cease trade order was issued by the Ontario Securities Commission against Mr. Kris Denis, the interim Chief Financial Officer of the Company, in connection with the Company's failure to file financial statements, annual information form, management's discussion and analysis and officer's certifications for the year ended September 30, 2023.
Bankruptcy
To the knowledge of the Company, as at the date of this document, no current director, executive officer, or shareholder holding a sufficient number of securities of the Company to affect materially the control of the Company is, or within the ten years prior to the date of this document has:
(a) been a director or executive officer of any company (including the Company) that, while that person was acting in that capacity, or within a year of that person ceasing to act in that capacity, became bankrupt, made a proposal under any legislation relating to bankruptcy or insolvency or was subject to or instituted any proceedings, arrangement or compromise with creditors or had a receiver, receiver manager or trustee appointed to hold its assets; or
(b) become bankrupt, made a proposal under any legislation relating to bankruptcy or insolvency, or become subject to or instituted any proceedings, arrangement or compromise with creditors, or had a receiver manager or trustee appointed to hold the assets of the current or proposed director, executive officer or shareholder.
except in the following case:
John McCoach was formerly a director and interim CEO of Nautilus Minerals Inc., a Toronto Stock Exchange listed company. Nautilus Minerals Inc. was not able to secure the funding it needed to proceed with its projects. In 68 February 2019, Nautilus Minerals Inc. filed for creditor protection under the Companies' Creditors Arrangement Act (Canada).
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Penalties and Sanctions
None of our current directors or executive officers has, within the past ten years, been subject to any penalties or sanctions imposed by a court or by a securities regulatory authority relating to securities legislation or has entered into a settlement agreement with a securities regulatory authority or has been subject to any other penalties or sanctions imposed by a court or regulatory body that would likely be considered important to a reasonable investor in making an investment decision, with the exception of the following:
On November 25, 2015, L-3, EOTECH, and Paul Mangano, who was then President of EOTECH, (collectively, the "Defendants") entered into a Settlement. The complaint alleged that EOTECH sold defective holographic weapon sights to the U.S. Department of Defense, the U.S. Department of Homeland Security, and the Federal Bureau of Investigation during the period from 2007 through 2014 and that the Defendants became aware that design defects in EOTECH's sights caused them to fail in cold temperature and humid environments. The Government of the United States alleged in its complaint that although EOTECH was contractually obligated to disclose these defects to the military, the Defendants nevertheless concealed them until they believed that EOTECH had product improvements that would correct the defects, and even then failed to disclose the nature and severity of the defects. Under the Settlement, the Defendants admitted, acknowledged and accepted responsibility for several claims. Mr. Mangano admitted, acknowledged and accepted responsibility.
L-3 paid the Settlement Amount of USD $25.6 million and the Government of the United States released the Defendants and all of their at-that-time and former officers, directors and employees from any civil or administrative monetary claims the United States has for the conduct covered in the complaint under the False Claims Act, the Civil Monetary Penalties Law, the Program Fraud Civil Remedies Act, the Financial Institutions Reform, Recovery and Enforcement Act, the Contract Disputes Act and the common law theories of breach of contract, payment by mistake, unjust enrichment and fraud. The Settlement does not contain any sanctions or penalties imposed on Mr. Mangano and Mr. Mangano did not pay any portion of the Settlement Amount.
Audit Committee Disclosure
The Audit Committee's Charter
Our directors have adopted a Charter for the Audit Committee, which sets out the Audit Committee's mandate, organization, powers and responsibilities. The full text of our Audit Committee Charter is available on request from us.
Composition of the Audit Committee
The members of the Audit Committee are John McCoach (Chairman), Paul Fortin, and Paul Mangano. All members are independent (as determined under Exchange Act Rule 10A-3 and Rule 5605(a)(2) of The Nasdaq Stock Market Rules and as defined in National Instrument 52-110 - Audit Committees ("NI 52-110") adopted by the Canadian Securities Administrators), and all members are financially literate (as defined in NI 52-110). The Audit Committee meets regularly on at least a quarterly basis. The members of the Audit Committee do not have fixed terms and are appointed and replaced from time to time by resolution of the Board.
The Board has determined that John McCoach qualifies as a financial expert (as defined in Item 407(d)(5)(ii) of Regulation S-K under the Exchange Act) and Rule 5605(c)(2)(A) of The Nasdaq Stock Market Rules; and (ii) is independent (as determined under Exchange Act Rule 10A-3 and Rule 5605(a)(2) of The Nasdaq Stock Market Rules).
Relevant Education and Experience
All of the Audit Committee members are senior-level professionals with experience in financial matters; each has a broad understanding of accounting principles used to prepare financial statements and varied experience as to general application of such accounting principles. Further, John McCoach has served on other Audit Committees of reporting issuers and was previously the President of the TSXV.
For further relevant education and experience of Messrs. McCoach, Fortin, and Mangano, refer to their respective biographies in Directors, Senior Management and Employees.
Audit Committee Oversight
At no time during this past fiscal year have any recommendations by the Audit Committee respecting the appointment and/or compensation of our external auditors not been adopted by the Board.
Pre-Approval Policies and Procedures
Under its charter, the Audit Committee is required to pre-approve all non-audit services to be performed by the external auditors in relation to us, together with approval of the engagement letter for such non-audit services and estimated fees thereof. The pre-approval process for non-audit services will also involve a consideration of the potential impact of such services on the independence of the external auditors.
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D. Employees
The following table sets forth the number of employees we had at the end of each fiscal period:
| Year | Full Time | Part Time | Total | |||
| Fiscal 2021 | 17 | 0.6 | 17.6 | |||
| Fiscal 2022 | 17 | 1.2 | 18.2 | |||
| Fiscal 2023(1) | 28 | 1.2 | 29.2 |
(1) Includes 5 full-time consultants at September 30, 2023.
None of our employees are members in a labor union.
E. Share Ownership
As of January 17, 2024, the NEOs named in this Annual Report as well as our current directors and executive officers, as a group, beneficially owned a total of 230,672 Common Shares, representing beneficial ownership of 4.1 % of the Common Shares.
The table below sets forth the number of Common Shares beneficially owned by the NEOs named in this Annual Report as well as our directors and executive officers as of January 17, 2024. The persons listed below are deemed to be the beneficial owners of Common Shares underlying options, RSUs, and warrants that are exercisable within 60 days from the above date, including "out-of-the money" options. The percentages shown below are based on 5,616,782 outstanding Common Shares as of January 17, 2024, plus 6,812,608 Common Shares underlying options, RSUs and warrants that are exercisable within 60 days for the indicated beneficial owner for an aggregate total of 12,429,390.
Shareholdings of Directors and Executive Officers
| Number of | ||||||||||||||||||
| Common | ||||||||||||||||||
| Shares | Percent of | |||||||||||||||||
| Common | Exercisable | Convertable | Exercisable | Beneficially | Outstanding | |||||||||||||
| Name of Beneficial Owner | Shares held | Options | RSUs | Warrants | Owned | Common Shares | ||||||||||||
| David Luxton (1) | 76,080 | 18,929 | - | 39,005 | 134,014 | 1.08% | ||||||||||||
| Sean Homuth | - | 13,750 | - | - | 13,750 | 0.11% | ||||||||||||
| Jeffrey MacLeod (2) | 141,361 | 3,929 | 3,000 | 12,000 | 160,290 | 1.29% | ||||||||||||
| John McCoach | 1,566 | 6,071 | - | 201 | 7,838 | 0.06% | ||||||||||||
| Paul Mangano | 4,610 | 6,071 | - | 11 | 10,692 | 0.09% | ||||||||||||
| Paul Fortin | 100 | 6,071 | - | 11 | 6,182 | 0.05% | ||||||||||||
| Steven Archambault | 4,414 | 8,571 | - | 1,192 | 14,177 | 0.11% | ||||||||||||
| Harry Webster | - | - | - | - | - | 0.00% | ||||||||||||
| Richard Bowes | 941 | 8,573 | - | - | 9,514 | 0.08% | ||||||||||||
| Rick Hillier | - | 2,500 | - | - | 2,500 | 0.02% | ||||||||||||
| Kris Denis | 1,600 | 2,500 | - | - | 4,100 | 0.03% | ||||||||||||
| Total | 230,672 | 76,965 | 3,000 | 52,420 | 363,057 | 2.92% |
(1) Includes 68,032 common shares, 1,429 exercisable options and 35,420 exercisable warrants held by Mr. Luxton's private company, Defsec.
(2) Includes 141,361 common shares held by Mr. MacLeod's private company, 2573685 Ontario Inc.
Refer to section titled, Compensation, for the details of the options held by our directors and executive officers as at September 30, 2023. We have since not granted any further options.
We do not have any other equity arrangements for involving employees in our capital, except for the grant of Security-Based Compensation Awards pursuant to our LTIP at the discretion of the Board.
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ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
A. Major Shareholders
To our best knowledge, the following are our only shareholders that beneficially own, directly or indirectly, or exercise control over, shares carrying more than 5% of the outstanding voting rights attached to our Common Shares as at January 17, 2024.
| Name of Shareholder | Number of Common Shares | Percentage of Common Shares | ||||
| AIGH Capital (1) | 556,175 | 9.90% | ||||
| The Hewlett Fund LP (2) | 559,000 | 9.95% |
Notes:
(1) Based on information provided by AIGH Capital in connection with the Private Placement and includes Common Shares subscribed for in the Private Placement.
(2) Based on information provided by The Hewlett Fund LP in connection with the Private Placement and includes Common Share subscribed for in the Private Placement.
Prior to the closing of our U.S. IPO and Canadian Offering in December 2022, the major changes in the last three years in the percentage ownership of persons who beneficially own 5% of the outstanding voting rights attached to our Common Shares were:
As a result of the U.S. IPO and Canadian Offering, all the above major shareholders now own less than 5% of the outstanding Common Shares.
Since the closing of the U.S. IPO and Canadian Offering, we now have two institutional shareholders (as noted in the above table) with more than 5% beneficial ownership of the outstanding Common Shares. This major shareholder does not have different voting rights from other shareholders. At January 12, 2024, there were a total of 54 record holders of our Common Shares, of which 9 record holders were resident in the United States, holding a total of 3,723,362 Common Shares, based on available information. This number represents approximately 66.3% of our total issued and outstanding Common Shares at that date.
We are a publicly owned company, and our Common Shares are owned by Canadian residents, United States residents, and residents of other countries. To our knowledge, we are not directly owned or controlled by another corporation, any foreign government or any other natural or legal person(s), whether severally or jointly. We are not aware of any arrangement, the operation of which may result in a change of control of us.
B. Related Party Transactions
To our knowledge, none of our directors or executive officers, nor any of our subsidiaries or insiders, nor any of our shareholders owning more than 10% of our voting shares, and no person with ties to any of the aforementioned, nor any member of the same group, has had or expects to have an interest in any transactions concluded since the beginning of Fiscal 2021 that has had or could have a material impact on us, or in any projected transactions, except as described below.
DEFSEC Purchase Agreement
The entering into the DEFSEC Purchase Agreement by us was considered to be a "related-party transaction" for purposes of Multilateral Instrument 61-101 - Protection of Minority Security Holders in Special Transactions ("MI 61-101") and Policy 5.9 - Protection of Minority Security Holders in Special Transactions of the TSXV. We relied on exemptions from the formal valuation and minority shareholder approval requirements available under MI 61-101. We were exempt from the formal valuation requirement in section 5.4 of MI 61-101 in reliance on sections 5.5(a) and (b) of MI 61-101 as the fair market value of the transaction was not more than the 25% of our market capitalization, and no securities of ours were listed or quoted for trading on prescribed stock exchanges or stock markets. Additionally, we were exempt from minority shareholder approval requirement in section 5.6 of MI 61- 101 in reliance on section 5.7(a) as the fair market value of the transaction was not more than the 25% of our market capitalization. The transaction was reviewed and approved by our independent directors and we obtained approval from over 51% of disinterested shareholders. Further, on February 19, 2021, the TSXV conditionally approved this asset acquisition. We closed the LEC Technology acquisition shortly after closing the April 2021 Private Placement.
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Employment and Consulting Agreements
We have entered into a professional services agreement with DEFSEC to obtain Executive Chairman services from David Luxton and employment agreements with Sean Homuth and Harry Webster (see Item 6.B. - Compensation - Employment and Consulting Agreements).
Voting Agreement
On September 14, 2020, we entered into a voting agreement with Messrs. Luxton and MacLeod, pursuant to which Messrs. Luxton and MacLeod agreed to vote the voting securities of us they own and exercise voting control over to ensure that the following individuals are members of our Board: Mr. Luxton, Mr. MacLeod, one person nominated by Mr. Luxton who is from the capital markets industry, one independent person nominated by Mr. Luxton and one independent person nominated by Mr. MacLeod. Further, Messrs. Luxton and MacLeod irrevocably appointed our President as their proxy and granted our President power of attorney to vote their voting securities in a manner described in the voting agreement should either Mr. Luxton or Mr. MacLeod fail to vote or attempt to vote in a manner inconsistent with the voting agreement. This voting agreement expired on March 31, 2022.
Related Party Loans
All related party loans were repaid in December 2022. During Fiscal 2023, we did not enter into any related party loans.
Other Related Party Transactions
From January 28, 2021, to June 24, 2022, the CEO and sole shareholder of SageGuild agreed to serve as director for our United States subsidiary, KWESST Defense Systems U.S. Inc, and as a result SageGuild was a related party to KWESST for this period. We previously entered into a consulting agreement with SageGuild in March 2020 to provide business development services in the United States. This consulting agreement, including compensation, was not modified as a result of the above. At the time, SageGuild was not a related party and the terms of this consulting agreement were negotiated at arm's length. From January 1, 2021, to September 30, 2021, the total compensation (cash and share-based) amounted to $339,309. For the three and nine months ended June 30, 2022 the total compensation was $81,761 and $251,809 respectively. Effective June 24, 2022, our Executive Chairman replaced SageGuild's CEO as the acting CEO and director for KWESST Defense Systems U.S. Inc. and therefore from this date SageGuild is no longer a related party.
For other immaterial related party transactions, refer to Note 11 of the audited consolidated financial statements for Fiscal 2023.
C. Interests of Experts and Counsel
Not applicable.
ITEM 8. FINANCIAL INFORMATION
A. Consolidated Statements and Other Financial Information
Financial Statements
This Annual Report contains the Company's our audited consolidated financial statements as at and for the year ended September 30, 2023, the year ended September 30, 2022, and the year ended September 30, 2021. The audit reports of KPMG LLP are included therein.
Legal Proceedings
We are not and have not been a party to any legal proceedings and are not aware of any such proceedings known to be contemplated.
Dividend Policy
We have not, for any of the three most recently completed fiscal years or our current fiscal year, declared or paid any dividends on our Common Shares, and do not currently have a policy with respect to the payment of dividends. For the foreseeable future, we anticipate that we will not pay dividends but will retain future earnings and other cash resources for the operation and development of our business. The payment of dividends in the future will depend on our earnings, if any, our financial condition, and such other factors as our directors consider appropriate.
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B. Significant Changes
Except as otherwise disclosed in this Annual Report, there have been no significant changes in our financial condition since the most recent audited consolidated financial statements for the year ended September 30, 2023.
ITEM 9. THE OFFER AND LISTING
A. Offer and Listing Details
Our Common Shares are listed and posted for trading on Nasdaq under the symbol "KWE", the TSXV under the trading stock symbol "KWE.V" and the Frankfurt Stock Exchange under the stock symbol of "62U".
Our Warrants are listed and posted for trading on Nasdaq under the symbol "KWESW".
B. Plan of Distribution
Not applicable.
C. Markets
See Item 9.A. - Offer and Listing Details.
D. Selling Shareholders
Not applicable.
E. Dilution
Not applicable.
F. Expenses of the Issue
Not applicable.
ITEM 10. ADDITIONAL INFORMATION
A. Share Capital
Not applicable.
B. Memorandum and Articles of Association
Incorporation
See Item 4.A. - Name, Address and Incorporation.
Objects and Purposes
The Articles of the Company (the "Articles") do not contain a limitation on objects and purposes.
Directors
Article 17 of the Articles deals with a directors' disclosable interest (as defined in the BCBCA) in contracts or transactions into which the Company has entered or proposes to enter. Article 17.2 provides that a director who holds such a disclosable interest is not entitled to vote on any directors' resolution to approve such contract or transaction, unless all the directors have a disclosable interest in that contract or transaction, in which case any or all of those directors may vote on such resolution.
Pursuant to the BCBCA, a director holds a disclosable interest in a contract or transaction if (a) the contract or transaction is material to the Company, (b) the Company has entered, or proposes to enter, into the contract or transaction, and (c) the director has a material interest in the contract or transaction or the director is a director or senior officer of, or has a material interest in, a person who has a material interest in the contract or transaction. Pursuant to the BCBCA, a director does not have a disclosable interest in a number of prescribed situations, including without limitation in respect of a contract or transaction merely because the contract or transaction relates to the remuneration of the director in that person's capacity as a director of the Company.
The directors may act notwithstanding any vacancy in the Board, but if the Company has fewer directors in office than the number set pursuant to the Articles as the quorum of directors, the directors may only act for the purpose of appointing directors up to that number or of summoning a meeting of shareholders for the purpose of filling any vacancies on the Board or, subject to the BCBCA, for any other purpose. The quorum necessary for the transaction of the business of the directors may be set by the directors and, if not so set, is deemed to be set at two directors or, if the number of directors is set at one, is deemed to be set at one director, and that director may constitute a meeting.
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Article 8 of the Articles deals with borrowing powers. The Company, if authorized by the directors, may: (i) borrow money in the manner and amount, on the security, from the sources and on the terms and conditions that they consider appropriate; (ii) issue bonds, debentures and other debt obligations either outright or as security for any liability or obligation of the Company or any other person and at such discounts or premiums and on such other terms as they consider appropriate; (iii) guarantee the repayment of money by any other person or the performance of any obligation of any other person; and (iv) mortgage, charge, whether by way of specific or floating charge, grant a security interest in, or give other security on, the whole or any part of the present and future assets and undertaking of the Company.
Qualifications of Directors
The Articles do not specify a retirement age for directors.
Directors are not required to own any Common Shares of the Company.
Section 124 of the BCBCA provides that an individual is not qualified to become or act as a director of a company if that individual is:
1. under the age of 18 years;
2. found by a court, in Canada or elsewhere, to be incapable of managing the individual's own affairs;
3. an undischarged bankrupt; or
4. convicted in or out of the Province of British Columbia of an offence in connection with the promotion, formation or management of a corporation or unincorporated business, or of an offence involving fraud, unless:
a. the court orders otherwise;
b. 5 years have elapsed since the last to occur of:
i. the expiration of the period set for suspension of the passing of sentence without a sentence having been passed;
ii. the imposition of a fine;
iii. the conclusion of the term of any imprisonment; and
iv. the conclusion of the term of any probation imposed; or
c. a pardon was granted or issued, or a record suspension ordered, under the Criminal Records Act (Canada) and the pardon or record suspension, as the case may be, has not been revoked or ceased to have effect.
A director who ceases to be qualified to act as a director of the Company must promptly resign.
Section 120 of the BCBCA provides that every company must have at least one director, and a public company must have at least three directors.
Rights, Preference and Restrictions
Holders of Common Shares are entitled to receive notice of any meeting of shareholders of the Company, to attend and to cast one vote per share at such meetings. Holders of Common Shares are also entitled to receive on a pro rata basis such dividends, if any, as and when declared by the Board at its discretion from funds legally available therefor and upon the liquidation, dissolution, or winding up of the Company are entitled to receive on a pro rata basis, the net assets of the Company after payment of debts and other liabilities, in each case subject to the rights, privileges, restrictions, and conditions attaching to any other series or class of shares ranking senior in priority. Common Shares do not carry any pre-emptive, subscription, redemption, conversion rights, sinking fund provisions, liability to further capital calls by the Company, or provisions discriminating against any existing or prospective holder of Common Shares as a result of such shareholder owning a substantial number of Common Shares.
The rights of shareholders of the Company may be altered only with the approval of the holders of two thirds or more of the Common Shares voted at a meeting of the Company's shareholders called and held in accordance with the Articles and applicable law.
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Shareholder Meetings
The BCBCA provides that: (i) a general meeting of shareholders must be held in the Province of British Columbia, unless otherwise provided in the Company's Articles or as approved by ordinary resolution of shareholders; (ii) the Company must hold an annual general meeting of shareholders not later than 15 months after the last preceding annual general meeting and once in every calendar year; (iii) for the purpose of determining shareholders entitled to receive notice of or vote at a meeting of shareholders, the directors may set a date as the record date for that determination, provided that such date shall not precede by more than 2 months (or, in the case of a general meeting requisitioned by shareholders under the BCBCA, by more than 4 months) or be less than 21 days before the date on which the meeting is to be held; (iv) a quorum for the transaction of business at a meeting of shareholders of the Company is the quorum established by the Articles (Article 11.3 of the Articles provide that the quorum for the transaction of business at a meeting of shareholders is two persons who are, or who represent by proxy, shareholders who, in the aggregate, hold at least 5% of Common Shares entitled to vote at the meeting, are present in person; (v) the holders of not less than 5% of the issued shares entitled to vote at a meeting may requisition the directors to call a meeting of shareholders for the purpose of transacting any business that may be transacted at a general meeting; and (vi) the Court may, on its own motion or on the application of the Company, upon the application of a director or the application of a shareholder entitled to vote at the meeting: (a) order that a meeting of shareholders be called, held and conducted in a manner that the Court considers appropriate; and (b) give directions it considers necessary as to the call, holding and conduct of the meeting.
Limitations on Ownership of Securities
Except as provided in the Investment Canada Act, there are no limitations specific to the rights of non-Canadians to hold or vote the Common Shares under the laws of Canada or the Province of British Columbia or in the Company's constating documents.
Change in Control
There are no provisions in the Company's constating documents or under applicable corporate law that would have the effect of delaying, deferring or preventing a change in the control of the Company, or that would operate with respect to any proposed merger, acquisition or corporate restructuring involving the Company or any of its subsidiaries.
Ownership Threshold
There are no provisions in the Company's constating documents or under applicable corporate law requiring share ownership to be disclosed. Securities legislation in Canada requires that shareholder ownership (as well as ownership of an interest in, or right or obligation associated with, a related financial instrument of a security of the Company) must be disclosed once a person beneficially owns or has control or direction over, directly or indirectly, securities of a reporting issuer carrying more than 10% of the voting rights attached to all the reporting issuer's outstanding voting securities. This threshold is higher than the 5% threshold under U.S. securities legislation at which stockholders must report their share ownership.
Changes to Capital
There are no conditions imposed by the Articles governing changes in the capital where such conditions are more significant than is required by the corporate laws of the Province of British Columbia for as long as the Company is a public company. Otherwise, Section 26.3 of the Articles provides that no share or designated security may be sold, transferred or otherwise disposed of without the consent of the directors and the directors are not required to give any reason for refusing to consent to any such sale, transfer or other disposition.
Description of Capital Structure
Our authorized share structure consists of an unlimited number of Common Shares without par value, of which 5,616,782 Common Shares were issued and outstanding as of January 17, 2024. All of the issued Common Shares are fully paid and non-assessable common shares in the capital of the Company. The Company does not own any of its Common Shares.
C. Material Contracts
We are a party to the following contracts which management currently considers to be material to the Company and our assets and operations.
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The terms and conditions of these material contracts are described below.
DEFSEC Purchase Agreement
See Note 4(b) of the audited consolidated financial statements for Fiscal 2023.
GhostStep Technology Purchase Agreement
See Note 4(b) of the audited consolidated financial statements for Fiscal 2023.
CPC Escrow Agreement
Upon completion of the initial public offering of Foremost on the TSXV on June 15, 2018, the Common Shares for the insiders of Foremost were subject to a three-year escrow period, to be released in in the manner described in Item 3.D. - The release of securities currently held in escrow may adversely impact the price of our Common Shares, Warrants and/or other outstanding securities.
Surplus Security Escrow Agreement
Pursuant to the TSXV Policy 5.4, at the closing of the QT certain holders of our Common Shares were subject to a three-year escrow, to be released in in the manner described in Item 3.D. - The release of securities currently held in escrow may adversely impact the price of our Common Shares, Warrants and/or other outstanding securities.
In the event we graduate from Tier 2 to Tier 1 on the TSXV, then the escrowed securities will be subject to accelerated releases in accordance with TSXV policy.
Value Security Escrow Agreement
Pursuant to the TSXV Policy 5.4, at closing of the QT certain holders of our Common Shares were subject to a three-year escrow, to be released in in the manner described in Risk Factors - The release of securities currently held in escrow may adversely impact the price of our Common Shares, Warrants and/or other outstanding securities.
In the event we graduate from Tier 2 to Tier 1 on the TSXV, then the escrowed securities will be subject to accelerated releases in accordance with TSXV policy.
GDMS MPSA
On December 1, 2021, we entered into a Master Professional Services Agreement with General Dynamic Mission Systems - Canada.
See Item 4.B.. - Business Overview - Economic Dependence.
Counter-Crisis Technology Subcontractor Agreement
On July 6, 2022, we entered into a three-year contract with CounterCrisis Technology to co-implement a national Ground Search and Rescue Incident Command System for Public Safety Canada, with the Ontario Provincial Police as technical advisory stakeholder for this project.
See Item 4.A. - History and Development of the Company - Events in the Development of the Business Fiscal 2022 Highlights.
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Luxton Agreement
See Item 6.B. - Employment and Consulting Agreements - David Luxton.
Canadian Government Contract
On May 2, 2023, we announced that DND awarded a CAD$136 million dollar five-year defense contract to the JV Group (KWESST, Akkodis (MODIS) Canada and Thales Canada). KWESSTs workshare under the joint venture agreement is up to 20% which would represent approximately CAD$27.2M (or an average of CAD$5.4M per year) of the contract. The contract is a professional services agreement whereby KWESST will provide qualified software and sustainment resources engineering (at rates agreed to in the contract) on a task-based (as-and-when requested basis) to develop specialized (Government of Canada owned) software applications for Land (Canadian Army) Command, Control, Communications, Computers Intelligence, Surveillance and Reconnaissance (LC4ISR) systems.
Homuth Agreement
See Item 6.B. - Employment and Consulting Agreements - Sean Homuth.
Placement Agency Agreement, Securities Purchase Agreement, and Registration Rights Agreement
See Item 5.A. - Operating Results - Overview
Webster Agreement
See Item 6.B. - Employment and Consulting Agreements - Harry Webster.
