UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the Quarterly Period Ended SeptemberJune 30, 20172018

or

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

For the Transition Period from _________ to _________

Commission file number: 333-150332

DRONE AVIATION HOLDING CORP.

(Exact name of registrant as specified in its charter)

11651 Central Parkway #118, Jacksonville, FL 32224

(Address of principal executive offices) (zip code)

(904) 834-4400

(Registrant’s telephone number, including area code)

Not applicable.

(Former name, former address and former fiscal year, if changed since last report)

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

Note: The registrant is a voluntary filer, but has filed all reports it would have been required to file by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months if it was subject to the filing requirements thereof.

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No☐

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

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 7(a)(2)(B) of the Securities Act and Section 13(a) of the Exchange Act. ☐

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

As of November 13, 2017,August 8, 2018, there were 9,182,470 shares of registrant’s common stock outstanding.

DRONE AVIATION HOLDING CORP.

DRONE AVIATION HOLDING CORP.

CONSOLIDATED BALANCE SHEETS

The accompanying notes are an integral part of these unaudited consolidated financial statements.

DRONE AVIATION HOLDING CORP.

CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

The accompanying notes are an integral part of these unaudited consolidated financial statements.

DRONE AVIATION HOLDING CORP.

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

The accompanying notes are an integral part of these unaudited consolidated financial statements.

DRONE AVIATION HOLDING CORP.

NOTES TO INTERIM UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

For the Period Ended SeptemberJune 30, 20172018

The following unaudited interim consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Accordingly, such interim financial statements do not include all the information and footnotes required by accounting principles generally accepted in the United States for complete annual financial statements. The information furnished reflects all adjustments, consisting only of normal recurring items which are, in the opinion of management, necessary in order to make the financial statements not misleading. The balance sheet as of December 31, 20162017 has been derived from the Company’s annual financial statements that were audited by an independent registered public accounting firm, but does not include all of the information and footnotes required for complete annual financial statements. The consolidated financial statements included in this Quarterly Report on Form 10-Q should be read in conjunction with the consolidated financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2016.2017. 

Uses and Sources of LiquidityRevenue Recognition

At September 30, 2017,

In May 2014, the FASB issued Accounting Standards Update No. 2014-09 (Topic 606) “Revenue from Contracts with Customers.” Topic 606 supersedes the revenue recognition requirements in Topic 605 “Revenue Recognition” (Topic 605) and requires entities to recognize revenues when control of the promised goods or services is transferred to customers at an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services. We adopted Topic 606 as of January 1, 2018 using the modified retrospective transition method. We recognized the cumulative effect of adopting this guidance as an adjustment to our opening balance of retained earnings. Prior periods will not be retrospectively adjusted. The adoption of Topic 606 does not have a material impact to our consolidated financial statements, including the presentation of revenues in our Consolidated Statements of Operations.

The accompanying consolidated financial statements and notes have been prepared assuming the Company had cash of $1,764,389, working capital of $333,434, and an accumulated deficit of $27,322,709. Furthermore,will continue as a going concern. For the six months ended June 30, 2018, the Company hasincurred a historynet loss of $2,754,390, generated negative cash flow from operations, primarily duehas an accumulated deficit of $32,751,167 and working capital deficit of $1,873,649. These circumstances raise substantial doubt as to heavy investment in research and development and costs associated with maintaining a public entity. In October 2016, the company issued $3,000,000 in Convertible Notes Payable with a maturity date of October 2017. As further discussed in Note 6 – Related Party Convertible Notes Payable and Derivative Liability, the Company does not currently have the liquid resources to repay the notes. On August 3, 2017, the maturity date of the notes were extended to April 1, 2019 and reclassified as long-term liability as of the balance sheet date. On August 2, 2017, the Company closed on a bank line of credit in the principal amount of $2,000,000 that was guaranteed by the Company’s Chairmanability to continue as a going concern. The Company’s ability to continue as a going concern is dependent upon the Company’s ability to create and CEOmarket innovative products, raise capital, reduce debt or renegotiate terms, and a private line of credit with a related party investor who is a significant shareholder in the amount of $2,000,000. The Company expects this financial backing has strengthened the balance sheet to support the level of sales necessary to maintain positivesustain adequate working capital to finance its operations. The failure to achieve the necessary levels of profitability and sufficient liquidity for operations.

The Company expects that it will need to raise substantial additional capital to accomplish its business plan over the next several years. In addition, the Company may wish to selectively pursue possible acquisitions of businesses, technologies,cash flows or products complementary to those of the Company in the future in order to expand its presence in the marketplace and achieve operating efficiencies. The Company expects to seek to obtain additional funding through a bank credit facility or private equity. There canwould be no assurance asdetrimental to the availability or terms upon which such financing and capitalCompany. The consolidated financial statements do not include any adjustments that might be available.necessary if the Company is unable to continue as a going concern.

The Company accounts for related party transactions in accordance with ASC 850 (“Related Party Disclosures”). A party is considered to be related to the Company if the party directly or indirectly or through one or more intermediaries, controls, is controlled by, or is under common control with the Company. Related parties also include principal owners of the Company, its management, members of the immediate families of principal owners of the Company and its management and other parties with which the Company may deal if one party controls or can significantly influence the management or operating policies of the other to an extent that one of the transacting parties might be prevented from fully pursuing its own separate interests. A party which can significantly influence the management or operating policies of the transacting parties or if it has an ownership interest in one of the transacting parties and can significantly influence the other to an extent that one or more of the transacting parties might be prevented from fully pursuing its own separate interests is also a related party.

