Unaudited Condensed Consolidated Interim Financial Statements of

KWESST MICRO SYSTEMS INC.

Three months ended December 31, 2024 and 2023

(Expressed in Canadian dollars)

KWESST MICRO SYSTEMS INC.

Table of contents for the three months ended December 31, 2024 and 2023

KWESST MICRO SYSTEMS INC.
Unaudited Condensed Consolidated Interim Statements of Financial Position
At December 31, 2024 and September 30, 2024   

See Note 2(a) Going concern and Note 17 Commitments and contingencies.
See accompanying notes to the unaudited condensed consolidated interim financial statements.

KWESST MICRO SYSTEMS INC.
Unaudited Condensed Consolidated Interim Statements of Net Loss and Comprehensive Loss
Three months ended December 31, 2024 and 2023

See accompanying notes to the unaudited condensed consolidated interim financial statements.

KWESST MICRO SYSTEMS INC.
Unaudited Condensed Consolidated Interim Statements of Changes in Shareholders' Equity
Three months ended December 31, 2024 and 2023

See accompanying notes to the unaudited condensed consolidated interim financial statements.

KWESST MICRO SYSTEMS INC.
Unaudited Condensed Consolidated Interim Statements of Cash Flows
Three months ended December 31, 2024 and 2023  

See Note 16 Supplemental cash flow information.

See accompanying notes to the unaudited condensed consolidated interim financial statements.

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) 2024 Reverse Stock Split

On October 23, 2024, KWESST effected a ten for one (10-for-1) reverse stock split of its common stock (the "2024 Reverse Split"). Accordingly, all shareholders of record at the opening of business on October 23, 2024, received one issued and outstanding common share of KWESST in exchange for ten outstanding common shares of KWESST. No fractional shares were issued in connection with the 2024 Reverse Split. All fractional shares created by the 2024 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 2024 Reverse Split, the exercise price and number of common shares issuable upon the exercise of outstanding stock options and warrants were proportionately adjusted to reflect the 2024 Reverse Split. 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 2024 Reverse Split.

2. Basis of preparation

(a) Going concern

These unaudited condensed consolidated interim 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 significant revenue levels 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 $3.5 million net loss and negative operating cash flows of $3.2 million for the three months ended December 31, 2024 (2023 - $0.4 million net loss and negative operating cash flows of $2.9 million). At December 31, 2024, we had $2.8 million in working capital (September 30, 2024 - negative $1.1 million) and $46.1 million in accumulated deficit (September 30, 2024 - $42.7 million).

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 sales 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; and
• Instability in Canada's elected leadership and the threatened tariffs from President Donald Trump.

Our strategy to mitigate these material risks and uncertainties is to execute on a timely basis 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 should it be required in the future. Accordingly, there are material risks and uncertainties that may cast substantial doubt about our ability to continue as a going concern.

These unaudited condensed consolidated interim 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 unaudited condensed consolidated interim financial statements have been prepared in accordance with IAS 34, Interim Financial Reporting, ("IAS 34") as issued by the International Accounting Standards Board ("IASB") and the interpretations of the IFRS Interpretations Committee.  They do not include all the information required for a complete set of financial statements prepared in accordance with International Financial Reporting Standards ("IFRS") and should be read in conjunction with our annual audited Consolidated Financial Statements for the year ended September 30, 2024 ("Annual Financial Statements"). However, selected explanatory notes are included to explain events and transactions that are material to an understanding of the changes in our financial position and performance since the last annual audited Consolidated Financial Statements as at and for the year ended September 30, 2024.

These unaudited condensed consolidated interim financial statements were authorized for issue by the Board of Directors on February 14, 2025.

(c) Basis of consolidation

These unaudited condensed consolidated interim 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.

At December 31, 2024, we have the following wholly owned subsidiaries:

(d) Functional and presentation currency

These unaudited condensed consolidated interim financial statements are presented in Canadian dollars ("CAD"), our functional currency and presentation currency.

While each of the Company's subsidiaries has its own functional currency, the functional currency of the parent company, KWESST Micro Systems Inc., is CAD as this is the currency of the primary economic environment in which the Company operates. Most of the revenues, cost of sales and operating expenses from significant subsidiaries are denominated in CAD.

(e) Basis of measurement

The unaudited condensed consolidated interim financial statements have been prepared on a 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 unaudited condensed consolidated interim 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 material effects on the amounts recognized in these unaudited condensed consolidated interim financial statements are the same as disclosed in Note 2(f) of the Annual Financial Statements for the year ended September 30, 2024.

Estimates

Information about assumptions and estimation uncertainties at December 31, 2024, that have a significant risk of resulting in a material adjustment to the carrying amounts of assets and liabilities in the next financial year are the same as disclosed in Note 2(f) of the Annual Financial Statements for the year ended September 30, 2024.

3. Material accounting policies

During the three months ended December 31, 2024, the accounting policies in these unaudited condensed consolidated interim financial statements are the same as those applied in the Annual Financial Statements.

4. Trade and other receivables

The following table presents trade and other receivables for KWESST:

There was no impairment of trade and other receivables during the three months ended December 31, 2024 (2023 - $nil).

The following table presents changes in unbilled receivables:

5. Inventories

The following table presents a breakdown of inventories:

 There was no impairment of inventories during the three months ended December 31, 2024 (2023 - $nil).

At December 31, 2024, a total of $0.4 million (2023 - $0.2 million) of inventory was included in profit or loss as an expense as part of cost of sales.

6. Intangible assets

The following table shows a breakdown of our intangible assets:

At December 31, 2024, management concluded there was no indication of impairment on the intangible assets.

7. Accounts payable and accrued liabilities

The following table presents a breakdown of our accounts payable and accrued liabilities:

8.  Related party transactions

At December 31, 2024, there was $112,641 (September 30, 2024 – $471,465) outstanding in accounts payable and accrued liabilities due to officers and directors for accrued wages and vacation, consulting fees, directors’ fees and expense reimbursements.

In December 2024, the LEC royalty payment that was due April 2025, in the amount of $200,000, was paid early to DEFSEC, a related party to the Company, in exchange for a $25,000 reduction resulting in a net payment of $175,000.

9. Contract liabilities

The following table presents the changes in contract liabilities:

10. Warrant liabilities

The following table shows a breakdown and balance of warrant liabilities at December 31, 2024:

The following table shows a breakdown and balance of warrant liabilities at September 30, 2024:

U.S. Public Offering (April 2024)

On April 9, 2024, we closed an underwritten U.S. public offering for gross proceeds of CAD$1.4 million (US$1 million) (see Note 11(a)). In this offering, 80,350 pre-funded warrants with an exercise price of US$0.01 per share for US$6.49 per pre-funded warrant were issued.

Refer to Note 11(a) for further information on the 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 from 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) of the Annual Financial Statements). Gains on revaluation of the warrant liabilities are presented in other income (expenses) on the unaudited condensed consolidated interim statements of net loss and comprehensive loss.

Warrant liabilities

All 80,350 warrants were subsequently exercised at a weighted average exercise price of US$0.01 and we recognized a loss of $104,227 in fair value of warrant liabilities during the year ended September 30, 2024, which was reported in the consolidated statements of net loss and comprehensive loss.

