As filed with the Securities and Exchange Commission on August 1, 2023.

Registration Statement No. 333-

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549
___________________________

FORM F-1

REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
___________________________

KWESST MICRO SYSTEMS INC.

(Exact name of registrant as specified in its charter)

British Columbia	3080	98-1650180
(State or other jurisdiction of incorporation or organization)	(Primary Standard Industrial Classification Code Number)	(I.R.S. Employer Identification No.)

155 Terence Matthews Crescent,
Unit #1, Ottawa, Ontario, K2M 2A8
(613) 241-1849
(Address, including zip code and telephone number, including area code, of registrant's principal executive offices)

C T Corporation System

1015 15th Street N.W., Suite 1000

Washington, DC 20005

(202) 572-3133
(Name, address, including zip code, and telephone number, including area code, of agent for service)

Copies to:

Richard Raymer
Dorsey & Whitney LLP
161 Bay Street, Unit #4310
Toronto, ON M5J 2S1, Canada
(416) 367-7370

Approximate date of commencement of proposed sale to the public: As soon as practicable after this Registration Statement becomes effective.

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box. ☒

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. ☐ 

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. ☐ 

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. ☐ 

Indicate by check mark whether the registrant is an emerging growth company as defined in Rule 405 of the Securities Act.

Emerging growth company ☒

If an emerging growth company that prepares its financial statements in accordance with U.S. GAAP, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 7(a)(2)(B) of the Securities Act.† ☐ 

† The term "new or revised financial accounting standard" refers to any update issued by the Financial Accounting Standards Board to its Accounting Standards Codification after April 5, 2012.

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, as amended, or until this Registration Statement shall become effective on such date as the United States Securities and Exchange Commission, acting pursuant to said Section 8(a), may determine.

______________________________

The information contained in this preliminary prospectus is not complete and may be changed. These securities may not be sold until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted.

PRELIMINARY PROSPECTUS SUBJECT TO COMPLETION DATED AUGUST 1, 2023

Up to        5,069,121 Common Shares

KWESST Micro Systems Inc.

This Prospectus relates to the offer and resale (the "Offering";), by the selling securityholders identified in this Prospectus (the "Selling Securityholders";), of up to an aggregate of 5,069,121 common shares, no par value per share (the "Common Shares";), of KWESST Micro Systems Inc. (the "Company";), consisting of (a) 1,542,194 Common Shares, (b) 2,596,379 Common Shares (the "Warrant Shares";) issuable upon the exercise of warrants (the "Warrants";) and (c) 930,548 Common Shares (the "Pre-Funded Warrant Shares";) issuable upon exercise of pre-funded warrants (the "Pre-Funded Warrants";). The Common Shares, 2,472,742 Warrants and the Pre-Funded Warrants were sold by the Company in a private placement pursuant to a securities purchase agreement dated July 18, 2023 by and among the Company and certain of the Selling Securityholders (the "Securities Purchase Agreement";), and 123,637 Warrants were issued to designees of ThinkEquity LLC, the placement agent in connection with the private placement.

Among other things, (i) each Warrant is exercisable for $2.66 per Common Share and has a term of 5 years from the issuance date and (ii) each Pre-Funded Warrant is exercisable for $0.001 per Common Share and expires upon the exercise of the Pre-Funded Warrant. If at the time of exercise there is no effective registration statement registering, or the prospectus contained therein is not available for the issuance of, the Warrant Shares, the holder may, in its sole discretion, elect to exercise the Warrant through a cashless exercise, in which case the holder would receive upon such exercise the net number of Warrant Shares determined according to the formula set forth in the Warrant. The holders of Pre-Funded Warrants may, in their sole discretion, elect to exercise the Pre-Funded Warrant through a cashless exercise, in which case the holder would receive upon such exercise the net number of Pre-Funded Warrant Shares determined according to the formula set forth in the Pre-Funded Warrant. If the Company does not issue the Common Shares in a timely fashion, the Warrant and the Pre-Funded Warrant each contain certain damages provisions. A holder will not have the right to exercise any portion of (i) the Warrant if the holder (together with its affiliates) would beneficially own in excess of 4.99% of the number of the Company's Common Shares outstanding immediately after giving effect to the exercise or (ii) the Pre-Funded Warrant if the holder (together with its affiliates) would beneficially own in excess of 4.99%, in each case as such percentage of beneficial ownership is determined in accordance with the terms of the Warrants and the Pre-Funded Warrants, as applicable. However, any holder could elect to increase such percentage to 9.99% prior to the issuance of the Warrants or Pre-Funded Warrants, as applicable. The exercise price of the Warrants is subject to appropriate adjustment in the event of certain stock dividends and distributions, stock splits, stock combinations, reclassifications or similar events affecting our Common Shares and also upon any distributions of assets, including cash, stock or other property to our shareholders. If a fundamental transaction occurs, then the successor entity will succeed to, and be substituted for us, and may exercise every right and power that we may exercise and will assume all of our obligations under the Warrants and Pre-Funded Warrants with the same effect as if such successor entity had been named in the Warrant and the Pre-Funded Warrants itself. If holders of our Common Shares are given a choice as to the securities, cash or property to be received in a fundamental transaction, then the holder shall be given the same choice as to the consideration it receives upon any exercise of the Warrant or Pre-Funded Warrant following such fundamental transaction. In addition, we or the successor entity, at the request of warrant holders, will be obligated to purchase any unexercised portion of the Warrants and the Pre-Funded Warrants in accordance with the terms of the Warrants and Pre-Funded Warrants, as applicable.

The Selling Securityholders are identified in the table commencing on page 108. No Common Shares are being registered hereunder for sale by us. We will not receive any proceeds from the sale of the Common Shares by the Selling Securityholders. All net proceeds from the sale of the Common Shares covered by this Prospectus will go to the respective Selling Securityholder. However, we may receive the proceeds from any exercise of Warrants if the holders do not exercise the Warrants on a cashless basis. See "Use of Proceeds." 

The Selling Securityholders may sell all or a portion of the Common Shares from time to time in market transactions through any market on which our Common Shares are then traded, in negotiated transactions or otherwise, and at prices and on terms that will be determined by the then prevailing market price or at negotiated prices directly or through a broker or brokers, who may act as agent or as principal or by a combination of such methods of sale. See "Plan of Distribution".

Our Common Shares are listed for trading the Nasdaq Capital Market (the "Nasdaq") under the stock symbol "KWE", listed for trading on the TSX Venture Exchange (the "TSXV") under the stock symbol "KWE.V", and listed on the Frankfurt Stock Exchange under the stock symbol of "62U".

On July 31, 2023, the closing price of our Common Shares on the Nasdaq was $2.05 per Common Share.

Investing in our securities involves a high degree of risk, including the risk of losing your entire investment. See "Risk Factors" beginning on page 13 to read about factors you should consider before buying our securities.

Neither the United States Securities and Exchange Commission nor any state securities commission nor any other regulatory body has approved or disapproved of these securities or determined if this Prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

The date of this Prospectus is      , 2023.

TABLE OF CONTENTS

ABOUT THIS PROSPECTUS	1
PROSPECTUS SUMMARY	3
THE OFFERING	11
NON-IFRS FINANCIAL MEASURES	12
RISK FACTORS	13
FORWARD-LOOKING STATEMENTS	33
PRIVATE PLACEMENT OF COMMON SHARES, PRE-FUNDED WARRANTS AND WARRANTS	35
CAPITALIZATION AND INDEBTEDNESS	35
USE OF PROCEEDS	36
INFORMATION ON THE COMPANY	37
OPERATING AND FINANCIAL REVIEW AND PROSPECTS	65
DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES	88
MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS	103
FINANCIAL INFORMATION	105
MARKET FOR OUR COMMON SHARES	106
PLAN OF DISTRIBUTION	106
SELLING SECURITYHOLDERS	108
DESCRIPTION OF SECURITIES	111
ADDITIONAL INFORMATION	113
MATERIAL CONTRACTS	116
MATERIAL UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS	118
MATERIAL CANADIAN FEDERAL INCOME TAX CONSIDERATIONS	123
LEGAL MATTERS	125
EXPERTS	125
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	125
FINANCIAL STATEMENTS	126
CHANGE IN COMPANY'S CERTIFYING ACCOUNTANT	126
WHERE YOU CAN FIND MORE INFORMATION	127
INDEX TO FINANCIAL STATEMENTS	129

ABOUT THIS PROSPECTUS

This Prospectus is part of a registration statement on Form F-1 that we filed with the United States Securities and Exchange Commission (the "SEC"). You should read this Prospectus and the related registration statement carefully. This Prospectus and registration statement contain important information you should consider when making your investment decision.

You should rely only on the information that we have provided in this Prospectus and any applicable prospectus supplement. We have not authorized anyone to provide you with different information. No dealer, salesperson or other person is authorized to give any information or to represent anything not contained in this Prospectus and any applicable prospectus supplement. You must not rely on any unauthorized information or representation. This Prospectus is an offer to sell only the securities offered hereby, but only under circumstances and in jurisdictions where it is lawful to do so. You should assume that the information in this Prospectus and any applicable prospectus supplement is accurate only as of the date on the front of the document, regardless of the time of delivery of this Prospectus, any applicable prospectus supplement, or any sale of a security.

Except as otherwise indicated, references in this Prospectus to "KWESST," "Company," "we," "us" and "our"  refer to KWESST Micro Systems Inc. and its consolidated subsidiaries.

Enforceability of Civil Liabilities

We are incorporated under the laws of British Columbia. Some of our directors and officers, and the experts named in this Prospectus, are residents of Canada or otherwise reside outside of the United States, and all or a substantial portion of their assets, and all or a substantial portion of our assets, are located outside of the United States. We have appointed an agent for service of process in the United States, but it may be difficult for shareholders who reside in the United States to effect service within the United States upon those directors, officers and experts who are not residents of the United States. It may also be difficult for shareholders who reside in the United States to realize in the United States upon judgments of courts of the United States predicated upon our civil liability and the civil liability of our directors, officers and experts under the United States federal securities laws. Furthermore, because substantially all of our assets and substantially all of our directors and officers are located outside the United States, any judgment obtained in the United States against us or any of our directors and officers may not be collectible within the United States. There can be no assurance that United States investors will be able to enforce against us, members of our board of directors, officers or certain experts named herein who are residents of Canada or other countries outside the United States, any judgments in civil and commercial matters, including judgments under the federal securities laws.

Market, Industry and Other Data

This Prospectus contains estimates, projections and other information concerning our industry, our business, and the markets for our products. Information that is based on estimates, forecasts, projections, market research or similar methodologies is inherently subject to uncertainties, and actual events or circumstances may differ materially from events and circumstances that are assumed in this information. Unless otherwise expressly stated, we obtained this industry, business, market and other data from our own internal estimates and research as well as from reports, research surveys, studies and similar data prepared by market research firms and other third parties, industry, medical and general publications, government data, and similar sources.

In addition, assumptions and estimates of our and our industry's future performance are necessarily subject to a high degree of uncertainty and risk due to a variety of factors, including those described in "Risk Factors". These and other factors could cause our future performance to differ materially from our assumptions and estimates. See "Forward-Looking Statements".

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 Prospectus 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 Prospectus 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.

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Financial Information and Currency

Our financial statements appearing in this Prospectus are prepared in Canadian dollars and in accordance with International Financial Reporting Standards ("IFRS") as issued by the International Accounting Standards Board ("IASB"), as described in Note 2 to the unaudited condensed consolidated interim financial statements for the three and six months ended March 31, 2023 ("Q2 Fiscal 2023") and Note 2 to the audited condensed consolidated financial statements for the fiscal year ended September 30, 2022 ("Fiscal 2022"), the fiscal year ended September 30, 2021 ("Fiscal 2021"), the nine months ended September 30, 2020  ("Fiscal 2020"). In September 2020, we changed our fiscal year from December 31^st to September 30^th.

Unless otherwise indicated, all references in this Prospectus to "dollars" or "CAD" or "$" are to Canadian dollars and all references to "USD" or "USD$" are to United States dollars.

Exchange Rates

The following tables set forth the annual average exchange rates for the year ended September 30, 2022, the year ended September 30, 2021 and the nine months ended September 30, 2020, and the monthly average exchange rates for each month during the previous twelve months, as supplied by the Bank of Canada. These exchange rates are expressed as one United States dollar converted into Canadian dollars.

Period	Average
Year Ended September 30, 2022	1.2772
Year Ended September 30, 2021	1.2644
Nine Months Ended September 30, 2020	1.3539

Month Ended	Average
July 31, 2023	1,3215
June 30, 2023	1.3288
May 31, 2023	1.3520
April 30, 2023	1.3485
March 31, 2023	1.3682
February 28, 2023	1.3450
January 31, 2023	1.3422
December 31, 2022	1.3592
November 30, 2022	1.3449
October 31, 2022	1.3700
September 30, 2022	1.3319
August 31, 2022	1.2922

The daily average exchange rate on July 31, 2023 as reported by the Bank of Canada for the conversion of USD into CAD was USD$1.00 equals CAD$1.3177.

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PROSPECTUS SUMMARY

This summary highlights certain information contained elsewhere in this Prospectus. This summary does not contain all of the information that may be important to you. You should read and carefully consider the following summary together with the entire Prospectus, including the sections of this Prospectus entitled "Risk Factors" and "Operating and Financial Review and Prospects" and our consolidated financial statements and the related notes included elsewhere in this Prospectus, before deciding to invest in our securities.

Overview of the Company

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.

We focus on three niche market segments as follows:

Our core mission is to protect and save lives and enhance operational effectiveness.

Non-Lethal

Our goal is to provide reliable and safer non-lethal alternatives for public safety and training. 

Sub-segments of the public safety and training markets addressed by our non-lethal products include: public order and riot control; subjugation of dangerous suspects; animal control; personal defense, and realistic force-on-force close quarters combat simulation training and gaming.

Our non-lethal product suite includes the following:

• PARA OPS, our innovative, patent-pending cartridge-based firing platform system, intended to provide more reliable non-lethal choices (single-shot and multi-shot);
• A line of projectiles that are fired by PARA OPS devices, including solid slug (kinetic), inert color powder (training and practice), and irritant pepper powder (for operational use).
• ARWEN less-lethal launchers and ammunition for law enforcement agencies, used primarily for riot control and police tactical teams during high-risk arrests against potentially armed or violent persons.  ARWEN products have been in the marketplace for over 30 years.