On November 10, 2017, the Company and Global Security Innovative Strategies, LLC (“GSIS”), a related party, entered in an agreement whereby GSIS will provide business development support and general consulting services for sales opportunities with U.S. government agencies and other identified prospects and consulting support services for the Company’s role and activities as part of the Security Center of Excellence in Orlando, Florida. The agreement was for a period of six months beginning on November 1, 2017 and is now month-to-month by oral agreement. The Company agreed to pay GSIS a fee of $10,000 per month and will evaluate the fee after 90 days. The Company agreed to pay the expenses of GSIS incurred in connection with the performance of its duties under the agreement. Either party may terminate or renew the agreement at any time, for any reason or no reason, upon at least 30 days’ notice to the other party. David Aguilar, a member of the Company’s board of directors, is a principal at GSIS.

As of SeptemberJune 30, 20172018, and December 31, 2016,2017, there was $188,217$173,666 and $46,849$171,981 accrued interest payable, respectively, to related parties on convertible notes payable.   

Inventories are stated at the lower of cost or market, using the first-in first-out method. Cost includes materials, labor and manufacturing overhead related to the purchase and production of inventories. We regularly review inventory quantities on hand, future purchase commitments with our supplies, and the estimated utility of our inventory. If the review indicates a reduction in utility below carrying value, we reduce our inventory to a new cost basis through a charge to cost of goods sold. Allowance for slow moving items increased $6,366 due to a type of aerostat material which was custom ordered. Inventory consists of the following at SeptemberJune 30, 20172018 and December 31, 2016:2017: 

Property and equipment is recorded at cost when acquired.  Depreciation is provided principally on the straight-line method over the estimated useful lives of the related assets, which is 3-7 years for equipment, furniture and fixtures, hardware and software and leasehold improvements.   During the ninesix months ended SeptemberJune 30, 2017,2018, the Company invested $675$1,930 in shop machinery and equipment. During that same time period, the company sold a company vehicle for $60,000 cash and wrote off several items of abandoned equipment resulting in a $9,428 loss on disposal of assets. Depreciation expense was $26,350$20,535 and $25,132$17,561 for the ninesix months ended SeptemberJune 30, 20172018 and 2016,2017, respectively. Property and equipment consists of the following at SeptemberJune 30, 20172018 and December 31, 2016:2017:

On July 20, 2015, the Company, through its wholly-owned subsidiary Drone AFS Corp., purchased substantially all the assets of Adaptive Flight, Inc. (“AFI”), a Georgia corporation. The Company purchased assets, including, but not limited to, intellectual property, licenses and permits, including commercial software licenses for the “GUST” (Georgia Tech UAV Simulation Tool) autopilot system and other transferable licenses which include flight simulation and fault tolerant flight control algorithms. The Company paid $100,000 in immediately available funds and $100,000 to be held in escrow. In addition, the Company issued 150,000 shares of unregistered common stock valued at $8.40 per share, on a post-October 29, 2015 reverse stock split basis, on the date of agreement, to be held in escrow. 

The Company had a milestone of twelve months to complete a technology integration plan, the non-completion of which could result in the return of the purchased assets and termination of the Company’s obligations to release the escrow cash and shares. Additional milestones included exclusive, no-cost and perpetual licenses to all contributing intellectual property included or related to the purchased assets. As such time as all milestones were met, one-half of the escrow shares were to be released to AFI. Upon termination of the escrow agreement, anticipated to be twelve months from the closing of the asset purchase, if all milestones had been met, the remaining escrow shares would be released to AFI; but if all milestones have not been met, the escrow cash and escrow shares would be released to the Company and the purchased assets would be returned to AFI. According to the terms of the Escrow Agreement, if the escrow share value was less than $1,400,000, the Company must issue an additional number of unregistered shares, not to exceed 50,000 shares. At December 31, 2015, the value of the 150,000 shares was $3.23 per share, or $484,500. The Company recorded $161,500 as an additional liability and expense at December 31, 2015 for the cost of 50,000 shares at $3.23 per share. On June 3, 2016, the Integration Plan was deemed to be completed. At June 3, 2016, the value of the 150,000 shares was $3.01 per share, or $451,150. The additional liability was reduced to $150,500 for the cost of 50,000 shares at $3.01 per share. The Company recorded the $11,000 reduction in the additional liability through the statement of operations at June 3, 2016. The Company began amortizing the $1,460,000 of purchased assets over a sixty-month period on June 3, 2016 in the amount of $24,333 per month. Total amortization expense for the ninesix months ended SeptemberJune 30, 20172018 was $219,000.$146,000. The remaining unamortized balance of $1,070,667$851,667 is estimated be amortized in the estimated amounts of $146,000 during 2018 and $292,000 per year for 20172019 through 2020 and $121,667 in 2021.

The asset acquisition did not qualify as a business combination under ASC 805-10 and has been accounted for as a regular asset purchase. 

On September 29, 2016, the Company issued Convertible Promissory Notes Series 2016 due October 1, 2017 in the aggregate principal amount of $3,000,000 in a private placement to the Chairman of the Board and the Chairman of the Strategic Advisory Board of the Company, both of whom are greater than 10% shareholders of the Company. The notes bear interest at a rate of six percent (6%) per annum. The Company may prepay the notes at any time without penalty. If the Company does not prepay a note in full or the holder does not convert the note before the maturity date, the Company may pay the outstanding principal amount and any accrued and unpaid interest on the maturity date with cash or with common stock or through a combination of cash and stock at the Company’s discretion. The conversion price of the notes is the lesser of $3.00 per share or eight-five percent (85%) of the lowest per share purchase price of common stock in the next sale of common stock in which the Company receives gross proceeds of an amount greater than or equal to $3,000,000. 