U.S. Registered Direct Offering (August 2024)

On August 13, 2024, we closed a direct offering for the purchase and sale of 471,500 common shares at a purchase price of US$2.00 per common share for gross proceeds of CAD$1.3 million (US$0.9 million) (see Note 11(a)). In a concurrent private placement, we issued unregistered warrants to purchase up to 471,500 common shares at an exercise price of US$2.50. This was a unit offering consisting of a share and a warrant. The fair value of the warrants attached to the units are valued based on the Black-Scholes model and the difference between the proceeds raised and the value assigned to the warrants is the residual fair value of the shares.

Refer to Note 11(a) for further information on the 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 from 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) of the Annual Financial Statements). Gains on revaluation of the warrant liabilities are presented in other income (expenses) on the unaudited condensed consolidated interim statements of net loss and comprehensive loss.

Warrant liabilities

At December 31, 2024, we remeasured the fair value of these warrants using the following assumptions:

(1) Fair value is based on the Black Scholes model on December 31, 2024, for the warrants.

We recognized a gain of $461,340 (2023 - nil) in fair value of warrant liabilities during the three months ended December 31, 2024, which was reported in the unaudited condensed consolidated net loss and comprehensive loss.

U.S. Public Offering (November 2024)

On November 1, 2024, the Company announced the closing of a public offering of 80,000 Common Shares and 3,809,000 pre-funded warrants (“PFW”) at a public offering price of $1.25 (US$0.90) per Common Share. The gross proceeds from the offering were $4.9 million (US$3.5 million). The fair value of the pre-funded warrants on initial recognition was 1.249, which is the purchase price less the exercise price of $0.001.

Refer to Note 11(a) for further information on the offering.

Under IFRS, the pre-funded warrants 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. Gains on revaluation of the warrant liabilities are presented in other income (expenses) on the unaudited condensed consolidated interim statements of net loss and comprehensive loss.

Warrant liabilities

639,000 pre-funded warrants were subsequently exercised at a weighted average exercise price of US$0.01. On November 12, 2024, we converted the remaining 3,170,000 pre-funded warrants to CAD denomination which led to the transfer of pre-funded warrants to equity and extinguishing the warrant liability. On November 12, 2024, we recognized a gain of $693,328 in the change in fair value of warrant liabilities, before reclassifying the pre-funded warrants to equity, which was reported in the unaudited condensed consolidated interim statements of net loss and comprehensive loss.

11. Share Capital and Contributed Surplus

As disclosed in Note 1(b), the 2024 Reverse Split has been applied retrospectively herein.

a) Share capital

Authorized

KWESST is authorized to issue an unlimited number of common shares.

Issued Common Shares

The following is a summary of changes in outstanding common shares since September 30, 2024:

Debt Settlement (January 2024)

On January 10, 2024, we issued 4,670 common shares in a settlement of debt in an amount of approximately $97,615. The debt resulted from a tail obligation relating to services rendered by a third-party consultant which the Company has elected to pay in common shares. The common shares issued pursuant to the Debt Settlement (signed October 31, 2023) were subject to a four-month hold period pursuant to applicable securities legislation and the policies of the TSX Venture Exchange.

U.S. Public Offering (April 2024)

On April 9, 2024, we closed a brokered U.S. public offering, resulting in the issuance of 73,500 common shares of KWESST, for aggregate gross proceeds of $1.4M (US$1.0M) (the "April 2024 Public Offering").

As a part of the April 2024 Public Offering, the Company issued 73,500 common shares and 80,350 pre-funded warrants with an exercise price of $0.01 ("Pre-funded Warrants") at a public offering price of $8.80 (US$6.50) per share and $8.81 (US$6.49) per Pre-funded Warrant, less the underwriting discount.

Brokers' Compensation and Share Offering Costs

ThinkEquity acted as sole book-running manager for the April 2024 Public Offering. As compensation for services rendered, the placement agent fees represent $0.4875 per unit (being an aggregate of $101,838 (US$75,002) or 7.5% of the public offering price of the securities). In addition, the Company issued 7,692 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 April 2024 Public 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 April 2024 Public Offering at an initial exercise price of $11.032 (US$8.125) per Common Share. The share offering costs related to the April 2024 Public Offering that was recognized in the consolidated statements of net loss and comprehensive loss was $339,324 and recognized in equity was $269,400.

The fair value of the broker compensation warrants at the closing of the April 2024 Public Offering was $43,868, calculated using the Black Scholes model, and total share offering costs were $608,724.

U.S. Public Offering (June 2024)

On June 14, 2024, we closed a brokered U.S. public offering, resulting in the issuance of 290,000 common shares of KWESST for aggregate gross proceeds of approximately $2.3M (US$1.7M) (the "June 2024 Public Offering").

As a part of the June 2024 Public Offering, the Company issued 290,000 common shares at a public offering price of $8.00 (US$5.80) per share, less the placement agent fees.

Brokers' Compensation and Share Offering Costs

ThinkEquity acted as sole book-running manager for the June 2024 Public Offering. As compensation for services rendered, the placement agent fees represent $0.435 per common share (being an aggregate of $173,469 (US$126,150) or 7.5% of the public offering price of the securities). In addition, the Company issued to the placement agent 14,500 common share purchase warrants with an exercise price of $10.00 (US$7.25) per Common Share, exercisable, in whole or in part, immediately upon issuance and will expire 60 months after the closing date of the June 2024 Public Offering. All of the share offering costs related to the June 2024 Public Offering were recognized in equity.

The fair value of the broker compensation warrants at the closing of the June 2024 Public Offering was $61,213, calculated using the Black Scholes model, and total share offering costs were $384,509.

U.S. Registered Direct Offering (August 2024)

On August 13, 2024, we closed a registered direct offering for the purchase and sale of 471,500 common shares at a purchase price of $2.74 (US$2.00) per common share for gross proceeds of $1.4M (US$0.9M) (the "August 2024 Offering"). In a concurrent private placement, the Company issued unregistered warrants to purchase up to 471,500 common shares at an exercise price of $3.43 (US$2.50) per share that are immediately exercisable upon issuance and will expire five years following the date of issuance.

Brokers' Compensation and Share Offering Costs

H.C. Wainwright & Co. ("Wainwright") acted as the exclusive placement agent for the August 2024 Offering. As compensation for services rendered, the placement agent fees were US$70,725 or 7.5% of the public offering price of the securities). In connection with the closing of the August 2024 Offering, we issued Wainwright or its designees warrants to purchase up to an aggregate of 35,362 common shares at an exercise price of US$2.50 per share, the warrants are exercisable upon issuance and have a expiry date of August 9, 2029. The shares offered as Brokers' Compensation related to the August 2024 Offering were recognized in equity.

The fair value of the broker compensation warrants at the closing of the August 2024 Offering was $28,632, calculated using the Black Scholes model. The share offering costs related to the August 2024 Offering that was recognized in the consolidated statements of net loss and comprehensive loss was $202,242 and recognized in equity was $281,869.

U.S. Public Offering (November 2024)

On November 1, 2024, the Company announced the closing of a public offering of 80,000 Common Shares and 3,809,000 pre-funded warrants ("PFW") at a public offering price of $1.25 (US$0.90) per Common Share (the "November 2024 Offering"). The gross proceeds from the offering were approximately $4.9 million (US$3.5 million), before deducting placement agent fees of $0.094 (US$0.0675) per Common Share (being an aggregate of $365,726 (US$262,508) or 7.5% of the public offering price of the securities). In addition, the Company issued to the placement agent as compensation for its services 194,450 common share purchase warrants with an exercise price of $1.567 (US$1.125) per share.