Denis Agreement
On June 26, 2023, we entered into an employment agreement, with effective date of June 26, 2023, with Mr. Denis to serve as Corporate Controller. Mr. Denis receives an annual base salary of CAD$125,000, may receive an annual bonus in an amount determined and approved by the Board, and three weeks of vacation per year. Mr. Denis may also receive, subject to approval of the Board, stock options and restricted stock units ("RSUs") with amount determined at the Board's discretion and vesting in accordance with the terms of the Company's LTIP plan. On November 27, 2023, Mr. Denis was appointed Interim CFO and Chief Compliance Officer and his employment agreement was amended and restated. Mr. Denis' salary was increased to $175,000, an annual incentive bonus up to 40% of his annual salary, four weeks of vacation per year, his employment may be terminated upon payment of a lump sum equal to 26 weeks salary plus accrued bonus and all security-based compensation held become vested if terminated prior to the first anniversary from the November 27, 2023 contract date. This lump sum is increased by one week per completed year of service to a maximum of 38 weeks and in the event of a change in control, the foregoing is changed from 26 weeks to 52 weeks and the reference to 38 weeks is changed to 64 weeks.
D. Exchange Controls
Canada has no system of exchange controls. There are no Canadian governmental laws, decrees, or regulations relating to restrictions on the repatriation of capital or earnings of the Company to non-resident investors. There are no laws in Canada or exchange control restrictions affecting the remittance of dividends or other payments made by the Company in the ordinary course to non-resident holders of the Common Shares by virtue of their ownership of such Common Shares, except as discussed below in Item 10.E. - Certain United States Federal Income Tax Considerations and Certain Canadian Federal Income Tax Consequences.
There are no limitations under the laws of Canada or in the organizing documents of the Company on the right of foreigners to hold or vote securities of the Company, except that the Investment Canada Act may require that a "non-Canadian" not acquire "control" of the Company without prior review and approval by the Minister of Innovation, Science and Economic Development, where applicable thresholds are exceeded. The acquisition of one-third or more of the voting shares of the Company would give rise a rebuttable presumption of an acquisition of control, and the acquisition of more than fifty percent of the voting shares of the Company would be deemed to be an acquisition of control. In addition, the Investment Canada Act provides the Canadian government with broad discretionary powers in relation to national security to review and potentially prohibit, condition or require the divestiture of, any investment in the Company by a non-Canadian, including non-control level investments. "Non-Canadian" generally means an individual who is neither a Canadian citizen nor a permanent resident of Canada within the meaning of the Immigration and Refugee Protection Act (Canada) who has been ordinarily resident in Canada for not more than one year after the time at which he or she first became eligible to apply for Canadian citizenship, or a corporation, partnership, trust or joint venture that is ultimately controlled by non-Canadians.
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E. Taxation
Certain United States Federal Income Tax Considerations
The following is a general summary of certain material U.S. federal income tax considerations applicable to a U.S. Holder (as defined below) arising from and relating to the acquisition, ownership, and disposition of Common Shares. This summary is for general information purposes only and does not purport to be a complete analysis or listing of all potential U.S. federal income tax considerations that may apply to a U.S. Holder arising from and relating to the acquisition, ownership, and disposition of Common Shares. In addition, this summary does not take into account the individual facts and circumstances of any particular U.S. Holder that may affect the U.S. federal income tax consequences to such U.S. Holder, including without limitation specific tax consequences to a U.S. Holder under an applicable income tax treaty. Accordingly, this summary is not intended to be, and should not be construed as, legal or U.S. federal income tax advice with respect to any U.S. Holder. This summary does not address the U.S. federal net investment income, U.S. federal alternative minimum, U.S. federal estate and gift, U.S. state and local, and non-U.S. tax consequences to U.S. Holders of the acquisition, ownership, and disposition of Common Shares. In addition, except as specifically set forth below, this summary does not discuss applicable tax reporting requirements. Each prospective U.S. Holder should consult its own tax advisor regarding the U.S. federal, U.S. federal net investment income, U.S. federal alternative minimum, U.S. federal estate and gift, U.S. state and local, and non-U.S. tax consequences relating to the acquisition, ownership, and disposition of Common Shares.
No legal opinion from U.S. legal counsel or ruling from the Internal Revenue Service (the "IRS") has been requested, or will be obtained, regarding the U.S. federal income tax consequences of the acquisition, ownership, and disposition of Common Shares. This summary is not binding on the IRS, and the IRS is not precluded from taking a position that is different from, and contrary to, the positions taken in this summary. In addition, because the authorities on which this summary is based are subject to various interpretations, the IRS and the U.S. courts could disagree with one or more of the conclusions described in this summary.
Scope of this Summary
Authorities
This summary is based on the United States Internal Revenue Code of 1986, as amended (the "Code"), Treasury Regulations (whether final, temporary, or proposed), published rulings of the IRS, published administrative positions of the IRS, the Convention between the United States and Canada with respect to taxes on income and on capital of 1980, as amended (the "Canada-U.S. Tax Convention"), and U.S. court decisions that are applicable and, in each case, as in effect and available, as of the date of this document. Any of the authorities on which this summary is based could be changed in a material and adverse manner at any time, and any such change could be applied on a retroactive or prospective basis which could affect the U.S. federal income tax considerations described in this summary. This summary does not discuss the potential effects, whether adverse or beneficial, of any proposed legislation that, if enacted, could be applied on a retroactive, current or prospective basis.
U.S. Holders
For purposes of this summary, the term "U.S. Holder" means a beneficial owner of Common Shares that is for U.S. federal income tax purposes:
Non-U.S. Holders
For purposes of this summary, a "non-U.S. Holder" is a beneficial owner of Common Shares that is not a U.S. Holder or is a partnership. This summary does not address the U.S. federal income tax considerations to non-U.S. Holders arising from and relating to the acquisition, ownership and disposition of Common Shares. Accordingly, a non-U.S. Holder should consult its own tax advisors regarding the U.S. federal, U.S. federal alternative minimum, U.S. federal estate and gift, U.S. state and local and non-U.S. tax consequences (including the potential application of, and operation of, any income tax treaties) relating to the acquisition, ownership and disposition of Common Shares.
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U.S. Holders Subject to Special U.S. Federal Income Tax Rules Not Addressed
This summary does not address the U.S. federal income tax considerations applicable to U.S. Holders that are subject to special provisions under the Code, including, but not limited to, U.S. Holders that: (a) are tax-exempt organizations, qualified retirement plans, individual retirement accounts, or other tax-deferred accounts; (b) are financial institutions, underwriters, insurance companies, real estate investment trusts, or regulated investment companies; (c) are broker-dealers, dealers, or traders in securities or currencies that elect to apply a mark-to-market accounting method; (d) have a "functional currency" other than the U.S. dollar; (e) own Common Shares as part of a straddle, hedging transaction, conversion transaction, constructive sale, or other integrated transaction; (f) acquired Common Shares in connection with the exercise of employee stock options or otherwise as compensation for services; (g) hold Common Shares other than as a capital asset within the meaning of Section 1221 of the Code (generally, property held for investment purposes); (h) are partnerships and other pass-through entities (and investors in such partnerships and entities); (i) are S corporations (and shareholders or investors in such S corporations); (j) own, have owned or will own (directly, indirectly, or by attribution) 10% or more of the total combined voting power or value of the outstanding shares of the Company; (k) U.S. expatriates or former long-term residents of the U.S., (l) hold Common Shares in connection with a trade or business, permanent establishment, or fixed base outside the United States, (m) are subject to special tax accounting rules with respect to Common Shares, or (n) are subject to the alternative minimum tax. U.S. Holders that are subject to special provisions under the Code, including, but not limited to, U.S. Holders described immediately above, should consult their own tax advisor regarding the U.S. federal, U.S. federal net investment income, U.S. federal alternative minimum, U.S. federal estate and gift, U.S. state and local, and non-U.S. tax consequences relating to the acquisition, ownership and disposition of Common Shares.
If an entity or arrangement that is classified as a partnership (or other "pass-through" entity) for U.S. federal income tax purposes holds Common Shares, the U.S. federal income tax consequences to such entity and the partners (or other owners) of such entity generally will depend on the activities of the entity and the status of such partners (or owners). This summary does not address the tax consequences to any such owner. Partners (or other owners) of entities or arrangements that are classified as partnerships or as "pass-through" entities for U.S. federal income tax purposes should consult their own tax advisors regarding the U.S. federal, U.S. federal net investment income, U.S. federal alternative minimum, U.S. federal estate and gift, U.S. state and local, and non-U.S. tax consequences arising from and relating to the acquisition, ownership, and disposition of Common Shares.
Ownership and Disposition of Common Shares
The following discussion is subject to the rules described below under the heading "Passive Foreign Investment Company Rules".
Taxation of Distributions
A U.S. Holder that receives a distribution, including a constructive distribution, with respect to a Common Share will be required to include the amount of such distribution in gross income as a dividend (without reduction for any foreign income tax withheld from such distribution) to the extent of the current or accumulated "earnings and profits" of the Company, as computed for U.S. federal income tax purposes. A dividend generally will be taxed to a U.S. Holder at ordinary income tax rates if the Company is a PFIC for the tax year of such distribution or the preceding tax year. To the extent that a distribution exceeds the current and accumulated "earnings and profits" of the Company, such distribution will be treated first as a tax-free return of capital to the extent of a U.S. Holder's tax basis in the Common Shares and thereafter as gain from the sale or exchange of such Common Shares (see "Sale or Other Taxable Disposition of Common Shares" below). However, the Company may not maintain the calculations of its earnings and profits in accordance with U.S. federal income tax principles, and each U.S. Holder should therefore assume that any distribution by the Company with respect to the Common Shares will constitute ordinary dividend income. Dividends received on Common Shares by corporate U.S. Holders generally will not be eligible for the "dividends received deduction". Subject to applicable limitations and provided the Company is eligible for the benefits of the Canada-U.S. Tax Convention or the Common Shares are readily tradable on a United States securities market, dividends paid by the Company to non-corporate U.S. Holders, including individuals, generally will be eligible for the preferential tax rates applicable to long-term capital gains for dividends, provided certain holding period and other conditions are satisfied, including that the Company not be classified as a PFIC (as defined below) in the tax year of distribution or in the preceding tax year. The dividend rules are complex, and each U.S. Holder should consult its own tax advisor regarding the application of such rules.
Sale or Other Taxable Disposition of Common Shares
A U.S. Holder will generally recognize gain or loss on the sale or other taxable disposition of Common Shares in an amount equal to the difference, if any, between (a) the amount of cash plus the fair market value of any property received and (b) such U.S. Holder's tax basis in such Common Shares sold or otherwise disposed of. Any such gain or loss recognized on such sale or other disposition generally will be capital gain or loss, which will be long-term capital gain or loss if, at the time of the sale or other disposition, such Common Shares are held for more than one year.
Preferential tax rates apply to long-term capital gains of a U.S. Holder that is an individual, estate, or trust. There are currently no preferential tax rates for long-term capital gains of a U.S. Holder that is a corporation. Deductions for capital losses are subject to significant limitations under the Code.
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Passive Foreign Investment Company ("PFIC") Rules
If the Company were to constitute a PFIC for any year during a U.S. Holder's holding period for its Common Shares, then certain potentially adverse rules would affect the U.S. federal income tax consequences to a U.S. Holder resulting from the acquisition, ownership and disposition of Common Shares. The Company believes that it was not a PFIC for its most recently completed tax year and based on current business plans and financial expectations, the Company does not anticipate that it will be a PFIC for its current tax year. No opinion of legal counsel or ruling from the IRS concerning the status of the Company as a PFIC has been obtained or is currently planned to be requested. However, PFIC classification is fundamentally factual in nature, generally cannot be determined until the close of the tax year in question and is determined annually. Additionally, the analysis depends, in part, on the application of complex U.S. federal income tax rules, which are subject to differing interpretations. Consequently, there can be no assurance that the Company has never been and will not become a PFIC for any tax year during which U.S. Holders hold Common Shares.
In addition, in any year in which the Company is classified as a PFIC, a U.S. Holder will be required to file an annual report with the IRS containing such information as Treasury Regulations and/or other IRS guidance may require. A failure to satisfy such reporting requirements may result in an extension of the time period during which the IRS can assess a tax. U.S. Holders should consult their own tax advisors regarding the requirements of filing such information returns under these rules, including the requirement to file an IRS Form 8621 annually.
The Company generally will be a PFIC under Section 1297 of the Code if, after the application of certain "look-through" rules with respect to subsidiaries in which the Company holds at least 25% of the value of such subsidiary, for a tax year, (a) 75% or more of the gross income of the Company for such tax year is passive income (the "income test") or (b) 50% or more of the value of the Company's assets either produce passive income or are held for the production of passive income (the "asset test"), based on the quarterly average of the fair market value of such assets. "Gross income" generally includes all sales revenues less the cost of goods sold, plus income from investments and incidental or outside operations or sources, and "passive income" generally includes, for example, dividends, interest, certain rents and royalties, certain gains from the sale of stock and securities, and certain gains from commodities transactions.
If the Company were a PFIC in any tax year during which a U.S. Holder held Common Shares, such holder generally would be subject to special rules with respect to "excess distributions" made by the Company on the Common Shares and with respect to gain from the disposition of Common Shares. An "excess distribution" generally is defined as the excess of distributions with respect to the Common Shares received by a U.S Holder in any tax year over 125% of the average annual distributions such U.S. Holder has received from the Company during the shorter of the three preceding tax years, or such U.S. Holder's holding period for the Common Shares. Generally, a U.S. Holder would be required to allocate any excess distribution or gain from the disposition of the Common Shares ratably over its holding period for the Common Shares. Such amounts allocated to the year of the disposition or excess distribution would be taxed as ordinary income, and amounts allocated to prior tax years would be taxed as ordinary income at the highest tax rate in effect for each such year and an interest charge at a rate applicable to underpayments of tax would apply.
While there are U.S. federal income tax elections that sometimes can be made to mitigate these adverse tax consequences (including the "QEF Election" under Section 1295 of the Code and the "Mark-to-Market Election" under Section 1296 of the Code), such elections are available in limited circumstances and must be made in a timely manner.
U.S. Holders should be aware that, for each tax year, if any, that the Company is a PFIC, the Company can provide no assurances that it will satisfy the record-keeping requirements of a PFIC, or that it will make available to U.S. Holders the information such U.S. Holders require to make a QEF Election with respect to the Company or any subsidiary that also is classified as a PFIC.
Certain additional adverse rules may apply with respect to a U.S. Holder if the Company is a PFIC, regardless of whether the U.S. Holder makes a QEF Election. These rules include special rules that apply to the amount of foreign tax credit that a U.S. Holder may claim on a distribution from a PFIC. Subject to these special rules, foreign taxes paid with respect to any distribution in respect of stock in a PFIC are generally eligible for the foreign tax credit. U.S. Holders should consult their own tax advisors regarding the potential application of the PFIC rules to the ownership and disposition of Common Shares, and the availability of certain U.S. tax elections under the PFIC rules.
Additional Considerations
Receipt of Foreign Currency
The amount of any distribution paid to a U.S. Holder in foreign currency, or payment received on the sale, exchange or other taxable disposition of Common Shares, generally will be equal to the USD value of such foreign currency based on the exchange rate applicable on the date of receipt (regardless of whether such foreign currency is converted into USD at that time). A U.S. Holder will have a basis in the foreign currency equal to its USD value on the date of receipt. Any U.S. Holder who converts or otherwise disposes of the foreign currency after the date of receipt may have a foreign currency exchange gain or loss that would be treated as ordinary income or loss, and generally will be U.S. source income or loss for foreign tax credit purposes. Different rules apply to U.S. Holders who use the accrual method with respect to foreign currency received upon the sale, exchange or other taxable disposition of the Common Shares. Each U.S. Holder should consult its own U.S. tax advisor regarding the U.S. federal income tax consequences of receiving, owning, and disposing of foreign currency.
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Foreign Tax Credit
Dividends paid on the Common Shares will be treated as foreign-source income, and generally will be treated as "passive category income" or "general category income" for U.S. foreign tax credit purposes. Any gain or loss recognized on a sale or other disposition of Common Shares generally will be United States source gain or loss. Certain U.S. Holders that are eligible for the benefits of Canada-U.S. Tax Convention may elect to treat such gain or loss as Canadian source gain or loss for U.S. foreign tax credit purposes. The Code applies various complex limitations on the amount of foreign taxes that may be claimed as a credit by U.S. taxpayers. In addition, Treasury Regulations that apply to taxes paid or accrued in taxable years beginning on or after December 28, 2021 (the "Foreign Tax Credit Regulations") impose additional requirements for Canadian withholding taxes to be eligible for a foreign tax credit, and there can be no assurance that those requirements will be satisfied. The Treasury Department has recently released guidance temporarily pausing the application of certain of the Foreign Tax Credit Regulations.
Subject to the PFIC rules and the Foreign Tax Credit Regulations, each as discussed above, a U.S. Holder that pays (whether directly or through withholding) Canadian income tax with respect to dividends paid on the Common Shares generally will be entitled, at the election of such U.S. Holder, to receive either a deduction or a credit for such Canadian income tax. Generally, a credit will reduce a U.S. Holder's U.S. federal income tax liability on a dollar-for-dollar basis, whereas a deduction will reduce a U.S. Holder's income that is subject to U.S. federal income tax. This election is made on a year-by-year basis and applies to all foreign taxes paid (whether directly or through withholding) by a U.S. Holder during a year. The foreign tax credit rules are complex and involve the application of rules that depend on a U.S. Holder's particular circumstances. Accordingly, each U.S. Holder should consult its own U.S. tax advisor regarding the foreign tax credit rules.
Backup Withholding and Information Reporting
Under U.S. federal income tax law and Treasury Regulations, certain categories of U.S. Holders must file information returns with respect to their investment in, or involvement in, a foreign corporation. For example, U.S. return disclosure obligations (and related penalties) are imposed on individuals who are U.S. Holders that hold certain specified foreign financial assets in excess of certain threshold amounts. The definition of specified foreign financial assets includes not only financial accounts maintained in foreign financial institutions, but also, unless held in accounts maintained by a financial institution, any stock or security issued by a non-U.S. person, any financial instrument or contract held for investment that has an issuer or counterparty other than a U.S. person and any interest in a foreign entity. U.S. Holders may be subject to these reporting requirements unless their Common Shares are held in an account at certain financial institutions. Penalties for failure to file certain of these information returns are substantial. U.S. Holders should consult their own tax advisors regarding the requirements of filing information returns, including the requirement to file an IRS Form 8938.
Payments made within the U.S. or by a U.S. payor or U.S. middleman, of dividends on, and proceeds arising from the sale or other taxable disposition of, Common Shares will generally be subject to information reporting and backup withholding tax, currently at the rate of 24%, if a U.S. Holder (a) fails to furnish such U.S. Holder's correct U.S. taxpayer identification number (generally on IRS Form W-9), (b) furnishes an incorrect U.S. taxpayer identification number, (c) is notified by the IRS that such U.S. Holder has previously failed to properly report items subject to backup withholding tax, or (d) fails to certify, under penalty of perjury, that such U.S. Holder has furnished its correct U.S. taxpayer identification number and that the IRS has not notified such U.S. Holder that it is subject to backup withholding tax. However, certain exempt persons generally are excluded from these information reporting and backup withholding rules. Backup withholding is not an additional tax. Any amounts withheld under the U.S. backup withholding tax rules will be allowed as a credit against a U.S. Holder's U.S. federal income tax liability, if any, or will be refunded, if such U.S. Holder furnishes required information to the IRS in a timely manner.
The discussion of reporting requirements set forth above is not intended to constitute a complete description of all reporting requirements that may apply to a U.S. Holder. A failure to satisfy certain reporting requirements may result in an extension of the time period during which the IRS can assess a tax, and under certain circumstances, such an extension may apply to assessments of amounts unrelated to any unsatisfied reporting requirement. Each U.S. Holder should consult its own tax advisor regarding the information reporting and backup withholding rules.
THE ABOVE SUMMARY IS NOT INTENDED TO CONSTITUTE A COMPLETE ANALYSIS OF ALL TAX CONSIDERATIONS APPLICABLE TO U.S. HOLDERS WITH RESPECT TO THE ACQUISITION, OWNERSHIP, AND DISPOSITION OF COMMON SHARES. U.S. HOLDERS SHOULD CONSULT THEIR OWN TAX ADVISORS AS TO THE TAX CONSIDERATIONS APPLICABLE TO THEM IN LIGHT OF THEIR OWN PARTICULAR CIRCUMSTANCES.
Certain Canadian Federal Income Tax Consequences
The following summarizes certain Canadian federal income tax consequences generally applicable under the Tax Act and the Canada-U.S. Tax Convention to the holding and disposition of Common Shares.
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This summary is restricted to holders of Common Shares each of whom, at all material times for the purposes of the Tax Act and the Canada-U.S. Tax Convention:
(i) are resident solely in the United States for the purposes of the Canada-U.S. Tax Convention;
(ii) are entitled to the benefits of the Canada-U.S. Tax Convention and is a "qualifying person" within the meaning of the Canada-U.S. Tax Convention;
(iii) hold all Common Shares as capital property and as beneficial owner;
(iv) hold no Common Shares that are "taxable Canadian property" (as defined in the Tax Act) of the holder;
(v) deal at arm's length with and are not affiliated with the Company;
(vi) do not use or hold and are not deemed to use or hold any Common Shares in the course of a business or part of a business carried on in Canada;
(vii) did not, do not and will not have a permanent establishment in Canada within the meaning of the Canada-U.S. Tax Convention;
(viii) did not acquire Common Shares by virtue of employment;
(ix) are not financial institutions, authorized foreign banks, partnerships or trusts for the purposes of the Tax Act; and
(x) are not insurers that carry on business in Canada and elsewhere;
(each such holder, a "U.S. Resident Holder").
Certain U.S.-resident entities that are fiscally transparent for United States federal income tax purposes (including limited liability companies) may not in all circumstances be entitled to the benefits of the Canada-U.S. Tax Convention. However, members of or holders of an interest in such entities that hold Common Shares may be entitled to the benefits of the Canada-U.S. Tax Convention for income derived through such entities. Such members or holders should consult their own tax advisors in this regard.
Generally, a holder's Common Shares will be considered to be capital property of the holder provided that the holder is not a trader or dealer in securities, did not acquire, hold or dispose of the Common Shares in one or more transactions considered to be an adventure or concern in the nature of trade and does not hold the Common Shares as inventory in the course of carrying on a business.
Generally, a holder's Common Shares will not be "taxable Canadian property" of the holder at a particular time at which the Common Shares are listed on a "designated stock exchange" (which currently includes the TSXV) unless both of the following conditions are met at any time during the 60-month period ending at the particular time:
(i) the holder, persons with whom the holder does not deal at arm's length, or any partnership in which the holder or persons with whom the holder did not deal at arm's length holds a membership interest directly or indirectly through one or more partnerships, alone or in any combination, owned 25% or more of the issued shares of any class of the capital stock of the Company; and
(ii) more than 50% of the fair market value of the Common Shares was derived directly or indirectly from, or from any combination of, real or immovable property situated in Canada, "Canadian resource properties" (as defined in the Tax Act), "timber resource properties" (as defined in the Tax Act), or options in respect of or interests in, or for civil law a right, in such properties.
In certain other circumstances, a Common Share may be deemed to be "taxable Canadian property" for purposes of the Tax Act.
This summary is based on the current provisions of the Tax Act and the Canada-U.S. Tax Convention in effect on the date hereof, all specific proposals to amend the Tax Act and Canada-U.S. Tax Convention publicly announced by or on behalf of the Minister of Finance (Canada) on or before the date hereof, and the current published administrative and assessing policies of the Canada Revenue Agency ("CRA"). It is assumed that all such amendments will be enacted as currently proposed, and that there will be no other material change to any applicable law or administrative or assessing practice, although no assurance can be given in these respects. Except as otherwise expressly provided, this summary does not take into account any provincial, territorial or foreign tax considerations, which may differ materially from those set out herein.
This summary is of a general nature only, is not exhaustive of all possible Canadian federal income tax considerations, and is not intended to be and should not be construed as legal or tax advice to any particular U.S. Resident Holder. U.S. Resident Holders are urged to consult their own tax advisers for advice with respect to their particular circumstances. The discussion below is qualified accordingly.
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A U.S. Resident Holder who disposes or is deemed to dispose of one or more Common Shares generally should not thereby incur any liability for Canadian federal income tax in respect of any capital gain arising as a consequence of the disposition.
A U.S. Resident Holder to whom the Company pays or is deemed to pay a dividend on the holder's Common Shares will be subject to Canadian withholding tax, and the Company will be required to withhold the tax from the dividend and remit it to the CRA for the holder's account. The rate of withholding tax under the Tax Act is 25% of the gross amount of the dividend (subject to reduction under the provisions of an applicable tax treaty). Under the Canada-U.S. Tax Convention, a U.S. Resident Holder who beneficially owns the dividend will generally be subject to Canadian withholding tax at the rate of 15% (or 5%, if the U.S. Resident Holder who beneficially owns the dividend is a company that is not fiscally transparent and which owns at least 10% of the voting stock of the Company) of the gross amount of the dividend.
F. Dividends and Paying Agents
Not applicable
G. Statement by Experts
Not applicable.
H. Documents on Display
Any statement in this Annual Report about any of our contracts or other documents is not necessarily complete. If the contract or document is filed as an exhibit to this Annual Report, the contract or document is deemed to modify the description contained in this Annual Report. Readers must review the exhibits themselves for a complete description of the contract or document.
We are subject to the informational requirements of the Exchange Act and file reports and other information with the SEC. The SEC maintains a website that contains reports, proxy and information statements and other information regarding registrants that file electronically with the SEC at http://www.sec.gov.edgar.
We are required to file reports and other information with the securities commissions in Canada. You are invited to read and copy any reports, statements or other information, other than confidential filings, that we file with the provincial securities commissions. These filings are also electronically available from SEDAR+, the Canadian equivalent of EDGAR.
Copies of our material contracts are kept at our registered office.
I. Subsidiary Information
Not applicable.
J. Annual Report to Security Holders
Not applicable.
ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to a number of financial risks arising through the normal course of business, including interest rate risk, foreign currency risk, credit risk, and liquidity risk. Refer to Note 23 of our audited consolidated financial statements for Fiscal 2023 (for the years ended September 30, 2023, 2022 and 2021).
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
Not applicable.
PART II
ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES
There has not been a material default in the payment of principal, interest, a sinking or purchase fund installment, or any other material default not cured within thirty days, relating to indebtedness of the Company or any of its significant subsidiaries. There are no payments of dividends by the Company in arrears, nor has there been any other material delinquency relating to any class of preference shares of the Company.
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS
A. to D.
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None.
E. Use of Proceeds
Not applicable.
ITEM 15. CONTROLS AND PROCEDURES
A. Disclosure Controls and Procedures
As required by National Instrument 52-109 Certification of Disclosure in Issuers Annual and Interim Filings and Rule 13a-15(b) of the Exchange Act, we have evaluated, under the supervision and with the participation of our management, including our CEO and CFO, the effectiveness of the design and operation of our disclosure controls and procedures ("DC&P") (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) as of the end of the period covered and disclosed by us in reports that we file under the Exchange Act is accumulated and communicated to our management, including out principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure and is recorded, processed, summarized and reported within the time periods specified un the rule and forms of the Canadian Securities Administrators and SEC.