On August 3, 2017 (the “Effective Date”), the Company entered into amendments (the “Convertible Note Amendments”) with the owners and holders of the following convertible promissory notes issued by the Company (the “Series 2016 Convertible Notes”):

The Convertible Note Amendments extend the maturity date for each of the Series 2016 Convertible Notes to April 1, 2019 (the “Maturity Date”) and revise the conversion price to mean $1.00 per share subject to proportional adjustment in the event of stock splits, stock dividends and similar corporate events. Accordingly, the notes have been reclassified as long-term debt. Consistent with the original terms of the Series 2016 Convertible Notes, interest accrues at the rate of 6% interest per annum and is payable on the Maturity Date. The accrued interest is payable at the holders’ option in cash or shares of our common stock valued at the $1.00 per share conversion price. The Convertible Note Amendments provide that an event of default in the City National Bank Loan will be treated as an event of default under the Series 2016 Convertible Notes.

On November 9, 2017, the Company entered into amendments (the “November 2017 Convertible Note Amendments”) with the owners and holders of the Series 2016 Convertible Notes to permit the payment of, at the holders’ election, accrued and unpaid interest either in monthly or quarterly payments at any time after the Effective Date. Accrued interest may be paid with: (i) cash; (ii) the issuance and delivery to the holder of shares of common stock of the Company at the conversion price provided for in the Series 2016 Convertible Note; or (iii) any combination of cash and shares of Common Stock, as determined by the holder in its sole discretion.

On March 23, 2018, the Company entered into amendments (the “March 2018 Convertible Note Amendments”) with the owners and holders of the Series 2016 Convertible Notes to extend the maturity date from April 1, 2019 until October 1, 2020. The Company evaluated the modification under ASC 470-50 and determined that is not qualified as an extinguishment of debt. The aggregate loss on extinguishment

As of debt inJune 30, 2018, and December 31, 2017, is $681,988, including ($378) on derivative liabilities,$165,617 and $682,366 on unamortized debt discount. The embedded conversion feature of the notes pre-modification required liability classification. $166,356 accrued interest has been recorded, respectively.

The Company analyzed the conversion option in the notes for derivative accounting treatment under ASC Topic 815, “Derivatives and Hedging,” and determined that the instrument does not qualify for derivative accounting.

The Company therefore performed an analysis to determine if the conversion option was subject to a beneficial conversion feature and determined that the instrument does not have a beneficial conversion feature.

The following table sets forth, by level within the fair value hierarchy, the Company’s financial liabilities that were accounted for at fair value as of September 30, 2017 and December 31, 2016:

The following table represents the change in the fair value of the derivative liabilities during the nine months ended September 30, 2017 and the year ended December 31, 2016:

On August 2, 2017, the Company issued a promissory note to City National Bank of Florida (“CNB”) in the principal amount of $2,000,000, the CNB Note.Note, with a maturity date of August 2, 2018. The note evidences a revolving line of credit with advances that may be requested by the Company until the maturity date of August 2, 2018 so long as no event of default exists under the note, the Company or Mr. Nussbaum does not cease doing business, Mr. Nussbaum does not seek to revoke or modify his guarantee of the Note, the Company does not misapply the proceeds of this loan or CNB in good faith does not believe itself insecure. The CNB Note bears interest at a variable rate equal to 0.250 percentage points over the Wall Street Journal Prime Rate payable monthly. The Company will pay to CNB a late charge of 5.0% of any monthly payment not received by Lender within 10 calendar days after its due date. The Company may prepay the note at any time without penalty. In the event of a default, the interest rate will increase to the highest lawful rate. The Company is obligated to maintain depository accounts with CNB with a minimum average annual balance of $600,000. In the event the Company does not maintain this account balance, CNB may charge the Company a fee equal to 2% of the deficiency as additional interest under the note. The CNB Note is personally guaranteed by Mr. Nussbaum, the Company’s Chief Executive Officer pursuant to written guarantee in favor of CNB (the “CNB Guarantee”). Mr. Nussbaum and the Company are obligated to maintain an unencumbered liquidity of no less than $6,000,000 in the form of cash, repurchase agreements, certificates of deposit or marketable securities acceptable to CNB. In addition, to secure our obligations under the note, we entered into a security agreement in favor of CNB (the “Security Agreement”) encumbering all of our accounts, inventory and equipment along with an assignment of a bank account we maintain at CNB with an approximate balance of $90,000. As of SeptemberJune 30, 2017, $1,000,0002018, $1,500,000 has been drawn against the line of credit. Accrued interest of $5,231$8,049 has been recognized as of SeptemberJune 30, 2017.2018.

Indemnification Agreement

On August 3, 2017, the Company entered into an Indemnification Agreement with Mr. Nussbaum in order to indemnify and defend him to the fullest extent permitted by law for any claim, expense or obligation which might arise as a result of his guarantee of the CNB Note.

On August 3, 2017, the Company issued a Secured Convertible Promissory Note Series 2017 due August 2, 2018 in the aggregate principal amount of $2,000,000 (the “Series 2017 Convertible Note”) in a private placement to Frost Nevada Investments Trust (“Frost Nevada”). Frost Nevada is a trust that is controlled by Dr. Frost, a substantial shareholder of the Company. The note evidences a revolving line of credit with advances that may be requested by the Company until the maturity date of August 2, 2018 so long as no event of default exists under the loan. The Company may request advances of principal under this note equal to and at the same time as it requests advances, if any, pursuant to the CNB Note. The note bears interest at a variable rate equal to 0.250 percentage points over the Wall Street Journal Prime Rate. The Company may prepay the notes at any time without penalty. If the Company does not prepay the note in full or the holder does not convert the note before the maturity date, the Company may pay the outstanding principal amount and any accrued and unpaid interest on the maturity date with cash or with common stock or through a combination of cash and stock at Frost Nevada’s discretion. The conversion price under the note is $1.00 per share subject to proportional adjustment in the event of stock splits, stock dividends and similar corporate events. The Series 2017 Convertible Note is secured by a security interest in all the Company’s assets. This security interest is subordinate to the security interest of CNB discussed in Footnote #7#8 above. As of SeptemberJune 30, 2017, $1,000,0002018, $1,500,000 has been drawn against the line of credit. Accrued interest of $7,231$8,049 has been recognized as of SeptemberJune 30, 2017.2018.