On November 12, 2024, we amended the PFWs whereas the exercise price of the warrants, along with all the other settlement amounts, were amended to be denominated in CAD currency, which is consistent with the Company's functional and presentation currency. As a result, we reclassified the remaining unexercised PFW's as equity instruments under IAS 32. This resulted in a transfer of $3,301,925 from warrant liabilities to equity warrants. The amendments effectively remove the cashless exercise option and ensure settlement in CAD, thereby meeting the criteria for equity classification. We also applied IFRIC 19 to appropriately derecognize the liabilities and recognize the equity effective November 12, 2024.

Accounting Treatment

Refer to Note 10 for the accounting of the warrants issued in the November 2024 Offering accounted for as warrant liabilities up to November 11, 2024.

The remaining 3,170,000 PFWs were subsequently exercised at a weighted average exercise price of $1.04, for proceeds of $3,301,925, during the three months ended December 31, 2024.

Brokers' Compensation and Share Offering Costs

In connection with the August 2024 Offering, Wainwright was also granted a tail obligation resulting in earning 7.5% on any equity financing raised from investors introduced to the Company as part of the offering. The November 1, 2024 financing fell entirely within the scope of the tail obligation and resulted in a payment of $362,618 (US$260,661), representing 7.5% of the $4.9 million (US$3.5 million) gross proceeds to Wainwright upon closing of the transaction.

ThinkEquity acted as the sole placement agent for the November 2024 Offering. As compensation for services rendered, the placement agent fees were $365,725 (US$262,508) or 7.5% of the public offering price of the securities). In addition, the Company issued to the placement agent as compensation for its services 194,450 common share purchase warrants with an exercise price of $1.567 (US$1.125) per share. The warrants are exercisable upon issuance and have an expiry date of November 1, 2029. The shares offered as Brokers' Compensation related to the November 2024 Offering were recognized in equity.

The fair value of the broker compensation warrants at the closing of the November 2024 Offering was $187,468, calculated using the Black Scholes model.

The share offering costs related to the November 2024 Offering that were recognized in the unaudited condensed consolidated statements of net loss and comprehensive loss was $1,807,686 and recognized in equity were $227,557, inclusive of the broker compensation warrants.

Debt Settlement (November 2024)

On November 11, 2024, we issued 119,047 common shares at a deemed price per Common Share of CAD$0.84 per share, representing a 20% discount on the closing price of the Shares on the TSX Venture Exchange on the last trading day prior to this news release, for settlement of business expenses incurred while representing the Company in an aggregate amount of $100,000 owed to a company controlled by Mr. David Luxton, Chairman of the Company.

Private Placement (November 2024)

On November 12, 2024, we closed a brokered private placement offering to an institutional accredited investor for aggregate gross proceeds of approximately $3.4 million (approximately US$2.5 million) (the "November 2024 PP").

As a part of the November 2024 PP, the Company issued 4,145,200 pre-funded warrants to acquire one common share of the Company, no par value per share at a price of $0.824 (US$0.592) per pre-funded warrant, inclusive of the exercise price of $0.001 per Common Share. Each pre-funded warrant was bundled with one common share purchase warrant ("Common Warrant") of the Company. Each Common Warrant is immediately exercisable and entitles the holder to acquire one Common Share at an exercise price of $1.03 (US$0.74) per Common Share for a period of 60 months following the closing of the November 2024 PP. Although the pre-funded warrants are each bundled with a Common Warrant, each security is issued separately. Since the instruments were bundled, the Company uses the bifurcation method to determine the fair value of each security. The Black Scholes model was used to determine the fair value of the underlying Common Warrant and the remainder of the purchase price was allocated to the pre-funded warrant, resulting in a fair value of the Common Warrants of $0.765 and a fair value of $0.06 for the pre-funded warrants.

Brokers' Compensation and Share Offering Costs

In connection with the August 2024 Offering, Wainwright was also granted a tail obligation resulting in earning 7.5% on any equity financing raised from investors introduced to the Company as part of the offering. The November 12, 2024 financing fell entirely within the scope of the tail obligation and resulted in a payment of $259,534 (US$184,047), representing 7.5% of the $3.4 million (US$2.5 million) gross proceeds to Wainwright upon closing of the transaction.

ThinkEquity acted as sole placement agent for the Offering. As compensation for services rendered, the Company (i) paid to ThinkEquity, at the closing of the November 2024 PP, a cash fee equal to $274,027 (US$196,400), representing 8.0% of the aggregate gross proceeds of the November 2024 PP; and (ii) issued to ThinkEquity or its designees 207,260 warrants ("Placement Agent Warrants") to purchase an equivalent number of Common Shares equal to 5% of the Pre-funded warrants sold in the November 2024 PP. The Placement Agent Warrants are immediately exercisable, and entitle the holder to acquire one Common Share at an exercise price of $1.03 (US$0.74) per Common Share for a period of 60 months following the closing of the November 2024 PP.

The fair value of the broker compensation warrants at the closing of the November 2024 PP was $158,554, calculated using the Black Scholes model.

The share offering costs related to the November 2024 PP that were recognized in equity were $681,185, inclusive of the broker compensation warrants.

b) Warrants

The following is a summary of changes in outstanding warrants since September 30, 2024:

The table below outlines the ratio upon which the above warrants are converted into common shares. 

(1) The Pre-Funded Warrants exercised in Fiscal 2025 had a strike price of $0.01.

In the three months ended December 31, 2024, there were 3,809,000 PFWs from the November 2024 Offering with fair values ranging from $1.03 to $1.29 and 2,300,000 PFWs from the November PP with a fair value of $0.06 exercised, resulting in an increase to share capital of $4,227,111, a decrease to warrants of $3,439,926 and a decrease to warrant liabilities of $667,634 with the difference being recorded in the change in fair value of the warrant liabilities that was recognized in the unaudited condensed consolidated statements of net loss and comprehensive loss.

In the three months ended December 31, 2024, there were 20,000 warrants that expired with a fair value of $6.60 resulting in $132,000 being recorded to contributed surplus.

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.

Share-based compensation

On August 26, 2024, KWESST shareholders approved the renewal of the Long-Term Incentive Plan (the "LTIP"). The number of RSUs, PSUs, deferred share units ("DSUs"), and stock appreciation rights ("SARs") (collectively "Share Units") authorized for issuance pursuant to the LTIP is 40,727 Share Units. Accordingly, we have 18,166 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 $36.00, 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.

We did not grant any stock options, RSUs, PSUs, and SARs, pursuant to our LTIP during the three months ended December 31, 2024. Accordingly, we had 22,561 outstanding stock options at December 31, 2024, we have 766,161 stock option units available for future grants.

For the three months ended December 31, 2024, we recorded share-based compensation of $51,055 (2023 - $63,489).

12. Loss per share

As disclosed in Note 1(b), the 2024 Reverse Split has been applied retrospectively herein.

The following table summarizes the calculation of the weighted average basic number of basic and diluted common shares to calculate the loss per share as reported in the unaudited condensed consolidated interim statements of net loss and comprehensive loss:

At December 31, 2024 and 2023, all dilutive securities, being warrants, pre-funded warrants and stock options, were anti-dilutive because we incurred a net loss for the above periods.

13. 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 contracts with customers is disaggregated by primary geographical market, major products and service lines, and timing of revenue recognition.

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 December 31, 2024, KWESST's contracted not yet recognized revenue was $158,011 (2023 - $392,636), of which 100% of this amount is expected to be recognized over the next 12 months.

For the three months ended December 31, 2024, three customers accounted for 58.75%, 11.31% and 10.94% (2023 - three customers accounted for 47.65%, 14.87%, and 12.95%) of revenue.