Based upon the evaluation, our CEO and CFO have concluded that our disclosure controls and procedures were not effective as of September 30, 2023 at the reasonable assurance level due to the material weaknesses described below under "Management's Assessment on Internal controls over Financial Reporting." As a result of the material weaknesses identified, we performed additional analysis and other post-closing procedures. Notwithstanding these material weaknesses, management has concluded that the consolidated financial statements included in their Annual Report present fairly, in all material respects, the financial position of the Company as at September 30, 2023 in conformance with International Financial Reporting Standards as issued by the International Accounting Standards Board and our external auditors have issued an unqualified option on our consolidated financial statements as of and for the year ended September 30, 2023.
B. Management's Annual Report on Internal Control Over Financial Reporting
In accordance with National Instrument 52-109 Certification of Disclosure in Issuer's Annual and Interim Filings and as required by Rule 13a-15(f) of the Exchange Act, management is responsible for establishing and maintaining adequate internal controls over financial reporting ("ICFR"), The Company's management, including the CEO and CFO, and designed ICFR based on the 2013 Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the "COSO Framework") to provide reasonable assurance regarding the reliability of financial reporting and the preparation of consolidated financial statements for external purposes in accordance with IFRS.
Disclosure controls and procedures ("DC&P")
Our CEO and Interim CFO are responsible for establishing and maintaining our DC&P. These DC&P are designed to provide reasonable assurance that information required to be publicly disclosed is recorded, processed, summarized and reported on a timely basis. Our CEO and Interim CFO have evaluated the design and effectiveness of our DC&P at the end of the quarter and based on the evaluation have concluded that, as a result of the material weakness described below, our DC&P were not effective as at September 30, 2023.
The material weakness in ICFR described below create a reasonable possibility that material misstatements in interim or annual financial statements would not be prevented or detected on a timely basis. As a result of the identification of this material weakness, we performed additional analysis and other post-closing procedures.
Internal Controls over Financial Reporting
ICFR is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. ICFR has inherent limitations. ICFR is a process that involves human diligence and compliance and is subject to lapses in judgement and breakdowns resulting from human failures. ICFR also can be circumvented by collusion or improper management override. Because of such limitations, there is a risk that material misstatements will not be prevented or detected on a timely basis by ICFR. However, these inherent limitations are known features of the financial reporting process. Therefore, it is possible to design into the process safeguards to reduce, though not eliminate, this risk.
Management, under the supervision and with the participation of our CEO and CFO and oversight of the Board, evaluated the effectiveness of our ICFR as at September 30, 2023 against the COSO Framework. Based on this evaluation, Management concluded that material weaknesses existed as of September 30, 2023, as described below, and due to these material weaknesses, ICFR is not effective as of September 30, 2023.
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Ineffective control environment: The Company did not have an effective control environment due to the lack of a sufficient complement of fully trained personnel in financial reporting, accounting and IT with assigned responsibility and accountability related to ICFR. This material weakness contributed to the other material weaknesses below.
Spreadsheet Controls: The Company did not implement and maintain effective controls surrounding certain spreadsheets. Spreadsheets are inherently prone to error due to the manual nature, which increases the risk of human error. The Company's controls related to complex spreadsheets did not address all identified risks associated with manual data entry, review of inputs into management assumptions and estimates, completeness of data entry, and the accuracy of mathematical formulas, impacting complex spreadsheets used in revenue, inventory, impairment and financial closing processes.
IT General Controls: The Company had an aggregation of deficiencies within its IT general controls across multiple systems, including deficiencies related to segregation of duties, user access and change management. As a result, the Company concluded that its process-level automated and manual controls in the areas of journal entries and financial reporting that are dependent on IT general controls, information, and data derived from affected IT systems were also ineffective because they could have been adversely impacted.
Management Review Controls: The Company did not consistently have documented evidence of management review controls and did not always maintain segregation of duties between preparing and reviewing analyses and reconciliations with respect to revenue, inventory, purchasing, and financial closing.
For the year ended September 30, 2023, KWESST is considered an Emerging Growth Company and, thus, is excluded from the audit requirements of S. 404(B). Accordingly, the Company's auditors have not issued a report on the effectiveness of Internal Controls over Financial Reporting.
Remediation Plan
Late in the second half of the fiscal year, and subsequent to the fiscal year-end, the Company strengthened its ability to remediate the above noted material weaknesses with the addition of:
- Additional qualified finance and HR staff;
- Addition of qualified CPAs in both the CFO and CEO roles;
- Engagement of an external IT consultant and reorganizing accountability for IT general controls within the Company's management team with a qualified internal leader.
These measures have made improvements to the deficiencies that aggregate to form the material weaknesses identified above. Management, with oversight from the Audit Committee will continue to implement remediation measures related to the identified material weaknesses with a focus on enhancing business processes and controls as the company continues to mature. Management will additionally:
- Review its IT strategy and investigating ways to improve key software applications and investigating ways to improve key software applications.
- Review key business processes and controls to determine where further system reliance can potentially mitigate the use of complex spreadsheets, improve segregation of duties, and reduce reliance on manual management review controls.
- Improve control tools and templates to aide with the sufficient and consistent documentation of review controls and procedures.
We believe these measures, and others that may be implemented, will remediate the material weaknesses in ICFR described above.
C. Attestation Report of Registered Public Accounting Firm
This Annual Report does not include an attestation report of the Company's registered public accounting firm because emerging growth companies are exempt from this requirement for so long as they remain emerging growth companies.
D. Changes in Internal Controls Over Financial Reporting
In Fiscal 2023, the Company underwent a series of changes that materially affected areas reasonably likely to continue to materially affect the Company's ICFR. Management has continued efforts to develop and enhance the performance of ICFR, including reducing complexity in the organization's application environment and physical footprint. The addition of additional qualified finance and HR staff as well as the appointment of its CFO and CEO who are both experienced and qualified CPAs, will have a positive effect on the Company's ability to remediate its internal control deficiencies.
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ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT
The Board has determined that John McCoach qualifies as a financial expert (as defined in Item 407(d)(5)(ii) of Regulation S-K under the Exchange Act) and Rule 5605(c)(2)(A) of The Nasdaq Stock Market Rules; and (ii) is independent (as determined under Exchange Act Rule 10A-3 and Rule 5605(a)(2) of The Nasdaq Stock Market Rules).
The SEC has indicated that the designation or identification of a person as an audit committee financial expert does not make such person an "expert" for any purpose, impose any duties, obligations or liability on such person that are greater than those imposed on members of the audit committee and the Board who do not carry this designation or identification, or affect the duties, obligations or liability of any other member of the audit committee or Board.
ITEM 16B. CODE OF ETHICS
Effective January 16, 2023, we adopted a Code of Business Conduct and Ethics applicable to all of our directors, officers and employees, including our CEO and CFO, which is a "code of ethics" as defined in section 406(c) of the Sarbanes-Oxley Act. The Code of Business Conduct and Ethics sets out the fundamental values and standards of behavior that we expect from our directors, officers and employees with respect to all aspects of our business.
If we grant any waiver of the Code of Business Conduct and Ethics, whether explicit or implicit, to a director or executive officer, we will disclose the nature of such waiver on its website to the extent required by, and in accordance with, the rules and regulations of the SEC.
The full text of the Code of Business Conduct and Ethics is posted on our website at www.kwesst.com and the System for Electronic Document Analysis and Retrieval (SEDAR+) profile at www.sedarplus.com. The information on or accessible through the website is not part of and is not incorporated by reference into this Annual Report, and the inclusion of the website address in this Annual Report is only for reference.
The Audit Committee is responsible for reviewing and evaluating the Code of Business Conduct and Ethics periodically and will recommend any necessary or appropriate changes thereto to the Board for consideration. The Audit Committee will also assist the Board with the monitoring of compliance with the Code of Business Conduct and Ethics.
ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Aggregate fees paid and payable to our external auditor, KPMG LLP (PCAOB ID 85) during the financial years ended September 30, 2023 and 2022 were as follows:
| 2023 Fee Amount ($) | 2022 Fee Amount ($) | |||||
| Audit Fees(1) | $ | 406,600 | $ | 508,250 | ||
| Audit-Related Fees(2) | 40,179 | 13,910 | ||||
| Tax Fees(3) | 56,603 | 47,223 | ||||
| All Other Fees(4) | - | - | ||||
| Total: | $ | 503,382 | $ | 569,383 | ||
Notes:
(1) "Audit fees" include fees rendered by the Company's external auditor for professional services necessary to perform the annual audit, quarterly reviews of the Company's financial statements, services rendered in connection with the filing of prospectuses in the United States and Canada, and review of documents filed with the SEC and consents and other services normally provided in connection with statutory and regulatory filings or engagements. This includes fees for the review of tax provisions and for accounting consultations on matters reflected in the financial statements.
(2) "Audit-related fees" include fees for assurance and related services that are reasonably related to the performance of the audit or review of the Company's financial statements and that are not included in the "Audit Fees" category.
(3) "Tax fees" include fees for professional services rendered by the Company's external auditor for tax compliance, tax advice and tax planning.
(4) "All other fees" include fees for products and services provided by the Company's external auditor, other than services reported under the table headings "Audit Fees", "Audit-Related Fees" or "Tax Fees".
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Pre-Approval Policies and Procedures
Under its charter, the Audit Committee is required to pre-approve all non-audit services to be performed by the external auditors in relation to us, together with approval of the engagement letter for such non-audit services and estimated fees thereof. The pre-approval process for non-audit services will also involve a consideration of the potential impact of such services on the independence of the external auditors.
ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES
Not applicable.
ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS
Not applicable.
ITEM 16F. CHANGE IN COMPANY'S CERTIFYING ACCOUNTANT
Not applicable.
ITEM 16G. CORPORATE GOVERNANCE
The Company is a "foreign private issuer" as defined in Rule 3b-4 under the Exchange Act and the Common Shares are listed on Nasdaq. Rule 5615(a)(3) of The Nasdaq Stock Market Rules permits foreign private issuers to follow home country practices in lieu of certain provisions of The Nasdaq Stock Market Rules. A foreign private issuer that follows home country practices in lieu of certain provisions of Nasdaq Stock Market Rules must disclose ways in which its corporate governance practices differ from those followed by domestic companies either on its website or in the annual report that it distributes to shareholders in the United States. A description of the ways in which the Company's governance practices differ from those followed by domestic companies pursuant to Nasdaq standards are as follows:
Shareholder Meeting Quorum Requirement: Nasdaq Stock Market Rule 5620(c) ("Rule 5620(c)") requires that the minimum quorum requirement for a meeting of shareholders be 33 1/3 % of the outstanding Common Shares. In addition, Rule 5620(c) requires that an issuer listed on Nasdaq state its quorum requirement in its by-laws. In lieu of following Rule 5620(c), the Company has elected to follow Canadian practices consistent with the requirements of the TSXV and the BCBCA.
Independent Nominating Committee: Nasdaq Stock Market Rule 5605(e)(1) ("Rule 5605(e)(1)") requires having a Nominations Committee comprised solely of independent directors. In lieu of following Rule 5605(e)(1), the Company has elected to follow Canadian practices consistent with the requirements of the TSXV and the BCBCA.
Independent Compensation Committee: Nasdaq Stock Market Rule 5605(d)(2) ("Rule 5605(d)(2)") requires having a Compensation Committee comprised solely of independent directors. In lieu of following Rule 5605(d)(2), the Company has elected to follow Canadian practices consistent with the requirements of the TSXV and the BCBCA.
Shareholder Approval Requirement: Nasdaq Stock Market Rule 5635(d) ("Rule 5635(d)") requires shareholder approval prior to a transaction involving the sale or issuance of a company's common stock (or securities convertible into or exercisable for its common stock): (i) at a price below the greater of book value or market value; and (ii) which together with sales by officers, directors, or substantial stockholders, is equal to 20% or more of the company's outstanding shares of common stock or 20% or more of the voting power prior to issuance. In lieu of following Rule 5635(d), the Company has elected to follow Canadian practices consistent with the requirements of the TSXV and the BCBCA.
ITEM 16H. MINE SAFETY DISCLOSURE
Not applicable.
ITEM 16I. DISCLOSURE REGARDING FOREIGN JURISDICTIONS THAT PREVENT INSPECTIONS
Not applicable.
PART III
ITEM 17. FINANCIAL STATEMENTS
See Item 18 - Financial Statements.
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ITEM 18. FINANCIAL STATEMENTS
The Consolidated Financial Statements and schedules appear on pages F-1 through F-51 of this Annual Report and are incorporated herein by reference. Our audited financial statements as prepared by our management and approved by the Board include:
| Consolidated Financial Statements for the Years Ended September 30, 2023, 2022 and 2021 |
| Consolidated Statements of Financial Position |
| Consolidated Statements of Net Loss and Comprehensive Loss |
| Consolidated Statements of Changes in Shareholders' Equity |
| Consolidated Statements of Cash Flows |
| Notes to the Consolidated Financial Statements |
Consolidated Financial Statements of
KWESST MICRO SYSTEMS INC.
Years ended September 30, 2023, 2022, and 2021
(Expressed in Canadian Dollars)
KWESST MICRO SYSTEMS INC.
Table of contents for the years ended September 30, 2023, 2022, and 2021
Report of Independent Registered Public Accounting Firm
To the Shareholders and Board of Directors KWESST Micro Systems Inc.:
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated statements of financial position of KWESST Micro Systems Inc. (the Company) as of September 30, 2023 and 2022, the related consolidated statements of net loss and comprehensive loss, shareholders’ equity (deficit), and cash flows for each of the years in the two-year period ended September 30, 2023, and the related notes (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of September 30, 2023 and 2022, and its financial performances and its cash flows for each of the years in the two-year period ended September 30, 2023, in conformity with International Financial Reporting Standards as issued by the International Accounting Standard Board.
Going Concern
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2(a) to the consolidated financial statements, the Company has incurred significant losses and negative cash flows from operations since inception that raise substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 2(a). The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audit provides a reasonable basis for our opinion.
/s/ KPMG LLP
Chartered Professional Accountants, Licensed Public Accountants
We have served as the Company's auditor since 2021.
Ottawa, ON
January 17, 2024
| F-1 | Page |
KWESST MICRO SYSTEMS INC.
Consolidated Statements of Financial Position
At September 30, 2023 and 2022
| September 30, | September 30, | |||||||
| In Canadian dollars | Notes | 2023 | 2022 | |||||
| ASSETS | ||||||||
| Cash and cash equivalents | $ | 5,407,009 | $ | 170,545 | ||||
| Restricted short-term investment | 12 | 30,000 | 30,000 | |||||
| Trade and other receivables | 5 | 300,269 | 171,882 | |||||
| Inventories | 6 | 542,388 | 393,538 | |||||
| Prepaid expenses and other | 562,408 | 122,166 | ||||||
| Deferred share offering costs | - | 628,262 | ||||||
| Current assets | 6,842,074 | 1,516,393 | ||||||
| Property and equipment | 7 | 417,296 | 832,481 | |||||
| Right-of-use assets | 8 | 361,036 | 208,131 | |||||
| Deposit | 8 | 26,076 | 23,604 | |||||
| Intangible assets | 9 | 4,112,350 | 4,742,854 | |||||
| Non-current assets | 4,916,758 | 5,807,070 | ||||||
| Total Assets | $ | 11,758,832 | $ | 7,323,463 | ||||
| LIABILITIES AND SHAREHOLDERS' EQUITY | ||||||||
| Liabilities | ||||||||
| Accounts payable and accrued liabilities | 10 | $ | 1,649,876 | $ | 4,459,481 | |||
| Accrued royalties liability | 4(b) | 150,000 | 150,000 | |||||
| Lease obligations | 13 | 127,116 | 69,150 | |||||
| Borrowings | 12 | - | 2,199,978 | |||||
| Contract liabilities | 14 | 120,970 | 47,271 | |||||
| Warrant liabilities | 15 | 4,335,673 | - | |||||
| Current liabilities | 6,383,635 | 6,925,880 | ||||||
| Accrued royalties liability | 4(b) | 1,137,170 | 1,115,207 | |||||
| Lease obligations | 13 | 302,407 | 206,471 | |||||
| Borrowings | 12 | - | 78,796 | |||||
| Non-current liabilities | 1,439,577 | 1,400,474 | ||||||
| Total Liabilities | 7,823,212 | 8,326,354 | ||||||
| Shareholders' Equity (Deficit) | ||||||||
| Share capital | 16(a) | 33,379,110 | 19,496,640 | |||||
| Warrants | 16(b) | 1,042,657 | 1,959,796 | |||||
| Contributed surplus | 16(c) | 4,769,115 | 3,551,330 | |||||
| Accumulated other comprehensive loss | (39,663 | ) | (101,418 | ) | ||||
| Accumulated deficit | (35,215,599 | ) | (25,909,239 | ) | ||||
| Total Shareholders' Equity (Deficit) | 3,935,620 | (1,002,891 | ) | |||||
| Total Liabilities and Shareholders' Equity (Deficit) | $ | 11,758,832 | $ | 7,323,463 |
See Note 2(a) Going concern and Note 27 Commitments and contingencies.
See accompanying notes to the consolidated financial statements.
On behalf of the Board of Directors:
| (signed) Paul Mangano, Director | (signed) David Luxton , Director |
| F-2 | Page |
KWESST MICRO SYSTEMS INC.
Consolidated Statements of Net Loss and Comprehensive Loss
Years ended September 30, 2023, 2022 and 2021
| September 30, | September 30, | September 30, | |||||||
| In Canadian dollars | 2023 | 2022 | 2021 | ||||||
| Revenue | $ | 1,234,450 | $ | 721,519 | $ | 1,275,804 | |||
| Cost of sales | (1,425,828 | ) | (536,735 | ) | (798,888 | ) | |||
| Gross profit | (191,378 | ) | 184,784 | 476,916 | |||||
| Operating expenses | |||||||||
| General and administrative | 7,244,762 | 4,915,263 | 4,057,167 | ||||||
| Selling and marketing | 3,024,283 | 3,296,373 | 3,484,159 | ||||||
| Research and development, net | 1,644,565 | 2,064,493 | 2,138,138 | ||||||
| Total operating expenses | 11,913,610 | 10,276,129 | 9,679,464 | ||||||
| Operating loss | (12,104,988 | ) | (10,091,345 | ) | (9,202,548 | ) | |||
| Other income (expenses) | |||||||||
| Share issuance costs | (1,985,074 | ) | - | - | |||||
| Net finance costs | (668,034 | ) | (506,002 | ) | (107,751 | ) | |||
| Foreign exchange gain (loss) | (98,275 | ) | 28,780 | (3,742 | ) | ||||
| Change in fair value of warrant liabilities | 5,841,192 | - | - | ||||||
| Loss on disposal of property and equipment | (291,181 | ) | (1,165 | ) | (1,331 | ) | |||
| Total other income (expenses), net | 2,798,628 | (478,387 | ) | (112,824 | ) | ||||
| Loss before income taxes | (9,306,360 | ) | (10,569,732 | ) | (9,315,372 | ) | |||
| Income tax recovery | |||||||||
| Deferred tax recovery | - | 49,442 | - | ||||||
| Net loss | $ | (9,306,360 | ) | $ | (10,520,290 | ) | $ | (9,315,372 | ) |
| Other comprehensive income: | |||||||||
| Items that are or may be reclassified subsequently to profit or loss: | |||||||||
| Foreign currency translation differences | 61,755 | (92,427 | ) | (8,991 | ) | ||||
| Total comprehensive loss | $ | (9,244,605 | ) | $ | (10,612,717 | ) | $ | (9,324,363 | ) |
| Net loss per share | |||||||||
| Basic and diluted | $ | (2.28 | ) | $ | (14.41 | ) | $ | (14.72 | ) |
| Weighted average number of shares outstanding | |||||||||
| Basic and diluted | 4,082,275 | 730,302 | 632,721 |
See accompanying notes to the consolidated financial statements.
| F-3 | Page |
KWESST MICRO SYSTEMS INC.
Consolidated Statements of Changes in Shareholders' Equity (Deficit)
Years ended September 30, 2023, 2022 and 2021
| In Canadian dollars | Total | ||||||||||||||||||||||
| Contingent | Contributed | Translation | Shareholders' | ||||||||||||||||||||
| Notes | Share capital | shares | Warrants | surplus | reserve | Deficit | Equity (Deficit) | ||||||||||||||||
| Balance, September 30, 2020 | 9,374,563 | - | 277,170 | 306,708 | - | (6,073,577 | ) | 3,884,864 | |||||||||||||||
| Shares issued for debt | 16(a) | 63,866 | - | - | - | - | - | 63,866 | |||||||||||||||
| Warrants exercised | 16(b) | 815,307 | - | (175,741 | ) | - | - | - | 639,566 | ||||||||||||||
| Shares and warrants issued on asset acquisition | 4(b) | 1,290,000 | - | 425,000 | - | - | - | 1,715,000 | |||||||||||||||
| Shares for amended license | 137,000 | - | - | - | - | - | 137,000 | ||||||||||||||||
| Shares and warrants issued for cash | 16(a),(b) | 4,721,818 | - | 1,280,654 | - | - | - | 6,002,472 | |||||||||||||||
| Stock options and warrants exercised | 16(c) | 1,639,695 | - | 41,306 | (531,263 | ) | - | - | 1,149,738 | ||||||||||||||
| Share-based compensation | 16(c) | - | - | - | 2,462,207 | - | - | 2,462,207 | |||||||||||||||
| Restricted share units vested | 16(c) | 12,498 | - | - | (12,498 | ) | - | - | - | ||||||||||||||
| Share offering costs | 16(a) | 839,679 | - | - | 233,057 | - | - | (606,622 | ) | ||||||||||||||
| Other comprehensive loss | - | - | - | - | (8,991 | ) | - | (8,991 | ) | ||||||||||||||
| Net loss | - | - | - | - | - | (9,315,372 | ) | (9,315,372 | ) | ||||||||||||||
| Balance, September 30, 2021 | $ | 17,215,068 | $ | - | $ | 1,848,389 | $ | 2,458,211 | $ | (8,991 | ) | $ | (15,388,949 | ) | $ | 6,123,728 | |||||||
| Shares issued for debt | 16(a) | 19,000 | - | - | - | - | - | 19,000 | |||||||||||||||
| Shares and warrants issued on acquisition | 4(a) | 377,503 | 83,319 | 132,000 | - | - | - | 592,822 | |||||||||||||||
| Shares and warrants issued for cash | 16(a),(b) | 272,000 | - | 72,000 | - | - | - | 344,000 | |||||||||||||||
| Contingent shares converted to common shares | 4(a) | 83,319 | (83,319 | ) | - | - | - | - | - | ||||||||||||||
| Warrants exercised | 16(b) | 277,098 | - | (61,173 | ) | - | - | - | 215,925 | ||||||||||||||
| Warrants expired | 16(b) | - | - | (31,420 | ) | 31,420 | - | - | - | ||||||||||||||
| Share-based compensation | 16(c) | - | - | - | 1,960,072 | - | - | 1,960,072 | |||||||||||||||
| Shares for vested RSUs and PSUs | 16(c) | 874,840 | - | - | (874,840 | ) | - | - | - | ||||||||||||||
| Vested RSUs and PSUs repurchased for | 16(c) | - | - | - | (23,533 | ) | - | - | (23,533 | ) | |||||||||||||
| Shares issued for unsecured loans | 12 | 411,692 | - | - | - | - | - | 411,692 | |||||||||||||||
| Share offering costs | 16(a) | (33,880 | ) | - | - | - | - | - | (33,880 | ) | |||||||||||||
| Other comprehensive loss | - | - | - | - | (92,427 | ) | - | (92,427 | ) | ||||||||||||||
| Net loss | - | - | - | - | - | (10,520,290 | ) | (10,520,290 | ) | ||||||||||||||
| Balance, September 30, 2022 | $ | 19,496,640 | $ | - | $ | 1,959,796 | $ | 3,551,330 | $ | (101,418 | ) | $ | (25,909,239 | ) | $ | (1,002,891 | ) | ||||||
| Shares issued for public offering | 16(a) | 16,725,436 | - | - | - | - | - | 16,725,436 | |||||||||||||||
| Share offering costs | 16(a) | (3,671,791 | ) | - | 393,911 | 125,086 | - | - | (3,152,794 | ) | |||||||||||||
| Shares issued for debt | 16(a) | 233,485 | - | - | - | - | - | 233,485 | |||||||||||||||
| Options exercised | 16(c) | 5,836 | - | - | (1,789 | ) | - | - | 4,047 | ||||||||||||||
| Warrants exercised | 16(b) | 60,000 | - | (60,000 | ) | - | - | - | - | ||||||||||||||
| Warrants expired | 16(b) | - | - | (1,251,050 | ) | 1,251,050 | - | ||||||||||||||||
| Share-based compensation | 16(c) | - | - | - | 373,554 | - | - | 373,554 | |||||||||||||||
| Shares for vested RSUs and PSUs | 16(c) | 529,504 | - | - | (529,504 | ) | - | - | - | ||||||||||||||
| Vested RSUs and PSUs repurchased for withholding taxes | - | - | - | 612 | - | - | 612 | ||||||||||||||||
| Other comprehensive income | - | - | - | - | 61,755 | - | 61,755 | ||||||||||||||||
| Net loss | - | - | - | - | - | (9,306,360 | ) | (9,306,360 | ) | ||||||||||||||
| Balance, September 30, 2023 | $ | 33,379,110 | $ | - | $ | 1,042,657 | $ | 4,769,115 | $ | (39,663 | ) | $ | (35,215,599 | ) | $ | 3,935,620 | |||||||
See accompanying notes to the consolidated financial statements.
| F-4 | Page |
KWESST MICRO SYSTEMS INC.