The stage of development for our non-lethal product suite is as follows:

• PARA OPS: We are currently in the low-rate initial production ("LRIP") phase for the .67 caliber single shot and multi-shot devices (Pro-5 Magnum). We began law enforcement customer evaluations for these devices during our third fiscal quarter ending June 30, 2023 ("Q3") (i.e., April 1, 2023 to June 30, 2023) of fiscal year 2023  ("Fiscal 2023"), and these are currently ongoing.

ARWEN: Both our ARWEN ACE (single-shot launcher) and ARWEN 37 (multi-shot launcher) are in full production, along with the related ammunition.  Our current sales and marketing efforts are primarily through tradeshows in the United States and Canada, pro bono training and direct sales to our existing law enforcement agency customers. To broaden our product offering, we are developing a 40mm ammunition product to function in third-party launchers worldwide.  This is currently undergoing final development and testing, and is expected to be available for sale in the fourth quarter ("Q4") (i.e., July 1, 2023, to September 30, 2023) of Fiscal 2023.

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For further details on our non-lethal products, refer to "Business Overview - Principal Products and Services."

Digitization

We offer proprietary next-generation real-time situational awareness solutions for both the military and public safety markets, including integration with all variants of ATAK ("Android Team Awareness Kit") and TAK ("Team Awareness Kit"), which are shared information operating systems developed by the U.S. military.  ATAK or TAK are increasingly the operating standard which many U.S. and NATO agencies have adopted or have stated their intent to. In the military market, our signature proprietary product, Tactical and Situational Control System ("TASCS"), offers an app that networks soldiers on the ground with each other through their smart devices so they can receive and share situational awareness information from any source including drones.  Further, we extend the TASCS app to "Joint Fires" applications (Joint Fires is a common terminology used in military for fires produced during the employment of forces from two or more components in a coordinated action toward a common objective) on indirect fire weapons like mortars, grenade launchers, heavy machine guns, rocket launchers, artillery and more. Effectively, we convert these "dumb" legacy weapon systems to "smart" precision weapon systems without any modification to the weapon or ammunition, and integrate them with ATAK where required by customers.

After successfully developing digital technologies for tactical military applications which provide real-time exchange of situational awareness, navigation, imagery, and operational information for soldiers on the ground, we became aware of opportunities to apply these digitization solutions to the public safety market. These solutions solve critical challenges for law enforcement, fire, emergency response, search and rescue, and natural disaster management, all of whom require networked situational awareness to understand, decide, and act faster and more effectively in response to a critical incident. When responders are facing a public emergency, they need information quickly. Whether it is a wildfire, active shooter scenario or a natural disaster, they need to know what they are walking into and where their resources are located. They also need to communicate and collaborate in real-time - across teams and information sources and often across departments.

We entered the public safety market by launching our Critical Incident Management System ("CIMS") for enhanced public safety. Our CIMS solution integrates emergency operations, incident command post, incident commanders, and all responders whether mobile or dismounted (on foot). Our CIMS architecture is a native cloud-based Microsoft environment (MS Azure) integrated with TAK. This provides key stakeholders with seamless fusion and sharing of crucial real-time position location, imagery, and time-sensitive emergency services data and information for effective and coordinated delivery of emergency services, including rescue, fire suppression, emergency medical care, law enforcement, and other forms of hazard control and mitigation.

The stage of development for our digitization products and services is as follows:

• TASCS Indirect Fire Modules System ("TASCS IFM"): We have completed the development for TASCS IFM for the 81mm mortar system and have conducted extensive user testing with the United States military.  We are also marketing this product to the Canadian forces and expect to conduct trials over the next twelve months. At this time, we do not expect further development unless funded by the military customer.  We will proceed to production only upon receiving a customer order.

• CIMS: Leveraging our ATAK integration experience with military customers, we are currently offering CIMS services to the public safety market.  In July 2022, we won our first contract with Counter-Crisis Technology Inc. to co-implement a national Ground Search and Rescue Incident Command System for Public Safety Canada, with the Ontario Provincial Police as technical advisory stakeholder for this project.

Sales and marketing efforts for our digitization products is primarily through tradeshows and direct sales to military and public safety markets. Further details on our digitization products, refer to Business Overview - Principal Products and Services. 

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Counter-Threat

We offer proprietary next-generation counter-threat solutions to protect against hostile enemy lasers, electronic detection and, potentially, drones.  Our patented Phantom product is a miniaturized electronic warfare device with the ability to emulate the electronic communications of NATO countries to spoof adversaries as to the location of NATO forces.  Due to its small size, it can be easily deployed by soldiers at the tactical level or by drones in an area of operation, or mounted on light tactical vehicles. Our Battlefield Laser Detection System ("BLDS") product suite specifically addresses a current NATO need to protect against laser threats: lasers used to "paint" or "lase" ground personnel to target them for attack, or weaponized lasers intended to cause direct injury to personnel from a high-energy laser beam itself.  Our latest product development project, referred to as GhostNet, is intended to provide an effective counter-measure against hostile drones including loitering munitions that can hover for hours waiting for a designed target.  Military and Homeland Security agencies are seeking additional options for stopping drones kinetically but without collateral damage. Our primary market focus is the domestic security market to protect against illegal drone incursions with a safe, non-kinetic solution.

The stage of development for our counter-threat product suite is as follows:

• BLDS: We have completed the operational prototype development of our vehicle and squad laser detection product suite.  We are currently producing the vehicle mounted version for a NATO customer to be delivered in late Q3 or early Q4 of Fiscal 2023. 

• Phantom: We have completed the development of Phantom Electromagnetic Spectrum Operations ("EMSO") operational prototypes for electronic deception and training. We have tested and are currently undergoing assessment with the United States military.  This may lead to further development to be funded by the military customer, upon receiving their specific requirements.  We will proceed to production only upon receiving a customer order.

• GhostNet: We are currently in the concept and design phase and discussion on strategic go-to-market partnerships and operating models. 

Sales and marketing efforts for our counter-threat products are primarily through tradeshows and direct sales to military. Further details on our counter-threat products, refer to "Business Overview - Principal Products and Services." 

Our Market Opportunity

Non-Lethal

According to Allied Market Research: Non-Lethal Market, May 2021, the global non-lethal weapons market was approximately USD$7.4 billion in 2020 and is projected to reach USD$12.5 billion in 2028 (a 7.4% compound annual growth rate). Today, competitors are offering either high-energy cartridge systems that can be lethal (e.g. rubber bullets, Taser) or air-based devices (e.g. Byrna ® HD brand) that are often unreliable and high maintenance based on our Executive Chairman's former experience with a non-lethal company in the United States.  Our PARA OPS devices provide a unique market solution addressing these weaknesses.  Our devices are based on a low-energy cartridge system with projectile velocity (kinetic energy) well below the lethal threshold, providing a reliable, low-maintenance device for the public safety market.  Based on the above global non-lethal market size, even if we win 1% global market share this represents a revenue opportunity of over USD$74 million per annum recurring.  We plan to initially focus our sales effort in the United States and selected overseas countries in the law enforcement market via distributors, a dedicated website and approved Federal Firearms License ("FFL") distributors.

In December 2021, we expanded our non-lethal business with the acquisition of Police Ordnance Company Inc. an Ontario (Canada) corporation ("Police Ordnance"), the owner of the ARWEN launchers sold worldwide to law enforcement agencies.

A key objective of our acquisition of ARWEN was to secure an initial ready channel to a base of prospective law enforcement customers for PARA OPS.  During SHOT Show in January 2023, pre-production versions of both the Para Ops single and Pro-5 Magnum devices were demonstrated at the 2023 Shot Show Range Day. Interest from U.S. domestic agencies from Police to the U.S. postal service was strong, and these contacts are expected to receive trial units beginning in Q3 of Fiscal 2023. International interest was also strong, and opportunities in Europe and the MENA countries are being pursued.  Feedback from these initial user evaluations will be utilized to incorporate any last "tweaks" to the PARA OPS system before moving to serial production, which is planned for Q4 of Fiscal 2023.

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As well, PARA OPS has been introduced and demonstrated to influential former police officers including Daniel V. Garcia (former Chief of Police, Phoenix AZ and Deputy Chief of Police, Dallas TX), Brandon Tatum (former Tucson police officer), and Chief Stephen Sund (Former Chief of the Capital Police) who have been advocates for PARA OPS.   

Digitization

On the military front, a top priority for the U.S. and its allies, is to modernize the soldier on the ground with a digital networked common operating picture to reduce combat casualties and enable greater operational effectiveness. Our proprietary TASCS solution specifically addresses this market need. In Fiscal 2022, we successfully completed the integration of our TASCS IFM with an 81 mm mortar system for a United States military customer. Additional live demonstrations have taken place in response to customer requests, which we expect will then lead to customer acceptance and future orders. A further demonstration for Canadian Forces was conducted in Q1 of Fiscal 2023.

Further, in November 2021, we entered into a master agreement with General Dynamics Mission System ("GDMS") (the "Master Agreement") to support the development of digitization solutions for the Canadian military in which we will assist GDMS in the development of an initial prototype system that networks soldiers with information from various sources in real time, including the location of friendly forces and adversaries, and facilitates more effective, coordinated fire. We have delivered timely on the first phase of the project in June 2022. The project is active but currently on hold due customer budgetary constraints.

In June 2022, we entered into a joint venture with Thales Canada Inc. ("Thales") and Modis Canada Inc. ("Modis"), both prominent defense contractors, (collectively referred as "JV Group") for a potential multi-year Canadian defense contract opportunity for specialized software development and integration solutions for the Canadian Army as part of its digital modernization.  As a JV Group, the three companies will combine their respective expertise in the Canadian and international defense Command, Control, Communications, Computers, Intelligence, Surveillance and Reconnaissance (C4ISR) domain. To qualify for this joint venture opportunity, we have upgraded our security clearances. On May 2, 2023, we announced that the Canadian Department of National Defence ("DND") awarded a $136 million dollar multi-year defense contract to the JV Group. KWESST's share of the contract is 20%.  We estimate that on average, our workshare will represent a  minimum of $4 million annually for the five-year initial contract.  There are also five, one-year options years.  The initial term of the contract is expected by begin late summer or early Fall 2023 and run to May 2028, after satisfying certain formalities and work plan definition customary for a military contract of this nature (the "Canadian Government Contract").

Additionally, public safety agencies across the United States and abroad are seeking to implement digital solutions that can improve responder safety and incident management.  According to Accenture, digital transformation presents one of the biggest challenges for public safety agencies. Globally, the public safety and security market was USD$435 billion in 2021 and is expected to reach USD$868 billion by 2028, growing at a CAGR of 10.4%, according to Fortune Business Insights.

Counter-Threats

In today's warfare, there is a greater need to provide innovative counter-threat solutions at the tactical edge (i.e. the frontline operations at the level of soldiers and armored vehicles). Our Phantom and BLDS are two product lines that are focused on addressing this need to save soldier lives. According to Fortune Business Insights: Electronic Warfare, June 2021, the global electronic warfare market size is projected to reach USD$33.5 billion by 2028, a 5.24% CAGR from 2021. 

The addressable market for miniaturized tactical electronic warfare devices such as our Phantom is new and therefore undefined.  In Fiscal 2022, General Dynamics Land Systems ("GDLS") selected our Phantom system to be incorporated into their next-generation armored vehicle for a bid proposal to a United States military customer for up to 500 armored vehicles, a requirement for the bid proposal.  While GDLS is currently the incumbent, there is no assurance that it will win this bid; however, if they do, we are very well positioned to win a large order for our Phantom.  The U.S. government plans to announce the winner in 2023. Further, in Q4 of Fiscal 2021, we partnered with Alare Technologies, LLC ("Alare") in the United States, a system design development engineering firm, to assist us with the development of our GhostNet to address the emerging market demand for counter-loitering munitions with no collateral damage. This project is currently on hold while we focus on commercializing other products for Fiscal 2023.

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Competitive Strengths

We believe the following strengths distinguish us from our competitors and position us well to take a leadership position in the non-lethal market and significant success in the military and security forces market:

• Experienced senior management: Our Executive Chairman has over 30 years of experience in the non-lethal market, including as founder of Simunition, the world-leading non-lethal combat training munitions system, and as the former Chairman and Chief Executive Officer ("CEO") of United Tactical Systems based in the United States (owner of the non-lethal PepperBall brand).  Further, he, along with our President and CEO and other members of senior management have collectively over 100 years' experience in the defense industry while serving in the military and working for defense contractors.

• Diversified business model: With a mix of anticipated non-lethal product sales (shorter sales cycle than the military market) and large military contracts, we offer a more diversified business platform than competitors in either the non-lethal or defense market. 

• Recurring business: While military contracts have longer sales cycle, once awarded, they tend to be for multiple years, providing a reliable source of recurring business.  Further, within our non-lethal business line, we will be able to sell to the same customer projectiles / ammunitions over the lifetime of their product, providing a good source of recurring revenue.

• Non-lethal cartridge-based system: Our patent-pending, proprietary cartridge-based PARA OPS system is innovative and could disrupt the non-lethal market because it specifically addresses the shortfalls from "air-powered" devices and dangerous high-energy cartridge systems currently offered in the marketplace.

• Teaming with original equipment manufacturers ("OEMs") for military contracts: By teaming with global defense OEMs as we have done in Fiscal 2022 with GDMS and GDLS for certain product lines, we are in a better position to indirectly win significant multi-year contracts.  OEMs are effectively integrators who look for technology partners like us to fill their technology gaps when bidding for a military contract.

• Teaming with OEMs for non-lethal applications: With our proprietary cartridge-based firing platform for non-lethal devices, we have an opportunity to partner with competitors for "white-labeling" our technology to complement their air-based product suites.

• Market synergies in non-lethal: With the acquisition of Police Ordnance in December 2021, we have immediate access to its law enforcement sales channel to cross-sell PARA OPS.

• Outsourced scalable model: While we continue to develop and research innovative technologies internally, we will outsource our production to a ready supply chain of proven vendors to provide scalability without taking any significant capital expenditure risks.