The Company analyzed the conversion option in the notes for derivative accounting treatment under ASC Topic 815, “Derivatives and Hedging,” and determined that the instrument does not qualify for derivative accounting.

The Company therefore performed an analysis to determine if the conversion option was subject to a beneficial conversion feature and determined that the instrument does not have a beneficial conversion feature.

On August 3, 2017, the Company entered into an amendment to the August 24, 2014 Independent Contractor Agreements it entered into with Dr. Philip Frost and Steven Rubin who serve as members of the Company’s Strategic Advisory Board (the “SAB Amendments”). The SAB Amendments extend the term of the agreements from May 1, 2017 until April 30, 2018 and provide for the following equity based compensation: (a) for Dr. Frost, a warrant to purchase 2,000,000 shares of the Company’s Common Stock (the “Frost Warrant”) and an award of 150,000 shares of the Company’s unregistered restricted Common Stock and (b) for Mr. Rubin, an award of 100,000 shares of the Company’s unregistered restricted Common Stock. The restricted stock vests upon the occurrence of a change of control (as defined in the SAB Amendments). The Warrant has a term of five years and exercise price of $1.00 per share subject to proportional adjustment in the event of stock splits, stock dividends and similar corporate events. The Company recognized $104,167$22,500 expense for the pro rata portion of shares earned by the two members during the ninesix months ended SeptemberJune 30, 2017,2018, amortizing the expense over the 12 months of the service agreement regardless of the vesting condition.

In September 2016, , the Company issued 1,349,000 shares of restricted common stock outside of the 2015 Equity Plan to Jay Nussbaum, Felicia Hess, Daniyel Erdberg, Kendall Carpenter, Mike Silverman and Reginald Brown pursuant to Stock Award Agreements. The shares will vest upon consummation of a significant equity and/or debt financing of at least $5,000,000 provided that the holder remains engaged by the Company through the vesting date. The Company recognized $970,067 stock based compensation during the six months ended June 30, 2017 and $28,808 in stock based compensation during the nine months ended September 30, 2016. As of August 3, 2017, the Company does not believe the vesting conditions are probable of being achieved, and as such, no stock-based compensation expense is expected to be recognized in connection with the September 2016 shares.  Consequently, previously recorded stock based compensation of $1,488,596 was reversed during the nine months ended September 30, 2017.

On August 3, 2017, these awards were modified so that the restrictions set forth in the RSA lapse upon the earlier of (i) consummation of a significant equity and/or debt financing from which the Company receives gross proceeds of at least $7,000,000 or (ii) a change in control (as defined in the RSA Amendment), provided that, in either case, the holder remains engaged by the Company through the date of such event. The Company does not believe the modified vesting conditions are probably of being achieved, and as such, no stock-based compensation expense has been recorded. The Company will reassess whether achievement of the vesting conditions is probable at each reporting date. If it is probable, stock-based compensation will be recognized.

In May 2016,On March 28, 2017, these awards were modified in recognition of the Company issued 150,000 shares of common stock with monthlysecuring a substantial sales order and recent business development activity and vested on that date. On that date, the awards were determined to be probable for vesting provisions to Strategic Advisory Board members, Dr. Philip Frost and Steven Rubin, for 12 months of services. The advisors can earn a pro rata portion of the shares, calculatedstock-based compensation was recognized based on the twelve-month vesting period, infair market value of the event the service agreements are terminated prior to the expiration date as described in the agreements. These shares vested during Maystock on March 28, 2017. The Company recognized a total of $29,500 and $211,890 expenserecorded $944,300 in stock-based compensation for the pro rata portion of shares earned by the two members during the nine months ended September 30, 2017 and 2016, respectively.these awards.  

In April 2016, the Company issued an aggregate of 1,150,000 shares of common stock outside of the 2015 Equity Plan to Jay Nussbaum, Felicia Hess, Daniyel Erdberg, Kendall Carpenter, and Kevin Hess pursuant to Stock Award Agreements. Stock based compensation of $3,346,615 was recognized during the nine months ended September 30, 2016 on the awards which fully vested on September 29, 2016. That same month, the Company issued 100,000 shares of stock to a director who subsequently resigned and forfeited the shares. The Company recognized a total of $60,495 stock compensation during the nine months ended September 30, 2016.

On September 4, 2015, the Company issued 450,000 shares of restricted common stock to four management employees and one director pursuant to stock award agreements. Stock based compensation of $604,440 was recognized during the nine months ended September 30, 2016.

On June 1, 2015, the Company issued 50,000 shares of restricted common stock with monthly vesting provisions to the Chairman of the Board for twenty-four months services pursuant to a Director Agreement. The Chairman can earn a pro rata portion of the shares, calculated on a twenty-four-month vesting period, in the event the Chairman relinquishes his position and Board seat prior to the expiration date of the Director Agreement. These shares vested on June 1, 2017. The Company recognized a total of $112,500 and $202,500 expense for the portion of such shares earned by the Chairman during the nine months ended September 30, 2017 and 2016, respectively.

On April 24, 2017, the holder of Series A preferred stock converted a total of 100,100 shares of Series A for an aggregate of 250,250 shares of restricted common stock in accordance with their conversion rights which includes a blocker with respect to individual ownership percentages.