Consolidated Statements of Cash Flows
Years ended September 30, 2023, 2022 and 2021
| September 30, | September 30, | September 30, | ||||||||
| In Canadian dollars | Notes | 2023 | 2022 | 2021 | ||||||
| OPERATING ACTIVITIES | ||||||||||
| Net loss | $ | (9,306,360 | ) | $ | (10,520,290 | ) | $ | (9,315,372 | ) | |
| Items not affecting cash: | ||||||||||
| Depreciation and amortization | 7, 8, 9 and 20 | 952,508 | 326,491 | 140,990 | ||||||
| Share-based compensation | 16(c) | 373,554 | 1,960,072 | 2,462,207 | ||||||
Change in fair value of warrant liabilities (including related | ||||||||||
| foreign exchange gain) | 15 | (5,786,593 | ) | - | - | |||||
| Net finance costs | 21 | 668,033 | 506,002 | 107,751 | ||||||
| Impairment of intangible assets | 9 | 1,169,440 | - | 55,376 | ||||||
| Loss on disposals | 291,181 | 1,165 | 1,331 | |||||||
| Shares for amended licence | - | - | 137,000 | |||||||
| Deferred tax recovery | 22 | - | (49,442 | ) | - | |||||
| Changes in non-cash working capital items | 24 | (2,310,266 | ) | 3,639,822 | 198,484 | |||||
| Interest paid | (130,126 | ) | (120,416 | ) | (42,980 | ) | ||||
| Cash used in operating activities | (14,078,629 | ) | (4,256,596 | ) | (6,255,213 | ) | ||||
| INVESTING ACTIVITIES | ||||||||||
| Additions of property and equipment | 7 | (176,949 | ) | (187,478 | ) | (809,964 | ) | |||
| Investments in intangible assets | 9 | (1,123,186 | ) | (1,176,664 | ) | (83,228 | ) | |||
| Deposit for advanced royalties | 4(b) | (148,410 | ) | - | (150,000 | ) | ||||
| Purchase of restricted short-term investment | 12 | - | - | (30,000 | ) | |||||
| Recognition of open orders from acquisition | 9 | 7,811 | 87,802 | - | ||||||
| Cash acquired on acquisition | 4 | - | 162,547 | - | ||||||
| Cash flows used in investing activities | (1,440,734 | ) | (1,113,793 | ) | (1,073,192 | ) | ||||
| FINANCING ACTIVITIES | ||||||||||
| Proceeds from U.S. IPO and Canadian Offering, net | 16(a) | 16,346,768 | - | - | ||||||
| Proceeds from the issuance of common shares and warrants | 16(a) | 7,357,012 | 344,000 | 6,002,472 | ||||||
| Payments of share offering costs | 16(a) | (542,591 | ) | (33,880 | ) | (606,622 | ) | |||
| Proceeds from borrowings | 12 | - | 2,543,230 | 326,000 | ||||||
| Payments of deferred financing fees | 12 | - | (150,409 | ) | - | |||||
| Repayment of borrowings | 12 | (2,333,315 | ) | - | (306,000 | ) | ||||
| Repayments of lease obligations | 13 | (75,487 | ) | (42,504 | ) | (44,128 | ) | |||
| Proceeds from related party advances | 11 | - | 60,000 | - | ||||||
| Repayments to related party advances | 11 | - | (60,000 | ) | (218,276 | ) | ||||
| Proceeds from exercise of warrants | 16(b) | - | 215,925 | 680,872 | ||||||
| Proceeds from exercise of stock options | 16(c) | 4,052 | - | 1,108,432 | ||||||
| Repurchase of vested RSUs and PSUs for withholding taxes | (612 | ) | (23,533 | ) | - | |||||
| Cash flows provided by financing activities | 20,755,827 | 2,852,829 | 6,942,750 | |||||||
| Net change in cash during the period | 5,236,464 | (2,517,560 | ) | (385,655 | ) | |||||
| Cash, beginning of period | 170,545 | 2,688,105 | 3,073,760 | |||||||
| Cash, end of period | $ | 5,407,009 | $ | 170,545 | $ | 2,688,105 | ||||
| Cash and cash equivalents consist of the following: | ||||||||||
| Cash held in banks | 4,407,009 | 170,545 | 2,688,105 | |||||||
| Short-term guaranteed investment certificates | 1,000,000 | - | - | |||||||
| Cash and cash equivalents, end of period | 5,407,009 | 170,545 | 2,688,105 |
See Note 24 Supplemental cash flow information.
See accompanying notes to the consolidated financial statements.
| 5 | Page |
KWESST MICRO SYSTEMS INC. |
1. Corporate information
a) Corporate information
KWESST Micro Systems Inc. (the "Company", "KWESST", "we", "our", and "us") was incorporated on November 28, 2017, under the laws of the Province of British Columbia. Our registered office is located at 550 Burrard Street, Suite 2900, Vancouver, British Columbia, Canada, and our corporate office is located at Unit 1, 155 Terrence Matthews Crescent, Ottawa, Ontario, Canada. We have representative offices in the following foreign locations: Washington DC (United States), London (United Kingdom), and Abu Dhabi (United Arab Emirates).
We develop and commercialize next-generation technology solutions that deliver a tactical advantage for military, public safety agencies and personal defense markets. Our core mission is to protect and save lives.
KWESST's common stock is listed on the TSX-Venture Exchange ("TSX-V'') under the stock symbol of KWE, on the Nasdaq Capital Market ("Nasdaq") under the stock symbol of KWE and on the Frankfurt Stock Exchange under the stock symbol of 62U. Additionally, warrants issued in the United States are also listed on the Nasdaq under the stock symbol of KWESW. Effective May 1, 2023, the warrants issued in Canada are listed on the TSX-V under the stock symbol of KWE.WT.U.
b) Reverse Stock Split
In August 2022, we submitted a Form F-1 Registration Statement to the U.S. Securities and Exchange Commission and applied to have its common shares listed on the Nasdaq. In connection with KWESST's listing application on Nasdaq, we effected a one for seventy (1-for-70) reverse stock split of its common stock on October 28, 2022 (the "Reverse Split"). Accordingly, all shareholders of record at the opening of business on October 28, 2022, received one issued and outstanding common share of KWESST in exchange for seventy outstanding common shares of KWESST. No fractional shares were issued in connection with the Reverse Split. All fractional shares created by the Reverse Split were rounded to the nearest whole number of common shares, with any fractional interest representing 0.5 or more common shares entitling holders thereof to receive one whole common share.
Effective on the date of the Reverse Split, the exercise price and number of common shares issuable upon the exercise of outstanding stock options were proportionately adjusted to reflect the Reverse Split. The restricted share units ("RSUs") and performance stock units ("PSUs") have also been adjusted for the Reverse Split. While the number of warrants has not changed as a result of the Reverse Split, the conversion rate for each warrant was adjusted from one common share to 0.01428571 common share. All information respecting outstanding common shares and other securities of KWESST, including net loss per share, in the current and comparative periods presented herein give effect to the Reverse Split.
2. Basis of preparation
(a) Going concern
These consolidated financial statements have been prepared assuming we will continue as a going concern. The going concern basis of presentation assumes we will continue in operation for the foreseeable future and can realize our assets and discharge our liabilities and commitments in the normal course of business.
As an early-stage company, we have not yet reached commercial production for most of our products and have incurred significant losses and negative operating cash flows from inception that have primarily been funded from financing activities. We have incurred a $9.3 million net loss and negative operating cash flows of approximately $14.1 million for the year ended September 30, 2023 (2022 - $10.5 million net loss and negative operating cash flows of $4.3 million, 2021 - $9.3 million net loss and negative operating cash flows of $6.3 million). At September 30, 2023, we had $0.5 million in positive working capital (2022 - negative working capital of $5.4 million, 2021 - positive working capital of $2.9 million).
| F-6 | Page |
| KWESST MICRO SYSTEMS INC. Notes to Consolidated Financial Statements Years ended September 30, 2023, 2022, 2021 (Expressed in Canadian dollars, except share amounts) |
Our ability to continue as a going concern and realize our assets and discharge our liabilities in the normal course of business is dependent upon closing timely additional sales orders, timely commercial launch of new products, and the ability to raise additional debt or equity financing, when required. There are various risks and uncertainties affecting our future financial position and our performance including, but not limited to:
• | The market acceptance and rate of commercialization of our product offerings; | |
• | Ability to successfully execute our business plan; | |
• | Ability to raise additional capital at acceptable terms; | |
• | General local and global economic conditions, including the ongoing conflict in Gaza and the global disruption from Russia's invasion of Ukraine. |
Our strategy to mitigate these material risks and uncertainties is to execute timely a business plan aimed at continued focus on revenue growth, product development and innovation, improving overall gross profit, managing operating expenses and working capital requirements, and securing additional capital, as needed.
Failure to implement our business plan could have a material adverse effect on our financial condition and/or financial performance. There is no assurance that we will be able to raise additional capital as they are required in the future. Accordingly, there are material risks and uncertainties that may cast significant doubt about our ability to continue as a going concern.
These consolidated financial statements do not include any adjustments to the carrying amounts and classification of assets, liabilities and reported expenses that may otherwise be required if the going concern basis was not appropriate.
(b) Statement of compliance
These consolidated financial statements have been prepared in accordance with International Financial Reporting Standards ("IFRS") as issued by the International Accounting Standards Board ("IASB") and interpretations of the IFRS Interpretations Committee ("IFRIC").
The consolidated financial statements were authorized for issue by the Board of Directors effective on January 17, 2024.
(c) Basis of consolidation
These consolidated financial statements incorporate the financial statements of KWESST and the entities it controls.
Control is achieved where we have the power to govern the financial and operating policies of an entity so as to obtain benefits from its activities, are exposed to, or have rights to, variable returns from our involvement with the entity and have the ability to affect those returns through its power over the entity. Subsidiaries are fully consolidated from the date on which control is transferred to us until the date on which control ceases. Profit or loss of subsidiaries acquired during the year are recognized from the date of acquisition or effective date of disposal as applicable. All intercompany transactions and balances have been eliminated.
| F-7 | Page |
| KWESST MICRO SYSTEMS INC. Notes to Consolidated Financial Statements Years ended September 30, 2023, 2022, 2021 (Expressed in Canadian dollars, except share amounts) |
At September 30, 2023, we have the following wholly owned subsidiaries:
Location | Equity % | |
KWESST Inc. | Ottawa, Canada | 100% |
2720178 Ontario Inc. | Guelph, Canada | 100% |
Police Ordnance Company Inc. | Guelph, Canada | 100% |
KWESST U.S. Holdings Inc. | Delaware, Canada | 100% |
KWESST Defense Systems U.S. Inc. | Virginia, United States | 100% |
KWESST Public Safety Systems U.S. Inc. | Virginia, United States | 100% |
KWESST Public Safety Systems Canada Inc. | Ottawa, Canada | 100% |
(d) Functional and presentation currency
The consolidated financial statements are presented in Canadian dollars ("CAD"), our functional and presentation currency.
(e) Basis of measurement
The consolidated financial statements have been prepared on the historical cost basis except for certain financial instruments measured at fair value. Historical cost is generally based on the fair value of the consideration given in exchange for assets.
(f) Use of estimates and judgments
The preparation of the consolidated financial statements in accordance with IFRS requires management to make judgments, estimates, and assumptions that affect the application of accounting policies and the reported amounts of assets and liabilities, income, expenses, and disclosure of contingent liabilities. Actual results may differ from these estimates.
Estimates and underlying assumptions are reviewed on an ongoing basis. Revisions to estimates are recognized prospectively.
Judgments
Information about judgments made in applying accounting policies that have the most significant effects on the amounts recognized in these consolidated financial statements is included in the following notes:
• | Note 4(a) - acquisition of Police Ordnance: whether the consideration transferred, and purchase price allocation assumptions used as inputs in determining the fair value of net assets acquired is reasonable; | |
• | Note 4(b) - acquisition of PARA OPSTM System: whether the estimated discount rate used to discount the minimum royalty payments is reasonable, and the reasonability of the volatility assumption used in the Black Scholes option model to estimate the fair value of the warrants issued to DEFSEC; | |
• | Note 12 - unsecured loans: whether the estimated market discount rate used to estimate the fair value of the unsecured loans is reasonable; | |
• | Note 15 - warrant liabilities: whether the valuation and the volatility assumptions used in the Black Scholes calculations for the warrant liabilities are reasonable; |
| F-8 | Page |
| KWESST MICRO SYSTEMS INC. Notes to Consolidated Financial Statements Years ended September 30, 2023, 2022, 2021 (Expressed in Canadian dollars, except share amounts) |
• | Note 16(c) - share-based compensation: whether the determination of KWESST's stock volatility, forfeiture rate, and expected life are reasonable in light of its limited operating history, all significant inputs in the valuation model to fair value options granted; and | |
• | Note 16(c) - broker compensation options: whether the Monte Carlo valuation model and number of simulations, coupled with the volatility assumption, are reasonable to estimate the fair value of these options. |
Estimates
Information about assumptions and estimation uncertainties at September 30, 2023, that have a significant risk of resulting in a material adjustment to the carrying amounts of assets and liabilities in the next financial year is included in the following notes:
| • | Note 9 - impairment test of intangible assets: key assumptions underlying recoverable amounts, including current and future market conditions, timing of commercialization, revenue and costs as well as market value inputs; and | |
| • | Note 18 - Revenue: key assumptions underlying the recognition of revenue based on percentage of completion, including remaining hours to complete. |
3. Significant accounting policies
(a) Revenue recognition
Revenue is recognized upon transfer of control of products or services to customers at an amount that reflects the transaction price we expect to receive in exchange for the products or services. Our contracts with customers may include the delivery of multiple products and services, which are generally capable of being distinct and accounted for as separate performance obligations. The accounting for a contract or contracts with a customer that contain multiple performance obligations requires us to allocate the contract or contracts transaction price to the identified distinct performance obligations based on the stand-alone selling price of each performance obligation.
Revenue from contracts with customers is recognized, for each performance obligation, either over a period of time or at a point in time, depending on which method reflects the transfer of control of the goods or services underlying the particular obligation to the customer.
For performance obligations satisfied over time, we recognize revenue over time using an input method, based on costs incurred to date relative to total estimated costs at completion, to measure progress toward satisfying such performance obligation (for non-recurring engineering services, the input method is based on hours). Under this method, costs that do not contribute to the performance of KWESST in transferring control of goods or services to the customer are excluded from the measurement of progress toward satisfying the performance obligation. In certain other situations, we might recognize revenue at a point in time, when the criteria to recognize revenue over time are not met. In any event, when the total anticipated costs exceed the total anticipated revenues on a contract, such a loss is recognized in its entirety in the period it becomes known.
We may enter into contractual arrangements with a customer to deliver services on one project with respect to more than one performance obligation, such as non-recurring engineering, procurement, and training. When entering into such arrangements, we allocate the transaction price by reference to the stand-alone selling price of each performance obligation. Accordingly, when such arrangements exist on the same project, the value of each performance obligation is based on its stand-alone price and recognized according to the respective revenue recognition methods described above. For example, for non-recurring engineering services rendered over a contract period the revenue is recognized using the percentage of completion method; whereas for training services the revenue is recognized after the training is delivered (i.e. point in time).
| F-9 | Page |
| KWESST MICRO SYSTEMS INC. Notes to Consolidated Financial Statements Years ended September 30, 2023, 2022, 2021 (Expressed in Canadian dollars, except share amounts) |
We account for a contract modification, which consists of a change in the scope or price (or both) of a contract, as a separate contract when the remaining goods or services to be delivered after the modification are distinct from those delivered prior to the modification and the price of the contract increases by an amount of consideration to a price which reflects KWESST's stand-alone selling price of the additional promised goods or services. When the contract modification is not accounted for as a separate contract, we recognize an adjustment to revenue on a cumulative catch-up basis at the date of contract modification.
The timing of revenue recognition often differs from performance payment schedules, resulting in revenue that has been earned but not billed. These amounts are included in unbilled receivables. Amounts billed in accordance with customer contracts, but not yet earned, are recorded and presented as part of contract liabilities.
When a contract includes a significant financing component, the value of such component is excluded from the transaction price and is recognized separately as finance income or expense, as applicable.
(b) Business combinations
We account for business combinations using the acquisition method. Goodwill arising on acquisitions is measured as the fair value of the consideration transferred less the net recognized amount of the estimated fair value of identifiable assets acquired and liabilities assumed, all measured as of the acquisition date. Transaction costs that we incur in connection with a business combination are expensed as incurred. We use our best estimates and assumptions to reasonably value assets acquired and liabilities assumed at the acquisition date as well as contingent consideration, where applicable, and these estimates are inherently uncertain and subject to refinement. As a result, during the measurement period, which may be up to one year from the acquisition date, we may record adjustments to the assets acquired and liabilities assumed with a corresponding offset to goodwill. Upon conclusion of the measurement period or final determination of the values of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recorded in profit or loss.
Where the total purchase consideration is less than the fair value of identifiable net assets, we recognize a gain on acquisition.
Acquisitions that do not meet the definition of a business are accounted for as asset acquisitions in accordance with the relevant IFRS standards and applicable to the type of asset acquired.
(c) Financial instruments
We recognize a financial asset or a financial liability when it becomes a party to the contractual provisions of the instrument.
Trade and other receivables without a significant financing component are initially measured at the transaction price. All other financial assets and financial liabilities are initially recognized at fair value. Transaction costs that are directly attributable to the acquisition or issue of financial assets and financial liabilities (other than financial assets and financial liabilities at fair value through profit or loss ("FVTPL")) are added to or deducted from the fair value of the financial assets or financial liabilities, as appropriate, on initial recognition. Transaction costs directly attributable to the acquisition of financial assets or financial liabilities at fair value through profit or loss are recognized immediately in profit or loss.
Financial assets
All financial assets are recognized and de-recognized on trade date.
Financial assets are recognized at fair value and subsequently classified and measured at:
a) Amortized cost;
b) Fair value through other comprehensive income ("FVOCI"); or
c) Fair value though profit or loss ("FVTPL").
| F-10 | Page |
| KWESST MICRO SYSTEMS INC. Notes to Consolidated Financial Statements Years ended September 30, 2023, 2022, 2021 (Expressed in Canadian dollars, except share amounts) |
We determine the classification of our financial assets on the basis of both the business model for managing the financial assets and the contractual cash flows characteristics of the financial asset. Financial assets are not reclassified subsequent to their initial recognition unless we change our business model for managing financial assets.
A financial asset is measured at amortized cost if it is held within a business model whose objective is to hold assets to collect contractual cash flows, and its contractual terms give rise on specified dates to cash flows that are solely payments of principal and interest of the principal amount outstanding. Financial assets classified at amortized cost are measured using the effective interest method. At September 30, 2023, we classified the following as amortized cost:
All financial assets not classified and measured at amortized cost or FVOCI are measured at FVTPL. At September 30, 2023, we did not have financial assets classified as FVOCI or FVTPL.
Expected credit losses
We measure a loss allowance based on the lifetime expected credit losses. Lifetime expected credit losses are estimated based on factors such as our past experience of collecting payments, the number of delayed payments in the portfolio past the average credit period, observable changes in national or local economic conditions that correlate with default on receivables, financial difficulty of the borrower, and it becoming probable that the borrower will enter bankruptcy or financial re-organization.
Financial assets are written off when there is no reasonable expectation of recovery.
Financial liabilities
Financial liabilities are recognized at fair value and subsequently classified and measured at amortized cost or fair value though profit or loss ("FVTPL").
We determine the classification of our financial liabilities at initial recognition. We have classified the following as amortized costs:
The warrant liabilities are classified as FVTPL.
Financial liabilities at amortized cost are measured using the effective interest rate method.
De-recognition of financial liabilities
KWESST de-recognizes financial liabilities when its obligations are discharged, cancelled or they expire.
| F-11 | Page |
| KWESST MICRO SYSTEMS INC. Notes to Consolidated Financial Statements Years ended September 30, 2023, 2022, 2021 (Expressed in Canadian dollars, except share amounts) |
(d) Cash and cash equivalents
Cash and cash equivalents include cash investments in interest-bearing accounts and term deposits which can readily be redeemed for cash without penalty or are issued for terms of three months or less from dated of acquisition.
(e) Inventories
KWESST's inventories may consist of raw materials, work-in-progress ("WIP") and finished goods. Inventories are measured at the lower of cost and net realizable value, with cost being determined using the weighted average cost method. The cost of WIP and finished goods includes the cost of raw materials, direct labour, and overhead. Net realizable value is the estimated selling price in the ordinary course of business, less the estimated costs of completion and selling expenses. At each reporting period, management estimates the provision for obsolete and slow-moving inventory which may be reversed in subsequent periods, should the value subsequently be recovered.
(f) Property and equipment
Property and equipment are measured at cost less accumulated depreciation and accumulated impairment losses. Cost comprises the fair value of consideration given to acquire or construct an asset and includes the direct charges associated with bringing the asset to the location and condition necessary for putting it into use along with the future cost of dismantling and removing the asset. These assets are depreciated over their estimated useful lives using the straight-line method as this most closely reflects the expected pattern of consumption of the future economic benefits. Depreciation methods, useful lives and residual values are reviewed at each financial year end and adjusted prospectively, if appropriate.
The following table provides a summary of estimated useful lives for our property and equipment:
| Rate | |
| Computer equipment | 3 years |
| Computer software | 3 years |
| Office furniture and equipment | 5 years |
| Low-rate initial production equipment | 5 years |
| R&D equipment | 5 years |
| Sales demo equipment | 2 years |
| Leasehold improvements | Shorter of useful life or remaining term of lease |
At the end of each reporting period, we review the carrying amounts of its property and equipment to determine whether there is any indication of impairment. If any such indication exists, the recoverable amount of the asset is estimated in order to determine the extent of the impairment loss (if any). The recoverable amount is the higher of fair value less costs to sell and value in use. In assessing value in use, the estimated future cash flows are discounted to their present value using a pre-tax discount rate that reflects current market assessments of the time value of money and the risks specific to the asset. For the purpose of impairment testing, assets that cannot be tested individually are grouped together into the smallest group of assets that generates cash inflows from continuing use that are largely independent of the cash flows of other assets or groups of assets (the "cash-generating unit, or CGU"). If the recoverable amount of an asset is estimated to be less than its carrying amount, the carrying amount of the asset is reduced to its recoverable amount. An impairment loss is recognized immediately in profit or loss.
Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.
(g) Leases
At inception of a contract, we assess whether a contract is, or contains, a lease based on whether the contract conveys the right to control the use of an identified asset for a period of time in exchange for consideration.
| F-12 | Page |
| KWESST MICRO SYSTEMS INC. Notes to Consolidated Financial Statements Years ended September 30, 2023, 2022, 2021 (Expressed in Canadian dollars, except share amounts) |
We recognize a right-of-use asset and a lease liability at the lease commencement date. The lease obligation is measured at the present value of the lease payments that are not paid at the commencement date of the lease, discounted using its incremental borrowing rate at the inception of the lease. The right-of-use asset is initially measured based on the initial amount of the lease liability adjusted for any lease payments made at or before the commencement date, plus any initial direct costs incurred and an estimate of costs to dismantle and remove the underlying asset or to restore the underlying asset or the site on which it is located, less any lease incentives received. The assets are depreciated to the earlier of the end of the useful life of the right-of-use asset or the lease term using the straight-line method as this most closely reflects the expected pattern of consumption of the future economic benefits. The lease term includes periods covered by an option to extend if we are reasonably certain to exercise that option. In addition, the right-of-use asset is periodically reduced by impairment losses, if any, and adjusted for certain remeasurements of the lease liability.
The lease liability is initially measured at the present value of the lease payments that are not paid at the commencement date, discounted using the interest rate implicit in the lease or, if that rate cannot be readily determined, our incremental borrowing rate. Variable lease payments that do not depend on an index or rate are not included in the measurement of the lease liability.
The lease liability is measured at amortized cost using the effective interest method. It is remeasured when there is a change in future lease payments arising from a change in an index or rate, if there is a change in our estimate of the amount expected to be payable under a residual value guarantee, or if we change our assessment of whether it will exercise a purchase, extension, or termination option. When the lease liability is remeasured in this way, a corresponding adjustment is made to the carrying value of the right-of-use asset or, is recorded in profit or loss if the carrying amount of the right-of-use asset has been reduced to zero.
We have elected to apply the practical expedient not to recognize right-of-use assets and lease liabilities for short-term leases that have a lease term of 12 months or less and leases of low-value assets. The lease payments associated with these leases are recognized as an expense on a straight-line basis over the lease term.
(h) Intangible assets
(i) Research and development ("R&D") costs
Expenditure on research activities, undertaken with the prospect of gaining new scientific or technical knowledge and understanding, is recognized in profit or loss when incurred.
Development expenditure is capitalized only if development costs can be measured reliably, the product or process is technically and commercially feasible, future economic benefits are probable, and we have the intention and sufficient resources to complete the development and to use or sell the asset. The expenditure capitalized in respect of development activities includes the cost of materials, direct labor and overhead costs that are directly attributable to preparing the asset for its intended use, and capitalized borrowing costs. Other development expenditures are recognized in profit or loss when incurred.
(ii) Subsequent expenditure
Subsequent expenditure is capitalized only when it increases the future economic benefits embodied in the specific asset to which it relates. All other expenditures, including expenditure on internally generated goodwill and brands, is recognized in profit or loss as incurred.
(iii) Acquired intangible assets
Acquired intangible assets consist of open customer orders, tradenames, customer relationships, patents, and technology assets acquired either through an asset purchase or a business combination transaction. These intangible assets are recorded at their fair value at the acquisition date.
| F-13 | Page |
| KWESST MICRO SYSTEMS INC. Notes to Consolidated Financial Statements Years ended September 30, 2023, 2022, 2021 (Expressed in Canadian dollars, except share amounts) |
After initial recognition, except for open customer orders, intangible assets are measured at cost less any accumulated amortization and impairment losses. For open customer orders, we reduce the amount when we have delivered under the customer contract, with an offset to accounts receivable (i.e. there is no revenue recognized for acquired open customer orders). Intangible assets with finite useful lives are amortized on a straight-line basis over their estimated useful lives. Amortization begins when the related acquired technology is commercialized. We anticipate the estimated useful life for the current technology assets to be five years once commercialized.
(iv) Amortization
Amortization is a systematic allocation of the amortizable amount of an intangible asset of its useful life. The amortizable amount is the cost of the asset less its estimated residual value. We recognize in profit or loss on a sales-based rate over the estimated useful lives of the intangible assets from the date they are available for use, since this method most closely reflects the expected pattern of consumption of the future economic benefits embodied in each asset. Where a sales-based rate could not be determined, the straight-line approach is used.
Internally generated intangible assets are not systematically amortized as long as they are not available for use i.e. they are not yet in working condition for their intended use. Accordingly, intangible assets such as development costs are assessed for impairment at least once a year, until such date as they are available for use.
(v) Impairment
All intangible assets are periodically reviewed for impairment. Management assesses intangible assets for triggers of impairment, including ability to produce future cash flows and the investments required to reach marketability. The estimated present value of future cash flows associated with the intangible asset is determined and an impairment loss is recognized for the difference between this amount and the carrying amount as follows: the carrying amount of the asset is reduced to estimated present value of the future cash flows associated with the asset, discounted at the financial asset's original effective interest rate, and the resulting loss is directly recognized in profit or loss for the period.
(i) Provisions
A provision is recognized if, as a result of a past event, we have a present legal or constructive obligation that can be estimated reliably, and it is probable that an outflow of economic benefits will be required to settle the obligation. Provisions are determined by discounting the expected future cash flows at a pre-tax rate that reflects current market assessments of the time value of money and the risk specific to the liability. The accretion of the discount is recognized as a finance cost.