Growth Strategies

We believe the following are the key pillars for our growth strategy:

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• Commercialization of PARA OPS: Over the next three to six months, we plan to offer our PARA OPS devices (Single and the Pro-5 Magnum) initially to the professional user due to high demand and then the consumer markets with an initial focus in the United States. This will provide a new source of revenue to us including recurring revenue from the sale of projectiles. We expect to drive most of our PARA OPS revenue through our upcoming new website and to a lesser extent from licensed distributors in the United States. Over time, we expect to expand to other international markets.

• OEM partnerships for revenue growth: In addition to GDMS, GDLS and Thales, we are in discussions with other potential OEMs for strategic partnerships to accelerate our go-to-market for our Digitization and Counter-Threat product solutions for the military and security markets.

• Law enforcement penetration: We see an attractive opportunity to increase ARWEN market penetration with law enforcement agencies internationally with increased marketing spend, coupled with the cross-selling opportunity for our non-lethal PARA OPS devices.

• Strategic acquisitions: We have successfully integrated two assets and one business acquisition over the last two years.  We expect to continue to acquire complementary acquisitions that are a strategic fit and attractively priced to accelerate our growth plans.

Risk Factors

Our business is subject to a number of risks which you should be aware before making an investment decision. You should carefully consider all of the information set forth in this Prospectus and, in particular, should evaluate the factors set forth under "Risk Factors" in deciding whether to invest in our securities. These risks include but are not limited to the following:

•The sale of a substantial amount of our Common Shares, including resale of the Warrant Shares or Pre-Funded Warrant Shares in the public market could adversely affect the prevailing market price of our Common Shares.

•Management will have broad discretion as to the use of the proceeds from the exercise of Warrants and Pre-Funded Warrants, if any, and may not use the proceeds effectively.

•The market price of our Common Shares may be adversely impacted by the release of certain of our securities that are currently escrowed if the holders immediately trade these securities upon release.

•We have limited operating experience as a publicly traded company in the United States.

•We incur significantly increased costs and devote substantial management time as a result of operating as a new United States public company.

•Global inflationary pressure may result in lower gross margins on our future product sales if we are unable to pass on the related increase in cost to our customers through an increase in the price of our products.

•We may incur higher costs or unavailability of components, materials and accessories.

•Our inability to comply with Nasdaq's continued listing requirements could result in our Common Shares being delisted, which could affect the market price and liquidity of our securities and reduce our ability to raise capital.

•We are an "emerging growth company," and we cannot be certain if the reduced reporting requirements applicable to emerging growth companies will make our securities less attractive to investors.

•There can be no certainty that we will ever achieve or sustain profitability or positive cash flow from our operating activities.

•Our ability to generate substantial revenue growth, or to sustain any revenue growth that is achieved.

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•Global economic turmoil, and other regional economic conditions may present a wide range of potential issues or disruptions in our business and the business of third parties who we depend on or might depend on in the future for materials and manufacturing.

•Reliance on third-party suppliers may create risks related to our potential inability to obtain an adequate supply of components or materials and reduced control over pricing and timing of delivery of components and materials.

•We will be reliant on information technology ("IT") systems and may be subject to damaging cyber-attacks.

•Protecting and defending against intellectual property claims may have a material adverse effect on our business.

•Our business is subject to certain risks inherent in international business, many of which are beyond our control.

•Our directors, officers or members of management may have conflicts of interest and it may not be possible for foreign investors to enforce actions against us, and our directors and officers.

•Our insurance policies may be inadequate to fully protect us from material judgments and expenses.

•Our Common Shares may experience extreme stock price volatility unrelated to our actual or expected operating performance, financial condition or prospects, making it difficult for prospective investors to assess the rapidly changing value of our Common Shares.

•We are subject to extensive government regulation in the United States for our products and may not be able to comply with changes in government policies and legislation.

•Rapidly changing technology and evolving industry standards could result in product obsolescence or short product life cycles.

•If we are unable to satisfy the requirements of Sarbanes-Oxley Act of 2002, as amended ("Sarbanes-Oxley") or our internal controls over financial reporting are not effective, the reliability of our financial statements may be questioned.

•We may lose foreign private issuer status in the future, which could result in additional costs and expenses.

Implications of Being an Emerging Growth Company

As a company with less than USD$1.235 billion in revenue for our last fiscal year, we qualify as an "emerging growth company" pursuant to the Jumpstart Our Business Startups Act of 2012, as amended (the "JOBS Act"). An emerging growth company may take advantage of specified reduced reporting and other requirements compared to those that are otherwise applicable generally to public companies. These provisions include:

• reduced executive compensation disclosure;

• exemptions from the requirement to hold a non-binding advisory vote on executive compensation, including golden parachute compensation; and

• an exemption from the auditor attestation requirement under Section 404 of Sarbanes-Oxley ("Section 404") in the assessment of the emerging growth company's internal control over financial reporting.

We will remain an emerging growth company until the earliest of (a) the last day of the fiscal year during which we have total annual gross revenues of at least USD$1.235 billion; (b) the last day of our fiscal year following the fifth anniversary of the completion of this Offering; (c) the date on which we have, during the preceding three-year period, issued more than USD$1.0 billion in non-convertible debt; or (d) the date on which we are deemed to be a "large accelerated filer" under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), which would occur if the market value of our Common Shares that are held by non-affiliates exceeds USD$700 million. Once we cease to be an emerging growth company, we will not be entitled to the exemptions provided in the JOBS Act discussed above.

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Foreign Private Issuer Status

We are a foreign private issuer within the meaning of the rules under the Exchange Act. As such, we are exempt from certain provisions applicable to United States domestic public companies. For example:

• we are not required to provide as many Exchange Act reports, or as frequently, as a domestic public company;

• for interim reporting, we are permitted to comply solely with our home country requirements, which may be less rigorous than the rules that apply to domestic public companies;

• we are not required to provide the same level of disclosure on certain issues, such as executive compensation;

• we are exempt from provisions of Regulation FD aimed at preventing issuers from making selective disclosures of material information;

• we are not required to comply with the sections of the Exchange Act regulating the solicitation of proxies, consents, or authorizations in respect of a security registered under the Exchange Act; and

• we are not required to comply with Section 16 of the Exchange Act requiring insiders to file public reports of their share ownership and trading activities and establishing insider liability for profits realized from any "short-swing" trading transaction.

Corporate Information

We are a corporation domiciled in Canada and were incorporated under the Business Corporations Act (British Columbia) (the "BCBCA") on November 28, 2017. Our registered and head office is located at 2900 - 550 Burrard Street, Vancouver, British Columbia V6C 0A3 and our principal place of business is located at 155 Terence Matthews Crescent, Unit #1, Ottawa, Ontario, Canada, K2M 2A8. Our internet site is https://www.kwesst.com; our telephone number is (613) 319-0537.

Our registered agent in the United States is C T Corporation System, located at 1015 15^th Street N.W., Suite 1000 and its telephone number is (202)572-3133.

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THE OFFERING

Issuer	KWESST Micro Systems Inc.
Common Shares offered by the Selling Securityholders	Up to 5,069,121 Common Shares consisting of:  (a) 1,542,194 Common Shares, (b) 2,596,379 Warrant Shares and (c) 930,548 Pre-funded Warrant Shares.
Common Shares to be outstanding after this Offering(1)	5,616,782 Common Shares
Symbol and Listing	Our Common Shares are listed for trading Nasdaq under the stock symbol "KWE", listed for trading on the TSXV under the stock symbol "KWE.V", and listed on the Frankfurt Stock Exchange under the stock symbol of "62U".
Use of proceeds	We will not receive any proceeds from the sale of the Common Shares by the Selling Securityholders. All net proceeds from the sale of the Common Shares covered by this Prospectus will go to the Selling Securityholders. However, we may receive the proceeds from any exercise of Warrants and Pre-Funded Warrants if the holders do not exercise the Warrants or Pre-Funded Warrants on a cashless basis. If all of the Warrants and Pre-Funded Warrants are exercised for cash in full, the proceeds would be approximately $6.9 million. We intend to use the net proceeds of such warrant exercise, if any, for general working capital purposes.
Lock-up	Our directors and executive officers have agreed to not offer, issue, sell, contract to sell, encumber, grant any option for the sale of or otherwise dispose of any of our securities for a period of sixty (60) days from July 21, 2023. See "Plan of Distribution" for additional information.
Risk Factors	Investing in our securities involves a high degree of risk. See "Risk Factors" in this Prospectus for a discussion of factors you should carefully consider before investing in our securities.

(1)The number of Common Shares shown above to be outstanding after this Offering is based on 4,074,588 Common Shares outstanding as of  June 30, 2023 and excludes as of such date (USD$ equivalent is based on a conversion rate of $1.324):

• warrants to purchase 4,130,840 Common Shares at a weighted average exercise price of $7.60 (USD$5.74) per common share;

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• pre-funded warrants to purchase 199,000 Common Shares at an exercise price of USD$0.01 per share;

• 62,409 Common Shares issuable upon the exercise of outstanding but unexercised stock options to purchase Common Shares, under our Long-Term Performance Incentive Plan as approved by our shareholders on March 31, 2023 ("LTIP") at a weighted average exercise price of $4.15 (USD$3.13) per share;

• 5,871 Common Shares issuable upon the conversion of 3,214 restricted share units ("RSUs") and 2,657 share appreciation rights ("SARs"), under our LTIP;

• 837 Common Shares issuable upon the conversion of 837 agent option units at an exercise price of $87.50 (USD$66.09) per share, each unit comprised of one Common Share and seventy warrants exercisable at $1.75 (USD$1.32) per 0.01428571 Common Shares (70 warrants for one Common Share);

• 59,907 Common Shares issuable upon the exercise of the Canadian Compensation Options (as defined below);

• 2,596,379 Warrant Shares and 930,548 Pre-Funded Warrant Shares.

NON-IFRS FINANCIAL MEASURES

In this Prospectus, we have presented earnings before interest, taxes, depreciation and amortization ("EBITDA") and EBITDA that has been adjusted for the removal of one-time, irregular and nonrecurring 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 by 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.

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RISK FACTORS

There are a number of risks that may have a material and adverse impact on our future operating and financial performance and could cause our operating and financial performance to differ materially from the estimates described in our forward-looking statements. These include widespread risks associated with any form of business and specific risks associated with our business and our involvement in the defense technology industry. Before making an investment in our securities, you should carefully consider the risk factors set forth below.

This section describes risk factors identified as being potentially significant to us. In addition, other risks and uncertainties not discussed to date or not known to management could have material and adverse effects on the valuation of our securities, existing business activities, financial condition, results of operations, plans and prospects.

Risks Relating to This Offering

The sale of a substantial amount of our Common Shares, including resale of the Warrant Shares issuable upon the exercise of the Warrants or Pre-Funded Warrant Shares issuable upon exercise of the Pre-Funded Warrants held by the Selling Securityholders in the public market could adversely affect the prevailing market price of our Common Shares.

We are registering for resale up to 5,069,121 Common Shares consisting of: (a) 1,542,194 Common Shares, (b) 2,596,379 Warrant Shares and (c) 930,548 Pre-funded Warrant Shares. Sales of substantial amounts of our Common Shares in the public market, or the perception that such sales might occur, could adversely affect the market price of our Common Shares. We cannot predict if and when the Selling Securityholders may sell such Common Shares in the public markets. Furthermore, in the future, we may issue additional Common Shares or other equity or debt securities convertible into Common Shares. Any such issuance could result in substantial dilution to our existing shareholders and could cause our stock price to decline.

Management will have broad discretion as to the use of the proceeds from the exercise of Warrants and Pre-Funded Warrants, if any, and may not use the proceeds effectively.

We may receive proceeds from the exercise of the Warrants and the Pre-Funded Warrants to the extent that these Warrants and Pre-Funded Warrants are exercised for cash. The Warrants and Pre-Funded Warrants, however, are exercisable on a cashless basis under certain circumstances. If all of the Warrants and Pre-Funded Warrants were exercised for cash in full, the proceeds would be approximately $6.9 million. Our management will have broad discretion as to the use of such proceeds. Accordingly, you will be relying on the judgment of our management with regard to the use of these proceeds, if any, and you will not have the opportunity, as part of your investment decision, to assess whether the proceeds are being used appropriately. It is possible that the proceeds will be invested in a way that does not yield a favorable, or any, return for our Company.

We have limited operating experience as a publicly traded company in the United States.

We have limited operating experience as a publicly traded company in the United States. Although the individuals who now constitute our management team have experience managing a publicly-traded company, there is no assurance that the past experience of our management team will be sufficient to operate our Company as a publicly traded company in the United States, including timely compliance with the disclosure requirements of the SEC. As an SEC registrant, we are required to maintain internal control systems and procedures in order to satisfy the periodic and current reporting requirements under applicable SEC regulations and comply with the Nasdaq listing standards. These requirements place significant strain on our management team, infrastructure and other resources. In addition, our management team may not be able to successfully or efficiently manage our Company as a United States public reporting company that is recently subject to significant regulatory oversight and reporting obligations.

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We incur significantly increased costs and devote substantial management time as a result of operating as a new United States public company.

As a new United States public company, we incur significant legal, accounting and other expenses that we did not incur as a private company or as a Canadian public company before our registration with the SEC in December 2022. For example, we are subject to the reporting requirements of the Exchange Act, and will be required to comply with the applicable requirements of Sarbanes-Oxley and the Dodd-Frank Wall Street Reform and Consumer Protection Act, as well as rules and regulations subsequently implemented by the SEC and the including the establishment and maintenance of effective disclosure and financial controls and changes in corporate governance practices. We expect that compliance with these requirements will increase our legal and financial compliance costs and will make some activities more time consuming and costly. In addition, we expect that management and other personnel will need to divert attention from operational and other business matters to devote substantial time to these public company requirements. In particular, we expect to incur significant expenses and devote substantial management effort toward ensuring compliance with the requirements of Section 404, which involve annual assessments of a company's internal controls over financial reporting. We plan to hire additional accounting and financial staff with appropriate public company experience and technical accounting knowledge and may need to establish an internal audit function. Furthermore, we expect the premium for director & officer insurance will increase significantly due to a more litigious environment in the United States. At this time, we cannot reasonably predict or estimate the amount of additional costs that we may incur as a result of becoming a United States public company or the timing of such costs.

As a foreign private issuer, we follow certain home country corporate governance practices instead of certain Nasdaq corporate governance requirements applicable to United States domestic companies.