All the preferred stock of the Company is convertible into common shares. The Series A stock conversion ratio is 1 to 2.5 common shares. All preferred stock has voting rights equal to the number of shares it would have on an ‘as if converted’ basis subject to any ownership limitations governing such preferred shares. All preferred stock is entitled to dividends rights equal to the number of shares it would have on an ‘as if converted’ basis. None of the preferred stock is redeemable, participating nor callable.

The Company analyzed the embedded conversion option for derivative accounting consideration under ASC 815-15 “Derivatives and Hedging” and determined that the conversion option should be classified as equity.

On April 24, 2017, the holder of Series A preferred stock converted a total of 100,100 shares of Series A for an aggregate of 250,250 shares of restricted common stock in accordance with their conversion rights which includes a blocker with respect to individual ownership percentages.

On August 3,May 16, 2018, upon approval of the Company’s board of directors, the Company granted outside its 2015 Equity Plan, 460,000 options to four employees. Reginald Brown, Jr. was issued 200,000 options and Kendall Carpenter was issued 130,000 options which were immediately vested, are exercisable at an exercise price of $1.00 per share and expire May 16, 2022. Two engineers received a total of 130,000 shares which vest 50% after one year and the remaining 50% after two years, are exercisable at an exercise price of $1.00 per share and expire May 16, 2022. During the six months ended June 30, 2018, $154,148 compensation expense was recognized on these 460,000 options with a remaining balance of $47,933 to be recognized over the vesting period.

On March 28, 2018, upon approval of the Company’s board of directors, the Company granted outside its 2015 Equity Plan, 100,000 options each to a newly-appointed director, Robert Guerra. These options vest 50% one year after the date of grant and the remaining 50% two years after the date of grant provided the director is still actively involved with the Company. The options are exercisable at an exercise price of $1.00 per share and expire on March 28, 2022. During the six months ended June 30, 2018, $7,394 compensation expense was recognized on these 100,000 options with a remaining balance of $31,195 to be recognized over the vesting period.

On December 13, 2017, upon approval of the Company’s board of directors, the Company issued outside its 2015 Equity Plan, 5,210,000100,000 options each to purchasetwo newly-appointed directors, or a total of 200,000 options. These options vest 50% after one year and the Company’s common stock to officers, directors and employees for services provided. Jay Nussbaum was issued 2,000,000remaining 50% after two years provided the director is still actively involved with the Company. The options Felicia Hess was issued 1,200,000 options, Dan Erdberg was issued 1,140,000 options, Kendall Carpenter was issued 275,000 options, Directors David Aguilar, Mike Haas and General Wayne Jackson were issued 100,000   , 10,000 and 10,000 options, respectively. The remaining 475,000 options were issued to employees and consultants. These stock options immediately vested, are exercisable at an exercise price of $1.00 per share and expire on August 3,December 13, 2021. During the ninesix months ended SeptemberJune 30, 2018 and twelve months ended December 31, 2017, $3,489,058$36,426 and $3,593, respectively, compensation expense was recognized on these 5,210,000 options.200,000 options with a remaining balance of $59,771 to be recognized over the vesting period.

OneDuring 2016, the Company granted 10,000 options to an employee with two-year vesting and an exercise price of $3.00 and an expiration date of December 6, 2019. The Company recognized $2,210 in compensation for the six months ended June 30, 2018. No additional compensation will be recognized on these options which were cancelled due to the termination of the employee. 

On June 1, 2015, the Company issued an option award to an employee for 37,500 shares vesting over three years with an exercise price of $10.80 and expiration date of May 4, 2019. During the ninesix months ended SeptemberJune 30, 2017 and 2016, $46,353 and $101,1412018, $14,369 compensation expense was recognized on these 37,500 options respectively.which are now fully vested.

On January 9, 2017, the Company issued an option to purchase 100,000 shares of common stock with an exercise price of $2.90 per share to a director. The option vests 50,000 after one year from grant date and another 50,000 two years from grant date with an expiration date of four years from grant date provided that the Director is still providing service to the Company. During the ninesix months ended SeptemberJune 30, 2017, $96,7942018, $22,556 compensation expense was recognized on these 100,000 options.options with a remaining balance of $22,557 to be recognized over the vesting period.

The Company used the Black-Scholes option pricing model to estimate the fair value on the date of grant of the 5,310,000560,000 options granted during the ninesix months ended SeptemberJune 30, 2017.2018.

The following table summarizes the assumptions used to estimate the fair value of the 5,310,000560,000 stock options granted during the ninesix months ended SeptemberJune 30, 20172018 on the date of grant.

Under the Black-Scholes option pricing model, the fair value of the 5,310,000560,000 options granted during the ninesix months ended SeptemberJune 30, 20172018 is estimated at $3,663,231$240,670 on the date of grant. During the ninesix months ended SeptemberJune 30, 2017, $3,585,8522018, $161,542 compensation expense was recognized on these 5,310,000 options.

During 2016, the Company granted 65,000 common stock options to employees for service provided. Of these, 50,000 options were granted to two employees and were immediately vested with an exercise price of $2.91 and the expiration date is April 27, 2019. One of these employees terminated and did not exercise her 10,000 options resulting in the expiration of the option. Another 5,000 options were immediately vested and were granted with an exercise price of $3.77 and the expiration date is July 29, 2019. Another employee received 10,000 options with two-year vesting and an exercise price of $3.00 and an expiration date of December 6, 2019. The employee who received 5,000 options in July 2016 was terminated and did not exercise his options resulting in the expiration of a total of 5,000 options. The Company recognized $107,941 in compensation for the first nine months ended September 30, 2016 on these options. 

The Company used the Black-Scholes option pricing model to estimate the fair value on the date of grant of the 10,000 stock-based awards that continue to vest during the nine months ended September 30, 2017. 