(j) Income taxes
Income tax expense comprises of current income tax expense and deferred income tax expense. Current and deferred income taxes are recognized as an expense and included in profit or loss for the period, except to the extent that the tax arises from a transaction which is recognized in other comprehensive income or directly in shareholder's deficiency.
| F-14 | Page |
| KWESST MICRO SYSTEMS INC. Notes to Consolidated Financial Statements Years ended September 30, 2023, 2022, 2021 (Expressed in Canadian dollars, except share amounts) |
Current income tax
Current tax expense is the amount of income taxes payable (recoverable) in respect of the taxable income (tax loss) for a period. Current liabilities (assets) for the current and prior periods are measured at the amount expected to be paid to (recovered from) the taxation authorities, using the tax rates that have been enacted or substantively enacted by the end of the reporting period.
Deferred income tax
Deferred tax assets and liabilities are recognized for the temporary differences between transactions and carrying amounts of assets and liabilities that have been included in the consolidated financial statements and the amounts used for taxation purposes. Deferred income taxes are provided for using the liability method. Under the liability method, deferred income taxes are recognized for all significant temporary differences between the tax and financial statement bases of assets and liabilities and for certain carry-forward items. Deferred income tax assets are recognized only to the extent that it is probable that the deferred income tax assets will be realized. Deferred tax assets are reviewed at each reporting date and are reduced to the extent it is no longer probable that the related tax benefit will be realized.
Deferred tax assets and liabilities are measured at the tax rates that are expected to apply in the year when the asset is realized or the liability is settled, based on tax rates (and tax laws) that have been enacted or substantively enacted at the reporting period. Deferred income tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of the enactment or substantive enactment. Deferred tax assets and liabilities are offset when there is a legally enforceable right to set off current tax assets against current tax liabilities and when they relate to income taxes levied by the same taxation authority, and we intend to settle our current tax assets and liabilities on a net basis.
Investment tax credits
Investment tax credits relating to scientific research and experimental development expenditures are recorded in the fiscal period the qualifying expenditures are incurred based on management's interpretation of applicable legislation in the Income Tax Act of Canada. Credits are recorded provided there is reasonable assurance that the tax credit will be realized. Credits claimed are subject to review by the Canada Revenue Agency.
Credits claimed in connection with R&D activities are accounted for using the cost reduction method. Under this method, assistance and credits relating to the acquisition of equipment is deducted from the cost of the related assets, and those relating to current expenditures, which are primarily salaries and related benefits, are included in the determination of profit or loss as a reduction of the R&D expenses.
(k) Related party transactions
Parties are considered to be related if one party has the ability, directly or indirectly, to control the other party or exercise significant influence over the other party in making financial and operating decisions. Parties are also considered to be related if they are subject to common control or common significant influence. Related parties may be individuals or corporate entities. A transaction is considered to be a related party transaction when there is a transfer of resources or obligations between related parties. Related party transactions are in the normal course of business and have commercial substance.
(l) Share-based compensation
We have a Long-Term Incentive Plan ("LTIP") in which we may grant stock options, restricted share units ("RSUs"), performance stock units ("PSUs"), deferred stock units ("DSUs"), and stock appreciation rights ("SARs") to directors, employees, and consultants. We measure share-based compensation at fair value for all share-based awards granted under the LTIP.
| F-15 | Page |
| KWESST MICRO SYSTEMS INC. Notes to Consolidated Financial Statements Years ended September 30, 2023, 2022, 2021 (Expressed in Canadian dollars, except share amounts) |
Equity-settled service award
The grant date fair value of equity-settled share-based awards is recognized as an expense on a straight-line basis over the requisite service period, with a corresponding increase in equity, over the vesting period of the awards. For stock options, the grant date fair value is determined using the Black-Scholes option model. For share units, the grant date fair value is based on KWESST's closing stock price. Each tranche of an award is considered a separate award with its own vesting period and grand date fair value. The amount recognized as an expense is adjusted for estimated forfeitures.
Equity-settled performance award
The accounting for equity-settled performance award is the same as above, except compensation expense is subject to periodic adjustment based on the achievement of establishment performance criteria.
Modified award
Where the terms of an equity-settled transaction award are modified, the minimum expense recognized is the expense as if the terms had not been modified and if the original terms of the award are met. An additional expense is recognized for any modification that increases the total fair value of the share-based payment transaction or is otherwise beneficial to the employees as measured at the date of acquisition.
(m) Foreign currency
Foreign currency transactions
The financial statements of KWESST and its Canadian wholly owned subsidiaries are measured using CAD as the functional currency. Transactions in currencies other than in CAD are translated at the exchange rates prevailing at the dates of the transactions. At the end of each reporting period, monetary items denominated in foreign currencies are translated to the functional currency at the rates prevailing at that date. Exchange differences on monetary items are recognized in profit or loss in the period in which they arise. Non-monetary items carried at fair value that are denominated in foreign currencies are translated to the functional currency at the rates prevailing at the date when the fair value was determined. Non-monetary items that are measured in terms of historical cost in a foreign currency are translated using the rates at the date of the transaction and are not subsequently retranslated.
Foreign operations
The financial statements of KWESST's U.S. owned subsidiaries are measured using the United States dollar ("USD") as its functional currency. Assets and liabilities have been translated into USD using exchange rates prevailing at the end of each reporting period. Income and expense items are translated at the average exchange rates for the period, unless exchange rates fluctuate significantly during that period, in which cases the exchange rates at the dates of the transactions are used. Exchange differences arising, if any, are recognized in other comprehensive income and accumulated in shareholders' equity.
(n) Earnings (loss) per share
Basic earnings (loss) per share is computed using net earnings (loss) over the weighted average number of common shares outstanding during the period. We use the treasury stock method to compute the dilutive effect of options, warrants, and similar instruments. Under this method, the dilutive effect on earnings per share is calculated presuming the exercise of outstanding options, warrants, and similar instruments. It assumes that the proceeds of such exercise would be used to repurchase common shares at the average market price during the period.
However, the calculation of diluted loss per share excludes the effects of various conversions and exercises of convertible debt, options and warrants that would be anti-dilutive.
| F-16 | Page |
| KWESST MICRO SYSTEMS INC. Notes to Consolidated Financial Statements Years ended September 30, 2023, 2022, 2021 (Expressed in Canadian dollars, except share amounts) |
4. Acquisitions
a) Police Ordnance
On December 15, 2021, we acquired 2720178 Ontario Inc., an Ontario (Canada) corporation, which owns all of the issued and outstanding shares of Police Ordnance Company Inc., an Ontario (Canada) corporation (together, "Police Ordnance"), herein referred as the "Police Ordnance Acquisition". Located in Bowmanville, Ontario, with ancillary operations in Florida, Police Ordnance owns all intellectual properties to the ARWENTM product line of launchers, and a proprietary line of 37 mm cartridges designed for riot control and tactical teams. Police Ordnance has law enforcement customers across Canada, the United States, and abroad. The Police Ordnance Acquisition provides us with a strategic opportunity to leverage its law enforcement customer base to accelerate growth within its specialty ordnance business.
We accounted for the acquisition of Police Ordinance pursuant to IFRS 3, Business Combinations.
Consideration Transferred:
The purchase consideration comprised of the following:
| Number | Fair Value | |||||
| Common shares | 3,965 | $ | 377,503 | |||
| Warrants | 200,000 | $ | 132,000 | |||
| Contingent shares | 875 | $ | 83,319 | |||
| Total fair value purchase consideration | $ | 592,822 |
The warrants are exercisable at $1.72 each and will expire on December 15, 2024. As a result of the Reverse Split (see Note 1(b)), each warrant converts into 0.01428571 common share or 70 warrants to receive one common share of KWE.
We issued the 875 contingent common shares to the sellers in April 2022 following the fulfillment of the financial milestone as defined in the share purchase agreement.
We have estimated the fair value as follows:
The net cash inflow as at the closing of the acquisition was as follows:
| Cash assumed on acquisition | $ | 162,547 | |
| less: consideration paid in cash | - | ||
| Net cash inflow on acquisition | $ | 162,547 |
| F-17 | Page |
| KWESST MICRO SYSTEMS INC. Notes to Consolidated Financial Statements Years ended September 30, 2023, 2022, 2021 (Expressed in Canadian dollars, except share amounts) |
Net Assets Acquired:
The purchase consideration was allocated to Police Ordnance's net assets as follows:
| Total purchase consideration at fair value | $ | 592,822 | |
| Police Ordnance's net assets: | |||
| Cash | 162,547 | ||
| Trade and other receivables | 104,432 | ||
| Inventories | 352,685 | ||
| Intangible assets: | |||
| Purchase orders | 100,000 | ||
| Customer relationships | 50,000 | ||
| ARWENTM tradename | 44,000 | ||
| Accounts payable and accrued liabilities | 82,963 | ||
| Corporate tax liability | 32,338 | ||
| Contract liabilities | 29,861 | ||
| Borrowings | 26,238 | ||
| Deferred tax liabilities | 49,442 | ||
| Net assets at fair value | $ | 592,822 |
As a result of the above purchase price allocation, we have recorded no goodwill for the Police Ordnance Acquisition.
Impact on KWESST's Results of Operations:
The results of operations of Police Ordnance are included in these consolidated statements of net loss and comprehensive loss from December 16, 2021. For the year ended September 30, 2023, Police Ordnance contributed revenue of $375,758 and net loss of $505,733 to our consolidated results.
If the acquisition had occurred on October 1, 2021, management estimates that Police Ordnance would have contributed approximately $846,600 of revenue and approximately $31,000 of net profit to our operating results for the year ended September 30, 2022, respectively. In determining these amounts, we have assumed that the fair value adjustments that arose on the date of the acquisition would have been the same if the acquisition had occurred on October 1, 2021.
We incurred immaterial acquisition-related costs.
b) LEC System
On April 29, 2021, we acquired the Low Energy Cartridge technology from DEFSEC, a proprietary non-lethal cartridge-based firing system (subsequently branded as PARA OPSTM system). This technology acquisition includes all intellectual property rights for the PARA OPSTM system. With this acquisition, we will target the following four market segments that currently use a variety of dated "non-lethal" or "less-lethal" systems:
(i) public order (riots and control of dangerous subjects);
(ii) military and law enforcement training (realistic force-on-force training);
(iii) personal defence (home, car, boat, RV, camping, hiking); and
(iv) high-action gaming.
As DEFSEC is a private company owned by our Executive Chairman, this asset acquisition is a related party transaction. We relied on exemptions from the formal valuation and minority shareholder approval requirements available under Multilateral Instrument 61-101, Protection of Minority Security Holders in Special Transactions. However, we obtained approval from over 51% disinterested shareholders as well as from the TSX-V prior to closing the acquisition.
| F-18 | Page |
| KWESST MICRO SYSTEMS INC. Notes to Consolidated Financial Statements Years ended September 30, 2023, 2022, 2021 (Expressed in Canadian dollars, except share amounts) |
We accounted for the acquisition of the PARA OPSTM pursuant to IFRS 2, Share-Based Payment.
The purchase consideration consisted of:
Additionally, we will pay 7% royalty on annual sales of the PARA OPSTM system to DEFSEC, net of taxes and duties, up to a maximum of $10 million, subject to minimum annual royalty payments starting in 2022. At the closing of the acquisition, we made an upfront payment of $150,000 as an advance on future royalty payments.
The minimum annual royalty payments are as follows:
| Date | Amount | ||
| April 29 2023 | $ | 150,000 | |
| April 29 2024 | $ | 150,000 | |
| April 29 2025 | $ | 200,000 | |
| April 29 2026 | $ | 200,000 | |
| April 29 2027 | $ | 250,000 | |
| April 29 2028 | $ | 250,000 | |
| April 29 2029 | $ | 300,000 | |
| April 29 2030 | $ | 300,000 | |
| April 29 2031 | $ | 350,000 | |
| April 29 2032 | $ | 350,000 | |
| Total | $ | 2,500,000 |
The royalty payment obligation of the Purchase Agreement ("Agreement") will expire in 20 years unless terminated earlier under the terms set out in the Agreement. At our sole discretion, we may terminate this Agreement for convenience, including if market conditions for sales of the PARA OPSTM system become unfavorable subject 60 day's prior written notice. Upon termination, we will be fully released and discharged by DEFSEC including the outstanding future royalties and any unvested warrants shall be immediately cancelled. In return, we will return all intellectual property rights relating to the PARA OPSTM system to DEFSEC.
The purchase price was determined as follows:
| Number | Fair Value | |||||
| Common shares | 14,286 | $ | 1,290,000 | |||
| Warrants | 500,000 | $ | 425,000 | |||
| Minimum royalty payments | $ | 1,191,219 | ||||
| Total | $ | 2,906,219 | ||||
| Identifiable intangible assets | ||||||
Technology asset | $ | 2,906,219 |
| F-19 | Page |
| KWESST MICRO SYSTEMS INC. Notes to Consolidated Financial Statements Years ended September 30, 2023, 2022, 2021 (Expressed in Canadian dollars, except share amounts) |
We estimated the fair value as follows:
During the year ended September 30, 2023, we recorded $170,373 of accretion cost relating to the discounted minimum royalty payments, which is included in net finance costs in the consolidated statements of net loss and comprehensive loss (2022 - $159,451, 2021 - $64,537). As at September 30, 2023, $1,287,170 of accrued royalties liability was outstanding (2022 - $1,265,207, 2021 - $1,105,756).
5. Trade and other receivables
The following table presents a breakdown of our trade and other receivables:
| September 30, | September 30, | |||||
| 2023 | 2022 | |||||
| Trade receivables | $ | 68,530 | $ | 114,877 | ||
| Unbilled revenue | 5,211 | 8,881 | ||||
| Sales tax recoverable | 226,528 | 48,124 | ||||
| Other receivable | - | - | ||||
| Total | $ | 300,269 | $ | 171,882 |
There was no impairment of trade and other receivables during the year ended September 30, 2023 (2022 - $nil).
The following table presents changes in unbilled receivables:
| September 30, | September 30, | |||||
| 2023 | 2022 | |||||
| Balance, beginning of period | $ | 8,881 | $ | 308,728 | ||
| Revenue billed during the period | (3,670 | ) | (308,728 | ) | ||
| Revenue in excess of billings, net of amounts transferred to trade receivables | - | 8,881 | ||||
| Balance, end of period | $ | 5,211 | $ | 8,881 | ||
| Current | $ | 5,211 | $ | 8,881 | ||
| Non-current | $ | - | $ | - |
6. Inventories
The following table presents a breakdown of our inventories:
| F-20 | Page |
| KWESST MICRO SYSTEMS INC. Notes to Consolidated Financial Statements Years ended September 30, 2023, 2022, 2021 (Expressed in Canadian dollars, except share amounts) |
| September 30, | September 30, | |||||
| 2023 | 2022 | |||||
| Finished goods | $ | 62,730 | $ | 49,643 | ||
| Work-in-progress | 116,435 | 21,350 | ||||
| Raw materials | 363,223 | 322,545 | ||||
| Total | $ | 542,388 | $ | 393,538 |
There was no impairment of inventories during the year ended September 30, 2023 (2022 - $nil, 2021 - $nil).
7. Property and equipment
The following is summary of changes in our property and equipment:
| Office | ||||||||||||||||||||||||
| furniture | LRIP | Sales | ||||||||||||||||||||||
| Computer | Computer | and | R&D | Leasehold | demo | |||||||||||||||||||
| Cost | equipment | software | equipment | equipment(1) | equipment | improvements | equipment | Total | ||||||||||||||||
| Balance at September 30, 2021 | $ | 59,757 | $ | - | $ | 90,116 | $ | - | $ | 217,940 | $ | 117,237 | 548,626 | $ | 1,033,676 | |||||||||
| Additions | 50,849 | 5,129 | 10,817 | 77,559 | 21,864 | 19,800 | 1,460 | 187,478 | ||||||||||||||||
| Disposals | (3,800 | ) | - | - | - | - | - | - | (3,800 | ) | ||||||||||||||
| Balance at September 30, 2022 | $ | 106,806 | $ | 5,129 | $ | 100,933 | $ | 77,559 | $ | 239,804 | $ | 137,037 | 550,086 | $ | 1,217,354 | |||||||||
| Additions | 37,047 | - | 8,645 | 20,099 | - | 2,680 | 108,478 | 176,949 | ||||||||||||||||
| Disposals | - | - | - | - | - | (7,925 | ) | (549,330 | ) | (557,255 | ) | |||||||||||||
| Balance at September 30, 2023 | $ | 143,853 | $ | 5,129 | $ | 109,578 | $ | 97,658 | $ | 239,804 | $ | 131,792 | $ | 109,234 | $ | 837,048 | ||||||||
| Office | ||||||||||||||||||||||||
| furniture | Sales | |||||||||||||||||||||||
| Computer | Computer | and | Moulding | R&D | Leasehold | demo | ||||||||||||||||||
| Accumulated depreciation | equipment | software | equipment | equipment | equipments | improvement | equipment | Total | ||||||||||||||||
| Balance at September 30, 2021 | $ | 18,398 | $ | - | $ | 40,364 | $ | - | $ | 38,287 | $ | 16,534 | 16,444 | $ | 130,027 | |||||||||
| Depreciation | 26,762 | 1,254 | 19,067 | 7,002 | 46,219 | 27,915 | 129,262 | 257,481 | ||||||||||||||||
| Disposals | (2,635 | ) | - | - | - | - | - | - | (2,635 | ) | ||||||||||||||
| Balance at September 30, 2022 | $ | 42,525 | $ | 1,254 | $ | 59,431 | $ | 7,002 | $ | 84,506 | $ | 44,449 | 145,706 | $ | 384,873 | |||||||||
| Depreciation | 34,937 | 1,710 | 20,753 | 18,749 | 50,618 | 21,141 | 153,045 | 300,953 | ||||||||||||||||
| Disposals | - | - | - | - | - | (7,925 | ) | (258,149 | ) | (266,074 | ) | |||||||||||||
| Balance at September 30, 2023 | $ | 77,462 | $ | 2,964 | $ | 80,184 | $ | 25,751 | $ | 135,124 | $ | 57,665 | $ | 40,602 | $ | 419,752 | ||||||||
| Carrying value at September 30, 2022 | $ | 64,281 | $ | 3,875 | $ | 41,502 | $ | 70,557 | $ | 155,298 | $ | 92,588 | $ | 404,380 | $ | 832,481 | ||||||||
| Carrying value at September 30, 2023 | $ | 66,391 | $ | 2,165 | $ | 29,394 | $ | 71,907 | $ | 104,680 | $ | 74,127 | $ | 68,632 | $ | 417,296 |
(1) Low-rate initial production equipment ("LRIP") includes moulds for developing PARA OPSTM device samples.
8. Right-of-use assets
The following table presents our right-of-use assets:
| Offices | |||
| Balance at September 30, 2021 | $ | 266,214 | |
| Depreciation | (58,083 | ) | |
| Balance at September 30, 2022 | $ | 208,131 | |
| Additions | 228,020 | ||
| Depreciation | (75,115 | ) | |
| Balance at September 30, 2023 | $ | 361,036 |
| F-21 | Page |
| KWESST MICRO SYSTEMS INC. Notes to Consolidated Financial Statements Years ended September 30, 2023, 2022, 2021 (Expressed in Canadian dollars, except share amounts) |
In connection with our current lease, we made a total deposit of $33,726 to be released only at the end of this lease. This was initially recorded at fair value, discounted using the implied interest rate in the lease. At September 30, 2023, $26,076 (2022 - $23,604, 2021 - $21,367) was the carrying value and reported as non-current deposit in the consolidated statements of financial position.
9. Intangible assets
The following table shows a breakdown of our intangible assets:
| KWE Inc | KWE PSSC | KWE PSSC | POC | POC | POC | ||||||||||||||||
| PhantomTM | PARA OPSTM | PARA OPSTM | ARWENTM | Customer | Purchase | ||||||||||||||||
| Cost | System | System | Patent | Tradename | Relationships | Orders | Total | ||||||||||||||
| Balance at September 30, 2021 | $ | 564,700 | $ | 2,906,219 | $ | - | $ | - | $ | - | $ | - | $ | 3,470,919 | |||||||
| Additions | 584,885 | 562,996 | 28,783 | - | - | - | 1,176,664 | ||||||||||||||
| Acquisition | - | - | - | 44,000 | 50,000 | 100,000 | 194,000 | ||||||||||||||
| Amortization | - | - | - | (6,968 | ) | (3,959 | ) | - | (10,927 | ) | |||||||||||
| Recognition of open orders | - | - | - | - | - | (87,802 | ) | (87,802 | ) | ||||||||||||
| Balance at September 30, 2022 | $ | 1,149,585 | $ | 3,469,215 | $ | 28,783 | $ | 37,032 | $ | 46,041 | $ | 12,198 | $ | 4,742,854 | |||||||
| Additions | 19,855 | 1,091,819 | 11,512 | - | - | - | 1,123,186 | ||||||||||||||
| Impairment charge | (1,169,440 | ) | - | - | - | - | - | (1,169,440 | ) | ||||||||||||
| Amortization | - | (562,640 | ) | - | (8,800 | ) | (5,000 | ) | - | (576,440 | ) | ||||||||||
| Recognition of open orders | - | - | - | - | - | (7,811 | ) | (7,811 | ) | ||||||||||||
| Balance at September 30, 2023 | $ | - | $ | 3,998,394 | $ | 40,295 | $ | 28,232 | $ | 41,041 | $ | 4,387 | $ | 4,112,350 |
The balance at September 30, 2023 for PARA OPSTM represents the acquired technology asset (i.e. intellectual properties), coupled with additional capitalized development costs. As it is available for its intended use, amortization charge was recorded for the year ended September 30, 2023 of $562,240 (2022 - $nil, 2021 - $nil).
ParaOps was tested for impairment at September 30, 2023. The key assumptions used in determining the recoverable amount were that commercialization would be reached by the second half of 2024 and that market penetration would be achieved at prices that would be accepted by the market place. If commercialization is not achieved or is not achieved on a timely basis or market acceptance and penetration is not inline with expectations then this would result in an impairment. The recoverable amount was determined based on value in use based on cash flows over a period of five years.
During the fourth quarter of 2023, the Company determined that the Phantom System was impaired and the asset was written off. The required investment to advance the system to commercialization is considered to be too high and the technology is no longer viable for the Company's operations. The carrying amount of the Phantom System at the beginning of the fiscal year was $1,149,585 and additions of $19,855 were made in the fiscal year. The entire carrying amount of $1,169,440 was written off as an impairment to intangible assets included in the general and administrative expenses in the Consolidated Statement of Net Loss and Comprehensive Loss. This has resulted in an expense in the consolidated statement of net loss.
In connection with Police Ordnance Acquisition (see Note 4(a)), we have recorded the following intangible assets at fair value: ARWENTM tradename, customer relationships and open purchase orders. During the year ended September 30, 2023, we have delivered on most open purchase orders resulting in a decrease of $7,811 (2022 - $87,802). Management has estimated the useful lives of tradename and customer relationships of five and ten years, respectively.
| F-22 | Page |
| KWESST MICRO SYSTEMS INC. Notes to Consolidated Financial Statements Years ended September 30, 2023, 2022, 2021 (Expressed in Canadian dollars, except share amounts) |
10. Accounts payable and accrued liabilities
The following table presents a breakdown of our accounts payable and accrued liabilities:
| September 30, | September 30, | |||||
| 2023 | 2022 | |||||
| Trade payable | $ | 367,128 | $ | 2,292,954 | ||
| Accrued liabilities | 1,189,678 | 1,045,409 | ||||
| Salary and vacation payable | 93,070 | 1,116,203 | ||||
| Interest payable | - | 4,915 | ||||
| Total | $ | 1,649,876 | $ | 4,459,481 |
11. Related party transactions
Key management personnel compensation
Key management personnel are those having authority and responsibility for planning, directing and controlling the activities of KWESST directly or indirectly, including any of our directors (executive and non-executive).
Key management personnel compensation comprised the following:
| Year ended | Year ended | Year ended | |||||||
| September 30, | September 30, | September 30, | |||||||
| 2023 | 2022 | 2021 | |||||||
| Wages and benefits | $ | 505,026 | $ | 641,338 | $ | 427,252 | |||
| Consulting fees | 628,264 | 529,529 | 180,000 | ||||||
| Directors compensation | 130,000 | 70,000 | 85,000 | ||||||
| Share-based compensation | 167,027 | 860,400 | 988,716 | ||||||
| Total | $ | 1,430,317 | $ | 2,101,267 | $ | 1,680,968 |
The consulting fees relate to compensation to our Executive Chairman (via his private corporation, DEFSEC Corp), as well as compensation to our previous Vice President who was an employee prior to fiscal year 2023 and was included in wages and benefits for fiscal year 2022. Fiscal year 2022 also included a bonus to the Executive Chairman, which was approved by our Board of Directors and paid only after the U.S. IPO and Canadian Offering. Consulting fees also includes fees payable to an independent director for advisory services relating to PARA OPSTM.
Other related party transactions:
| F-23 | Page |
| KWESST MICRO SYSTEMS INC. Notes to Consolidated Financial Statements Years ended September 30, 2023, 2022, 2021 (Expressed in Canadian dollars, except share amounts) |
At September 30, 2023 there was $216,730 (2022 - $672,531) outstanding amount in accounts payable and accrued liabilities due to our officers and directors for unpaid wages, bonuses, director fees and expense reimbursements.
12. Borrowings
| CEBA Term | March 2022 | August 2022 | Total | |||||||||
| Loans | �� | Loans | Loans | Borrowings | ||||||||
| Balance, September 30, 2021 | $ | 53,251 | $ | - | $ | - | $ | 53,251 | ||||
| Assumed from acquisition (Note 4) | 26,238 | - | - | 26,238 | ||||||||
| Issuance at fair value | - | 1,634,283 | 475,591 | 2,109,874 | ||||||||
| Deferred financing fees | - | (74,055 | ) | (76,354 | ) | (150,409 | ) | |||||
| Net borrowings | 79,489 | 1,560,228 | 399,237 | 2,038,954 | ||||||||
| Adjustment | (5,496 | ) | - | - | (5,496 | ) | ||||||
| Accrued interest and accretion expense | 4,803 | 304,922 | 11,588 | 321,313 | ||||||||
| Foreign exchange loss | - | - | 24,523 | 24,523 | ||||||||
| Interest paid | - | (100,520 | ) | - | (100,520 | ) | ||||||
| Balance, September 30, 2022 | $ | 78,796 | $ | 1,764,630 | $ | 435,348 | $ | 2,278,774 | ||||
| Accrued interest and accretion expense | 11,204 | 274,887 | 179,096 | 465,187 | ||||||||
| Interest paid | - | (39,517 | ) | (63,661 | ) | (103,178 | ) | |||||
| Repayment of principal | (70,000 | ) | (1,988,000 | ) | (275,315 | ) | (2,333,315 | ) | ||||
| Settled in equity (Notes 12 and 18) | - | (12,000 | ) | (275,468 | ) | (287,468 | ) | |||||
| Forgivable amount | (20,000 | ) | - | - | (20,000 | ) | ||||||
| Balance, September 30, 2023 | $ | - | $ | - | $ | - | $ | - |
August 2022 Loans
On August 25, 2022, we closed two unsecured loans in the amount of USD$200,000 per loan with a third-party lender ("Lender") for an aggregate amount of USD$400,000 (the "August 2022 Loans").