As a foreign private issuer whose securities are listed on Nasdaq, we are permitted to follow certain home country corporate governance practices instead of certain corporate governance requirements of Nasdaq. We follow the TSXV listing rules in respect of private placements instead of Nasdaq requirements to obtain shareholder approval for certain dilutive events (such as issuances that will result in a change of control, certain transactions other than a public offering involving issuances of a 20% or greater interest in us and certain acquisitions of the stock or assets of another company) and the minimum quorum requirement for a shareholders meeting. Under Nasdaq listing rules, the required minimum quorum for a shareholders meeting is 33 1/3% of the outstanding Common Shares. Under Canadian law and pursuant to our notice of articles, a quorum shall be present at a shareholder meeting if two or more holders of Common Shares representing at least 5% of the total number of voting rights attaching to the said Common Shares entitled to be voted at the meeting are present or represented by proxy. Accordingly, our shareholders may not be afforded the same protection as provided under Nasdaq corporate governance rules for domestic issuers.

Risks Relating to Our Business

We are an early-stage company.

We are an early-stage company and as such, we are subject to many risks including under-capitalization, cash shortages, and limitations with respect to personnel, financial and other resources and the lack of revenue. There is no assurance that we will be successful in achieving a return on shareholders' investment and the likelihood of success must be considered in light of our early stage of operations. Our prospects must be considered speculative in light of the risks, expenses, and difficulties frequently encountered by companies in their early stages of operations, particularly in the highly competitive and rapidly evolving markets in which we operate. To attempt to address these risks, we must, among other things, successfully implement our business plan, marketing, and commercialization strategies, respond to competitive developments, and attract, retain, and motivate qualified personnel. A substantial risk is involved in investing in us because, as a smaller commercial enterprise that has fewer resources than an established company, our management may be more likely to make mistakes, and we may be more vulnerable operationally and financially to any mistakes that may be made, as well as to external factors beyond our control.

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We currently have negative operating cash flows.

Since inception, we have generated significant negative cash flow from operations, financed in great part through equity financing. There can be no certainty that we will ever achieve or sustain profitability or positive cash flow from our operating activities. In addition, our working capital and funding needs may vary significantly depending upon a number of factors including, but not limited to:

•progress of our manufacturing, licensing, and distribution activities;

•collaborative license agreements with third parties;

•opportunities to license-in beneficial technologies or potential acquisitions;

•potential milestone or other payments that we may make to licensors or corporate partners;

•technological and market consumption and distribution models or alternative forms of proprietary technology for game-changing applications in the military and homeland security market that affect our potential revenue levels or competitive position in the marketplace;

•the level of sales and gross profit;

•costs associated with production, labor, and services costs, and our ability to realize operation and production efficiencies;

•fluctuations in certain working capital items, including product inventory, short-term loans, and accounts receivable, that may be necessary to support the growth of our business; and

•expenses associated with litigation.

There is no guarantee that we will ever become profitable. To date, we have generated limited revenues and a large portion of our expenses are fixed, including expenses related to facilities, equipment, contractual commitments and personnel. With the anticipated commercialization for certain of our product offerings during Fiscal 2023, we expect our net losses from operations will improve. Our ability to generate additional revenues and potential to become profitable will depend largely on the timely productization of our products, coupled with securing timely, cost-effective outsourced manufacturing arrangements and marketing our products. There can be no assurance that any such events will occur or that we will ever become profitable. Even if we achieve profitability, we cannot predict the level of such profitability. If we sustain losses over an extended period of time, we may be unable to continue our business.

Global inflationary pressure may have an adverse impact on our gross margins and our business.

Since December 31, 2021, we have experienced increases in global inflation, resulting in an increase in cost for some of the raw materials (batons / custom chemicals and casings) that we source to manufacture the ammunition for our ARWEN launchers. However, this increase in cost had a small negative impact to the overall gross margin earned from the sales of ARWEN ammunition (our current gross margin for ammunition is greater than 30% excluding indirect costs).

As we are not yet in the production phase for digitization and counter-threat business lines, we do not currently procure large volume of raw materials and therefore the current inflation is negligible for these business lines except for labor costs relating to research and development ("R&D") activities. During Fiscal 2022, we incurred significant payroll cost increases for some of our employees in order to retain and hire engineers given the strong local demand for experienced software and hardware engineers.  While we believe we will be able to pass on this inflation cost to our prospect military customers, there is no assurance that we will succeed.  Accordingly, continued inflationary pressure may have an adverse impact on our gross margins and could have a material adverse effect on our business, financial condition, results of operations or cash flows.

We may not be able to successfully execute our business plan.

The execution of our business plan poses many challenges and is based on a number of assumptions. We may not be able to successfully execute our business plan. If we experience significant cost overruns, or if our business plan is more costly than we anticipate, certain activities may be delayed or eliminated, resulting in changes or delays to our current plans. Also, we may be compelled to secure additional funding (which may or may not be available or available at conditions unfavorable to us) to execute our business plan. We cannot predict with certainty our future revenues or results from our operations. If the assumptions on which our revenues or expenditures forecasts are based change, the benefits of our business plan may change as well. In addition, we may consider expanding our business beyond what is currently contemplated in our business plan. Depending on the financing requirements of a potential business expansion, we may be required to raise additional capital through the issuance of equity or debt. If we are unable to raise additional capital on acceptable terms, we may be unable to pursue a potential business expansion.

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A significant portion of our revenues are non-recurring.

A significant portion of our revenue for Fiscal 2021 was prior to commercial production of TASCS IFM and considered to be non-recurring. We have significantly reduced our reliance on non-recurring revenues during Fiscal 2022 as a result of the acquisition of Police Ordnance (see Business Overview). While we expect to reach commercialization stage for certain product offerings during Fiscal 2023, there is no assurance we will succeed.

With the completion of the PARA OPS system technology acquisition in April 2021 (see Business Overview), we expect to launch the commercialization of our non-lethal PARA OPS devices during Fiscal 2023 which we anticipate will drive product revenue on a monthly basis with the use of distributors and an e-commerce platform. However, there is no assurance that we will successfully complete timely the productization of our PARA OPS or obtain market acceptance of these products. See Business Overview - Government Regulations. 

There is uncertainty with respect to our revenue growth.

There can be no assurance that we can generate substantial revenue growth, or that any revenue growth that is achieved can be sustained. Revenue growth that we have achieved or may achieve may not be indicative of future operating results. In addition, we may further increase our operating expenses ("OPEX") in order to fund higher levels of R&D, increase our sales and marketing efforts and increase our administrative resources in anticipation of future growth. To the extent that increases in such expenses precede or are not subsequently followed by increased revenues, our business, operating results and financial condition will be materially adversely affected.

We may not be able to fully develop our products, which could prevent us from ever becoming profitable.

If we experience difficulties in the development process, such as capacity constraints, quality control problems or other disruptions, we may not be able to fully develop market-ready commercial products at acceptable costs, which would adversely affect our ability to effectively enter the market. A failure by us to achieve a low-cost structure through economies of scale or improvements in manufacturing processes would have a material adverse effect on our commercialization plans and our business, prospects, results of operations and financial condition.

We may experience delays in product sales due to marketing and distribution capabilities.

In order to successfully commercialize our products, we must continue to develop our internal marketing and sales force with technical expertise and with supporting distribution capabilities or arrange for third parties to perform these services. In order to successfully commercialize any of our products, we must have an experienced sales and distribution infrastructure. The continued development of our sales and distribution infrastructure will require substantial resources, which may divert the attention of our management and key personnel and defer our product development and commercialization efforts. To the extent that we enter into marketing and sales arrangements with other companies, our revenues will depend on the efforts of others.

Additionally, in marketing our products, we would likely compete with companies that currently have extensive and well-funded marketing and sales operations. Despite marketing and sales efforts, we may be unable to compete successfully against these companies. We may not be able to do so on favorable terms.

In the event we fail to develop substantial sales, marketing and distribution channels, or to enter into arrangements with third parties for those purposes, we will experience delays in product sales, which could have a material adverse effect on prospects, results of operations, financial condition and cash flows.

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There is no assurance that our products will be accepted in the marketplace or that we will turn a profit or generate immediate revenues.

There is no assurance as to whether our products will be accepted in the marketplace. While we believe our products address customer needs, the acceptance of our products may be delayed or not materialize. We have incurred and anticipate incurring substantial expenses relating to the development of our products, the marketing of our products and initial operations of our business. Our revenues and possible profits will depend upon, among other things, our ability to successfully market our products to customers. There is no assurance that revenues and profits will be generated.

Strategic alliances may not be achieved or achieve their goals.

To achieve a scalable operating model with minimal capital expenditures, we plan to rely upon strategic alliances with OEMs for the manufacturing and distribution of our products. There can be no assurance that such strategic alliances can be achieved or will achieve their goals.

We are dependent on key suppliers for our ARWEN product line.

We may only be able to purchase certain key components of our products from a limited number of suppliers for our ARWEN product line within our non-lethal business line. As of the date of this Prospectus, we do not have any commercial or financial contracts with any key suppliers who we have procured raw materials from.  Procurement is done in the form of individual, non-related standard purchase orders. As a result, there is no contract in place to ensure sufficient quantities are available timely on favorable terms and consequently this could result in possible lost sales or uncompetitive product pricing. The ongoing COVID-19 pandemic could adversely impact the supply chain relating to these components.

We may incur higher costs or unavailability of components, materials and accessories.

As we expect to commercialize certain of our product lines in Fiscal 2023, we may depend on certain domestic and international suppliers for the delivery of components and materials used in the assembly of our products and certain accessories including ammunition, used with our products. Further, any reliance on third-party suppliers may create risks related to our potential inability to obtain an adequate supply of components or materials and reduced control over pricing and timing of delivery of components and materials. We currently have no long-term agreements with any of our suppliers and there is no guarantee the supply will not be interrupted.

In light of the current global supply chain challenges caused by COVID-19 and Russia's invasion of Ukraine, components used in the manufacture of our products may be delayed, become unavailable or discontinued. Any delays may take weeks or months to resolve. Further, parts obsolescence may require us to redesign our product to ensure quality replacement components. While we have not been impacted significantly from the above events to date, there is no assurance that we will not experience significant setback in operations if the global supply chain challenges worsen or continue to persist for a longer period of time.  Accordingly, supply chain delays could cause significant delays in manufacturing and loss of sales, leading to adverse effects significantly impacting our financial condition or results of operations.

Additionally, our shipping costs and the timely delivery of our products could be adversely impacted by a number of factors which could reduce the profitability of our operations, including: higher fuel costs, potential port closures, customs clearance issues, increased government regulation or changes for imports of foreign products into Canada, delays created by terrorist attacks or threats, public health issues and pandemics and epidemics, national disasters or work stoppages, and other matters. Any interruption of supply for any material components of our products could significantly delay the shipment of our products and have a material adverse effect on our revenues, profitability, and financial condition.

We rely upon a limited number of third parties for manufacturing, shipping, transportation, logistics, marketing and sales of our products.

We rely on third parties to ship, transport, and provide logistics for our products. Further, we plan on relying on third parties to manufacture, market and sell our PARA OPS system products. Our dependence on a limited number of third parties for these services leaves us vulnerable due to our need to secure these parties' services on favorable terms. Loss of, or an adverse effect on, any of these relationships or failure of any of these third parties to perform as expected could have a material and adverse effect on our business, sales, results of operations, financial condition, and reputation.

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We may be subject to product liability proceedings or claims.

We may be subject to proceedings or claims that may arise in the ordinary conduct of the business, which could include product and service warranty claims, which could be substantial. Product liability for us is a major risk as some of our products will be used by military personnel in theaters-of-war (for the Tactical and Counter-Threat product offerings) and by consumers and law enforcement (for the non-lethal systems). The occurrence of product defects due to non-compliance of our manufacturing specifications and the inability to correct errors could result in the delay or loss of market acceptance of our products, material warranty expense, diversion of technological and other resources from our product development efforts, and the loss of credibility with customers, manufacturers' representatives, distributors, value-added resellers, systems integrators, OEMs and end-users, any of which could have a material adverse effect on our business, operating results and financial conditions. To mitigate product liability risk, our products will be sold with a liability disclaimer for misuse of the product.

If we are unable to successfully design and develop or acquire new products, our business may be harmed.

To maintain and increase sales we must continue to introduce new products and improve or enhance our existing products or new products. The success of our new and enhanced products depends on many factors, including anticipating consumer preferences, finding innovative solutions to consumer problems or acquiring new solutions through mergers and acquisitions, differentiating our products from those of our competitors, and maintaining the strength of our brand. The design and development of our products as well as acquisitions of other businesses.

Our business could be harmed if we are unable to accurately forecast demand for our products or our results of operations.

To ensure adequate inventory supply, we forecast inventory needs and often place orders with our manufacturers before we receive firm orders from our retail partners or customers. If we fail to accurately forecast demand, we may experience excess inventory levels or a shortage of product.

If we underestimate the demand for our products, we or our suppliers may not be able to scale to meet our demand, and this could result in delays in the shipment of our products and our failure to satisfy demand, as well as damage to our reputation and retail partner relationships. If we overestimate the demand for our products, we could face inventory levels in excess of demand, which could result in inventory write-downs or write-offs and the sale of excess inventory at discounted prices, which would harm our gross margins. In addition, failures to accurately predict the level of demand for our products could cause a decline in sales and harm our results of operations and financial condition.

In addition, we may not be able to accurately forecast our results of operations and growth rate. Forecasts may be particularly challenging as we expand into new markets and geographies and develop and market new products for which we have no or limited historical data. Our historical sales, expense levels, and profitability may not be an appropriate basis for forecasting future results. Our lack of historical data related to new products makes it particularly difficult to make forecasts related to such products. The lead times and reliability of our suppliers has been inconsistent as a result of the COVID-19 pandemic and may be affected by global events in the future. These effects are expected to last through the remainder of the pandemic. Pandemic related variances require a very quick pivot and adjustments to the supply chain, production and marketing. If we are unable to make these changes quickly or at all our inventory, production and sales may be materially affected.

Failure to accurately forecast our results of operations and growth rate could cause us to make poor operating decisions that we may not be able to correct in a timely manner. Consequently, actual results could be materially different than anticipated. Even if the markets in which we compete expand, we cannot assure you that our business will grow at similar rates, if at all.