14. Net finance costs

The following table presents a breakdown of net finance costs for the following periods:

15. Financial instruments

For the three months ended December 31, 2024, there were no material changes to our financial risks as disclosed in Note 23 of the Annual Financial Statements, except for the following:

Foreign currency risk

For the three months ended December 31, 2024, we raised grossed proceeds of $4.9 million (US$3.5 million) in a November US Public Offering (see Note 11(a)), including the issuance of warrants with exercise price denominated in U.S. dollar in the November U.S. Public Offering (see Note 10). Warrants exercised in the three months ended December 31, 2024 resulted in proceeds of $0.8 million (US$0.6 million). On November 12, 2024, the warrants were subsequently converted to CAD denomination and extinguished from liabilities as they were transferred to equity. We also raised gross proceeds of $3.4 million (US$2.5 million) in a November CAD Private Placement (see Note 11(a)), including the issuance of warrants with exercise price denominated in CAD dollar in the November Private Placement (see Note 10). Although the financing was denominated in CAD, the terms of the deal allowed for the proceeds to be sent to the Company in the U.S. dollar currency for convenience. Also, certain of our revenues were denominated in U.S. dollars and we also procure certain raw materials denominated in U.S. dollars 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 the U.S. dollar exposure. Throughout the year we maintained the majority of our cash assets in the U.S. dollar currency and converted to CAD as needed as we primarily raise our funds in the U.S. dollar currency.

At December 31, 2024, we had the following net U.S. dollar exposure:

During the three months ended December 31, 2024, we recorded a foreign exchange gain of $113,283 (2023 - gain of $91,710).

Liquidity risk

At December 31, 2024, our contractual obligations were as follows:

At December 31, 2024, we had $2.9 million in cash and $2.8 million in working capital (current assets less current liabilities).

16.   Supplemental cash flow information

The following table presents changes in non-cash working capital:

The following is a summary of non-cash items that were excluded from the Unaudited Condensed Consolidated Statements of Cash Flows for the three months ended December 31, 2024:

• 119,047 shares issued for debt settlement of business expenses incurred while representing the Company in an aggregate amount of $100,000 owed to a company controlled by Mr. David Luxton, Chairman of the Company;
• $187,468 non-cash share offering costs as part of the net proceeds settlement at the closing of the November 1, 2024 U.S. Public Offering (see Note 11(a));
• $221,088 non-cash share offering costs as part of the net proceeds settlement at the closing of the November 12, 2024 Private Placement (see Note 11(a)); and
• 20,000 warrants in connection with the acquisition of Police Ordnance Company (see Note 4 of the Annual Financial Statements) expired December 15, 2024.

There were no significant non-cash items that were excluded from the Statements of Cash Flows for the three months ended December 31, 2023.

17. Commitments and contingencies

There were no commitments and contingencies at December 31, 2024 other than the royalty payment disclosed in Note 8.

18.   Segmented information

Our Chairman has been identified as the chief operating decision maker. Our 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 December 31, 2024, we had one right-of-use asset ($41,699) (2023 - $72,315), some inventory ($153,087) (2023 - $57,955) and equipment ($66,204) (2023 - $106,274) in the United States while all other property and equipment are located in Canada.

KWESST MICRO SYSTEMS INC.

MANAGEMENT'S DISCUSSION AND ANALYSIS

Three months ended December 31, 2024

(Expressed in Canadian Dollars)

All references in this management's discussion and analysis (the "MD&A") to "KWESST", "we", "us", "our", and the "Company" refer to KWESST Micro Systems Inc. and its subsidiaries as at December 31, 2024. This MD&A has been prepared with an effective date of February 14, 2025.

This MD&A should be read in conjunction with our unaudited condensed consolidated interim financial statements for the three months ended December 31, 2024 ("Q1 Fiscal 2025 FS") and the annual audited consolidated financial statements and related notes for the year ended September 30, 2024 ("Fiscal 2024 FS"). The financial information presented in this MD&A is derived from these unaudited condensed consolidated interim financial statements prepared in accordance with International Financial Reporting Standards ("IFRS") as issued by the International Accounting Standards Board ("IASB"). This MD&A contains forward-looking statements that involves risk, uncertainties and assumptions, including statements regarding anticipated developments in future financial periods and our future plans and objectives. There can be no assurance that such information will prove to be accurate, and readers are cautioned not to place undue reliance on such forward-looking statements. See "Forward-Looking Statements".

All references to $ or dollar amounts in this MD&A are to Canadian currency unless otherwise indicated.

Additional information, including press releases, relating to KWESST is available for view on SEDAR+ at www.sedar.com.

In this MD&A, we have presented earnings before interest, taxes, depreciation and amortization ("EBITDA") and EBITDA that has been adjusted for the removal of share-based compensation, foreign exchange loss (gain), change in fair value of derivative liabilities, and any one-time, irregular and non-recurring items ("Adjusted EBITDA") to provide readers with a supplemental measure of our operating performance and thus highlight trends in our core business that may not otherwise be apparent when relying solely on IFRS financial measures. Management also uses non-IFRS measures, in addition to IFRS financial measures, to understand and compare operating results across accounting periods, for financial and operational decision making, for planning and forecasting purposes, and to evaluate our financial performance. We believe that these non-IFRS financial measures enable us to identify underlying trends in our business that could otherwise be hidden by the effect of certain expenses that we exclude in the calculations of the non-IFRS financial measures.

Accordingly, we believe that these non-IFRS financial measures reflect our ongoing business in a manner that allows for meaningful comparisons and analysis in the business and provides useful information to investors and securities analysts, and other interested parties in understanding and evaluating our operating results, enhancing their overall understanding of our past performance and future prospects.

We caution readers that these non-IFRS financial measures do not replace the presentation of our IFRS financial results and should only be used as a supplement to, not as a substitute for, our financial results presented in accordance with IFRS. There are limitations in the use of non-IFRS measures because they do not include all the expenses that must be included under IFRS as well as they involve the exercise of judgment concerning exclusions of items from the comparable non-IFRS financial measure. Furthermore, other peers may use other non-IFRS measures to evaluate their performance, or may calculate non-IFRS measures differently, all of which could reduce the usefulness of our non-IFRS financial measures as tools for comparison.

As an early-stage company, we have not yet reached significant revenue levels 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. KWESST's Q1 Fiscal 2025 FS have been prepared on the going concern basis which presumes that KWESST will be able to realize its assets and discharge its liabilities in the normal course of business for the foreseeable future. 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. Refer to Note 2(a) of the Q1 Fiscal 2025 FS for further information.

TRADEMARKS

We own or have rights to various trademarks, service marks and trade names that we use in connection with the operation of our business. This MD&A also contains additional trademarks, trade names and service marks belonging to other companies. Solely for convenience, trademarks, trade names and service marks referred to in this MD&A may appear without the ®, ™ or SM symbols, but such references are not intended to indicate, in any way, that we will not assert, to the fullest extent under applicable law, our rights or the right of the applicable licensor to these trademarks, trade names and service marks. We do not intend our use or display of other parties' trademarks, trade names or service marks to imply, and such use or display should not be construed to imply a relationship with, or endorsement or sponsorship of us by, these other parties.