The August 2022 Loans bear interest at a rate of 6.0% per annum, compounded monthly and not in advance, and have a maturity of twelve months, with KWESST having the option to repay the whole or any part of the August 2022 Loans, without penalty or premium, at any time prior to the close of business on the maturity date. On repayment of the August 2022 Loans, we will pay 110% of the principal amount plus accrued interest on the August 2022 Loans. As part of the terms of one of the August 2022 Loans, we issued an aggregate of 4,239 common shares to the Lender (the "Bonus Shares"), being an amount equal to twenty percent (20%) of USD$200,000, converted to CAD$ at an exchange rate of $1.2983, divided by the market price of our common shares on the TSX-V at market close on August 24, 2022, being $12.25. The Bonus Shares were issued in accordance with applicable prospectus exemptions under Canadian securities laws.
As a result of issuing common shares and debt for the first loan of USD$200,000 (or $260,698), in Fiscal 2022 we allocated the gross proceeds to these two financial instruments based on their relative fair value. To measure the fair value of the loan, we used the income approach and estimated a market discount rate of 24% to discount the future cash flows of the loan resulting in an estimated fair value of $214,893. Accordingly, we allocated $214,893 of the $260,698 to the first loan and $45,804 to share capital for the bonus common shares issued (see Note 16(a)).
Concurrently with the closing of the August 2022 Loans, our Executive Chairman and President and Chief Executive Officer (the "KWESST Principals") entered into call option agreements with the Lender whereby the Lender will have the option, pursuant to the terms and conditions of the call option agreements, to purchase 10,591 common shares held by the KWESST Principals at a price of $12.25 for a period of five years. Additional free-trading common shares may be offered by the KWESST Principals to the Lender should we elect to proceed with a share-for-debt transaction in connection with one of the Loans. KWESST is not a party to the call option agreements.
| F-24 | Page |
| KWESST MICRO SYSTEMS INC. Notes to Consolidated Financial Statements Years ended September 30, 2023, 2022, 2021 (Expressed in Canadian dollars, except share amounts) |
In connection with the August 2022 Loans, we paid a cash finder's fee to a third-party intermediary in the amount of USD$32,000.
March 2022 Loans
On March 11, 2022, we closed an unsecured loan financing with various lenders in an aggregate amount of $1,800,000 and an additional $200,000 on March 15, 2022, for a total of $2,000,000 (the "March 2022 Loans"). Certain directors and officers participated in this financing for an aggregate amount of $74,000. The March 2022 Loans bear interest at a rate of 9.0% per annum, compounded monthly and not in advance, and have a maturity of thirteen months, with KWESST having the option to repay the whole or any part of the March 2022 Loans, without penalty or premium, at any time prior to the close of business on the maturity date. The principal amount is due only at maturity. As part of the terms of the March 2022 Loans, we issued an aggregate of 14,286 bonus common shares to the lenders.
As a result of issuing common shares and debt for a total combined cash consideration of $2,000,000, we allocated the gross proceeds to these two financial instruments based on their relative fair value. To measure the fair value of the March 2022 Loans, we used the income approach and estimated a market discount rate of 22% to discount the future cash flows of the March 2022 Loans resulting in an estimated fair value of $1,634,112. Accordingly, we allocated $1,634,112 of the $2,000,000 to March 2022 Loans and $365,888 to share capital for the bonus common shares issued (see Note 12(a)).
The total offering costs were $90,636, $74,055 of which was allocated to deferred financing fees and $16,581 allocated to share offering costs. The deferred financing fees are recognized as a reduction of the gross borrowings to be accreted over the life of the March 2022 Loans as a financing cost and the share offering costs were recognized as a reduction to common shares.
CEBA Term Loans
In December 2020, the Canadian Federal Government amended the CEBA Term Loan program to increase the loan amount by $20,000 to $60,000. We borrowed $40,000 during the nine-month period ended September 30, 2020, and an additional $20,000 during the fiscal year ended September 30, 2021. As a result of the Police Ordnance Acquisition (see Note 4(a)), we assumed an additional CEBA Term Loan of $40,000 during fiscal year ended September 30, 2022.
The CEBA Term Loans are initially recorded at fair value, discounted based on our estimated incremental borrowing rate. This resulted in recording a gain on government grant of $3,514 for the year ended September 30, 2021 (2020 - $9,096).
Effective January 1, 2021, the CEBA Term Loans were automatically converted to a 2-year interest free term loan. This was further amended on January 12, 2022, where the government of Canada announced the repayment deadline for the CEBA Term Loans to qualify for partial loan forgiveness is being extended from December 31, 2022, to December 31, 2023, for all eligible borrowers in good standing. Repayment on or before the new deadline of December 31, 2023, will result in loan forgiveness of up to a third of the loans.
Loan Repayments
In December 2022, the Company repaid the remaining balance on the March 2022, August 2022, and CEBA Term Loans, including accrued unpaid interest, net of the total forgivable amount on the CEBA Term loan of $20,000 and a 10% premium on the August 2022 loan. The loans were repaid with a combination of cash and equity.
| F-25 | Page |
| KWESST MICRO SYSTEMS INC. Notes to Consolidated Financial Statements Years ended September 30, 2023, 2022, 2021 (Expressed in Canadian dollars, except share amounts) |
RBC Credit Facility
We maintain corporate credit cards for our key employees with Royal Bank of Canada ("RBC"). To provide security, we entered into a cash collateral agreement for $30,000 and a general security agreement providing a first lien on all assets. The $30,000 was invested in a short-term guaranteed investment certificate.
13. Lease obligation
We have entered into a long-term office lease contracts which expire on April 30, 2026, May 31, 2026, and October 31, 2026. The office leases include the right to renew for an additional term following its expiry. Management has not included the renewal option because it was deemed too uncertain whether we would renew at September 30, 2023.
Under the current office lease agreements, we have benefited from the following lease inducements:
The following table presents the movement in our lease obligation for the respective periods:
| Current | Non-current | ||||||||
| Offices | Portion | portion | |||||||
| Balance at September 30, 2021 | $ | 307,909 | $ | 32,288 | $ | 275,621 | |||
| Lease payments (including interest) | (62,400 | ) | - | - | |||||
| Interest expense | 30,112 | - | - | ||||||
| Balance at September 30, 2022 | $ | 275,621 | $ | 69,150 | $ | 206,471 | |||
| Additions | 228,020 | - | - | ||||||
| Lease payments (including interest) | (111,903 | ) | - | - | |||||
| Interest expense | 37,785 | - | - | ||||||
| Balance at September 30, 2023 | $ | 429,523 | $ | 127,116 | $ | 302,407 |
The following table presents the contractual undiscounted cash flows for the lease obligations:
| September 30, | September 30, | |||||
| 2023 | 2022 | |||||
| Less than one year | $ | 197,367 | $ | 93,600 | ||
| One to five years | 361,388 | 234,000 | ||||
| Total | $ | 558,755 | $ | 327,600 |
| F-26 | Page |
| KWESST MICRO SYSTEMS INC. Notes to Consolidated Financial Statements Years ended September 30, 2023, 2022, 2021 (Expressed in Canadian dollars, except share amounts) |
14. Contract Liabilities
The following table presents the changes in contract liabilities:
| September 30, | September 30, | |||||
| 2023 | 2022 | |||||
| Balance, beginning of fiscal year | $ | 47,271 | $ | - | ||
| Acquired in acquisition of POC (see Note 4(a)) | - | 29,759 | ||||
| Amounts invoiced and revenue deferred | 120,970 | 17,512 | ||||
| Recognition of deferred revenue included in the balance at the beginning of period | (47,271 | ) | - | |||
| Balance, end of fiscal year | $ | 120,970 | $ | 47,271 |
15. Warrant liabilities
The following is a reconciliation of warrant liabilities since September 30, 2022:
| U.S. IPO and Canadian Offering | Private Placement | Debt Settlement | |||||||||||||||||||
| Over-allotment | |||||||||||||||||||||
| 2022 | Pre-Funded | Over-allotment | 2023 | Pre-Funded | |||||||||||||||||
| Warrants | Warrants | Warrants | Warrants | Warrants | Warrants | Total | |||||||||||||||
| Balance, beginning of period | $ | - | $ | - | $ | - | $ | - | $ | - | $ | - | $ | - | |||||||
| Initial recognition | 4,617,451 | 832,698 | 536,681 | 1,528,160 | 2,778,534 | 80,617 | 10,374,141 | ||||||||||||||
| (Gain) Loss on revaluation of financial instruments | (3,553,175 | ) | (415,996 | ) | (412,247 | ) | (765,212 | ) | (883,961 | ) | (62,476 | ) | (6,093,067 | ) | |||||||
| Exchange gain on revaluation | (21,738 | ) | (2,368 | ) | (3,261 | ) | 35,625 | 46,341 | - | 54,599 | |||||||||||
| Balance, end of period | $ | 1,042,538 | $ | 414,334 | $ | 121,173 | $ | 798,573 | $ | 1,940,914 | $ | 18,141 | $ | $ 4,335,673 | |||||||
| Number of outstanding securities as at September 30, 2023 | 3,226,392 | 199,000 | 375,000 | 1,542,194 | 930,548 | 56,141 | 6,329,275 | ||||||||||||||
U.S. IPO and Canadian Offering
On December 9, 2022, we closed the U.S. IPO and the Canadian Offering. In the U.S. IPO, we sold 2.5 million units, consisting of one share of common share and one warrant to purchase one common share. In connection with the closing of the U.S. IPO, the underwriter partially exercised its over-allotment option to purchase an additional 199,000 pre-funded common share purchase warrants and 375,000 option warrants. In the Canadian Offering, we sold 726,392 units, each consisting of one common share and one warrant to purchase one common share (see Note 16(a)). In summary, for the U.S. IPO and the Canadian Offering, we have issued 3,226,392 warrants (the "2022 Warrants") with an exercise price of US$5.00 per share. Additionally, the U.S. underwriter exercised its over-allotment option to purchase:
| • | 199,000 Pre-Funded Warrants with an exercise price of US$0.01 per share for $3.81024 per pre-funded warrant (net of underwriter discount); and | |
| • | 375,000 warrants with exercise price of US$5.00 per share for $0.0001 per warrant. |
Refer to Note 16(a) for further information on the U.S. IPO and Canadian Offering.
Under IFRS, the above securities are classified as financial liabilities (referred herein as "warrant liabilities") because the exercise price is denominated in U.S. dollars, which is different to our functional currency (Canadian dollars). Accordingly, the ultimate proceeds in Canadian dollars from the potential exercise of the above securities are not known at inception. These financial liabilities are classified and measured at FVTPL (see Note 3(c)). Gains on revaluation of the warrant liabilities are presented in other income (expenses) on the consolidated statements of net loss and comprehensive loss.
Warrant liabilities
While the warrants issued in the U.S. IPO were listed on Nasdaq and closed at US$0.90 per warrant on December 9, 2022, management concluded that this closing price was not reflective of an active market due to short trading window and therefore not representative of fair value. Accordingly, at inception, the 2022 Warrants were measured at fair value using the Black Scholes option pricing model (Level 2). We used the following assumptions:
| F-27 | Page |
| KWESST MICRO SYSTEMS INC. Notes to Consolidated Financial Statements Years ended September 30, 2023, 2022, 2021 (Expressed in Canadian dollars, except share amounts) |
| Over-allotment | |||||||||
| 2022 | Pre-Funded | Over-allotment | |||||||
| Warrants (1) | Warrants (2) | Warrants (3) | |||||||
| Number of dilutive securities | 3,282,533 | 199,000 | 375,000 | ||||||
| Exercise price (in USD) | $ | 5.00 | $ | 0.01 | |||||
| Share price (in USD) | $ | 4.13 | $ | 3.08 | |||||
| Expected life | 2.50 | ||||||||
| Dividend | $ | - | |||||||
| Volatility | 75% | ||||||||
| Risk free rate | 4.20% | ||||||||
| Exchange rate (USD/CAD) | $ | 1.363 | |||||||
| Fair value per warrant (CAD) | $ | 1.43 | $ | 4.18 | $ | 1.43 |
(1) Includes debt settlement warrants
(2) Fair value is measured at the underlying common share closing price on Nasdaq on December 9, 2022, less US$0.01 exercise price.
(3) Same fair value as calculated for Warrants.
The share price (in USD) for the over-allotment pre-funded warrants was based on the estimated fair value of the common shares issued on December 9, 2022, by deducting the fair value of the warrants of US$1.05 from the US$4.13 Unit price and the exercise price of US$0.01 (see Note 16(a)).
Based on the above fair value, the issuance of the over-allotment pre-funded warrants and warrants to the underwriter resulted in a non-cash charge of $251,877, which is included in the change in fair value of warrant liabilities in the consolidated statements of net loss and comprehensive loss.
At September 30, 2023, we remeasured the fair value of these warrants using the following assumptions:
| Over-allotment | |||||||||
| 2022 | Pre-Funded | Over-allotment | |||||||
| Warrants (1) (2) | Warrants (3) | Warrants (1) | |||||||
| Number of securities | 3,282,533 | 199,000 | 375,000 | ||||||
| Nasdaq closing price (in USD) | $ | 0.24 | $ | 1.55 | $ | 0.24 | |||
| Exchange rate (USD/CAD) | $ | 1.352 | $ | 1.352 | $ | 1.352 | |||
| Fair value per warrant (CAD) | $ | 0.32 | $ | 2.08 | $ | 0.32 |
(1) Fair value is based on the Nasdaq closing pricing on September 30, 2023, for the warrants.
(2) Includes debt settlement warrants.
(3) Fair value is measured at the Nasdaq closing price on September 30, 2023, for the underlying common stock less US$0.01 exercise price.
December 2022 Debt Settlement
On December 13, 2022, we entered into share for debt arrangements with existing lenders (see Note 16(a)), which resulted in issuing 56,141 Units, same terms as the Units as issued in the Canadian Offering except that the underlying securities are subject to a four-month hold period. Accordingly, this resulted in issuing 56,141 common shares and 56,141 warrant liabilities with an exercise price of US$5.00 per share and maturing on December 13, 2027. We initially recorded the fair value of the warrant liabilities using the Black Scholes option pricing model with an underlying stock price equivalent to the unit price of US$4.13.
| F-28 | Page |
| KWESST MICRO SYSTEMS INC. Notes to Consolidated Financial Statements Years ended September 30, 2023, 2022, 2021 (Expressed in Canadian dollars, except share amounts) |
At September 30, 2023, we remeasured the fair value of these warrant liabilities using the Nasdaq closing price on September 30, 2023, of US$0.24. The remeasurement resulted in a change in fair value of warrant liabilities $62,476 for the year ended September 30, 2023, which was reported in the consolidated statements of net loss and comprehensive loss.
Private Placement
On July 21, 2023, we closed an underwritten U.S. private placement for gross proceeds of CAD$7.4 million (US$5.59 million) (see Note 16(a)). As part of the private placement, we have issued 1,542,194 warrants (the "2023 Warrants") with an exercise price of US$2.66 per share. Additionally, 930,548 pre-funded Warrants with an exercise price of US$0.001 per share for US$2.259 per pre-funded warrant were issued.
Refer to Note 16(a) for further information on the private placement.
Under IFRS, the above securities are classified as financial liabilities (referred herein as "warrant liabilities") because the exercise price is denominated in U.S. dollars, which is different to our functional currency (Canadian dollars). Accordingly, the ultimate proceeds in Canadian dollars from the potential exercise of the above securities are not known at inception. These financial liabilities are classified and measured at FVTPL (see Note 3(c)). Gains on revaluation of the warrant liabilities are presented in Other income (expenses) on the consolidated statements of net loss and comprehensive loss.
Warrant liabilities
The 2023 warrants issued in the private placement were not listed on Nasdaq and does not represent an active market Level 1 input. Accordingly, at inception, the 2023 Warrants were measured at fair value using the Black Scholes option pricing model (Level 2). We used the following assumptions:
2023 | Pre-Funded | |||||
| Warrants | Warrants (1) | |||||
| Number of dilutive securities | 1,542,194 | 930,548 | ||||
| Exercise price (in USD) | $ | 2.66 | $ | 0.001 | ||
| Share price (in USD) | $ | 2.08 | $ | 2.08 | ||
| Expected life | 2.50 | |||||
| Dividend | $ | - | ||||
| Volatility | 67% | |||||
| Risk free rate | 4.44% | |||||
| Exchange rate (USD/CAD) | $ | 1.321 | $ | 1.321 | ||
| Fair value per warrant (CAD) | $ | 0.99 | $ | 1.98 |
(1) Fair value is measured at the underlying common share closing price on Nasdaq on July 21, 2023, less US$0.001 exercise price.
The share price (in USD) for the pre-funded warrants was based on the estimated fair value of the common shares issued on July 21, 2023, by deducting the fair value of the warrants of US$0.75 from the US$2.26 Unit price and the exercise price of US$0.001 (see Note 16(a)).
| F-29 | Page |
| KWESST MICRO SYSTEMS INC. Notes to Consolidated Financial Statements Years ended September 30, 2023, 2022, 2021 (Expressed in Canadian dollars, except share amounts) |
At September 30, 2023, we remeasured the fair value of these warrants using the following assumptions:
| 2023 | Pre-Funded | |||||
| Warrants (1) | Warrants (2) | |||||
| Number of securities | 1,542,194 | 930,548 | ||||
| Nasdaq closing price (in USD) | $ | - | $ | 1.55 | ||
| Black Scholes fair value (in USD) | $ | 0.38 | $ | - | ||
| Exchange rate (USD/CAD) | $ | 1.352 | $ | 1.352 | ||
| Fair value per warrant (CAD) | $ | 0.52 | $ | 2.08 |
(1) Fair value is based on the Black Scholes model on September 30, 2023, for the warrants.
(2) Fair value is measured at the Nasdaq closing price on September 30, 2023, for the underlying common stock less US$0.001 exercise price.
16. Share capital and Contributed Surplus
As disclosed in Note 1(b), the 1-for-70 Reverse Split effected on October 28, 2022, has been applied retrospectively herein.
a) Share capital
Authorized
KWESST is authorized to issue an unlimited number of common shares.
Issued Common Shares
| September 30, 2023 | September 30, 2022 | September 30, 2021 | ||||||||||||||||
| Number | Amount | Number | Amount | Number | Amount | |||||||||||||
| Balance, beginning of year | 773,225 | $ | 19,496,640 | 699,511 | $ | 17,215,068 | 589,518 | $ | 9,374,563 | |||||||||
| Issued for U.S. IPO and Canadian Offering | 3,226,392 | $ | 13,675,120 | - | $ | - | - | $ | - | |||||||||
| Issued in private placement | 1,542,194 | $ | 3,050,316 | 22,857 | $ | 272,000 | 10,714 | $ | 1,110,000 | |||||||||
| Issued for debt settlements | 56,141 | $ | 233,485 | 143 | $ | 19,000 | 1,305 | $ | 63,866 | |||||||||
| Issued for conversion of share units | 14,134 | $ | 529,504 | 8,349 | $ | 874,840 | 138 | $ | 12,498 | |||||||||
| Issued for exercise of warrants | 3,571 | $ | 60,000 | 19,000 | $ | 277,098 | 10,380 | $ | 815,307 | |||||||||
| Issued for exercise of stock options | 1,125 | $ | 5,836 | - | $ | - | 18,195 | $ | 1,292,015 | |||||||||
| Issued for bonus shares relating to borrowings (Note 10) | - | $ | - | 18,525 | $ | 411,692 | - | $ | - | |||||||||
| Issued for acquisition (Note 4(a)) | - | $ | - | 3,965 | $ | 377,503 | - | $ | - | |||||||||
| Issued for conversion of contingent shares (Note 4(a)) | - | $ | - | 875 | $ | 83,319 | - | $ | - | |||||||||
| Issued in brokered private placement | - | $ | - | - | $ | - | 51,087 | $ | 3,611,818 | |||||||||
| Issued for asset acquisition (Note 4(b)) | - | $ | - | - | $ | - | 14,286 | $ | 1,290,000 | |||||||||
| Issued for exercise of broker compensation options | - | $ | - | - | $ | - | 2,459 | $ | 347,680 | |||||||||
| Issued for amended license (Note 27) | - | $ | - | - | $ | - | 1,429 | $ | 137,000 | |||||||||
| Less: share offering costs for the year | - | $ | (3,671,791 | ) | - | $ | (33,880 | ) | - | $ | (839,679 | ) | ||||||
| Balance, end of year | 5,616,782 | $ | 33,379,110 | 773,225 | $ | 19,496,640 | 699,511 | $ | 17,215,068 | |||||||||
2023 Activities
Share Consolidation
On October 28, 2022, we finalized the consolidation of our common shares on the basis of one post-consolidation common share for every seventy pre-consolidation common shares issued and outstanding.
| F-30 | Page |
| KWESST MICRO SYSTEMS INC. Notes to Consolidated Financial Statements Years ended September 30, 2023, 2022, 2021 (Expressed in Canadian dollars, except share amounts) |
U.S. IPO and Canadian Offering
On December 9, 2022, we closed the U.S. IPO and the Canadian Offering. In the U.S. IPO, we sold 2.5 million units at a public offering price of USD $4.13 per unit (the "Unit"), consisting of one share of common stock and one warrant to purchase one share of common stock ("Warrant"). The Warrants have a per share exercise price of USD $5.00 and can be exercised immediately. In connection with the closing of the U.S. IPO, the underwriter partially exercised its over-allotment option to purchase an additional 199,000 pre-funded common share purchase warrants ("Pre-Funded Warrants") at US$4.12 (before underwriter discount) and 375,000 option warrants to purchase common shares at US$0.0001 each. A Pre-Funded Warrant is a financial instrument that requires the holder to pay little consideration (exercise price of US$0.01) to receive the common share upon exercise of the Pre-Funded Warrant (see Note 15). The holder of Pre-Funded Warrants has no voting rights. All of these warrants expire on December 9, 2027.
In the Canadian Offering, we sold 726,392 units, each consisting of one common share and one warrant to purchase one common share, at a price to the public of USD $4.13 per unit. The warrants will have a per common share exercise price of USD $5.00, are exercisable immediately and expire in five years on December 9, 2027. Effective May 1, 2023, the warrants are listed on the TSX-V under the stock symbol of KWE.WT.U.
The closing of the U.S. IPO and Canadian Offering resulted in aggregate gross proceeds of CAD$19.4 million (USD $14.1 million), before deducting underwriting discounts and offering expenses.
The common shares of KWESST and the Warrants sold in the U.S. IPO began trading on the Nasdaq Capital Market under the symbols "KWE" and "KWESW", respectively, on December 7, 2022.
ThinkEquity acted as sole book-running manager for the U.S. IPO and PI Financial acted as sole book-running manager for the Canadian Offering.
Accounting Treatment
Refer to Note 15 for the accounting of the warrants issued in the U.S. IPO and Canadian Offering and the July Private Placement accounted for as warrant liabilities.
The U.S. underwriter warrants as well as the Canadian broker options from the U.S. IPO and Canadian Offering, 134,950 warrants and 50,848 warrants respectively, were accounted for as equity on initial recognition. The U.S. underwriter warrants from the July Private Placement, 123,637 warrants, was accounted for as equity on initial recognition.
Brokers' Compensation and Share Offering Costs
As consideration for the services provided in connection with the U.S. IPO, ThinkEquity received: (a) a broker-dealer cash commission of US$835,000 (or CAD$1,138,105) equal to 7.5% of the gross offering proceeds of the U.S. Offering; and (b) underwriter warrants (the "U.S. Underwriter Warrants") to purchase up to 134,950 common shares equal to 5% of the common shares and pre-funded common share purchase warrants issued under the U.S. Offering. Each U.S. Underwriter Warrant is exercisable to acquire one common share at a price of US$5.1625, exercisable as of June 4, 2023, and expiring on December 9, 2027.
As consideration for the services provided in connection with the Canadian Offering, PI Financial received: (a) a cash commission of approximately US$210,000 (or CAD$286,230); and (b) 50,848 compensation options (the "Canadian Compensation Options"). Each Canadian Compensation Option is exercisable to acquire one Canadian Unit at a price of US$4.13 and expiring on December 9, 2024.
| F-31 | Page |
| KWESST MICRO SYSTEMS INC. Notes to Consolidated Financial Statements Years ended September 30, 2023, 2022, 2021 (Expressed in Canadian dollars, except share amounts) |
In addition to the above brokers' compensation, we also incurred US$2.1 million share offering costs (or CAD$2.8 million) for the U.S. IPO and Canadian Offering, of which CAD$628,262 was incurred and deferred at September 30, 2022.
The total brokers compensation (including fair value of U.S. Underwriter Warrants and Canadian Compensation Options) and share offering costs was US$3.2 million (or CAD$4.4 million). This total was allocated proportionately to the fair value of common shares and to share offering costs for the portion allocated to warrants accounted for as warrant liabilities.
Shares for Debt Settlement
We entered into share for debt arrangements with existing lenders, which closed on December 13, 2022, following TSXV's conditional approval. This resulted in issuing 56,141 Units to settle $12,000 of the March 2022 Loans and USD$223,321 (or CAD$302,197) of the August 2022 Loans, including unpaid accrued interest and 10% premium at maturity (the "Debt Settlements") (see Note 12). The terms of the Units are the same as the Units issued in the Canadian Offering.
Private Placement
On July 21, 2023, we closed a brokered private placement, resulting in the issuance of 1,542,194 common shares of KWESST, for aggregate gross proceeds of USD$5,588,397 (approximately CAD$7.4M) (the "July 2023 Offering").
As a part of the July 2023 Offering, the Company issued 1,542,194 common shares at a price of US$2.26 (CAD$2.98) per common share (each a "Common Share") and 930,548 pre-funded warrants at a price of US$2.259 (CAD$2.979) per pre-funded warrant (each a "Pre-funded Warrant"), with each Common Share and Pre-funded Warrant being bundled with one common share purchase warrant of the Company (each a "Common Warrant"). Each Pre-Funded Warrant entitles the holder to acquire one Common Share at an exercise price of US$0.001 per Common Share, and each Common Warrant is immediately exercisable and entitles the holder to acquire one Common Share at an exercise price of US$2.66 (CAD$3.50) per Common Share for a period of 60 months following the closing of the July 2023 Offering. Although the Common Shares and Pre-funded Warrants are each bundled with a Common Warrant, each security is issued separately.