The following table summarizes the assumptions used to estimate the fair value of the 10,000 outstanding stock options granted during 2016 on the date of grant:

Under the Black-Scholes option price model, fair value of the options granted during 2016 is estimated at $16,889 on the date of grant. During the nine months ended September 30, 2017, $9,353 compensation expense was recognized on these 10,000560,000 options.

The following table represents stock option activity as of and for the ninesix months ended SeptemberJune 30, 2017:2018:

On August 3, 2017, upon approval of the Company’s board of directors, the Company issued outside its 2015 Equity Plan, 30,000 warrants to purchase the Company’s common stock to consultants for services provided. These warrants are immediately vested, are exercisable at an exercise price of $1.00 per share and expire on August 3, 2021. The Company recognized $18,617 in compensation cost during the nine months ended September 30, 2017.

On August 3, 2017, the Company issued a warrant to purchase 2,000,000 shares of the Company’s common stock to Dr. Philip Frost for services to be provided under the terms of his service to the Strategic Advisory Board through April 2018. These warrants immediately vested, are exercisable at an exercise price of $1.00 per shares and expire on August 3, 2022. The Company recognized $1,445,252 in compensation cost during the nine months ended September 30, 2017.

The following table summarizes the assumptions used to estimate the fair value of the 2,030,000 warrants granted during 2017 as of re-measurement dates:

For the year 2016, 60,000 common stock purchase warrants were granted to four consultants for services provided. Each warrant was granted with the exercise price of $2.91, which immediately vested, and the expiration date is April 27, 2019. The Company recognized $114,779 in compensation cost during the nine months ended September 30, 2016.

During 2016, 10,472 warrants expired that were issued in 2011 with exercise prices ranging between $141.00 and $404.50 on a post-reverse split basis.

The Company used the Black-Scholes warrant pricing model to estimate the fair value on the re-measurement dates of the 12,500 warrants that vested on June 10, 2017.

The following table summarizes the assumptions used to estimate the fair value of the 12,500 warrants granted during 2015 as of re-measurement dates:

Under the Black-Scholes warrant pricing model, fair value of the 12,500 warrants granted during 2015 is estimated at $0 as of re-measurement dates. During the nine months ended September 30, 2017, $(3,467) compensation expense was recognized on these 12,500 warrants. 

The following table represents warrant activity as of and for the period ended SeptemberJune 30, 2017:2018:

On November 17, 2014, the Company entered into a 60-month lease for 5,533 square feet of office and manufacturing space at 11651 Central Parkway Suite 118, Jacksonville, Florida, with an anticipated lease commencement date of February 1, 2015. The actual commencement date was July 1, 2015 and the lease was amended to 61 months expiring July 31, 2020. The monthly rent, including operating expenses and sales tax, for each year of the initial lease term is estimated to be $5,915. Anticipated total rent during the term of the lease is as follows:

Rent expense was $44,474 for the six months ended June 30, 2018.

On May 16, 2016, Banco Popular North America (“Banco”) filed a lawsuit in Duval County, Florida in the Circuit Court of the Fourth Judicial Circuit against Aerial Products Corporation d/b/a Southern Balloon Works (“Aerial Products”), Kevin M. Hess, LTAS, and the Company to collect on a delinquent Small Business Administration loan that Banco made in 2007 to Aerial Products with Mr. Hess as the personal guarantor. LTAS and the Company filed an Answer on June 30, 2016 and Responses to Interrogatories on December 16, 2016. The lawsuit is active and discovery is ongoing. It is our position that neither LTAS nor the Company are continuations of Aerial Products, and LTAS and the Company have denied all allegations made by Banco and will vigorously defend that position. The Company has evaluated the probability of loss as possible but the range of loss is unable to be estimated.

Other than the Banco matter, there are no material claims, actions, suits, proceedings inquiries, labor disputes or investigations pending.

Amendment to Related Party Convertible Promissory Notes

On November 9, 2017,July 30, 2018, the Company entered into amendments (the “Novembertook a draw of $150,000 from the CNB note and a draw of $150,000 from the Series 2017 Convertible Note Amendments”) with the ownerswhich are described in Footnotes #8 and holders of the Series 2016 Convertible Notes to permit the payment of, at the holders’ election, accrued and unpaid interest either in monthly or quarterly payments at any time after the Effective Date. Accrued interest may be paid with: (i) cash; (ii) the issuance and delivery to the holder of shares of common stock of the Company at the conversion price provided for in the Series 2016 Convertible Note; or (iii) any combination of cash and shares of Common Stock, as determined by the holder in its sole discretion.

Related Party Consulting Agreement

On November 10, 2017, the Company and Global Security Innovative Strategies, LLC (“GSIS”), a related party, entered in an agreement whereby GSIS will provide business development support and general consulting services for sales opportunities with U.S. government agencies and other identified prospects and consulting support services for the Company’s role and activities as part of the Security Center of Excellence in Orlando, Florida. The agreement is for a period of six months beginning on November 1, 2017. The Company agreed to pay GSIS a fee of $10,000 per month and will evaluate the fee after 90 days. The Company agreed to pay the expenses of GSIS incurred in connection with the performance of its duties under the agreement. Either party may terminate or renew the agreement at any time, for any reason or no reason, upon at least 30 days’ notice to the other party. David Aguilar, a member of the Company’s board of directors, is a principal at GSIS.

Options and Warrants issued

On November 9, 2017, upon approval of the Company’s board of directors, the Company issued outside its 2015 Equity Plan, 2,000,000 options and 70,000 warrants to purchase the Company’s common stock to officers, directors, employees and consultants for services provided. Jay Nussbaum was issued 900,000 options, Felicia Hess was issued 300,000 options, Dan Erdberg was issued 200,000 options, Kendall Carpenter was issued 170,000 options, Directors David Aguilar, Mike Haas and General Wayne Jackson were issued 10,000, 10,000 and 10,000 options, respectively. Reginald Brown, Jr. was issued 400,000 options. The remaining 70,000 warrants were issued to three consultants. These stock options and warrants immediately vested, are exercisable at an exercise price of $1.35 per share and expire on November 9, 2021.