Certain statements in this document constitute "forward-looking statements" and "forward-looking information" within the meaning of applicable Canadian and United States securities laws (together, "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:

• our expectations regarding our business, financial condition and results of operations;
• the future state of the legislative and regulatory regimes, both domestic and foreign, in which we conduct business and/or may conduct business in the future;
• our expansion into domestic and international markets;
• our ability to attract customers and clients;
• our marketing and business plans and short-term objectives;
• our ability to obtain and retain the licenses and personnel we require to undertake our business;
• our ability to deliver under contracts with customers;
• anticipated revenue and related margin from professional service contracts with customers;
• our strategic relationships with third parties;
• our anticipated trends and challenges in the markets in which we operate;
• governance of us as a public company; and
• expectations regarding future developments of products and our ability to bring these products to market.

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, some of which are discussed in greater detail under the section "Risk Factors" in our 20-F dated December 27, 2024:

• limited operating history;

• failure to realize our growth strategy;
• failure to complete transactions or realize anticipated benefits;
• reliance on key personnel;
• regulatory compliance;
• competition;
• changes in laws, regulations and guidelines;
• demand for our products;
• fluctuating prices of raw materials;
• pricing for products;
• ability to supply sufficient product;
• potential cancellation or loss of customer contracts if we are unable to meet contract performance requirements;
• expansion to other jurisdictions;
• damage to our reputation;
• operating risk and insurance coverage;
• negative operating cash flows;
• management of growth;
• product liability;
• product recalls;
• environmental regulations and risks;
• ownership and protection of intellectual property;
• constraints on marketing products;
• fraudulent or illegal activity by our employees, contractors and/or consultants;
• breaches of security at our facilities or in respect of electronic documents and data storage and risks related to breaches of applicable privacy laws;
• government regulations regarding public or employee health and safety regulations, including public health measures in the event of pandemics or epidemics;
• regulatory or agency proceedings, investigations and audits;
• additional capital requirements to support our operations and growth plans, leading to further dilution to shareholders;
• the terms of additional capital raises;
• conflicts of interest;
• litigation;
• risks related to United States' and other international activities, including regional conflicts that may impact our operations;
• risks related to security clearances;
• risks relating to the ownership of our securities, such as potential extreme volatility in the price of our securities;
• risks related to our foreign private issuer status;
• risks related to our emerging growth status;
• risks related to our failure to meet the continued listing requirements of the Nasdaq Capital Market ("Nasdaq"), particularly the minimum bid price requirements within the second extension period;
• risks related to the shareholder vote required for a share consolidation to remediate our current Nasdaq minimum bid price deficiency;
• risks related to the liquidity of our common shares (the "Common Shares"); and
• significant changes or developments in United States trade policies and tariffs which may have a material adverse effect on our business and financial statements.

Although the forward-looking statements contained herein 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 operations. 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.

BUSINESS OVERVIEW

Corporate Information

We are a Canadian corporation 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).

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.

Our product development has focused on three niche market segments as follows:

Our core mission is to protect and save lives. We group our offerings for commercialization purposes into Military and Public Safety missions, as shown on our website at www.kwesst.com.

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;

• Digitized firing platforms ("Digital Fires" or "Joint Fires");
• Battlefield Laser Detection Systems ("BLDS"); and
• Digitized Electro Magnetic Spectrum Operations ("EMSO").

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"). The Company is currently engaging in trials and pilots of the product as it continues development towards the commercial release that is currently expected to be available in Fiscal 2025.

• Less-Lethal Munitions Systems:

• PARA OPSTM, a next-generation less-lethal system just being introduced to market now.
• ARWENTM 37mm system, plus a new 40mm munition.

Strategy

Our strategy is to pursue and win large defense contracts for multi-year revenue visibility with prime defense contractors for next-generation situational awareness, with a particular focus on ATAK applications that can be leveraged to address similar requirements in the Public Safety Market complemented by our proprietary ARWEN and PARA OPSTM  less-lethal products, where it is possible to drive sales and where the sales cycle is typically shorter than the more programmatic defense market. 

Major Highlights - Quarter ended December 31, 2024 ("Q1 Fiscal 2025")

The following is a summary of the major highlights that occurred during Q1 Fiscal 2025:

• On October 1, we updated investors on the ramp-up of activity on our sub-contract to Thales Canada in support of the Canadian DND Land C4ISR (Land Command, Control, Communications, Computers, Intelligence, Surveillance and Reconnaissance) series of contracts to modernize the Canadian Army's capabilities through advanced Land C4ISR systems program. KWESST was in various stages of completing its staffing with conditional offers accepted for all 16 positions on the program, representing an annualized revenue of approximately $3.3 million. The Company expects to continue to increase staffing, and related revenue, as future taskings are received. The Company's maximum potential workshare under the Land C4ISR and DSEF (Directorate Land Command Systems Program Management Software Engineering Facility) remains approximately CAD$48 million and $27 million for the initial contract periods of six and five years respectively.

• On October 10, we announced our plan to proceed with a consolidation of our outstanding Common Shares on the basis of ten (10) pre-consolidation shares for each one (1) post-consolidation share (the "Consolidation"). The Company believed that the Consolidation was in the best interests of shareholders as it allowed the Company to ensure continued compliance with the Nasdaq minimum bid price requirements.

• On October 21, we announced that, further to the Company's press release on October 10, 2024, the Company has received approval of the TSX Venture Exchange for the consolidation of the Company's issued and outstanding Common Shares on the basis of ten (10) pre-consolidation shares for each one (1) post-consolidation share.

• On October 23, we announced that our wholly-owned subsidiary, KWESST Inc., had entered into a receivables factoring agreement with a US-based global financing company. The facility provides up to CAD$250,000 advanced at a rate of 2.5% for the first thirty days and 1% for each ten days thereafter until receipt of funds from the receivable payee and is limited to a total of 20% of the value of the receivable funded. Funds are advanced at 80% up front of the face value of the receivable with a 20% fee deposit retained by the financing company until the amount funded is fully repaid, following which any balance remaining of the 20% fee deposit is returned to KWESST Inc. The agreement grants security against KWESST Inc.'s receivables and other assets for funds advanced by the financing company. The initial term is for 12 months and may be terminated within such term by KWESST Inc., subject to the payment of an early termination fee of 3% of the total limit of the facility.

• On October 23, we announced we had completed our plan to ramp up volume production of ARWEN cartridges, including the new 40mm baton round following successful characterization testing by a recognized ballistics laboratory. The ARWEN system is long-established in the law enforcement community and was designed as an alternative to lethal force for maintaining public order in the event of riots and civil unrest during protests and demonstrations. Historically, the Company has offered a 37mm cartridge that fires from its ARWEN launchers. In a move to expand the market for ARWEN branded products and to leverage the large installed base of third-party 40mm firing platforms, KWESST announced and showcased a new 40mm baton cartridge at the annual SHOT Show in January 2024. Live fire demonstrations at the SHOT Show Range Day and other events since then have demonstrated the notable performance of the new 40mm baton cartridge.

• On November 1, we announced the closing of a public offering of 3,889,000 pre-funded warrants at a public offering price of $1.25 (US$0.90) per Common Share. The gross proceeds from the offering were approximately $4.9 million (US$3.5 million), before deducting placement agent fees of US$0.0675 (CAD$0.094) per Common Share (being an aggregate of $365,726 (US$262,508 ) or 7.5% of the public offering price of the securities) and estimated offering expenses were $417,960 (US$300,000). In addition, the Company issued to the placement agent as compensation for its services 194,450 Common Share purchase warrants with an exercise price of $1.567 (US$1.125) per share.