Brokers' Compensation and Share Offering Costs
ThinkEquity acted as sole placement agent for the Offering. As compensation for services rendered, the Company paid to ThinkEquity a cash fee of $475,013.14 representing 8.5% of the aggregate gross proceeds of the Offering and issued 123,637 warrants to purchase a number of Common Shares (the "Placement Agent Warrants"), representing 5% of the Common Shares and Pre-Funded Warrants sold in the Offering. The Placement Agent Warrants will be exercisable, in whole or in part, immediately upon issuance and will expire 60 months after the closing date of the Offering at an initial exercise price of US$2.66 (CAD$3.50) per Common Share.
2022 Activities
Private Placement
On July 14, 2022, we closed a non-brokered private placement, resulting in the issuance of 22,857 units of KWESST ("July 2022 Units"), at a price of $15.05 per July 2022 Unit (the "Issue Price"), for aggregate gross proceeds of $344,000 (the "July 2022 Offering").
| F-32 | Page |
| KWESST MICRO SYSTEMS INC. Notes to Consolidated Financial Statements Years ended September 30, 2023, 2022, 2021 (Expressed in Canadian dollars, except share amounts) |
Each July 2022 Unit is comprised of one common share and seventy one-half common share purchase warrant (the "July 2022 Warrants"). Accordingly, we issued 800,000 Warrants exercisable at $0.285 each for a period of 24 months from the closing date. Each Warrant converts into 0.01428571 common shares or 70 warrants for one common share. There was no finder fee paid in this private placement.
Certain of our directors and officers (the "Insiders") purchased 5,814 Units for a total consideration of $87,500. The issuance of Units to the Insiders constitutes a related party transaction but is exempt from the formal valuation and minority approval requirements of Multilateral Instrument 61-101 - Protection of Minority Security Holders in Special Transactions ("MI 61-101") as KWESST's securities are not listed on any stock exchange identified in Section 5.5(b) of MI 61-101 and neither the fair market value of the units issued to the Insiders, nor the fair market value of the entire private placement, exceeds 25% of our market capitalization.
The securities were issued in accordance with applicable prospectus exemptions under Canadian securities laws.
Police Ordnance Acquisition
As disclosed in Note 4(a), we issued 3,965 common shares to the selling shareholders in December 2021 at the closing of the acquisition and an additional 875 common shares in April 2022 following the achievement of the financial milestone as defined in the share purchase agreement.
Debt for Equity Settlement
During the year ended September 30, 2022, we settled $19,000 of legal fees for 143 common shares.
2021 Activities
Brokered Private Placement
In April 2021, we closed our over-subscribed brokered private placement, resulting in the issuance of 51,087 units ("Units") of KWESST, at a price of $87.50 per Unit (the "Issue Price"), for aggregate gross proceeds of $4,470,071 (the "April 2021 Offering"), as amended in August 2021.
Under the April 2021 Offering, we sold a total of 51,087 units at a price of $87.50 per Unit. Each Unit is comprised of one common share of the Company and seventy common share purchase warrants ("April 2021 Warrant"). Each April 2021 Warrant is exercisable to acquire 1/70 of a common share at a price of $1.75 each (70 warrants for one common share) for a period of 24 months from the closing of the April 2021 Offering ("Closing Date"). If at any time after four (4) months and one (1) day following the Closing Date, the trading price of KWESST common stock on the TSX Venture Exchange is equal to or exceeds $210.00 for a period of 10 consecutive trading days, as evidenced by the price at the close of market, we will be entitled to notify the holders of the April 2021 Warrants of its intention to force the exercise of the April 2021 Warrants. Upon receipt of such notice, the holders of April 2021 Warrants shall have 30 days to exercise the April 2021 Warrants, failing which the April 2021 Warrants will automatically expire. Our directors and officers purchased 1,029 Units for a total consideration of $90,000.
In connection with this Offering, management has concluded the Unit qualified as an equity instrument under IAS 32, Financial Instruments: Presentation. Furthermore, management used the residual method to allocate the $87.50 consideration between common shares and the April 2021 Warrants. Because the April 2021 Warrants include an accelerator provision for expiration, management used the Barrier option model to estimate the fair value of these April 2021 Warrants at $0.24 each (70 warrants for one common share). As a result, $70.70 of the $87.50 consideration was allocated to common shares and is reflected in the above table of outstanding common shares.
The total cash and non-cash share offering costs were $630,680 for the Offering, including cash commission of $288,405 paid to the Agents and $233,057 of Compensation Options granted to the Agents (see part (c) Contributed Surplus).
| F-33 | Page |
| KWESST MICRO SYSTEMS INC. Notes to Consolidated Financial Statements Years ended September 30, 2023, 2022, 2021 (Expressed in Canadian dollars, except share amounts) |
Asset Acquisition
In April 2021, following the closing of the brokered private placement, KWESST closed on the acquisition of the PARA OPSTM System technology resulting in the issuance of 14,286 common shares and 500,000 warrants (see Note 4(a)). Management estimated a fair value of $0.85 per warrant, using the Black-Scholes option model (see below - Warrants).
Private Placement
In September 2021, we closed a non-brokered private placement, resulting in the issuance of 10,714 units ("September Units") of KWESST, at a price of $140.00 per September Unit (the "Issue Price"), for aggregate gross proceeds of $1,500,000 (the "September 2021 Offering").
Under the September 2021 Offering, each September Unit is comprised of one common share and seventy Warrant Shares at a price of $2.35 for each 1/70 of a common share (70 warrants for one common share) for a period of 24 months from September 16, 2021 ("September 2021 Warrants"). If at any time after four months and one day following September 16, 2021, the trading price of KWESST common stock on the TSX-V is equal to or exceeds $322.00 for a period of 3 consecutive trading days, as evidenced by the price at the close of market, we will be entitled to notify the holders of Warrants of its intention to force the exercise of the Warrants. Upon receipt of such notice, the holders of the Warrants shall have 30 days to exercise the Warrants, failing which the Warrants will automatically expire.
We paid cash commissions to Haywood Securities Inc. in the amount of $90,000 and granted 45,000 broker warrants ("September 2021 Broker Warrants"). Each September 2021 Broker Warrant is exercisable to acquire 1/70 of a common share at a price of $2.00 for a period of 24 months from the closing of the September 2021 Offering. Management estimated a fair value of $0.72 per warrant, using the Black-Scholes option model (see below - Warrants).
In connection with this private placement, management has concluded the September Unit qualified as an equity instrument under IAS 32, Financial Instruments: Presentation. Furthermore, management used the residual method to allocate the $140.00 consideration between the common share and the Warrant. Because the warrant includes an accelerator provision for expiration, management used the Barrier option model to estimate the fair value of these September 2021 Warrants at $0.52 each (70 warrants for one common share). As a result, $103.60 of the $140.00 consideration was allocated to common shares and is reflected in the above table of outstanding common shares at September 30, 2021.
The total cash and non-cash share offering costs were $130,730 for this private placement.
Amended License
In April 2021, we issued 1,429 common shares for the exclusivity with AerialX as disclosed in Note 27.
Debt for Equity Settlement
During the year ended September 30, 2021, we settled the following liabilities with our common shares:
| F-34 | Page |
| KWESST MICRO SYSTEMS INC. Notes to Consolidated Financial Statements Years ended September 30, 2023, 2022, 2021 (Expressed in Canadian dollars, except share amounts) |
b) Warrants
The following reflects the warrant activities:
| September 30, 2023 | September 30, 2022 | September 30, 2021 | ||||||||||||||||
| Weighted | Weighted | Weighted | ||||||||||||||||
| Number of | average | Number of | average | Number of | average | |||||||||||||
| warrants | exercise price | warrants | exercise price | warrants | exercise price | |||||||||||||
| Outstanding, beginning of year | 13,417,156 | $0.78 | 13,901,640 | $0.74 | 9,585,050 | $0.24 | ||||||||||||
| Issued | 6,587,862 | $ | 5.29 | 1,000,000 | $ | 0.57 | 5,043,165 | $ | 1.73 | |||||||||
| Exercised | (250,000 | ) | $ | 0.50 | (1,330,000 | ) | $ | 0.26 | (726,575 | ) | $ | 1.05 | ||||||
| Expired | (4,247,156 | ) | $ | 1.86 | (154,484 | ) | $ | 0.56 | - | $ | - | |||||||
| Outstanding, end of year | 15,507,862 | $ | 2.49 | 13,417,156 | $ | 0.78 | 13,901,640 | $ | 0.74 | |||||||||
| Exercisable, end of year | 15,382,862 | $ | 2.50 | 12,792,156 | $ | 0.82 | 12,901,640 | $ | 0.75 | |||||||||
The following table provides additional information on the total outstanding warrants at September 30, 2023:
| Number | Conversion ratio | |||||||||||
| outstanding | to Common Shares | Book value | Expiry Date | |||||||||
| Classified as Equity | ||||||||||||
| Founders' warrants: | ||||||||||||
| Exercise price of $0.20 | 5,520,000 | 70 for 1 | $ | 1,013 | January 1, 2024 | |||||||
| Exercise price of $0.20 | 1,900,000 | 70 for 1 | $ | 18,865 | June 14, 2024 | |||||||
| LEC's warrants: | ||||||||||||
| Exercise price of $0.70 | 500,000 | 70 for 1 | $ | 425,000 | April 29, 2026 | |||||||
| Acquisition of Police Ordnance (Note 4): | ||||||||||||
| Exercise price of $1.72 | 200,000 | 70 for 1 | $ | 132,000 | December 15, 2024 | |||||||
| July 2022 equity financing: | ||||||||||||
| Exercise price of $0.285 | 800,000 | 70 for 1 | $ | 72,000 | July 14, 2024 | |||||||
| December 2022 U.S. Underwriter Warrants | ||||||||||||
| Exercise price of US$5.1625 | 134,950 | 1 for 1 | $ | 189,592 | December 6, 2024 | |||||||
| July 2023 U.S. Underwriter Warrants | ||||||||||||
| Exercise price of US$2.66 | 123,637 | 1 for 1 | $ | 204,187 | December 6, 2024 | |||||||
| Classified as liability | 9,178,587 | $ | 1,042,657 | |||||||||
| December 2022 public offerings: | ||||||||||||
| Exercise price of US$5.00 | 3,226,392 | 1 for 1 | $ | 1,042,538 | December 9, 2027 | |||||||
| December 2022 Pre-Funded Warrants | ||||||||||||
| Exercise price of US$0.01 | 199,000 | 1 for 1 | $ | 414,334 | No expiry | |||||||
| December 2022 Option Warrants | ||||||||||||
| Exercise price of US$5.1625 | 375,000 | 1 for 1 | $ | 121,173 | December 9, 2024 | |||||||
| December 2022 debt settlement | ||||||||||||
| Exercise price of US$5.00 | 56,141 | 1 for 1 | $ | 18,141 | December 9, 2027 | |||||||
| July 2023 public offerings: | ||||||||||||
| Exercise price of US$2.66 | 1,542,194 | 1 for 1 | $ | 798,573 | July 21, 2028 | |||||||
| July 2023 Pre-Funded Warrants | ||||||||||||
| Exercise price of US$0.001 | 930,548 | 1 for 1 | $ | 1,940,914 | No expiry | |||||||
| 6,329,275 | 4,335,673 | |||||||||||
| Total outstanding warrants | 15,507,862 | $ | 5,378,330 |
| F-35 | Page |
| KWESST MICRO SYSTEMS INC. Notes to Consolidated Financial Statements Years ended September 30, 2023, 2022, 2021 (Expressed in Canadian dollars, except share amounts) |
The fair value for the warrants issued during the year ended September 30, 2023, was determined by the Black Scholes option pricing model using the following key inputs:
| 2023 | 2022 | |||||
| Warrants | Warrants | |||||
| Exercise Price (in USD) | $ | 2.66 | $ | 5.00 | ||
| Stock price (in USD) | $ | 2.08 | $ | 4.13 | ||
| Volatility | 67% | 75% | ||||
| Dividend Yield | Nil | Nil | ||||
| Risk-free interest rate | 4.44% | 4.20% | ||||
| Expected life | 2.5 | 2.5 | ||||
| Weighted average fair value per warrant | $ | 0.99 | $ | 1.43 |
The fair value for the warrants issued during the year ended September 30, 2022, was determined by the Black Scholes option pricing model using the following key inputs:
| Acquisition of | July 2022 | |||||
| POC | Warrants | |||||
| Exercise Price | $ | 1.72 | $ | 0.285 | ||
| 1/70 of stock price | $ | 1.36 | $ | 0.215 | ||
| Volatility | 84.7% | 90.5% | ||||
| Dividend Yield | Nil | Nil | ||||
| Risk-free interest rate | 1.04% | 3.12% | ||||
| Expected life | 3 | 2 | ||||
| Weighted average fair value per warrant | $ | 0.66 | $ | 0.09 |
The fair value for the warrants issued during the year ended September 30, 2021, was determined by the following valuation models and key inputs:
| Barrier Option Model | Black-Scholes Option Model | |||||||||||
| September | ||||||||||||
| September | 2021 | |||||||||||
| April 2021 | 2021 | broker | LEC | |||||||||
| warrants | warrants | warrants | warrants | |||||||||
| Exercise Price | $ | 1.75 | $ | 2.35 | $ | 2.00 | $ | 0.70 | ||||
| 1/70 of stock price | $ | 1.01 | $ | 2.14 | $ | 2.14 | $ | 0.40 | ||||
| Volatility | 80% | 80% | 80% | 0% | ||||||||
| Dividend Yield | Nil | Nil | Nil | Nil | ||||||||
| Risk-free interest rate | 0.31% | 0.26% | 0.26% | 69.00% | ||||||||
| Barrier (accelerator on life of warrants) | $ | 3.00 | $ | 4.60 | N/A | N/A | ||||||
| Rebate | $ | 1.25 | $ | 2.00 | N/A | N/A | ||||||
| Expected life | 2 | 1 | 1 | 0.85 | ||||||||
| Weighted average fair value per warrant | $ | 0.24 | $ | 0.52 | $ | 0.72 | $ | 0.85 | ||||
| F-36 | Page |
| KWESST MICRO SYSTEMS INC. Notes to Consolidated Financial Statements Years ended September 30, 2023, 2022, 2021 (Expressed in Canadian dollars, except share amounts) |
c) Contributed Surplus
Contributed surplus consists of issued broker compensation options at fair value, the cumulative amortized fair value of share-based compensation grants since inception, less amounts transferred to share capital for exercises. If outstanding options expire or are forfeited, there is no reversal of contributed surplus.
Broker Compensation Options
In the Canadian Offering, we issued 50,848 Canadian Compensation Options. Each Canadian Compensation Option is exercisable to acquire one Unit, as defined in Note 16(a), at a price equal to US$4.13 for a period of two years (expiring on December 9, 2024). Based on the structure of the Compensation Option, management estimated its fair value using the Monte Carlo method (Level 2). We used the following key inputs in the Monte Carlo model (100,000 simulations):
| Initial | |||
| Recognition | |||
| Number of securities | 50,848 | ||
| Exercise price - compensation option (in USD) | $ | 4.13 | |
| 1-Year CAD/USD Forward Exchange Rate | $ | 1.3560 | |
| Exercise price - compensation warrant (in USD) | $ | 5.00 | |
| 2-Year CAD/USD Forward Exchange Rate | $ | 1.3483 | |
| Share price (in CAD) | $ | 4.20 | |
| Expected life - compensation option | 1.00 | ||
| Expected life - compensation warrant | 2.50 | ||
| Dividend | $ | - | |
| Volatility - compensation option | 90% | ||
| Volatility - compensation warrant | 75% | ||
| Risk free rate - compensation option | 4.38% | ||
| Risk free rate - compensation warrant | 3.15% | ||
| Fair value per compensation option (CAD) | $ | 2.46 |
We have recorded $125,086 of Canadian Compensation Options in contributed surplus, with an equal offset to share offering costs (a non-cash transaction).
The April 2021 Offering was completed by PI Financial Corp., the lead agent and sole bookrunner (the "Lead Agent"), and other dealers (the "Agents"). As consideration for the services provided by the Agents in connection with the April 2021 Offering, the Agents received: (a) a cash commission of $288,405; and (b) 3,296 compensation options (the "Compensation Options"). Each Compensation Option is exercisable to acquire one unit of KWESST (a "Compensation Option Unit") at a price equal to $87.50 for a period of two years after the closing of the Offering. Each Compensation Option Unit is comprised of one Common Share and seventy Common Share purchase warrants (a "Compensation Option Warrant"). Each Compensation Option Warrant is exercisable to acquire 1/70 of a Common Share (a "Compensation Option Warrant Share") at a price of $1.75 per Compensation Option Warrant Share (70 Compensation Option Warrant for one Compensation Option Warrant Share) for a period of 24 months from the closing of the Offering.
Based on the structure of the Compensation Option, management estimated its fair value using the Monte Carlo method. Management estimated a fair value of $77.00 per Compensation Option. The following were key inputs used in the Monte Carlo simulation: estimated life of 2 years, underlying stock price of $90.30, exercise price of Compensation Option of $87.50, exercise price of 70 Compensation Option Warrants of $87.50, estimated volatility of 80%, risk free rate of 0.31%, and discount for lack of marketability of 0%.
| F-37 | Page |
| KWESST MICRO SYSTEMS INC. Notes to Consolidated Financial Statements Years ended September 30, 2023, 2022, 2021 (Expressed in Canadian dollars, except share amounts) |
Accordingly, we recorded $233,057 of Compensation Options in contributed surplus, with an equal offset to share offering costs (a non-cash transaction).
During the year ended September 30, 2021, the Agents have exercised 2,459 Compensation Option Units for total gross proceeds of $215,148. At September 30, 2022, the total outstanding Compensation Option Units was 837.
Share-based compensation
On March 31, 2023, KWESST shareholders approved the renewal of the Long-Term Incentive Plan (the "LTIP"). Additionally, the disinterested shareholders of KWESST approved an amendment to the LTIP to increase the number of RSUs, PSUs, DSUs, and SARs (collectively "Share Units") authorized for issuance pursuant to the LTIP from 60,682 to 407,274 Share Units. Accordingly, we have 11,153 Share Units available for future grants.
Further, the disinterested shareholders (shareholders that are not directors, officers, or other insiders of the Company) of KWESST approved to revise the exercise price of 50,981 stock options to $3.60, the closing price of KWESST common shares on the TSX-V on March 31, 2023. In accordance with IFRS 2, this resulted in an immediate fair value increase of $77,001 included in share-based compensation, with an offset to contributed surplus.
During the year ended September 30, 2023, we granted 340,000 stock options and did not grant any RSUs, PSUs, or SARs, pursuant to our LTIP during the year ended September 30, 2023. Accordingly, we had 389,907 outstanding stock options at September 30, 2023.
For the year ended September 30, 2023, we recorded share-based compensation of $373,554, (2022 - $1,960,072, 2021 - $2,462,207).
(i) Stock Options
The following is summary of changes in outstanding stock options for the respective periods:
| Weighted | ||||||
| Number | average | |||||
| of options | exercise price | |||||
| Outstanding at September 30, 2020 | 28,838 | $ | 45.50 | |||
| Granted | 52,988 | $ | 104.30 | |||
| Exercised | (18,194 | ) | $ | 50.40 | ||
| Cancelled | (4,096 | ) | $ | 48.30 | ||
| Outstanding at September 30, 2021 | 59,536 | $ | 95.90 | |||
| Granted | 9,500 | $ | 69.59 | |||
| Cancelled | (11,928 | ) | $ | 131.76 | ||
| Outstanding at September 30, 2022 | 57,108 | $ | 83.87 | |||
| Granted | 340,000 | $ | 2.59 | |||
| Exercised | (1,125 | ) | $ | 3.60 | ||
| Cancelled | (6,076 | ) | $ | 70.65 | ||
| Outstanding at September 30, 2023 | 389,907 | $ | 2.80 | |||
| Options exercisable at September 30, 2023 | 49,496 | $ | 4.21 |
| F-38 | Page |
| KWESST MICRO SYSTEMS INC. Notes to Consolidated Financial Statements Years ended September 30, 2023, 2022, 2021 (Expressed in Canadian dollars, except share amounts) |
During the year ended September 30, 2023, we granted 340,000 (2022 - 9,500, 2021 - 52,988) options at a weighted average exercise price of $2.59 (2022 - $69.59, 2021 - $104.30). At September 30, 2023, the weighted average remaining vesting period was 1.87 years (2022 - 0.88 years, 2021 - 1.82 years).
For the options granted during the year ended September 30, 2023, the per share weighted-average fair value of stock options was $38.21 (2022 - $38.21, 2021 - $50.40), using the Black-Scholes option model with the following weighted-average assumptions:
| 2023 | 2022 | 2021 | ||||||
| Stock price | $2.55 to $4.00 | $14.70 to $126.70 | $49.00 to $159.60 | |||||
| Exercise price | $2.55 to $4.00 | $14.70 to $126.70 | $49.00 to $159.60 | |||||
| Volatility | 96.37% | 90.48% | 76.46% | |||||
| Dividend yield | Nil | Nil | Nil | |||||
| Risk-free interest rate | 4.65% | 2.04% | 0.35% | |||||
| Expected life (years) | 2.93 | 2.91 | 2.26 | |||||
| Weighted-average fair value per option | $1.42 | $38.21 | $50.40 |
The following table summarizes information about stock options outstanding at September 30, 2023:
| Weighted | ||||||||||||||||||
| average | Weighted | Remaining | Weighted | |||||||||||||||
| remaining | average | exercisable | average | |||||||||||||||
| Exercise | Number | contractual | outstanding | contractual | exercisable | |||||||||||||
| price | outstanding | life | strike price | Exercisable | life | strike price | ||||||||||||
| $2.55 | 330,000 | 2.88 | 2.55 | - | - | - | ||||||||||||
| $3.60 | 49,550 | 2.55 | 3.60 | 49,139 | 2.54 | 3.60 | ||||||||||||
| $4.06 | 10,000 | 4.62 | 4.06 | - | - | - | ||||||||||||
| $87.50 | 357 | 2.76 | 87.50 | 357 | 2.76 | 87.50 | ||||||||||||
| 389,907 | 2.88 | 2.80 | 49,496 | 2.54 | 4.21 |
Amendment to stock option grants
For the years ended September 30, 2023 and 2022, we had no amended stock option grants.
During the year ended September 30, 2021, our Board of Directors approved the acceleration of vesting for 5,507 options and the cancellation of 3,571 options. This contributed an additional stock-based compensation charge of $65,813 (included in the above total share-based compensation expenses).
| F-39 | Page |
| KWESST MICRO SYSTEMS INC. Notes to Consolidated Financial Statements Years ended September 30, 2023, 2022, 2021 (Expressed in Canadian dollars, except share amounts) |
(ii) Share Units
The following table shows the changes in Share Units:
| RSUs | PSUs | SARs | Total | |||||||||
| Outstanding at September 30, 2020 | - | - | - | - | ||||||||
| Granted | 16,412 | 2,857 | 2,143 | 21,412 | ||||||||
| Vested and converted | (139 | ) | - | - | (139 | ) | ||||||
| Outstanding at September 30, 2021 | 16,273 | 2,857 | 2,143 | 21,273 | ||||||||
| Granted | 10,726 | 17,942 | 514 | 29,182 | ||||||||
| Vested and converted to common shares | (5,681 | ) | (2,666 | ) | - | (8,347 | ) | |||||
| Vested and repurchased for withholding taxes | (144 | ) | (249 | ) | - | (393 | ) | |||||
| Expired / cancelled | - | (17,714 | ) | - | (17,714 | ) | ||||||
| Outstanding at September 30, 2022 | 21,174 | 170 | 2,657 | 24,001 | ||||||||
| Granted | - | - | - | - | ||||||||
| Vested and converted to common shares | (20,103 | ) | (170 | ) | - | (20,273 | ) | |||||
| Vested and repurchased for withholding taxes | - | - | - | - | ||||||||
| Expired / cancelled | - | - | - | - | ||||||||
| Outstanding at September 30, 2023 | 1,071 | - | 2,657 | 3,728 |
RSUs:
Each RSU entitles the holder to receive one common share in the future, based on continued service during the applicable period.
During the year ended September 30, 2023, we granted nil RSUs (2022 - 10,726, 2021 - 16,412), with a weighted-average grant date fair value of $nil per unit (2022 - $43.50, 2021 - $105.70). The weighted average vesting period for the outstanding RSUs was 0.1 years at September 30, 2023 (2022 - 0.18 years, 2021 - 0.69 years).
PSUs:
Each PSU entitles the holder to receive one common share in the future, based on the achievement of established performance criteria and continued service during the applicable performance period.
During the year ended September 30, 2023, we granted nil PSUs (2022 - 17,942, 2021 - 2,857), with a weighted-average grant date fair value of $nil per unit (2022 - $126.70, 2021 - $105.00). The outstanding PSUs were fully vested at September 30, 2023 (2022 - fully vested, 2021 - Weighted average vesting period was 0.40 years).
SARs:
Each SAR entitles the holder to receive cash or common share at our discretion in the future, based on continued service during the applicable period. The amount of the cash payment or the value of common shares is determined based on the increase of the share price of KWESST between the grant date and the exercise date. Because we intend to always settle in common shares, we account for SARs as equity-settled awards.
During the year ended September 30, 2023, we granted nil SARs (2022 - 514, 2021 - 2,143) at an exercise price of $nil (2022 - $126.70, 2021 - $115.50 each). The 2,657 SARs will expire on January 22, 2024.