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Undetected flaws may be discovered in our products.

There can be no assurance that, despite testing by us, flaws will not be found in our products and services, resulting in loss of, or delay in, market acceptance. We may be unable, for technological or other reasons, to introduce products and services in a timely manner or at all in response to changing customer requirements. In addition, there can be no assurance that while we are attempting to finish the development of our technologies, products and services, a competitor will not introduce similar or superior technologies, products and services, thus diminishing our advantage, rendering our technologies, products and services partially or wholly obsolete, or at least requiring substantial re-engineering in order to become commercially acceptable. Failure by us to maintain technology, product and service introduction schedules, avoid cost overruns and undetected errors, or introduce technologies, products and services that are superior to competing technologies, products and services would have a materially adverse effect on our business, prospects, financial condition, and results of operations.

We will be reliant on IT systems and may be subject to damaging cyber-attacks.

We use third parties for certain hardware, software, telecommunications and other IT services in connection with our operations. Our operations depend, in part, on how well we and our suppliers protect networks, equipment, IT systems and software against damage from a number of threats, including, but not limited to, cable cuts, damage to physical plants, natural disasters, intentional damage and destruction, fire, power loss, hacking, computer viruses, vandalism and theft. Our operations also depend on the timely maintenance, upgrade and replacement of networks, equipment, IT systems and software, as well as pre-emptive expenses to mitigate the risks of failures. Any of these and other events could result in information system failures, delays and/or increase in capital expenses. The failure of information systems or a component of information systems could, depending on the nature of any such failure, adversely impact our reputation and results of operations. Moreover, failure to meet the minimum cybersecurity requirements for defense contracts may disqualify us from participating in the tendering process. To date, we have not experienced any losses relating to cyber-attacks or other information security breaches, but there can be no assurance that we will not incur such losses in the future. Our risk and exposure to these matters cannot be fully mitigated because of, among other things, the evolving nature of these threats. As a result, cybersecurity and the continued development and enhancement of controls, processes and practices designed to protect systems, computers, software, data and networks from attack, damage or unauthorized access is a priority. As cyber threats continue to evolve, we may be required to expend additional resources to continue to modify or enhance protective measures or to investigate and remediate any security vulnerabilities.

In certain circumstances, our reputation could be damaged.

Damage to our reputation can be the result of the actual or perceived occurrence of any number of events, and could include any negative publicity, whether true or not. Reputational risk for us is a major risk as some of our products will be used by military personnel in theaters-of-war or by law enforcement personnel. The increased usage of social media and other web-based tools used to generate, publish and discuss user-generated content and to connect with other users has made it increasingly easier for individuals and groups to communicate and share opinions and views regarding us and our activities, whether true or not. Although we believe that we operate in a manner that is respectful to all stakeholders and that we take care in protecting our image and reputation, we do not ultimately have direct control over how we are perceived by others. Reputational loss may result in decreased investor confidence, increased challenges in developing and maintaining community relations and an impediment to our overall ability to advance our projects, thereby having a material adverse impact on financial performance, financial condition, cash flows and growth prospects.

Our results of operations are difficult to predict and depend on a variety of factors.

There is no assurance that the production, technology acquisitions, and the commercialization of proprietary technology for game-changing applications in the military, security forces and personal defense markets will be managed successfully. Any inability to achieve such commercial success could have a material adverse effect on our business, financial condition, operating results, liquidity, and prospects. In addition, the comparability of results may be affected by changes in accounting guidance or changes in our ownership of certain assets. Accordingly, the results of operations from year to year may not be directly comparable to prior reporting periods. As a result of the foregoing and other factors, the results of operations may fluctuate significantly from period to period, and the results of any one period may not be indicative of the results for any future period.

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Protecting and defending against intellectual property claims may have a material adverse effect on our business.

Our ability to compete depends, in part, upon successful protection of our intellectual property. While we have some patents and trademarks, we also rely on trade secrets to protect our technology, which is inherently risky. Going forward, we will attempt to protect proprietary and intellectual property rights to our technologies through available copyright and trademark laws, patents and licensing and distribution arrangements with reputable international companies in specific territories and media for limited durations. Despite these precautions, existing copyright, trademark and patent laws afford only limited practical protection in certain countries where we distribute our products. As a result, it may be possible for unauthorized third parties to copy and distribute our products or certain portions or applications of our intended products, which could have a material adverse effect on our business, financial condition, operating results, liquidity, and prospects.

Litigation may also be necessary to enforce our intellectual property rights, to protect our trade secrets, or to determine the validity and scope of the proprietary rights of others or to defend against claims of infringement or invalidity. Any such litigation, infringement or invalidity claims could result in substantial costs and the diversion of resources and could have a material adverse effect on our business, financial condition, operating results, liquidity, and prospects.

We face risks from doing business internationally.

Our commercialization strategies for our products include sales efforts outside Canada and deriving revenues from international sources. As a result, our business is subject to certain risks inherent in international business, many of which are beyond our control.

These risks may include:

•laws and policies affecting trade, investment and taxes, including laws and policies relating to the repatriation of funds and withholding taxes, and changes in these laws;

•geo-political turbulence and uncertainty arising from regional conflicts;

•realignment of global security arrangements;

•anti-corruption laws and regulations such as the Foreign Corrupt Practices Act that impose strict requirements on how we conduct our foreign operations and changes in these laws and regulations;

•changes in local regulatory requirements, including restrictions on content and differing cultural tastes and attitudes;

•international jurisdictions where laws are less protective of intellectual property and varying attitudes towards the piracy of intellectual property;

•financial instability and increased market concentration of buyers in foreign markets;

•the instability of foreign economies and governments;

•fluctuating foreign exchange rates;

•pandemics and the spread of communicable diseases in such jurisdictions, which may impact business in such jurisdictions; and

•war and acts of terrorism.

Events or developments related to these and other risks associated with international trade could adversely affect our revenues from non-Canadian sources, which could have a material adverse effect on our business, financial condition, operating results, liquidity, and prospects. Protection of electronically stored data is costly and if our data is compromised in spite of this protection, we may incur additional costs, lost opportunities, and damage to our reputation.

We maintain information in digital form as necessary to conduct our business, including confidential and proprietary information and personal information regarding our employees.

Data maintained in digital form is subject to the risk of intrusion, tampering, and theft. We develop and maintain systems to prevent this from occurring, but it is costly and requires ongoing monitoring and updating as technologies change and efforts to overcome security measures become more sophisticated. Moreover, despite our efforts, the possibility of intrusion, tampering, and theft cannot be eliminated entirely, and risks associated with each of these acts remain. In addition, we provide confidential information, digital content and personal information to third parties when it is necessary to pursue business objectives. While we obtain assurances that these third parties will protect this information and, where appropriate, monitor the protections employed by these third parties, there is a risk that data systems of these third parties may be compromised. If our data systems or data systems of these third parties are compromised, our ability to conduct our business may be impaired, we may lose profitable opportunities or the value of those opportunities may be diminished and we may lose revenue as a result of unlicensed use of our intellectual property. A breach of our network security or other theft or misuse of confidential and proprietary information, digital content or personal employee information could subject us to business, regulatory, litigation, and reputation risk, which could have a materially adverse effect on our business, financial condition, and results of operations.

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Our success depends on management and key personnel.

Our success depends largely upon the continued services of our executive officers and other key employees. From time to time, there may be changes in our executive management team resulting from the hiring or departure of executives, which could disrupt our business. If we are unable to attract and retain top talent, our ability to compete may be harmed. Our success is also highly dependent on our continuing ability to identify, hire, train, retain and motivate highly qualified personnel. Competition for highly skilled executives and other employees is high in our industry, especially from larger and better capitalized defense and security companies. We may not be successful in attracting and retaining such personnel. Failure to attract and retain qualified executive officers and other key employees could have a material adverse effect on our business, prospects, financial condition, results of operations, and cash flows.

Our directors, officers or members of management may have conflicts of interest.

Certain of our directors, officers, and other members of management serve (and may in the future serve) as directors, officers, and members of management of other companies and therefore, it is possible that a conflict may arise between their duties as one of our directors, officers or members of management and their duties as a director, officer or member of management of such other companies. Our directors and officers are aware of the existence of laws governing accountability of directors and officers for corporate opportunity and requiring disclosures by directors of conflicts of interest and we will rely upon such laws in respect of any directors' and officers' conflicts of interest or in respect of any breaches of duty by any of our directors or officers. All such conflicts will be disclosed by such directors or officers in accordance with the BCBCA and they will govern themselves in respect thereof to the best of their ability in accordance with the obligations imposed upon them by law.

It may not be possible for foreign investors to enforce actions against us, and our directors and officers.

We are a corporation organized under the laws of the Province of British Columbia and our Canadian subsidiaries are organized under the laws of the Province of Ontario and our United States subsidiaries are organized under the laws of Delaware. All of our directors and executive officers reside principally in Canada. Because all or a substantial portion of our assets and the assets of these persons are located in Canada, it may not be possible for foreign investors, including United States investors, to effect service of process from outside of Canada upon us or those persons, or to realize in the United States upon judgments of United States courts predicted upon civil liabilities under the Exchange Act or other United States laws. Furthermore, it may not be possible to enforce against us foreign judgments obtained in courts outside of Canada based upon the civil liability provisions of the securities laws or other laws in those jurisdictions.

Any disruption at our places of business could delay revenues or increase our expenses.

Most of our operations are conducted at locations in the Province of Ontario. We maintain a significant business development operation in the United States, through our contractual relationship with SageGuild, LLC ("SageGuild") and other U.S. business development partners (see "History and Development of the Company - Principal Capital Expenditures and Divestitures"). A natural disaster, such as a fire, flood or earthquake, could cause substantial delays in our operations, damage or destroy our offices, and cause us to incur additional expenses.

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In addition, because we do not maintain "key person" life insurance on any of our executive officers, employees or consultants, any delay in replacing such persons, or an inability to replace them with persons of similar expertise, would have a material adverse effect on our business, financial condition, and results of operations.

Our internal computer systems are vulnerable to damage and failure.

Despite the implementation of security measures and backup storage, our internal computer systems are vulnerable to damage from computer viruses, unauthorized access, natural disasters, terrorism, war, and telecommunication and electrical failure. Any system failure, accident or security breach that causes interruption in our operations could result in a material disruption of our projects. To the extent that any disruption or security breach results in a loss or damage to our data or applications, or inappropriate disclosure of confidential or proprietary information, we may incur liability as a result. In addition, our technology program may be adversely affected and the further development of our technology may be delayed. We may also incur additional costs to remedy the damages caused by these disruptions or security breaches.

Business interruptions could adversely affect our operations.

Our operations are vulnerable to outages and interruptions due to fire, floods, power loss, telecommunications failures, and similar events beyond our control. Although we have developed certain plans to respond in the event of a disaster, there can be no assurance that they will be effective in the event of a specific disaster. Any losses or damages incurred by us could have a material adverse effect on our business and results of operations.

We are subject to risks associated with possible acquisitions, licensing, business combinations, or joint ventures.

While to date we have mainly focused on developing our own products, from time to time, we could be engaged in discussions and activities with respect to possible business and/or technology acquisitions or licensing, sale of assets, business combinations, or joint ventures with the view of either complementing or expanding our internally developed products. These acquisitions and licensing activities are not crucial to our long-term business success. The anticipated benefit from any of the transactions we may pursue may not be realized as expected. Regardless of whether any such transaction is consummated, the negotiation of a potential transaction and the integration of the acquired business or technology, acquired or licensed, could incur significant costs and cause diversion of management's time and resources. Any such transaction could also result in impairment of goodwill and other intangibles, development write-offs, and other related expenses. Such transactions may pose challenges in the consolidation and integration of IT, accounting systems, personnel, and operations. We may have difficulty managing the combined entity in the short term if we experience a significant loss of management personnel during the transition period after a significant acquisition. We may also have difficulty managing the product development and commercialization following a technology acquisition or licensing. No assurance can be given that expansion, licensing or acquisition opportunities will be successful, completed on time, or that we will realize expected operating efficiencies, cost savings, revenue enhancements, synergies or other benefits. Any of the foregoing could have a material adverse effect on our business, financial condition, operating results, liquidity, and prospects.

Claims against us relating to any acquisition, licensing or business combination may necessitate seeking claims against the seller for which the seller may not indemnify us or that may exceed the seller's or licensor's indemnification obligations.

There may be liabilities assumed in any technology acquisition or licensing or business combination that we did not discover or that we underestimated in the course of performing our due diligence. Although a seller or licensor generally will have indemnification obligations to us under a licensing, acquisition or merger agreement, these obligations usually will be subject to financial limitations, such as general deductibles and maximum recovery amounts, as well as time limitations. There is no assurance that our right to indemnification from any seller or licensors will be enforceable, collectible or sufficient in amount, scope or duration to fully offset the amount of any undiscovered or underestimated liabilities that we may incur. Any such liabilities could have a material adverse effect on our business, financial condition, operating results, liquidity, and prospects.

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Growth may cause pressure on our management and systems.

Our future growth may cause significant pressure on our management, and our operational, financial, and other resources and systems. Our ability to manage our growth effectively will require that we implement and improve our operational, financial, manufacturing, and management information systems, hire new personnel and then train, manage, and motivate these new employees. These demands may require the hiring of additional management personnel and the development of additional expertise within the existing management team. Any increase in resources devoted to production, business development, and distribution efforts without a corresponding increase in our operational, financial, and management information systems could have a material adverse effect on our business, financial condition, and results of operations.

We may infringe intellectual property rights of third parties.