• On November 11, we announced that we intended to issue a total of 119,047 Common Shares at a deemed price per Common Share of $0.84 per share, representing a 20% discount on the closing price of the Shares on the TSXV for settlement of business expenses incurred while representing the Company in an aggregate amount of CAD$100,000 owed to a company controlled by Mr. David Luxton, Chairman of the Company.

• On November 12, we announced the closing of a brokered private placement offering to an institutional accredited investor for aggregate gross proceeds of approximately $3.4 million (the "November 2024 Offering"). As a part of the November 2024 Offering, the Company issued 4,145,200 pre-funded warrants to acquire one Common Share at a price of $0.824 per pre-funded warrant, inclusive of the exercise price of $0.001 per Common Share. Each pre-funded warrant was bundled with one Common Share purchase warrant of the Company. We also announced that the Company amended the terms of the outstanding pre-funded warrants issued on November 1, 2024, as part of the Company's best efforts public offering in the United States. The amendments revised the exercise price of the pre-funded warrant from USD$0.001 to CAD$0.0014, revised currency references from USD to CAD, and removed the ability for the holder to exercise the pre-funded warrant on a cashless basis. The foregoing amendments were agreed to by the holder of such pre-funded warrants pursuant to a pre-funded warrant amendment agreement.

• On November 13, we announced that we received a letter from Nasdaq, notifying the Company that it is eligible for an additional 180 calendar day period, or until May 12, 2025, to regain compliance with the minimum bid price requirement. The Company was first notified by Nasdaq of its failure to maintain the minimum bid price requirement on May 16, 2024 and was given until November 12, 2024 to regain compliance. The Company did not regain compliance with the minimum bid price requirement during the first 180 calendar day period. On November 13, 2024, in accordance with Nasdaq Listing Rule 5810(c)(3)(A), the Company was provided with an additional and final 180 calendar day period, or until May 12, 2025, to regain compliance with the minimum bid price requirement. To regain compliance, the closing bid price of our Common Shares must meet or exceed US$1.00 per share for a minimum of ten consecutive business days at any time prior to the Compliance Date, unless the Nasdaq staff exercises its discretion to extend this ten-day period pursuant to Nasdaq Listing Rule 5810(c)(3)(H). Should the Company fail to cure the deficiency in the second 180-day extension period which ends May 12, 2025, no further extensions will be granted and the Nasdaq will initiate delisting procedures. 

• In December 2024, the LEC royalty payment (see Contractual Obligations and Commitments below) that was due April 2025, in the amount of $200,000 was paid early to DEFSEC in exchange for a $25,000 reduction, resulting in a net payment of $175,000.

The following is a summary of major highlights that occurred after December 31, 2024:

• On January 6, the Company announced the appointment of Mrs. Jennifer Welsh as Chief Financial Officer and Chief Compliance Officer of the Company, replacing Mr. Kris Denis, who will transition to a new role within the KWESST finance team, reporting to Mrs. Welsh. The Company also announced the appointment of Mr. James Yersh as a director of the Company and Chair of the Audit Committee.

The following selected financial data has been extracted from Q1 Fiscal 2025 FS.

(1) EBITDA and Adjusted EBITDA are non-IFRS measures. See "Non-IFRS Measures". See below for reconciliation of Non-IFRS Measures.

In the following table, we have reconciled EBITDA and Adjusted EBITDA to the most comparable IFRS financial measure.

Current Quarter Variance Analysis (Q1 Fiscal 2025 vs. Q1 Fiscal 2024)

For Q1 Fiscal 2025, KWESST's net loss was $3.5 million compared to $0.4 million in Q1 Fiscal 2024. Q1 Fiscal 2025 EBITDA loss was $3.1 million, an increase of $3.0 million over the comparable prior year period mainly due to the share issuance costs incurred on the November 2024 public offering of $1.8 million whereas there were no equity raises in the comparable prior year period, a decrease in the gain on the change in fair value of the warrant liabilities which fluctuates depending on the Company's stock price, an increase in G&A and S&M expenses of $0.8 million due to increased professional fees and personnel costs offset by an increase in gross profit of $0.5 million on our digitization contracts.

Revenue

Total revenue increased by $0.8 million in Q1 Fiscal 2025 compared to Q1 Fiscal 2024, mainly due to an additional $0.6 million generated from our digitization business line, along with an increase of $0.1 million from our non-lethal business line (driven from the sale of ARWEN products).

We expect revenue to increase with the commercial launch of KWESST LightningTM which we expect to be in Fiscal 2025, as well as from the expected demand/future orders for the new ARWEN 40mm ammunition and PARA OPS products. Management continues to work with our industry partners to determine the outlook for ramp-up on the DSEF and LC4ISR programs.  The Company continues to expect no material impact to the overall potential revenue over the life of the contract.

Gross Profit

In Q1 Fiscal 2025, the gross profit was $0.4 million or 45.6% as compared to a gross loss of $0.1 million in Q1 Fiscal 2024. The increase in gross profit is due primarily to the ramp up of digitization revenue from government programs, the Canadian Red Cross contract that concluded in the period as well as the ramp up of higher margin ARWEN product sales. In Q1 Fiscal 2024, there were higher than anticipated costs on a fixed price digitization contract as well as initial ramp up costs on one of the government programs.

Operating Expenses ("OPEX")

Total OPEX increased by $0.9 million from the comparable prior year period in the three months ended December 31, 2024 due to the following factors:

• S&M increased by $0.2 million, primarily due to an increase in personnel costs due to a shift in allocation of senior management as they focus their current strategies on sales and marketing as well as increased head count, offset by a decrease in consulting costs as the Company increased head count to reduce the reliance on consultants;

• G&A increased by $0.6 million, primarily due to an increase in professional fees due to work relating to the Nasdaq Minimum Price requirement and the internal control consulting work, the impairment of a right-of-use asset, an increase in overall general expenses, along with an increase in personnel costs due to an increased head count along with a short-term incentive plan expense, offset by a decrease in consulting fees; and

• R&D increased by $0.1 million, primarily due to an increase in personnel costs advancing the KWESST LightningTM and BLDS projects in Q1 Fiscal 2025, offset by a decrease in engineering costs related to the PARA OPS products.

Other income (expenses), net

For Q1 2025, our total other expenses were $0.5 million, compared to total other income of $2.1 million in Q1 2024 resulting in a decrease of $2.6 million. The change in other income (expenses) was driven mainly by:

• a $0.8 million unfavorable change in the fair value of warrant liabilities as a result of the remeasurement of the warrant liabilities at December 31, 2024. Under IFRS, we are required to remeasure the warrant liabilities at each reporting date until they are exercised or expired; and

• $1.8 million in share offering costs related to the November 2024 public offering. There were no equity financings in the comparable prior year period.

SUMMARY OF QUARTERLY RESULTS

The following table summarize selected results for the eight most recently completed quarters to December 31, 2024 (unaudited):

Quarterly Results Trend Analysis

There is no material change to our quarterly results trend from our disclosure in our annual MD&A dated December 27, 2024 except that we expect further volatility with our quarterly revenue during Fiscal 2025 due to the uncertain magnitude and timeline of ramp-up on our military government contracts, ramp-up of revenue for new ARWEN and PARA OPS products, as well as the uncertain magnitude and timeline of any equity financings and related share issuance costs. 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 the statements of changes in net loss and comprehensive loss.

FINANCIAL CONDITION, LIQUIDITY, AND CAPITAL RESOURCES

FINANCIAL CONDITION

The following table summarizes our financial position:

   (1) Working capital is calculated as current assets less current liabilities.