#9 above.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Certain statements in Management’s Discussion and Analysis (“MD&A”), other than historical information, including estimates, projections, statements relating to our business plans, objectives and expected operating results, and the assumptions upon which those statements are based, are “forward-looking statements”. Forward-looking statements generally can be identified by the use of forward-looking terminology, such as “may,” “would,” “expect,” “intend,” “could,” “estimate,” “should,” “anticipate,” “believe,” and similar expressions. Forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties which may cause actual results to differ materially from the forward-looking statements. These statements are subject to a number of risks, uncertainties and developments beyond our control or foresight, including changes in the trends of the advanced aerostats and tethered drone industry, formation of competitors, changes in governmental regulation or taxation, changes in our personnel and other such factors. We undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events, or otherwise. Readers should carefully review the risk factors and related notes included under Item 1A of our Annual Report on Form 10-K for the year ended December 31, 20162017 filed with the Securities and Exchange Commission on March 17, 2017.23, 2018.

The following MD&A is intended to help readers understand the results of our operations and financial condition and is provided as a supplement to, and should be read in conjunction with, our Unaudited Consolidated Financial Statements and the accompanying Notes to Unaudited Consolidated Financial Statements under Part I, Item 1 of this Quarterly Report on Form 10-Q.

Growth and percentage comparisons made herein generally refer to the ninesix months ended SeptemberJune 30, 20172018 compared with the ninesix months ended SeptemberJune 30, 20162017 unless otherwise noted. Unless otherwise indicated or unless the context otherwise requires, all references in this document to “we,” “us,” “our,” the “Company,” and similar expressions refer to Drone Aviation Holding Corp. and, depending on the context, its subsidiaries.

Business Overview

We design, develop, market and sell lighter-than-air (“LTA”) tacticaladvanced aerostats and accessories, tethered drones, and land-based intelligence, surveillance and reconnaissance (“ISR”) solutions. We focus primarily on the development of a tethered aerostat known as the Winch Aerostat Small Platform (“WASP”), as well asour tethered drone products, includingproduct, the WATT and BOLT electric tethered drones launched on March 2, 2015 and July 13, 2016, respectively. The WATT and BOLTthe FUSE Tether System designed for DJI Matrice 200 (M200) professional drones. Our products are designed for commercial and military applications and provide secure and reliable aerial monitoring for extended durations while being tethered to the ground via a high strength armored tether. We also developed FUSE, a cost-effective tether system for DJI Inspire and Matrice 200 drones. The FUSE winch system enables flights up to 200 feet and offers continuous power distribution monitoring and virtually unlimited flight time.

While sales in the past quarter decreased compared to the same period in 2016, this decrease was primarily a result of a longer sales cycle stemming in part from the recent change in administration and congressional budgeting delays. We expect increased sales in future periods based on a product pipeline that is developing following our increased marketing efforts and our announcement of the following:

Our marketing efforts include submission of proposals and bids on a several government procurement projects that we expect will be awardedto the U.S. Government as well as customer demonstrations at customer identified sites and in the fourth quarter of 2017 and 2018.Jacksonville, Florida We also showcased our products and technologies at numerous conferences and live demonstrations, including the 2017 Special Operations Forces Industry Conference, 2018 Warrior Expo East, State of Florida HURREX exercise, CyberQuest 2017, and presentations to a variety of federal and state government agencies. In anticipation ofWe have also increased sales resulting from our developing product pipeline, we completed financing transactions that provide us with up to $4,000,000 in cashmarketing efforts and extendedannounced the maturity date on $3,000,000 of convertible debt until April 2019 providing us with significant increased liquidity and a strengthened balance sheet. While there is no assurance that the opportunities included in our developing pipeline will result in orders for our products, we have positioned ourselves to be able to deliver the goods and services we have bid on.following:

In addition to our plans to organically grow our lighter than air systems through increased marketing and sales, we intend to continue to consider potential strategic transactions, which could involve acquisitions of businesses or assets, joint ventures or investments in businesses, products or technologies that expand, complement or otherwise relate to our current or future business.

Results of Operations

Three Months Ended SeptemberJune 30, 20172018 compared to Three Months Ended SeptemberJune 30, 20162017 

Revenues: Revenues of $93,105$42,000 for the quarter ended SeptemberJune 30, 2017 decreased $53,1032018 increased $28,124 or 36%203% from $146,208$13,876 for the same period in 2016.2017. Sources of revenue were derived primarily from aerostat products, FUSE tether systems and accessories. The decreaseincrease in sales volume was primarily a result of a longer sales cycle stemming in part from the recent change in presidential administration and congressional budgeting delays.delivery of additional aerostats to an existing customer. We expect increased sales in future periods based on a product pipeline developed following our increased marketing efforts discussed in the Business Overview section above.

Cost of Goods Sold and Gross Profit: Cost of goods sold of $33,594$11,637 for the quarter ended SeptemberJune 30, 2017 decreased $31,0572018 increased $5,171 or 48%80% from $64,651$6,466 for the same period in 2016.2017. Costs included materials, parts and labor associated with the sale of aerostat products, FUSE tether systems and accessories. The $59,511$30,363 gross profit for the quarter ended SeptemberJune 30, 20172018 was a decreasean increase of $22,046$22,953 or 27%310% from the $81,557$7,410 in gross profit for the same quarter of 2016.2017. Gross profit margins were 64%72% and 56%53% for the quarters ended June 30, 2018 and 2017, respectively, due to the higher margins built into the pricing for the aerostats delivered in 2018. 