For certain of our product lines, we have elected to protect our technology and products as trade secrets as opposed to seeking patent protection. We may, in future, elect to seek patent protection for some of our future products. While we believe that our products and other intellectual property do not infringe upon the proprietary rights of third parties, our commercial success depends, in part, upon us not infringing intellectual property rights of others. A number of our competitors and other third parties have been issued or may have filed patent applications or may obtain additional patents and proprietary rights for technologies similar to those utilized by us. Some of these patents may grant very broad protection to the owners of the patents. While we have engaged external intellectual property legal counsels to undertake an extensive review of existing third-party patents and prepare our patent applications for some of our products (see "Business Overview"), there is no assurance that their reviews and conclusion will not prevail if challenged by a third party of an alleged infringement of their intellectual properties. We may become subject to claims by third parties that our technology infringes their intellectual property rights due to the growth of products in our target markets, the overlap in functionality of those products and the prevalence of products. We may become subject to these claims either directly or through indemnities against these claims that we provide to end-users, manufacturer's representatives, distributors, value-added resellers, system integrators and OEMs. Litigation may be necessary to determine the scope, enforceability and validity of third-party proprietary rights or to establish our proprietary rights. Some of our competitors have, or are affiliated with companies having, substantially greater resources than we and these competitors may be able to sustain the costs of complex intellectual property litigation to a greater degree and for a longer period of time than us. Regardless of their merit, any such claims could be time consuming to evaluate and defend, result in costly litigation, cause product shipment delays or stoppages, divert management's attention and focus away from the business, subject us to significant liabilities and equitable remedies, including injunctions, require that we enter into costly royalty or licensing agreements and require that we modify or stop using infringing technology.

We may be prohibited from developing or commercializing certain technologies and products unless we obtain a license from a third party. There can be no assurance that we will be able to obtain any such license on commercially favorable terms or at all. If we do not obtain such a license, we could be required to cease the sale of certain of our products.

Risks Relating to Our Industry

The following risks relate specifically to Digitization and Counter-Threat business lines:

We are subject to extensive government regulation in the United States for our products designed for the military market.

Our customers in the United States are global defense contractors and they are subject to various United States government regulations which some may be passed on to us in order for them to be compliant. The most significant regulations and regulatory authorities that may affect our future business include the following:

•the Federal Acquisition Regulations and supplemental agency regulations, which comprehensively regulate the formation and administration of, and performance under, United States government contracts;

•the Truth in Negotiations Act, which requires certification and disclosure of all factual cost and pricing data in connection with contract negotiations;

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•the False Claims Act and the False Statements Act, which impose penalties for payments made on the basis of false facts provided to the government and on the basis of false statements made to the government, respectively;

•the Foreign Corrupt Practices Act, which prohibits United States companies from providing anything of value to a foreign official to help obtain, retain or direct business, or obtain any unfair advantage; and

•laws, regulations and executive orders restricting the use and dissemination of information classified for national security purposes or determined to be "controlled unclassified information" and the exportation of certain products and technical data.

Our failure to comply with applicable regulations, rules and approvals; changes in the United States government's interpretation of such regulations, rules and approvals as have been and are applied to our contracts, proposals or business or misconduct by any of our employees could result in the imposition of fines and penalties, the loss of security clearances, a decrease in profitability, or the loss of our subcontract contracts with United States defense contractors generally, any of which could harm our business, financial condition and results of operations.

A decline in the United States and other government budgets, changes in spending or budgetary priorities, or delays in contract awards may significantly and adversely affect our future revenue.

Since inception, except for Fiscal 2022, most of our revenue was driven by contracts from the United States government, through United States prime defense contractors. Our results of operations could be adversely affected by government spending caps or changes in government budgetary priorities, as well by delays in the government budget process, program starts, or the award of contracts or orders under existing contracts. As a result, the market for our military solution may be impacted due to shifts in the political environment and changes in the government and agency leadership positions under the new United States administration. If annual budget appropriations or continuing resolutions are not enacted timely, we could face United States government shutdown, which could adversely impact our business and our ability to receive indirectly timely payment from United States government entities on future contracts.

United States government contracts are generally not fully funded at inception and contain certain provisions that may be unfavorable to us.

We have entered into defense contracts with United States prime defense contractors, which it in turns transact directly with the United States government.

United States government contracts typically involve long lead times for design and development, and are subject to significant changes in contract scheduling. Congress generally appropriates funds on a fiscal year basis even though a program may continue for several years. Consequently, programs are often only partially funded initially, and additional funds are committed only as Congress makes further appropriations. The termination or reduction of funding for a government program would result in a loss of anticipated future revenue attributable to that program. In addition, United States government contracts generally contain provisions permitting termination, in whole or in part, at the government's convenience or for contractor default.

The actual receipt of revenue on future awards subcontracted to us may never occur or may change because a program schedule could change or the program could be cancelled, or a contract could be reduced, modified or terminated early.

While we had no outstanding United States government contracts (directly or indirectly) as of the date of this Prospectus, we are exposed to the above risk for future United States government related contracts.

We may not be able to comply with changes in government policies and legislation.

The manufacture, sale, purchase, possession and use of weapons, ammunitions, firearms, and explosives are subject to federal, provincial and foreign laws. If such regulation becomes more expansive in the future, it could have a material adverse effect on our business, operating results, financial condition, and cash flows. New legislation, regulations, or changes to or new interpretations of existing regulation could impact our ability to manufacture or sell our products and our projectiles, or limit their market, which could impact our cost of sales and demand for our products. Similarly changes in laws related to the domestic or international use of chemical irritants by civilians or law enforcement could impact both our cost of sales and the size of our reachable market.

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We may be subject, both directly and indirectly, to the adverse impact of existing and potential future government regulation of our products, technology, operations, and markets. For example, the development, production, exportation, importation, and transfer of our products and technology is subject to Canadian and provincial laws. Further, as we plan to conduct business in the United States, we will also be subject to United States and foreign export control, sanctions, customs, import and anti-boycott laws and regulations, including the Export Administration Regulations (the "EAR") (collectively, "Trade Control Laws"). If one or more of our products or technology, or the parts and components we buy from others, is or become subject to the International Traffic in Arms Regulations or national security controls under the EAR, this could significantly impact our operations, for example by severely limiting our ability to sell, export, or otherwise transfer our products or technology, or to release controlled technology to foreign person employees or others in the United States or abroad. We may not be able to retain licenses and other authorizations required under the applicable Trade Control Laws. The failure to satisfy the requirements under the Trade Control Laws, including the failure or inability to obtain necessary licenses or qualify for license exceptions, could delay or prevent the development, production, export, import, and/or in-country transfer of our products and technology, which could adversely affect our revenues and profitability.

Failure by us, our employees, or others working on our behalf to comply with the applicable government policies and regulations could result in administrative, civil, or criminal liabilities, including fines, suspension, debarment from bidding for or performing government contracts, or suspension of our export privileges, which could have a material adverse effect on us.

The following risk relates specifically to PARA OPS business line:

We will be subject to regulation in the United States for our non-lethal systems.

While our PARA OPS devices are non-lethal (based on the kinetic energy of our projectiles), these are automatically classified as form of a firearm under the United States Bureau of Alcohol, Tobacco and Firearms ("ATF") rules and regulations because we use pyrotechnic based primers in our proprietary ammunition cartridges. We have therefore self-classified our .67 caliber PARA OPS single shot device as not only a firearm, but a "destructive device" in accordance with the ATF regulations. We intend to self-classify our other PARA OPS devices as a form of a firearm under ATF regulations until such time we have found an alternative for primers (i.e., a non-pyrotechnic gas generator) to launch our projectiles, and therefore be subject to ATF regulations. We are currently reviewing an alternative to replace the primer with actuator technology that is in the developmental phase and accordingly, there is no assurance that we will succeed and consequently the replacement of the primer may adversely affect our future revenues and related results of operations, business, prospects, and financial condition.  Further, in the event we have implemented an alternative to replace the primer and then self-classify our PARA OPS devices as "non-firearm", there is no assurance that the ATF may not contest our self-classification, which could result in discontinuing sales to consumers with no firearm license where required by state law. Accordingly, this could also adversely affect our future revenues and related results of operations, business, prospects, and financial condition.

Because our business model relies on outsourced production, we have no plans to become a firearm manufacturer in the United States but rather to continue to partner with a FFL manufacturer for the production and distribution of our PARA OPS products. Accordingly, post commercialization in the United States the burden to comply with ATF rules and regulations applicable to the manufacturing and distribution process will be with our FFL business partners.  Our primary risk of governmental interruption of manufacturing and distribution therefore lies within the operations and attendant internal control environment of our FFL business partners. 

Furthermore, with respect to transfers to end users (government, military, or consumer), the obligation to comply with ATF rules and regulations and any applicable state laws resides with the downstream FFL wholesaler/distributor/retailer  and any penalties levied upon such parties do not flow up the distribution chain. 

See Business Overview - Government Regulation - Non-Lethal for a summary of relevant regulation in the United States for our non-lethal business line. 

The following risks apply to all business lines:

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Rapid technological development could result in obsolescence or short product life cycles of our products.

The markets for our products are characterized by rapidly changing technology and evolving industry standards, which could result in product obsolescence or short product life cycles. Accordingly, our success is dependent upon our ability to anticipate technological changes in the industries we serve and to successfully identify, obtain, develop and market new products that satisfy evolving industry requirements. There can be no assurance that we will successfully develop new products or enhance and improve our existing products or that any new products and enhanced and improved existing products will achieve market acceptance. Further, there can be no assurance that competitors will not market products that have perceived advantages over our products or which render the products currently sold by us obsolete or less marketable.

We must commit significant resources to developing, testing and demonstrating new products before knowing whether our investments will result in products the market will accept. To remain competitive, we may be required to invest significantly greater resources than currently anticipated in R&D and product enhancement efforts, and result in increased OPEX.

Our industry is highly competitive.

The industry for military and security forces and personal defense is highly competitive and composed of many domestic and foreign companies. We have experienced and expect to continue to experience, substantial competition from numerous competitors whom we expect to continue to improve their products and technologies. Competitors may announce and introduce new products, services or enhancements that better meet the needs of end-users or changing industry standards, or achieve greater market acceptance due to pricing, sales channels or other factors. With substantially greater financial resources and operating scale than we do currently, certain competitors may be able to respond more quickly than us to changes in end-user requirements and devote greater resources to the enhancement, promotion and sale of their products. Such competition could adversely affect our ability to win new contracts and sales.

Since we operate in evolving markets, our business and future prospects may be difficult to evaluate.

Our technological solutions are in new and rapidly evolving markets. The military, civilian public safety, professional and personal defense markets we target are in early stages of customer adoption. Accordingly, our business and future prospects may be difficult to evaluate. We cannot accurately predict the extent to which demand for our products and services will develop and/or increase, if at all. The challenges, risks and uncertainties frequently encountered by companies in rapidly evolving markets could impact our ability to do the following:

•generate sufficient revenue to obtain and/or maintain profitability;

•acquire and maintain market share;

•achieve or manage growth in operations;

•develop and renew contracts;

•attract and retain additional engineers and other highly-qualified personnel;

•successfully develop and commercially market products and services;

•adapt to new or changing policies and spending priorities of governments and government agencies; and

•access additional capital when required or on reasonable terms.

If we fail to address these and other challenges, risks and uncertainties successfully, our business, results of operations and financial condition would be materially harmed.

Uncertainty related to exportation could limit our operations in the future.

We must comply with Canadian federal and provincial laws regulating the export of our products. In some cases, explicit authorization from the Canadian government is needed to export certain products. The export regulations and the governing policies applicable to our business are subject to change. We cannot provide assurance that such export authorizations will be available for our products in the future. To date, compliance with these laws has not significantly limited our operations, but could significantly limit them in the future. Noncompliance with applicable export regulations could potentially expose us to fines, penalties and sanctions. If we cannot obtain required government approvals under applicable regulations, we may not be able to sell our products in certain international jurisdictions, which could adversely affect our business, prospects, financial condition and results of operations.

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Global economic turmoil and regional economic conditions in the United States could adversely affect our business.

In addition to the risks pertaining to COVID-19 disclosed above, global economic turmoil may cause a general tightening in the credit markets, lower levels of liquidity, increases in the rates of default and bankruptcy, levels of intervention from the United States federal government and other foreign governments, decreased consumer confidence, overall slower economic activity, and extreme volatility in credit, equity, and fixed income markets. A decrease in economic activity in the United States or in other regions of the world in which we do business could adversely affect demand for our products, thus reducing our revenues and earnings. A decline in economic conditions could reduce sales of our products.

Risks Relating to Our Financial Condition

We face substantial capital requirements and financial risk.

To be successful, our business requires a substantial investment of capital. The production, acquisition, and distribution of proprietary technology for game-changing applications in the military and security forces and personal defense markets require substantial capital. A significant amount of time may elapse between our expenditure of funds and the receipt of revenues. This may require a significant portion of funds from equity, credit, and other financing sources to fund the business. There can be no assurance that these arrangements will continue to be successfully implemented or will not be subject to substantial financial risks relating to the production, acquisition, and distribution of proprietary technology for game-changing applications in the military and security forces and personal defense markets. In addition, if demand increases through internal growth or acquisition, there may be an increase to overhead and/or larger up-front payments for production and, consequently, these increases bear greater financial risks. Any of the foregoing could have a material adverse effect on our business, financial condition, operating results, liquidity, and prospects.

We may require additional capital which may result in dilution to existing shareholders.

We may need to engage in additional equity or debt financings to secure additional funds to fund our working capital requirement and business growth. If we raise additional funds through further issuances of equity or convertible debt securities, our existing shareholders could suffer significant dilution, and any new equity securities we issue could have rights, preferences, and privileges superior to those of holders of the Common Shares. Any debt financing secured by us in the future could involve restrictive covenants relating to our capital-raising activities and other financial and operational matters, which might make it more difficult for us to obtain additional capital and to pursue business opportunities.

We can provide no assurance that sufficient debt or equity financing will be available on reasonable terms or at all to support our business growth and to respond to business challenges and failure to obtain sufficient debt or equity financing when required could have a material adverse effect on our business, prospects, financial condition, results of operations, and cash flows.

Over the short-term, we expect to incur operating losses and generate negative cash flow until we can produce sufficient revenues to cover our costs. We may never become profitable. Even if we do achieve profitability, we may be unable to sustain or increase our profitability in the future. There are substantial uncertainties associated with our ability to achieving and sustaining profitability. We expect our current cash position will be reduced due to future operating losses and working capital requirements, and we cannot provide certainty as to how long our cash position will last or that we will be able to access additional capital if and when necessary.

Exercise of options or warrants or vesting of restricted stock units will have a dilutive effect on your percentage ownership and will result in a dilution of your voting power and an increase in the number of Common Shares eligible for future resale in the public market, which may negatively impact the trading price of our Common Shares. 

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We may need to divest assets if there is insufficient capital.