Our working capital was $2.8 million at December 31, 2024, a $4.0 million increase from September 30, 2024. The increase was primarily due to the proceeds from two financings in Q1 Fiscal 2025 and a decrease in accounts payable and royalties payable. Current liabilities include warrant liabilities, a non-cash liability item (see Note 10 of the Q1 Fiscal 2025 FS). Excluding warrant liabilities, we would have working capital of $3.2 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 $2.5 million from September 30, 2024, mainly due to an increase in cash of $2.6 million from two financing activities in the first quarter of Fiscal 2025 and an increase in accounts receivable of $0.5 million due to the digitization contracts, offset by a decrease in the unamortized value of non-current assets of $0.3 million and a decrease in the deferred financing costs recognized in Q1 Fiscal 2025 of $0.3 million.

Total liabilities decreased by $1.2 million from September 30, 2024, mainly due to a decrease in accounts payable and accrued liabilities of $0.5 million due to the timing of payments to suppliers, a $0.2 million decrease in royalties payable due to an early repayment in Q1 Fiscal 2025 resulting in a $25,000 discount. The royalty payable is from the purchase of the LEC patents from a company owned by the Company’s Chairman. A decrease in warrant liabilities of $0.4 million due to the fluctuation in the Company's stock price and a $0.1 million decrease in existing lease obligations.

LIQUIDITY AND CAPITAL RESOURCES

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 November 1, 2024, we closed a public offering pursuant to which we received aggregate gross proceeds of USD$3.5 million (CAD$4.9 million), before underwriting and offering costs. On November 12, 2024, we closed a private placement pursuant to which we received aggregate gross proceeds of CAD$3.4 million, before underwriting and offering costs.

At December 31, 2024, our cash position was $2.9 million, an increase of $2.6 million since September 30, 2024 primarily due to two financing activities of CAD$8.3 million before underwriting and offering costs, offset by cash used in operations of $5.1 million.

As an early-stage company, we have not yet reached significant revenue levels 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. On October 23, 2024, the Company entered into a receivable factoring agreement. The facility provides up to CAD$250,000 advanced at a rate of 2.5% for the first thirty days and 1% for each ten days thereafter until receipt of funds from the receivable payee and limited to a total of 20% of the value of the receivable funded. Funds are advanced at 80% up front of the face value of the receivable with a 20% fee deposit retained by the financing company until the amount funded is fully repaid, following which any balance remaining of the 20% fee deposit is returned to KWESST Inc. The agreement grants security against KWESST Inc.'s receivables and other assets for funds advanced by the financing company. The initial term is for 12 months and may be terminated within the term by KWESST Inc. subject to the payment of an early termination fee of 3% of the total limit of the facility. In our view, the availability of capital will be affected by, among other things, capital market conditions, the success of our PARA OPS system market development efforts, timing for winning new customer contracts, potential acquisitions, and other relevant considerations. 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.

Consolidated Statements of Cash Flows

The following table summarizes our consolidated statements of cash flows for the respective periods:

Cash used in operating activities

Cash flow used in operating activities increased by $0.4 million to $3.2 million for the three months ended December 31, 2024 primarily due to payments on payables, an increase in G&A and S&M expenses, compared to regular operating activities in Q1 Fiscal 2024, with no significant transactions.

Cash used in investing activities

Cash flow used in investing activities in Q1 Fiscal 2025 was comparable to Q1 Fiscal 2024 mainly due to minor investments in property and equipment as well as related patents.

Cash provided by (used in) financing activities

Cash flow provided by financing activities was $5.9 million in Q1 Fiscal 2025 compared to an insignificant amount of cash flows used in financing activities in Q1 Fiscal 2024 related to the repayment of lease obligations. The increase was due to the two financing activities with gross proceeds of $8.3 million offset by share offering costs of 2.4 million.

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. Senior management is responsible for managing capital through regular review of financial information to ensure sufficient resources are available to meet operating requirements and investments to support the 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. 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, revenue.  The following is a breakdown of our capital:  

Contractual Obligations and Commitments

At December 31, 2024, our contractual obligations and commitments were as follows:

Refer to the summary of major highlights that occurred in Q1 Fiscal 2025 section above regarding the minimum royalty payment due within one year.

Shares Outstanding

At December 31, 2024, 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 December 31, 2024:

(1) Represents the number of shares to be issued upon exercise.

The following table shows the outstanding Common Shares and dilutive securities at February 14, 2025:

(2) Represents the number of shares to be issued upon exercise.

Shares for Debt Settlement - January 2024

On January 10, 2024, we issued 4,670 Common Shares in a settlement of debt in an amount of approximately $97,615. See Note 11(a) of the Q1 Fiscal 2025 FS for further details.

US Public Offering - April 2024

On April 9, 2024, we closed a brokered US public offering, resulting in the issuance of 73,500 Common Shares, for aggregate gross proceeds of US$1,000,025 (approximately CAD$1.4 million) (the "April 2024 Public Offering"). See Note 11(a) of the Q1 Fiscal 2025 FS for further details.

For the estimated use of proceeds from the April 2024 Public Offering, refer to our annual MD&A for Fiscal 2024 dated December 27, 2024.

US Public Offering - June 2024

On June 14, 2024, we closed a brokered US public offering, resulting in the issuance of 290,000 Common Shares, for aggregate gross proceeds of approximately US$1,682,000 (approximately CAD$2.3 million) (the "June 2024 Public Offering"). See Note 11(a) of the Q1 Fiscal 2025 FS for further details.

For the estimated use of proceeds from the June 2024 Public Offering, refer to our annual MD&A for Fiscal 2024 dated December 27, 2024.

US Registered Direct Offering - August 2024

On August 13, 2024, we closed the August 2024 Offering for the purchase and sale of 471,500 Common Shares at a purchase price of US$2.00 per Common Share for gross proceeds of US$943,000 (approximately CAD$1.4 million) (the "August 2024 Direct Offering"). See Note 11(a) of the Q1 Fiscal 2025 FS for further details.

For the estimated use of proceeds from the August 2024 Direct Offering, refer to our annual MD&A for Fiscal 2024 dated December 27, 2024.

US Public Offering - November 2024

On November 1, 2024, we closed the November 2024 Public Offering for the purchase and sale of 3,889,000 pre-funded warrants at a purchase price of US$0.90 per pre-funded warrant. The gross proceeds were US$3.5 million (approximately CAD$4.9 million). See Note 11(a) of the Q1 Fiscal 2025 FS for further details.

Shares for Debt Settlement - November 2024

On November 11, 2024, we issued 119,047 Common Shares in a settlement of debt in an amount of $100,000. See Note 11(a) of the Q1 Fiscal 2025 FS for further details.

Private Placement - November 2024

On November 12, 2024, we closed the November 2024 Private Placement for the purchase and sale of 4,145,200 pre-funded warrants at a purchase price of $0.824 for gross proceeds of $3.4 million. Each pre-funded warrant was bundled with one Common Share purchase warrant of the Company. See Note 11(a) of the Q1 Fiscal 2025 FS for further details.

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.

RELATED PARTY TRANSACTIONS

Refer to Note 8 of the Q1 Fiscal 2025 FS for disclosure about KWESST's related party transactions conducted in the normal course of business.

FINANCIAL INSTRUMENTS AND OTHER INSTRUMENTS

We recognize financial assets and liabilities when we become party to the contractual provisions of the instrument. On initial recognition, financial assets and liabilities are measured at fair value plus transaction costs directly attributable to the financial assets and liabilities, except for financial assets or liabilities at fair value through profit and loss, whereby the transactions costs are expensed as incurred.