(iii) Share-based Compensation
For the year ended September 30, 2023, we recorded share-based compensation of $373,554 (2022 - $1,960,072, 2021 - $2,462,207).
| F-40 | Page |
| KWESST MICRO SYSTEMS INC. Notes to Consolidated Financial Statements Years ended September 30, 2023, 2022, 2021 (Expressed in Canadian dollars, except share amounts) |
The following table presents a breakdown of total share-based compensation expense by function:
| Year ended | Year ended | Year ended | |||||||
| September 30, | September 30, | September 30, | |||||||
| 2023 | 2022 | 2021 | |||||||
| General and administrative | $ | 246,436 | $ | 1,104,858 | $ | 1,425,111 | |||
| Selling and marketing | 53,800 | 552,627 | 754,167 | ||||||
| Research and development, net | 73,318 | 302,587 | 282,929 | ||||||
| Total share-based compensation | $ | 373,554 | $ | 1,960,072 | $ | 2,462,207 |
17. Earnings (loss) per share
The following table summarizes the calculation of the weighted average basic number of basic and diluted common shares to calculate the earnings (loss) per share as reported in the statements of net loss and comprehensive loss:
| Year ended | Year ended | Year ended | |||||||
| September 30, | September 30, | September 30, | |||||||
| 2023 | 2022 | 2021 | |||||||
| Issued common shares, beginning of year | 773,225 | 699,511 | 589,518 | ||||||
| Effect of shares issued from: | |||||||||
| December 2022 U.S. IPO and Canadian Offering (Note 16) | 2,607,632 | - | - | ||||||
| Over-allotment Pre-Funded Warrants (Note 15) | 160,836 | - | - | ||||||
| July 2023 Private Placement (Note 16) | 299,988 | - | - | ||||||
| July 2023 Pre-Funded Warrants (Note 15) | 181,011 | - | - | ||||||
| Debt settlements | 44,759 | 132 | 1,038 | ||||||
| Conversion of stock units | 11,817 | 3,703 | 31 | ||||||
| Exercise of options | 2,671 | - | 9,118 | ||||||
| Exercise of warrants | 336 | 10,593 | 4,383 | ||||||
| Issuance of bonus shares (Note 12) | - | 8,262 | - | ||||||
| Private placements | - | 4,571 | 21,810 | ||||||
| Acquisition of Police Ordnance (Note 4(a)) | - | 3,144 | - | ||||||
| Conversion of contingent shares (Note 4(a)) | - | 386 | - | ||||||
| Asset acquisitions (Note 4(b)) | - | - | 6,027 | ||||||
| Amended license agreement | - | - | 626 | ||||||
| Exercise of broker options | - | - | 170 | ||||||
| Weighted average number of basic common shares | 4,082,275 | 730,302 | 632,721 | ||||||
| Dilutive securities: | |||||||||
| Stock options | - | - | - | ||||||
| Warrants | - | - | - | ||||||
| Weighted average number of dilutive common shares | 4,082,275 | 730,302 | 632,721 |
At September 30, 2023, 2022 and 2021, all the stock options and warrants were anti-dilutive because we incurred a net loss for the periods.
As the $0.01 and $0.001 exercise price per Pre-Funded Warrant is non-substantive, the 199,000 Pre-Funded Warrants issued in the U.S. IPO and the 930,548 Pre-Funded Warrants issued in the July 2023 Private Placement are included in the basic net loss per share calculation.
| F-41 | Page |
| KWESST MICRO SYSTEMS INC. Notes to Consolidated Financial Statements Years ended September 30, 2023, 2022, 2021 (Expressed in Canadian dollars, except share amounts) |
18. Revenue
a) Revenue streams
KWESST generates revenue from the sale of products to its customers.
b) Disaggregation of revenue from contracts with customers
In the following table, revenue from contacts with customers is disaggregated by primary geographical market, major products and service lines, and timing of revenue recognition.
| Year ended | Year ended | Year ended | |||||||||
| September 30, | September 30, | September 30, | |||||||||
| 2023 | 2022 | 2021 | |||||||||
| Major products / service lines | |||||||||||
| Digitization | $ | 819,604 | $ | 354,620 | $ | 1,255,982 | |||||
| Non-Lethal | 411,758 | 330,658 | - | ||||||||
| Training and services | - | 34,590 | - | ||||||||
| Other | 3,088 | 1,651 | 19,822 | ||||||||
| $ | 1,234,450 | $ | 721,519 | $ | 1,275,804 | ||||||
| Primary geographical markets | |||||||||||
| United States | 42,780 | 389,210 | 1,238,063 | ||||||||
| Canada | 743,200 | 332,309 | 37,741 | ||||||||
| Europe | 448,470 | - | - | ||||||||
| 1,234,450 | 721,519 | 1,275,804 | |||||||||
| Timing of revenue recognition | |||||||||||
| Products and services transferred over time | $ | 819,604 | $ | 389,210 | $ | 1,238,063 | |||||
| Products transferred at a point in time | 414,846 | 332,309 | 37,741 | ||||||||
| $ | 1,234,450 | $ | 721,519 | $ | 1,275,804 |
Revenue allocated to remaining performance obligations represents contracted revenue that has not yet been recognized ("contracted not yet recognized") and includes unearned revenue and amounts that will be invoiced and recognized as revenue in future periods. At September 30, 2023, our contracted not yet recognized revenue was $496,199 (2022 - $625,177, 2021 - $16,545), of which 76% of this amount is expected to be recognized over the next 12 months with the remaining 25% expected to be recognized in 2 to 3 years.
For the year ended September 30, 2023, one customer accounted for 23% of revenue and one customer accounted for 18% of revenue (2022 - one customer accounted for 41%, 2021 - one customer accounted for 95%).
| F-42 | Page |
| KWESST MICRO SYSTEMS INC. Notes to Consolidated Financial Statements Years ended September 30, 2023, 2022, 2021 (Expressed in Canadian dollars, except share amounts) |
19. Expenses by nature
The following table presents a breakdown of expenses by nature for the following periods:
| Year ended | Year ended | Year ended | |||||||||
| September 30, | September 30, | September 30, | |||||||||
| 2023 | 2022 | 2021 | |||||||||
| Employee benefits | $ | 3,011,923 | $ | 4,883,062 | $ | 4,746,316 | |||||
| Advertising and promotion | 19,090 | 1,352,750 | 1,914,630 | ||||||||
| Consulting fees | 2,743,272 | 1,315,917 | 1,138,782 | ||||||||
| Professional fees | 940,667 | 1,028,240 | 778,337 | ||||||||
| Travel and conferences | 804,481 | 518,140 | 246,418 | ||||||||
| R&D consulting and material costs, net | 556,013 | 420,378 | 482,348 | ||||||||
| Depreciation and amortization | 952,508 | 326,491 | 140,990 | ||||||||
Impairment of intangible assets | 1,174,354 | - | - | ||||||||
| Other expenses | 691,566 | 266,822 | 252,961 | ||||||||
| Insurance | 716,931 | 236,150 | 154,931 | ||||||||
| Transfer agent and listing fees | 120,690 | 94,885 | 110,769 | ||||||||
| Royalty and license costs | 305,918 | - | 287,000 | ||||||||
| M&A costs | - | - | - | ||||||||
| Total expenses | 12,037,413 | 10,442,835 | 10,253,482 | ||||||||
| Allocation to cost of sales: | |||||||||||
| Employee benefits | (123,803 | ) | (166,706 | ) | (574,018 | ) | |||||
| Total operating expenses | $ | 11,913,610 | $ | 10,276,129 | $ | 9,679,464 |
20. Depreciation and Amortization
The following table presents total depreciation and amortization expense of property and equipment, intangible assets, and right-of-use assets by function:
| 2023 | 2022 | 2021 | |||||||||
| General and administrative | $ | 833,029 | $ | 123,960 | $ | 95,310 | |||||
| Selling and marketing | 77,804 | 129,265 | 16,443 | ||||||||
| Research and development | 41,675 | 73,266 | 29,237 | ||||||||
| Total depreciation and amortization | $ | 952,508 | $ | 326,491 | $ | 140,990 |
| F-43 | Page |
| KWESST MICRO SYSTEMS INC. Notes to Consolidated Financial Statements Years ended September 30, 2023, 2022, 2021 (Expressed in Canadian dollars, except share amounts) |
21. Net finance costs
The following table presents a breakdown of net finance costs for the following periods:
| Year ended | Year ended | Year ended | |||||||||
| September 30, | September 30, | September 30, | |||||||||
| 2023 | 2022 | 2021 | |||||||||
| Interest expense from: | |||||||||||
| Unsecured loan | $ | 503,251 | $ | 321,313 | $ | 4,527 | |||||
| Accretion cost - accrued royalties liability | 170,373 | 159,451 | 64,537 | ||||||||
| Lease obligations | 37,786 | 30,112 | 33,872 | ||||||||
| Related party loans | - | - | 4,581 | ||||||||
| CEBA term loan | 8,281 | - | 4,481 | ||||||||
| 2019 convertible notes | - | - | - | ||||||||
| Other | 3,857 | 1,114 | 4,115 | ||||||||
| Total interest expense | 723,548 | 511,990 | 116,113 | ||||||||
| Interest income | (55,514 | ) | (5,988 | ) | (4,848 | ) | |||||
| Gain on termination of lease obligations | - | - | - | ||||||||
| Gain on government grant | - | - | (3,514 | ) | |||||||
| Net finance costs | $ | 668,034 | $ | 506,002 | $ | 107,751 |
22. Income taxes
a) Income tax recovery
Income tax recovery is made up of the following components:
| Year end ended | Year ended | Year ended | |||||||
| September 30, | September 30, | September 30, | |||||||
| 2023 | 2022 | 2021 | |||||||
| Current income tax recovery (expense): | - | - | - | ||||||
| Deferred income tax (recovery) expense: | - | (49,442 | ) | - | |||||
| $ | - | $ | (49,442 | ) | $ | - |
| F-44 | Page |
| KWESST MICRO SYSTEMS INC. Notes to Consolidated Financial Statements Years ended September 30, 2023, 2022, 2021 (Expressed in Canadian dollars, except share amounts) |
b) Reconciliation of effective income tax rate
Our effective income tax rate differs from the statutory rate of 26.5% that would be obtained by applying the combined Canadian basic federal and provincial income tax rate to loss before income taxes. These differences result from the following:
| Year ended | Year ended | Year ended | |||||||
| September 30, | September 30, | September 30, | |||||||
| 2023 | 2022 | 2021 | |||||||
| Loss before income taxes | $ | (9,306,360 | ) | (10,569,732 | ) | (9,315,372 | ) | ||
| Expected statutory tax rate | 26.5% | 26.5% | 26.5% | ||||||
| Expected tax recovery resulting from loss | (2,466,185 | ) | (2,800,979 | ) | (2,468,574 | ) | |||
| Increase (reduction) in income taxes resulting from: | |||||||||
Non-deductible expenses | 149,270 | 563,842 | 654,956 | ||||||
Foreign operations subject to different tax rates | 1,447 | 5,329 | 3,593 | ||||||
| Fair value of warrant liabilities | (1,547,916 | ) | |||||||
Unrecognized temporary differences | 3,863,384 | 2,182,366 | 1,826,279 | ||||||
Prior year differences | - | - | (16,254 | ) | |||||
| $ | - | $ | (49,442 | ) | $ | - |
KWESST claims research and development deductions and related Investment Tax Credits ("ITC") for tax purposes based on management's interpretation of the applicable legislation in the Income Tax Act of Canada. These claims are subject to audit by the Canada Revenue Agency ("CRA") and any adjustments that results could affect ITCs recorded in the consolidated financial statements. The following table shows the breakdown of R&D expenses, net of ITCs:
| Year ended | Year ended | Year ended | |||||||
| September 30, | September 30, | September 30, | |||||||
| 2023 | 2022 | 2021 | |||||||
| R&D expenses | $ | 1,644,565 | $ | 2,064,493 | $ | 2,369,145 | |||
| Less: | |||||||||
| Investment tax credits | - | - | (231,007 | ) | |||||
| R&D expenses, net | $ | 1,644,565 | $ | 2,064,493 | $ | 2,138,138 |
c) Deferred tax balances
The following tables deferred tax assets (liabilities) have been recognized in the consolidated financial statements:
| Balance at | Arising on a | Balance at | ||||||||||
| September 30, | business | Recognized in | September 30, | |||||||||
| 2022 | combination | profit or loss | 2023 | |||||||||
| Deferred tax assets (liabilities): | ||||||||||||
Net operating loss carryforwards | 26,459 | - | (9,590 | ) | 16,869 | |||||||
Intangibles and development costs | (26,459 | ) | 9,590 | (16,869 | ) | |||||||
| - | - | - | - |
| F-45 | Page |
| KWESST MICRO SYSTEMS INC. Notes to Consolidated Financial Statements Years ended September 30, 2023, 2022, 2021 (Expressed in Canadian dollars, except share amounts) |
| Balance at | Arising on a | Balance at | ||||||||||
| September 30, | business | Recognized in | September 30, | |||||||||
| 2021 | combination | profit or loss | 2022 | |||||||||
| Deferred tax assets (liabilities): | ||||||||||||
| Net operating loss carryforwards | - | - | 26,459 | 26,459 | ||||||||
| Intangibles and development costs | - | (49,442 | ) | 22,983 | (26,459 | ) | ||||||
| - | (49,442 | ) | 49,442 | - | ||||||||
| Balance at | Balance at | |||||||||||
| September 30, | Recognized in | Recognized in | September 30, | |||||||||
| 2020 | profit or loss | Equity | 2021 | |||||||||
| Deferred tax assets (liabilities): | ||||||||||||
| Net operating loss carryforwards | 48,045 | (48,045 | ) | - | - | |||||||
| Impairment provision | (48,045 | ) | 48,045 | - | - | |||||||
| - | - | - | - |
d) Unrecognized net deferred tax assets
Deferred taxes reflect the impact of loss carryforwards and of temporary differences between amounts of assets and liabilities for financial reporting purposes and such amounts as measured by enacted tax laws. However, KWESST has not recorded net deferred tax assets at September 30, 2023 and 2022 on the following deductible temporary differences, due to the uncertainty involved in determining whether these deferred tax assets will be realized upon expiration due to KWESST's limited history and cumulative operating losses since its inception.
The following is a summary of KWESST's unrecognized deductible temporary differences:
| Balance at | Balance at | Balance at | |||||||
| September 30, | September 30, | September 30, | |||||||
| 2023 | 2022 | 2021 | |||||||
| Net operating loss carryforwards | $ | 30,178,141 | $ | 18,589,894 | $ | 9,429,436 | |||
| Share issuance costs | 5,275,081 | 1,298,783 | 1,810,927 | ||||||
| Intangibles and development costs | 1,356,922 | 608,705 | 780,607 | ||||||
| Scientific research and development expenditures | 1,583,058 | 1,583,058 | 1,789,571 | ||||||
| Other | 1,467,509 | 46,300 | 104,793 | ||||||
| $ | 39,860,711 | $ | 22,126,741 | $ | 13,915,334 |
| F-46 | Page |
| KWESST MICRO SYSTEMS INC. Notes to Consolidated Financial Statements Years ended September 30, 2023, 2022, 2021 (Expressed in Canadian dollars, except share amounts) |
e) Available net operating losses
At September 30, 2023, KWESST has the following net operating losses in Canada available to reduce future year's taxable income which expire as follows:
| Year of Expiry | Amount | ||
| 2036 | $ | 512,163 | |
| 2037 | 744,022 | ||
| 2038 | 1,174,797 | ||
| 2039 | 1,732,039 | ||
| 2040 | 336,562 | ||
| 2041 and thereafter | 25,678,558 | ||
| $ | 30,178,141 |
f) Available research and development investment tax credits
The Company has the following research and development investment tax credits available to reduce future years' income taxes payable which expire as follows:
| Year of Expiry | Amount | ||
| 2037 | $ | 13,361 | |
| 2038 | 6,742 | ||
| 2039 | - | ||
| 2040 | 328,480 | ||
| 2041 and thereafter | - | ||
| $ | 348,583 |
23. Financial instruments
Fair value of financial instruments
The fair values of our cash, restricted short-term investment, trade and other receivables, accounts payable and accrued liabilities, deposit (included in non-current other assets), warrant liabilities and related party loans approximate carrying value because of the short-term nature of these instruments.
Under IFRS, the levels of fair value hierarchy are as follows:
Level 1: Unadjusted quoted prices in active markets for identical assets or liabilities;
Level 2: Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly (i.e. as prices) or indirectly (i.e. derived from prices); and
Level 3: inputs for the asset or liability that are not observable market data (unobservable inputs).
The lease deposit, lease obligations, accrued royalties liability, warrant liabilities and borrowings were recorded at fair value at initial recognition. The fair value measurement for these was Level 2. Subsequently, these were measured at amortized cost and accreted to their nominal value over their respective terms. At September 30, 2023, the fair value for accrued royalties liability determined using a discount rate of 24% (2022 - 24%, 2021 - 13.7%) would be $928,776 (2022 - $869,219, 2021 - $1,105,756). Using the same market discount rate, the fair value of the borrowings would be $nil at September 30, 2023 (2022 - $68,750, 2021 - $49,825).
Financial risk management
We are exposed to a number of financial risks arising through the normal course of business as well as through its financial instruments. Our overall business strategies, tolerance of risk and general risk management philosophy are determined by our Board of Directors in accordance with prevailing economic and operating conditions.
| F-47 | Page |
| KWESST MICRO SYSTEMS INC. Notes to Consolidated Financial Statements Years ended September 30, 2023, 2022, 2021 (Expressed in Canadian dollars, except share amounts) |
(a) Interest rate risk
Interest rate risk is the risk that the fair value of cash flows of a financial instrument will fluctuate because of changes in market interest rates. At September 30, 2023, our loans were all repaid and therefore not subject to interest rate risk. At September 30, 2022, our borrowings were all subject to fixed interest rates and therefore these were not subject to interest rate risk. At September 30, 2021, our borrowing was interest free.
(b) Foreign currency risk
Foreign currency risk is the risk that the future cash flows or fair value of our financial instruments that are denominated in a currency that is not our functional currency will fluctuate due to a change in foreign exchange rates.
For the years ended September 30, 2023, 2022 and 2021, our revenue was substantially denominated in U.S. dollar driven by contracts with U.S. prime contractors in the defense sector. We also procure certain raw materials denominated in U.S. dollar for product development. Accordingly, we are exposed to the U.S. dollar currency. Where a natural hedge cannot be achieved, a significant change in the U.S. dollar currency could have a significant effect on our financial performance, financial position, and cash flows. Currently, we do not use derivative instruments to hedge its U.S. dollar exposure.
At September 30, 2023, we had the following net U.S. dollar exposure:
| Total USD | |||
| Net assets in U.S. subsidiary | $ | - | |
| US denominated: | |||
| Assets | $ | 2,926,334 | |
| Liabilities | (59,552 | ) | |
| Net US dollar exposure | $ | 2,866,782 | |
| Impact to profit or loss if 5% movement in the US dollar | $ | 143,339 |
During the year ended September 30, 2023, we recorded foreign exchange loss of $98,275 (2022 - foreign exchange gain of $28,780, 2021 - foreign exchange loss of $3,742).
(c) Credit risk
Credit risk is the risk of financial loss to KWESST if a counterparty to a financial instrument fails to meet its contractual obligations. Our credit risk exposure is limited to cash, and trade and other receivables. Refer to Note 5 for the breakdown of our trade and other receivables. We enter into contracts with either large, financially sound global general contractors or law enforcement agencies, which mitigates the credit risk. At September 30, 2023, our trade receivable was $68,530 (2022 - $114,877, 2021 - $nil), of which $31,527 was overdue by more than 60 days from law enforcement agencies.
(d) Liquidity risk
Liquidity risk is the risk that we will be unable to meet our financial obligations as they become due. Our objective is to ensure that we have sufficient cash to meet our near-term obligations when they become due, under both normal and stressed condition, without incurring unacceptable losses or risking reputational damage to KWESST. A key risk in managing liquidity is the degree of uncertainty in our cash flows due to our early stage in operations and the need for additional capital to fund our business strategies (see Note 2(a)).
| F-48 | Page |
| KWESST MICRO SYSTEMS INC. Notes to Consolidated Financial Statements Years ended September 30, 2023, 2022, 2021 (Expressed in Canadian dollars, except share amounts) |
At September 30, 2023, our contractual obligations were as follows:
| 5 years and | |||||||||||||||
| Payment due: | Total | Within 1 Year | 1 to 3 years | 3 to 5 years | beyond | ||||||||||
| Minimum royalty commitments | $ | 2,350,000 | $ | 150,000 | $ | 400,000 | $ | 500,000 | $ | 1,300,000 | |||||
| Accounts payable and accrued liabilities | 1,649,876 | 1,649,876 | - | - | - | ||||||||||
| Lease obligations | 558,755 | 197,367 | 355,430 | 5,958 | - | ||||||||||
| Total contractual obligations | $ | 4,558,631 | $ | 1,997,243 | $ | 755,430 | $ | 505,958 | $ | 1,300,000 |
At September 30, 2023, we had $5,407,009 in cash and $458,439 in positive working capital (current assets less current liabilities).
24. Supplemental cash flow information
The following table presents changes in non-cash working capital:
| Year ended | Year ended | Year ended | |||||||
| September 30, | September 30, | September 30, | |||||||
| 2023 | 2022 | 2021 | |||||||
| Trade and other receivables | $ | (128,387 | ) | $ | 631,801 | $ | (218,334 | ) | |
| Inventories | (148,850 | ) | 49,446 | 17,555 | |||||
| Prepaid expenses and other | (440,242 | ) | 425,876 | (106,205 | ) | ||||
| Accounts payable and accrued liabilities | (1,666,486 | ) | 2,515,289 | (828,698 | ) | ||||
| Contract liabilities | 73,699 | 17,410 | (7,053 | ) | |||||
| Deposits | - | - | 150,000 | ||||||
| Accrued royalties liability | - | - | 1,191,219 | ||||||
| $ | (2,310,266 | ) | $ | 3,639,822 | $ | 198,484 |
The following is a summary of non-cash items that were excluded from the Statements of Cash Flows for the year ended September 30, 2023:
The following is a summary of non-cash items that were excluded from the consolidated statements of cash flows for the year ended September 30, 2022:
| F-49 | Page |
| KWESST MICRO SYSTEMS INC. Notes to Consolidated Financial Statements Years ended September 30, 2023, 2022, 2021 (Expressed in Canadian dollars, except share amounts) |
The following is a summary of non-cash items that were excluded from the consolidated statements of cash flows for the year ended September 30, 2021:
25. Segmented information
Our Executive Chairman has been identified as the chief operating decision maker. Our Executive Chairman evaluates the performance of KWESST and allocates resources based on the information provided by our internal management system at a consolidated level. We have determined that we have only one operating segment.
At September 30, 2023, we had one right-of-use asset ($79,867) and some inventory ($78,039) in the United States while all other property and equipment are located in Canada, at September 30, 2022, and 2021, all of our property and equipment were located in Canada, including the right-of-use assets.
26. Capital management
Our objective in managing our capital is to safeguard our ability to continue as a going concern and to sustain future development of the business. Our senior management is responsible for managing the capital through regular review of financial information to ensure sufficient resources are available to meet operating requirements and investments to support our growth strategy. Our Board of Directors is responsible for overseeing this process. From time to time, we could issue new common shares or debt to maintain or adjust our capital structure (see Note 27). KWESST is not subject to any externally imposed capital requirements.
KWESST's capital is composed of the following:
| September 30, | September 30, | |||||||
| 2023 | 2022 | |||||||
| Debt: | ||||||||
| Borrowings | $ | - | $ | 2,278,774 | ||||
| Lease obligations | 429,523 | 275,621 | ||||||
| Equity: | ||||||||
| Share capital | 33,379,110 | 19,496,640 | ||||||
| Warrants | 1,042,657 | 1,959,796 | ||||||
| Contributed surplus | 4,769,115 | 3,551,330 | ||||||
| Accumulated other comprehensive loss | (39,663 | ) | (101,418 | ) | ||||
| Accumulated deficit | (35,215,599 | ) | (25,909,239 | ) | ||||
| Total capital | $ | 4,365,143 | $ | 1,551,504 |
27. Commitments and contingencies
AerialX Drone Solutions ("AerialX")
| F-50 | Page |
| KWESST MICRO SYSTEMS INC. Notes to Consolidated Financial Statements Years ended September 30, 2023, 2022, 2021 (Expressed in Canadian dollars, except share amounts) |
On April 5, 2021, we entered into an amended and restated licensing agreement with AerialX to gain exclusive rights to manufacture, operate, and use its drone for the C-UAS (Counter Unmanned Aerial Systems) market, specifically for the United States Department of Defense and Canada's Department of National Defence for a period of two years from the date upon which AerialX will meet certain technical milestones. In consideration for this exclusivity, we have issued 1,429 common shares to AerialX ("Exclusive License Shares"). Based on our closing stock price of $95.90 on April 23, 2021 (TSX-V approval date), the fair value for these shares was $137,000. We recorded the $137,000 fair value as a license cost for the year ended September 30, 2021, with an equal offset to our share capital.
In addition to the Exclusive License Shares, we also agreed to issue an additional 1,429 common shares upon AerialX achieving the technical milestones. For the years ended September 30, 2023, 2022 and 2021, AerialX has not delivered on the technical milestones and therefore no recognition was made.
Additionally, we also agreed to issue up to 4,286 common shares subject to achieving the following performance milestones:
# of Common Shares | Milestones |
1,071 | $3 million in sales |
1,429 | $9 million in sales |
1,786 | $18 million in sales |
The amended and restated licensing agreement also changed the terms of the annual minimum royalty payment to AerialX. The initial minimum royalty payment is not due prior to the first anniversary year of the Prototype Date, which is defined under the agreement as the date upon which a functioning prototype is received by us.
Under this agreement, we will pay a royalty ranging from 8% to 15% of sales of AerialX technology, subject to the following minimum payments:
| • | 1st anniversary: $150,000 | |
| • | 2nd anniversary: $200,000 | |
| • | 3rd anniversary: $300,000 | |
| • | 4th anniversary: $400,000 | |
| • | 5th anniversary: $500,000 |
In accordance with the original agreement dated November 18, 2019, in the first quarter of Fiscal 2020 we made a payment of $150,000 as an advance for future royalty payments (the "Advance"). This Advance was recorded as a non-current deposit at December 31, 2019, and September 30, 2020. During the year ended September 30, 2021, management performed a recoverability review of all our financial assets, including this Advance. Management made the recoverability assessment on the Advance based on anticipated future sales of the licensed technology. Due to the lack of delivery of a functional prototype during the year ended September 30, 2021, management concluded the timing and volume of future sales of the licensed drone was too uncertain. Accordingly, we took a charge to net loss for the year ended September 30, 2021. This charge is included in general and administrative expenses in the consolidated statements of net loss and comprehensive loss. As at September 30, 2023, ArielX has not delivered a functional prototype and no further royalties have been paid.
Under the amended and restated licensing agreement, we will continue to have a non-exclusive worldwide license. This agreement will expire on April 30, 2026.
28. Subsequent Events
Announces Issuance of Shares in Payment of Certain Obligations
On October 31, 2023, the Company announced that it will issue 46,706 common shares at a deemed price per share of CAD$2.09 in settlement of an obligation in an amount of approximately CAD$97,615. The obligation resulted from a tail obligation relating to services rendered by a third-party consultant, which the Company has elected to pay for in common shares.
| F-51 | Page |
ITEM 19. EXHIBITS
Financial Statements
| Description | Page | |
| Consolidated Financial Statements and Notes | F1- F51 |
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† Portions of this exhibit have been omitted in accordance with the rules of the SEC. KWESST Micro Systems Inc. agrees to furnish a copy of all omitted exhibits and schedules to the SEC upon its request.
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SIGNATURES
The Registrant hereby certifies that it meets all of the requirements for filing on Form 20-F and that it has duly caused and authorized the undersigned to sign this Annual Report on its behalf.
| KWESST MICRO SYSTEMS INC. | ||
| Date: January 19, 2024 | By: | /s/ Kris Denis |
| Name: Kris Denis | ||
| Title: Interim Chief Financial Officer | ||
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