If sufficient capital is not available, we may be required to delay, reduce the scope of, eliminate or divest one or more of our assets or products, any of which could have a material adverse effect on our business, financial condition, prospects, or results of operations.

We have broad discretion over the use of net proceeds from future capital raises.

We will have broad discretion over the use of the net proceeds from any future capital raises. Because of the number and variability of factors that will determine our use of such proceeds, the ultimate use might vary substantially from the planned use. Investors may not agree with how we allocate or spend the proceeds from future capital raises. We may pursue collaborations that ultimately do not result in an increase in the market value of the Common Shares and that instead increase our losses.

Currency fluctuations may have a material effect on us.

Fluctuations in the exchange rate between the United States dollar, other currencies and the Canadian dollar may have a material effect on our results of operations. To date, we have not engaged in currency hedging activities. To the extent that we may seek to implement hedging techniques in the future with respect to our foreign currency transactions, there can be no assurance that we will be successful in such hedging activities.

Unavailability of adequate director and officer insurance could make it difficult for us to retain and attract qualified directors and could also impact our liquidity.

We have directors and officers liability insurance ("D&O Insurance") we believe to be adequate to cover risk exposure for us and our directors and officers, who we indemnify to the full extent permitted by law, there is no guaranty that such coverage will be adequate in the event of litigation.

Our coverage needs for D&O Insurance may change or increase in the future for various reasons including changes in our market capitalization, changes in trading volume or changes in the listing rules of exchanges or marketplaces on which our securities may trade from time to time. There is no guaranty that such coverage will be available or available at reasonable rates or at all, or in amounts adequate to cover expenses and liability should litigation occur. Without adequate D&O Insurance, the costs of litigation including amounts we would pay to indemnify our officers and directors should they be subject to legal action based on their service to us could have a material adverse effect on our financial condition, results of operations and liquidity. Further, if we are unable to obtain adequate D&O Insurance in the future for any reason, we may have difficultly retaining and attracting talented and skilled directors and officers, which could adversely affect our business.

Our insurance policies may be inadequate to fully protect us from material judgments and expenses.

We require insurance coverage for a number of risks, including business interruption, environmental matters and contamination, personal injury and property damage as well as general aviation liability coverage. Although we maintain insurance policies, we cannot provide assurance that this insurance will be adequate to protect us from all material judgments and expenses related to potential future claims or that these levels of insurance will be available in the future at economical prices or at all. A successful product liability claim could result in substantial cost to us. If insurance coverage is unavailable or insufficient to cover any such claims, our financial resources, results of operations and prospects could be adversely affected.

Even if we are fully insured as it relates to a claim, the claim could nevertheless diminish our brand and divert management's attention and resources, which could have a negative impact on our business, prospects, financial condition and results of operations.

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Risks Relating to the Ownership of our Securities

An investment in our securities involves significant risks.

Additional risks and uncertainties not presently known to us or that we currently consider immaterial may also impair our business and operations and cause the trading price of our securities to decline. If any of the following or other risks occur, our business, prospects, financial condition, results of operations and cash flows could be materially adversely impacted. In that event, the trading price of our securities could decline and security holders could lose all or part of their investment. There is no assurance that risk management steps taken will avoid future loss due to the occurrence of the risks described below or other unforeseen risks.

Our Common Shares may experience extreme stock price volatility unrelated to our actual or expected operating performance, financial condition or prospects, making it difficult for prospective investors to assess the rapidly changing value of our Common Shares.

Recently, there have been instances of extreme stock price run-ups followed by rapid price declines and strong stock price volatility with a number of recent initial public offerings, especially among companies with relatively smaller public floats. As a relatively small-capitalization company with relatively small public float, we may experience greater stock price volatility, extreme price run-ups, lower trading volume and less liquidity than large-capitalization companies. In particular, our Common Shares may be subject to rapid and substantial price volatility, low volumes of trades and large spreads in bid and ask prices. Such volatility, including any stock-run up, may be unrelated to our actual or expected operating performance, financial condition or prospects, making it difficult for prospective investors to assess the rapidly changing value of our Common Shares.

In addition, if the trading volumes of our Common Shares are low, persons buying or selling in relatively small quantities may easily influence prices of our Common Shares. This low volume of trades could also cause the price of our Common Shares to fluctuate greatly, with large percentage changes in price occurring in any trading day session. Holders of our Common Shares may also not be able to readily liquidate their investment or may be forced to sell at depressed prices due to low volume trading. If high spreads between the bid and ask prices of our Common Shares exist at the time of a purchase, the stock would have to appreciate substantially on a relative percentage basis for an investor to recoup their investment. Broad market fluctuations and general economic and political conditions may also adversely affect the market price of our Common Shares.

As a result of this volatility, investors may experience losses on their investment in our Common Shares. A volatile market price of our Common Shares also could adversely affect our ability to issue additional shares of Common Shares or other securities and our ability to obtain additional financing in the future.

The market price of our securities may be volatile.

The market price for our securities may be volatile and subject to wide fluctuations in response to numerous factors, many of which are beyond our control, including, but not limited to, the following: (i) actual or anticipated fluctuations in our quarterly results of operations; (ii) recommendations by securities research analysts; (iii) changes in the economic performance or market valuations of other issuers that investors deem comparable to us; (iv) departure of executive officers or other key personnel; (v) issuances or anticipated issuances of additional Common Shares; (vi) significant acquisitions or business combinations, strategic partnerships, joint ventures or capital commitments by or involving us or our competitors; and (vii) news reports relating to trends, concerns, technological or competitive developments, regulatory changes and other related issues in our industry or target markets.

Financial markets have historically experienced significant price and volume fluctuations that have particularly affected the market prices of equity securities of public entities and that have, in many cases, been unrelated to the operating performance, underlying asset values or prospects of such entities. Accordingly, the market price of our securities may decline even if our operating results, underlying asset values or prospects have not changed. Additionally, these factors, as well as other related factors, may cause decreases in asset values that are deemed to be other than temporary, which may result in impairment losses. There can be no assurance that continuing fluctuations in price and volume will not occur. If such increased levels of volatility and market turmoil continue for a protracted period of time, the trading price of the Common Shares may be materially adversely affected.

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There can be no assurance of an active market for our Common Shares.

Our Common Shares are listed for trading on the TSXV since September 22, 2020, Nasdaq since December 7, 2022, and the Frankfurt Stock Exchange since March 29, 2022. Additionally, the U.S. IPO Warrants are listed on Nasdaq (KWESW) and the Canadian Warrants are listed on TSXV (KWE.WT.U). There can be no assurance an active and liquid market for the Common Shares will be maintained.

If an active public market is not maintained, our shareholders may have difficulty selling the Common Shares.

If we are unable to satisfy the requirements of Sarbanes-Oxley or our internal controls over financial reporting are not effective, the reliability of our financial statements may be questioned.

We are subject to the requirements of Section 404 which requires companies subject to the reporting requirements of United States securities laws to complete a comprehensive evaluation of their internal controls over financial reporting. To comply with this statute, we are required to document and test our internal control procedures and our management is required to assess and issue a report concerning our internal controls over financial reporting. Pursuant to the JOBS Act, we are classified as an "emerging growth company." Under the JOBS Act, emerging growth companies are exempt from certain reporting requirements, including the independent auditor attestation requirements of Section 404(b) of Sarbanes-Oxley. Under this exemption, our independent auditor is not required to attest to and report on management's assessment of our internal controls over financial reporting during a five year transition period, except in the event this is accelerated if we lose our status as an "emerging growth company". The continuous process of strengthening our internal controls and complying with Section 404 is complicated and time-consuming. Furthermore, we believe that our business will grow both domestically and internationally, organically and through acquisitions, in which case our internal controls will become more complex and will require significantly more resources and attention to ensure our internal controls remain effective overall. During the course of our testing, management may identify material weaknesses or significant deficiencies, which may not be remedied in a timely manner to meet the deadline imposed by Sarbanes-Oxley. If management cannot favorably assess the effectiveness of our internal controls over financial reporting, or our independent registered public accounting firm identifies material weaknesses in our internal controls, investor confidence in our financial results may weaken, and the market price of our securities may suffer.

We are an emerging growth company and rely on exemptions from certain disclosure requirements which may make our securities less attractive to investors.

We are an "emerging growth company" as defined in section 3(a) of the Exchange Act (as amended by the JOBS Act), and we will continue to qualify as an emerging growth company until the earliest to occur of: (a) the last day of the fiscal year during which we have total annual gross revenues of USD$1.235 billion (as such amount is indexed for inflation every five years by the SEC) or more; (b) the last day of our fiscal year following the fifth anniversary of the date of our first sale of common equity securities pursuant to an effective registration statement under the United States Securities Act of 1933, as amended (the "Securities Act"); (c) the date on which we have, during the previous three year period, issued more than USD$1 billion in non-convertible debt; and (d) the date on which we are deemed to be a "large accelerated filer", as defined in Rule 12b-2 under the Exchange Act. We will qualify as a large accelerated filer (and would cease to be an emerging growth company) at such time when on the last business day of our second fiscal quarter of such year the aggregate worldwide market value of our common equity held by non-affiliates is USD$700 million or more.

For so long as we remain an emerging growth company, we are permitted to and intend to rely upon exemptions from certain disclosure requirements that are applicable to other public companies that are not emerging growth companies. These exemptions include not being required to comply with the auditor attestation requirements of Section 404. We cannot predict whether investors will find our securities less attractive because we rely upon certain of these exemptions. If some investors find our securities less attractive as a result, there may be a less active trading market for such securities and the price of our Common Shares and other outstanding securities may be more volatile. On the other hand, if we no longer qualify as an emerging growth company, we would be required to divert additional management time and attention from our development and other business activities and incur increased legal and financial costs to comply with the additional associated reporting requirements, which could negatively impact the our business, financial condition and results of operations.

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We may lose foreign private issuer status in the future, which could result in significant additional costs and expenses.

We are a "foreign private issuer", under applicable United States federal securities laws, and are, therefore, not subject to the same requirements that are imposed upon United States domestic issuers by the SEC. Under the Exchange Act, we are subject to reporting obligations that, in certain respects, are less detailed and less frequent than those of United States domestic reporting companies. As a result, we do not file the same reports that a United States domestic issuer would file with the SEC, although we are required to file with or furnish to the SEC the continuous disclosure documents that we are required to file in Canada under Canadian securities laws. In addition, our officers, directors, and principal shareholders are exempt from the reporting and short-swing profit recovery provisions of Section 16 of the Exchange Act. Therefore, our shareholders may not know on as timely a basis when our officers, directors and principal shareholders purchase or sell Common Shares, as the reporting periods under the corresponding Canadian insider reporting requirements are longer.

As a foreign private issuer, we are exempt from the rules and regulations under the Exchange Act related to the furnishing and content of proxy statements. We are also exempt from Regulation FD, which prohibits issuers from making selective disclosures of material non-public information. While we comply with the corresponding requirements relating to proxy statements and disclosure of material non-public information under Canadian securities laws, these requirements differ from those under the Exchange Act and Regulation FD and shareholders should not expect to receive the same information at the same time as such information is provided by United States domestic companies. In addition, we may not be required under the Exchange Act to file annual and quarterly reports with the SEC as promptly as U.S. domestic companies whose securities are registered under the Exchange Act.

In order to maintain our status as a foreign private issuer, a majority of the Common Shares must be either directly or indirectly owned by non-residents of the United States unless we satisfy one of the additional requirements necessary to preserve this status. We may in the future lose our foreign private issuer status if a majority of our Common Shares are held in the United States and if we fail to meet the additional requirements necessary to avoid loss of our foreign private issuer status. The regulatory and compliance costs under United States federal securities laws as a United States domestic issuer may be significantly more than the costs incurred as a Canadian foreign private issuer using the standard foreign form. If we are not a foreign private issuer, we would not be eligible to use the foreign issuer forms and would be required to file periodic and current reports and registration statements on United States domestic issuer forms with the SEC, which are more detailed and extensive than the forms available to a foreign private issuer.

Our failure to meet the continued listing requirements Nasdaq could result in a delisting of our securities.

If we fail to satisfy the continued listing requirements of Nasdaq, such as minimum bid price requirements, Nasdaq may take steps to delist our Common Shares and/or U.S. IPO Warrants. Such a delisting would have a materially adverse effect on the price of our outstanding securities, impair the ability to sell or purchase our Common Shares or securities convertible or exercisable into Common Shares when persons wish to do so, and materially adversely affect our ability to raise capital or pursue strategic restructuring, refinancing or other transactions on acceptable terms, or at all. A delisting from Nasdaq could also have other negative results, including the potential loss of institutional investor interest and fewer business development opportunities, as well as a limited amount of news and analyst coverage. In the event of a delisting, we would attempt to take actions to restore our compliance with Nasdaq's listing requirements, but we can provide no assurance that any such action taken by us would allow our securities to become listed again, stabilize the market price or improve the liquidity of our securities, prevent our Common Shares from dropping below the Nasdaq minimum bid price requirement or prevent future non-compliance with Nasdaq's listing requirements.

If we are a ''passive foreign investment company'' (or "PFIC"), adverse U.S. federal income tax consequences may result for U.S. investors.