Refer to Note 15 of the Q1 Fiscal 2025 FS for further disclosure of our financial instruments.

Refer to Note 2(f) of the Fiscal 2024 audited consolidated financial statements for a discussion of the accounting policies and estimates that are critical to the understanding of our business operations and the results of our operations.

OUTSTANDING SHARE INFORMATION

At December 31, 2024, KWESST's authorized capital consists of an unlimited number of Common Shares with no stated par value. There were 7,887,223 outstanding and issued Common Shares as at December 31, 2024.

SUBSEQUENT EVENTS

DISCLOSURE CONTROLS AND PROCEDURES AND INTERNAL CONTROLS OVER FINANCIAL REPORTING

As required by National Instrument 52-109 Certification of Disclosure in Issuers Annual and Interim Filings and Rule 13a-15(b) of the Securities Exchange Act of 1934 (the "Exchange Act"), as amended, we have evaluated, under the supervision and with the participation of management, including our Chief Executive Officer ("CEO") and Chief Financial Officer ("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 quarter. 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.

Based upon the evaluation, our CEO and CFO have concluded that the operation of our DC&P were effective as of September 30, 2024. Since the September 30, 2024, evaluation, there have been no changes in our DC&P that materially affected or are reasonably likely to materially affect our DC&P, accordingly their design remains effective.

Management's Assessment on Internal Controls 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 Securities Exchange Act of 1934 (the "Exchange Act"), as amended, the CEO and CFO are responsible for establishing and maintaining adequate internal controls over financial reporting ("ICFR"), The Company's management, including the CEO and CFO, 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.

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 of Directors, evaluated the effectiveness of our ICFR as at September 30, 2024 against the COSO Framework. Based on these evaluations, our management, including our CEO and CFO, concluded that no material weaknesses existed and our ICFR were effective as of September 30, 2024. During the first quarter ended on December 31, 2024, there have been no changes that have materially affected or is reasonably likely to materially affect our ICFR, accordingly their design remains effective.

Due to its inherent limitations, internal control over financial reporting may not prevent or detect misstatements on a timely basis. Additionally, projections of any evaluation of the effectiveness of internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. 

FORM 52-109F2

CERTIFICATION OF INTERIM FILINGS

FULL CERTIFICATE

I, Sean Homuth, Chief Executive Officer of KWESST Micro Systems Inc., certify the following:

1. Review: I have reviewed the interim financial report and interim MD&A (together, the "interim filings") of KWESST Micro Systems Inc. (the "issuer") for the financial quarter ended December 31, 2024.

2. No misrepresentations: Based on my knowledge, having exercised reasonable diligence, the interim filings do not contain any untrue statement of a material fact or omit to state a material fact required to be stated or that is necessary to make a statement not misleading in light of the circumstances under which it was made, with respect to the period covered by the interim filings.

3. Fair presentation: Based on my knowledge, having exercised reasonable diligence, the interim financial report together with the other financial information included in the interim filings fairly present in all material respects the financial condition, financial performance and cash flows of the issuer, as of the date of and for the periods presented in the interim filings.

4. Responsibility: The issuer's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (DC&P) and internal control over financial reporting (ICFR), as those terms are defined in National Instrument 52-109 Certification of Disclosure in Issuers' Annual and Interim Filings, for the issuer.

5. Design: Subject to the limitations, if any, described in paragraphs 5.2 and 5.3, the issuer's other certifying officer(s) and I have, as at the end of the period covered by the interim filings

(a) designed DC&P, or caused it to be designed under our supervision, to provide reasonable assurance that

(i) material information relating to the issuer is made known to us by others, particularly during the period in which the interim filings are being prepared; and

(ii) information required to be disclosed by the issuer in its annual filings, interim filings or other reports filed or submitted by it under securities legislation is recorded, processed, summarized and reported within the time periods specified in securities legislation; and

(b) designed ICFR, or caused it to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with the issuer's GAAP.

5.1 Control framework: The control framework the issuer's other certifying officer(s) and I used to design the issuer's ICFR is the Internal Control - Integrated Framework (COSO Framework) published by The Committee of Sponsoring Organizations of the Treadway Commission (COSO).

5.2 ICFR - material weakness relating to design: The issuer has disclosed in its interim MD&A for each material weakness relating to design existing at the end of the interim period:

(a) a description of the material weakness;

(b) the impact of the material weakness on the issuer's financial reporting and its ICFR; and

(c) the issuer's current plans, if any, or any actions already undertaken, for remediating the material weakness.

5.3 Limitation on scope of design: N/A

6. Reporting changes in ICFR: The issuer has disclosed in its interim MD&A any change in the issuer's ICFR that occurred during the period ended December 31, 2024 hat has materially affected, or is reasonably likely to materially affect, the issuer's ICFR.

Date: February 14, 2025

FORM 52-109F2

CERTIFICATION OF INTERIM FILINGS

FULL CERTIFICATE

I, Jennifer Welsh, Chief Financial Officer of KWESST Micro Systems Inc., certify the following:

1. Review: I have reviewed the interim financial report and interim MD&A (together, the "interim filings") of KWESST Micro Systems Inc. (the "issuer") for the financial quarter ended December 31, 2024.

2. No misrepresentations: Based on my knowledge, having exercised reasonable diligence, the interim filings do not contain any untrue statement of a material fact or omit to state a material fact required to be stated or that is necessary to make a statement not misleading in light of the circumstances under which it was made, with respect to the period covered by the interim filings.

3. Fair presentation: Based on my knowledge, having exercised reasonable diligence, the interim financial report together with the other financial information included in the interim filings fairly present in all material respects the financial condition, financial performance and cash flows of the issuer, as of the date of and for the periods presented in the interim filings.

4. Responsibility: The issuer's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (DC&P) and internal control over financial reporting (ICFR), as those terms are defined in National Instrument 52-109 Certification of Disclosure in Issuers' Annual and Interim Filings, for the issuer.

5. Design: Subject to the limitations, if any, described in paragraphs 5.2 and 5.3, the issuer's other certifying officer(s) and I have, as at the end of the period covered by the interim filings

(a) designed DC&P, or caused it to be designed under our supervision, to provide reasonable assurance that

(i) material information relating to the issuer is made known to us by others, particularly during the period in which the interim filings are being prepared; and

(ii) information required to be disclosed by the issuer in its annual filings, interim filings or other reports filed or submitted by it under securities legislation is recorded, processed, summarized and reported within the time periods specified in securities legislation; and

(b) designed ICFR, or caused it to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with the issuer's GAAP.

5.1 Control framework: The control framework the issuer's other certifying officer(s) and I used to design the issuer's ICFR is the Internal Control - Integrated Framework (COSO Framework) published by The Committee of Sponsoring Organizations of the Treadway Commission (COSO).

5.2 ICFR - material weakness relating to design: The issuer has disclosed in its interim MD&A for each material weakness relating to design existing at the end of the interim period:

(a) a description of the material weakness;

(b) the impact of the material weakness on the issuer's financial reporting and its ICFR; and

(c) the issuer's current plans, if any, or any actions already undertaken, for remediating the material weakness.

5.3 Limitation on scope of design: N/A

6. Reporting changes in ICFR: The issuer has disclosed in its interim MD&A any change in the issuer's ICFR that occurred during the period ended December 31, 2024 that has materially affected, or is reasonably likely to materially affect, the issuer's ICFR.

Date: February 14, 2025