General and Administrative Expense: General and administrative expense primarily consists of payroll and related costs, sales and marketing costs, research and development costs, business overhead and costs related to maintaining a public entity. General and administrative expenses decreased $339,439 or 25% to $1,028,319 in the quarter ended June 30, 2018 from $1,367,758 for the same period in 2017. Contributing to the decrease was non-cash stock-based compensation of $180,406 which decreased $401,653 from $582,059 in the same period of 2017. Payroll expenses increased by $126,814 to $391,681 from $264,867 as a result of putting the CEO on salary in the third quarter of 2017 and the bonus effect of payroll taxes paid on the vesting of the September 2016 stock awards, offset by research and develop costs of $28,323, a decrease of $25,417 from $53,740 in the same period in 2017 and legal expenses of $4,554 which decreased $19,622 from $24,176 for the same period in 2017 and marketing expenses of $53,412 which decreased $30,990 from $84,402 in the same period in 2017.

Loss from Operations: Loss from operations for the quarter ended June 30, 2018 decreased $362,392 or 27% to $997,956 from loss from operations of $1,360,348 for the same period in 2017. The decrease was primarily due to an increase in gross profit of $22,953 and the decrease of general and administrative expense of $339,439 as discussed above.

Other Expense: Total other expense of $78,144 for the quarter ended June 30, 2018 was $324,213 less than the total other expense of $402,357 in the same period in 2017. This decrease was primarily due to interest expense of $78,144 for that quarter which was $622,263 or 89% less than the $700,407 interest expense recognized for the same period in 2017 which also included recognition of a $298,050 derivative gain.

Net Loss: Net loss decreased $686,605 or 39% to $1,076,100 for the quarter ended June 30, 2018 from net loss of $1,762,705 for the same period in 2017. The decrease in net loss was due to factors discussed above.

Six Months Ended June 30, 2018 compared to Six Months Ended June 30, 2017 

Revenues: Revenues of $911,023 for the six months ended June 30, 2018 increased $529,494 or 139% from $381,529 for the same period in 2017. Sources of revenue were derived primarily from aerostat products, FUSE tether systems and 2016, respectively.accessories. The increase in sales volume was primarily a result of the delivery of a WASP system valued in excess of $800,000 to the U.S. Army which was ordered in the fourth quarter of 2017 and delivered in the first quarter of 2018. We expect increased sales in future periods based on a product pipeline developed following our increased marketing efforts discussed in the Business Overview section above.

Cost of Goods Sold and Gross Profit: Cost of goods sold of $486,030 for the six months ended June 30, 2018 increased $236,034 or 94% from $249,996 for the same period in 2017. Costs included materials, parts and labor associated with the sale of aerostat products, FUSE tether systems and accessories. The $424,993 gross profit for the six months ended June 30, 2018 was an increase of $293,460 or 223% from the $131,533 in gross profit for the same period in 2017. Gross profit margins were 47% and 34% for the six months ended June 30, 2018 and 2017, respectively, due to the higher margins built into the pricing of the system delivered in 2018. 

General and Administrative Expense: General and administrative expense primarily consists of payroll and related costs, sales and marketing costs, research and development costs, business overhead and costs related to maintaining a public entity. General and administrative expenses increased $657,447$143,201 or 17%5% to $4,544,499$3,030,928 in the quartersix months ended SeptemberJune 30, 20172018 from $3,887,052$2,887,727 for the same period in 2016. Contributing2017. Payroll expense increased by $269,545 to $822,698 from $553,153 as a result of putting the CEO on salary in the third quarter of 2017 and the bonus effect of payroll taxes paid on the vesting of the September 2016 stock awards. Travel expense increased by $57,880 to $141,505 from $83,625 as a result of an increase was non-cash stock based compensationin business development activity, offset by research and development costs of $3,591,430 which increased $974,945$67,382, a decrease of $112,516 from $2,616,485 in the same period in 2017 and legal expenses of 2016 and an increase of $54,343 in marketing expense to $97,215$38,823 which decreased $59,637 from $42,872$98,460 for the same period in 2016, offset by research and develop costs of $97,979, a decrease of $306,925 from the same period in 2016 and legal expenses of $16,015 which decreased $84,013 from $100,028 for the same period in 2016.2017.

Loss from Operations: Loss from operations for the quartersix months ended SeptemberJune 30, 2017 increased $679,4932018 decreased $150,259 or 18%5% to $4,484,988$2,605,935 from loss from operations of $3,805,495$2,756,194 for the same period in 2016.2017. The decrease was primarily due to a decreasean increase in gross profit of $22,046 and$293,460 offset by the increase of general and administrative expense of $657,447$143,201 as discussed above.

Other Expense: Total other expense of $278,837$148,455 for the quartersix months ended SeptemberJune 30, 20172018 was $350,992$18,550 greater than the total other incomeexpense of $72,155$129,905 in the same period in 2016.2017. This increase was primarily due to $376,636 interest expense associated with convertible notes payable, bank and related party lines of credit and amortization of debt discount, $681,988 loss recorded on debt extinguishment from$148,455 for the modification of terms ofsix-month period which was $1,033,298 or 87% less than the 2016 related party convertible note payable partially offset by $779,787 non-cash income due to a derivative gain on convertible debt. In$1,181,753 interest expense recognized for the same period in 2017 which also included recognition of 2016, the other income mainly included $75,000 debt forgiveness.a $1,051,848 derivative gain.

Net Loss: Net loss increased $1,030,485decreased $131,709 or 28%5% to $4,763,825$2,754,390 for the quartersix months ended SeptemberJune 30, 20172018 from net loss of $3,733,340$2,886,099 for the same period in 2016.2017. The decrease in net loss was due to factors discussed above.