Based on current business plans and financial expectations, the Company expects that it should not be a PFIC for its current tax year and expects that it should not be a PFIC for the foreseeable future. No opinion of legal counsel or ruling from the IRS concerning the status of the Company as a PFIC has been obtained or is currently planned to be requested.  The Company's PFIC classification for its current or future tax years may depend on, among other things, the manner in which, and how quickly, the Company utilizes its cash on hand, as well as on changes in the market value of Common Shares. If the Company is a PFIC for any year during a U.S. taxpayer's holding period of Common Shares, then such U.S. taxpayer generally will be required to treat any gain realized upon a disposition of the Common Shares or any so-called "excess distribution" received on its Common Shares as ordinary income, and to pay an interest charge on a portion of such gain or distribution. In certain circumstances, the sum of the tax and the interest charge may exceed the total amount of proceeds realized on the disposition, or the amount of excess distribution received, by the U.S. taxpayer. Subject to certain limitations, these tax consequences may be mitigated if a U.S. taxpayer makes a timely and effective QEF Election (as defined herein) or a Mark-to-Market Election (as defined herein). Subject to certain limitations, such elections may be made with respect to the Common Shares. A U.S. taxpayer who makes a timely and effective QEF Election generally must report on a current basis its share of the Company's net capital gain and ordinary earnings for any year in which the Company is a PFIC, whether or not the Company distributes any amounts with respect to the Common Shares. However, U.S. taxpayers should be aware that, for each tax year, if any, that the Company is a PFIC, the Company can provide no assurances that it will satisfy the record keeping requirements of a PFIC, or that it will make available to U.S. Holders the information such U.S. taxpayers require to make a QEF Election with respect to the Company or any Subsidiary PFIC (as defined herein). Accordingly, U.S. taxpayers may not be able to make a QEF Election with respect to their Common Shares. A U.S. taxpayer who makes the Mark-to-Market Election generally must include as ordinary income each year the excess of the fair market value of the Common Shares over the taxpayer's basis therein. This paragraph is qualified in its entirety by the discussion below under the heading "Material United States Federal Income Tax Considerations - Passive Foreign Investment Company Rules." Each potential investor who is a U.S. taxpayer should consult its own tax advisor regarding the tax consequences of the PFIC rules and the acquisition, ownership, and disposition of the Common Shares.

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Proposed legislation in the U.S. Congress, including changes in U.S. tax law, and the Inflation Reduction Act of 2022 may adversely impact the Company.

Changes to U.S. tax laws (which changes may have retroactive application) could adversely affect the Company or holders of the Common Shares. In recent years, many changes to U.S. federal income tax laws have been proposed and made, and additional changes to U.S. federal income tax laws are likely to continue to occur in the future.

The U.S. Congress is currently considering numerous items of legislation which may be enacted prospectively or with retroactive effect, which legislation could adversely impact the Company's financial performance and the value of the Common Shares. Additionally, states in which the Company operates or owns assets may impose new or increased taxes. If enacted, most of the proposals would be effective for the current or later years. The proposed legislation remains subject to change, and its impact on the Company and purchasers of Common Shares is uncertain.

In addition, the Inflation Reduction Act of 2022 includes provisions that will impact the U.S. federal income taxation of corporations. Among other items, this legislation includes provisions that will impose a minimum tax on the book income of certain large corporations and an excise tax on certain corporate stock repurchases that would be imposed on the corporation repurchasing such stock. It is unclear how this legislation will be implemented by the U.S. Department of the Treasury and the Company cannot predict how this legislation or any future changes in tax laws might affect the Company or purchasers of the Common Shares.

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FORWARD-LOOKING STATEMENTS

Certain statements in this Prospectus constitute "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 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 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:

• limited operating history;
• failure to realize 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;
• expansion to other jurisdictions;
• damage to our reputation;
• operating risk and insurance coverage;
• negative operating cash flow;
• management of growth;
• product liability;
• product recalls;
• environmental regulations and risks;
• ownership and protection of intellectual property;
• constraints on marketing products;
• reliance on management;
• fraudulent or illegal activity by our employees, contractors and consultants;

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• 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 employee health and safety regulations;
• regulatory or agency proceedings, investigations and audits;
• additional capital requirements to support our operations and growth plans, leading to further dilution to shareholders;
• conflicts of interest;
• litigation;
• risks related to United States' and other international activities;
• changes in government spending priorities;
• risks related to security clearances and risks relating to the ownership of our securities, such as potential extreme volatility in the price of our securities;
• no assurance of an active market for Common Shares or warrants;
• risks related to our foreign private issuer status;
• risks related to our emerging growth company status; and
• risks related to meeting the continued listing requirements of Nasdaq.

Although the forward-looking statements contained in this Prospectus 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.

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PRIVATE PLACEMENT OF COMMON SHARES, PRE-FUNDED WARRANTS AND WARRANTS

On July 19, 2023, we announced a brokered private placement offering in the United States (the "Private Placement") and in connection with the Private Placement, that we had entered into a placement agency agreement (the "Placement Agency Agreement") with ThinkEquity LLC ("ThinkEquity"), and the Securities Purchase Agreement and a registration rights agreement (the "Registration Rights Agreement") with certain of the Selling Securityholders, all of whom are accredited or institutional accredited investors.

Under the Securities Purchase Agreement, on July 21, 2023 we sold 1,542,194 Common Shares at a price of USD$2.26 (CAD$2.98) per share and 930,548 Pre-Funded Warrants at a price of USD$2.259 (CAD$2.979) per warrant to the Selling Securityholders, with each Common Share and Pre-funded Warrant being bundled with one Warrant. Although the Common Shares and Pre-Funded Warrants were each bundled with a Warrant, each security was issued separately. In addition, we agreed not to issue any Common Shares (or Common Share equivalents) at a price lower than the subscription price in the Private Placement, subject to customary exceptions, for a period of six months and we granted the Selling Securityholders a right to participate in subsequent financings, if any, in an amount equal to 50% of any such financing for a period of 24-months.

Under the Placement Agency Agreement, ThinkEquity acted as sole placement agent for the Private Placement. As compensation for services rendered, we paid ThinkEquity a cash fee of USD$475,013.14 representing 8.5% of the aggregate gross proceeds of the Private Placement and issued 123,637 Warrants to purchase 123,637 Common Shares, representing 5% of the Common Shares and Pre-Funded Warrants sold in the Private Placement to designees of ThinkEquity, who are Selling Securityholders identified in this prospectus. The Warrants issued to ThinkEquity’s designees were exercisable, in whole or in part, immediately upon issuance and expire 60 months after July 21, 2023 and have an initial exercise price of USD$2.66 (CAD$3.50) per Common Share. In addition, we granted ThinkEquity a right of first refusal for a period of twelve (12) months beginning on May 19, 2023, to  act  as  sole investment banker, sole book-runner and/or sole placement agent for public and private equity and debt offerings.

Under the Registration Rights Agreement, we agreed with certain of the Selling Securityholders to use reasonable best efforts to file a resale registration statement on Form F-1 with the SEC to register for resale the Common Shares, Pre-funded Warrant Shares and Warrant Shares sold in the Private Placement and to use reasonable best efforts to cause such registration statement to be declared effective by the SEC.

CAPITALIZATION AND INDEBTEDNESS

The following table presents our unaudited capitalization and indebtedness as of June 30, 2023, in accordance with IFRS as well as the as adjusted capitalization and indebtedness as of June 30, 2023, reflecting: (a) the sale by the Selling Securityholders of 5,069,121 Common Shares that may be sold in this Offering, (b) the exercise of 2,596,379 Warrants and (c) 930,548 Pre-Funded Warrants.

(CAD$ in thousands)	June 30, 2023 (Unaudited)	30-Jun-23 As adjusted for the Offering (Unaudited)1
Debt:
Lease obligations	$                224	$                224
Warrant liabilities	3,027	9,170
Total debt	3,251	9,394
Equity:
Share capital	30,950	32,132
Warrants	2,089	2,089
Contributed surplus	3,461	3,461
Accumulated other comprehensive loss	(75)	(75)
Accumulated deficit	(32,797)	(33,489)
Total equity	3,628	4,118
TOTAL CAPITALIZATION	$              6,879	$          13,512

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⁽¹⁾ The adjusted capitalization contemplates the values of the respective securities and CAD/USD exchange rate at the date of closing the Private Placement, and included as if Private Placement had been completed at June 30, 2023.  Consistent with our financial statement presentation of past transactions, the Pre-Funded Warrants, placement agent Warrants, and Warrants are measured at fair value and presented as a liability.  The value of the Pre-Funded Warrants and Common Shares has been determined by first determining the value of the Warrants using the Black-Scholes valuation model, subtracting this value from the total proceeds, and allocating the amount that remains to the Common Shares and Pre-Funded Warrants using the residual method.  We used the following assumptions when applying the Black-Scholes valuation model: Warrant strike price - CAD $3.50, Common Share Value on Day of Valuation - CAD - $2.79, Risk free rate - 3.7%, Annualized Volatility - 98.399%, Time to expiry - 5 years.  Consistent with prior transactions we have also included the effect of issuance costs of USD $579,913.74 which includes the Placement Agent's fee as well as legal costs reimbursed to the Placement Agent.  We have not included the effect of the Company's legal expenses which will be known with certainly once the transaction and related regulatory filing has been complete.  These costs will be included in our fiscal 2023 annual financial statements and allocated accordingly.

USE OF PROCEEDS

We  will not receive any proceeds from the sale of the Common Shares by the Selling Securityholders. All net proceeds from the sale of the Common Shares covered by this Prospectus will go to the respective Selling Securityholders. We expect that the Selling Securityholders will sell their Common Shares as described under "Plan of Distribution."

We may receive proceeds from the exercise of the Warrants and the Pre-Funded Warrants to the extent that these Warrants and Pre-Funded Warrants are exercised for cash. The Warrants and Pre-Funded Warrants, however, are exercisable on a cashless basis under certain circumstances. If all of the Warrants and Pre-Funded Warrants were exercised for cash in full, the proceeds would be approximately $6.9 million. We intend to use the net proceeds of such warrant exercise, if any, for general working capital purposes.

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INFORMATION ON THE COMPANY

Business Overview

Principal Products and Services

KWESST Micro Systems Inc. is an early-stage technology company that develops and commercializes next-generation tactical systems for military and security forces and public safety markets.

We focus on three niche market segments as follows:

Our core mission is to protect and save lives and enhance operational effectiveness.

The following is a summary of our main product and service categories for each business line:

Non-Lethal	Digitization	Counter-Threat
PARA OPS products: Non-reciprocating devices: A single-shot device A five-shot device 12 gauge shotgun Reciprocating devices Replica pistol AR style Ammunition Blunt / training Inert marking powder Irritant powder ARWEN products: Single shot 37mm launcher Multi-round 37mm launcher Ammunition	Products: TASCS IFM TASCS NORS Services: ATAK Centre of Excellence Critical Incident Management System	Products: Battlefield Laser Defense System Phantom Electronic Warfare device

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Non-Lethal Products

Non-reciprocating PARA OPS devices

We are in the LRIP phase for the .67 caliber single shot and multi-shot devices. We expect to complete our sales, marketing and distribution plan and begin the commercialization phase for these devices during our fourth quarter of Fiscal 2023, which ends September 30, 2023. Both will be offered to the public safety market, including our proprietary projectiles for these devices.

(Single shot - need to insert new pic)	(Pro 5 Magnum)

(Proprietary cartridge and projectile)

We will offer three types of payload for projectiles based on customer needs:

• solid slug for practice or pain compliance,
• inert colored powder for practice or realistic close quarters combat simulation, and
• incapacitating irritant pepper powder for operation use.

Reciprocating PARA OPS devices

We plan to begin the design and prototype of PARA OPS high-capacity automatic pistols and carbines (referred as reciprocating devices) for non-lethal operations and force-on-force training in Q1 of the fiscal year ending September 30, 2024. 

See below for further details of our projected product development cycle and estimated additional investment to reach full commercialization for our PARA OPS devices.

ARWEN launchers

As a result of the Police Ordinance Acquisition, we are currently selling the following ARWEN products and related ammunition to law enforcement agencies:

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(Multi-shot launcher)	(Single-shot launcher)

Digitization

For the Digitization business line, our products share the same core technology platforms and leverage our domain knowledge, proprietary sensor-software integration, algorithms and electronic circuity in order to develop and deliver integrated solutions to our clients who operate in the primarily dismounted domain (i.e., away from supporting platforms such as vehicles, aircraft and armored vehicles):

• Micro Integrated Sensor Software Technology ("MISST") a proprietary integration of miniaturized sensors, optics, ballistics and software that provides an advancement in affordable smart systems and mission capability. Current applications and offerings of the MISST technology enable: (i) a real-time networked situational awareness for soldiers and their weapons systems, and (ii) smart management of ordnance systems.  MISST also provides solutions for countering drone attacks and countermeasures against weaponized lasers in our Counter-Threat business line.

• Android Team Awareness Kit ("ATAK"). ATAK is a United States government owned situational awareness software application that is hosted on Android end user devices. Based on our observation, ATAK is becoming the de facto standard in the United States, Canada, and NATO for software based situational awareness and as a command and control battle management application in the dismounted domain. While the base software is United States Government owned and is available at no cost, being able to develop specific plug-ins and secure tactical networks is beyond the capacity of most user organizations. We have the experience and expertise to offer ATAK integration and networking services to prospective clients.

• After successfully developing digital technologies for tactical military applications which provide real-time exchange of situational awareness, navigation, imagery, and operational information for soldiers on the ground, we saw opportunities to apply these digitization solutions to the public safety market. These solutions solve critical challenges for law enforcement, fire, emergency response, search and rescue, and natural disaster management, all of whom require networked situational awareness to understand, decide, and act faster and more effectively in response to a critical incident. When responders are facing a public emergency, they need information quickly. Whether it is a wildfire, active shooter scenario or a natural disaster, they need to know what they're walking into and where their resources are located. They also need to communicate and collaborate in real-time - across teams and information sources and often across departments.

• We entered the civilian public safety market by launching our CIMS for enhanced public safety. A critical incident is any situation that requires swift, decisive action involving multiple components in response to and occurring outside of the normal routine business activities of a public safety response, which generally involves the police department, the fire department, and can also involve the Office of Emergency Management.  The primary goal of addressing a critical incident is the resource management of first responders, equipment, and the integration of communications and technology. Our CIMS is a digital technology solution that addresses this need by integrating emergency operations, incident command post, incident commanders, and all responders whether mobile or dismounted. Our CIMS architecture is a native cloud-based Microsoft environment (MS Azure) integrated with TAK. This provides key stakeholders with seamless fusion and sharing of crucial real-time position location, imagery, and time-sensitive emergency services data and information for effective and coordinated delivery of emergency services, including rescue, fire suppression, emergency medical care, law enforcement, and other forms of hazard control and mitigation.

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The following is a summary of our Digitization main products that are ready for commercialization in Fiscal 2023, subject to customer orders:

TASCS Indirect Fire Module •The TASCS IFM equips existing direct and indirect weapons systems with a sensor pack, that accurately locates the weapon on the battlefield and provides a high-resolution bearing line indicating the direction in which the weapon is pointed. When connected to a display, and combined with our ballistic algorithm built into ATAK, the operator can engage targets in less time and with greater accuracy. When networked across an ATAK-based network, targeting information can be received from and on any source of the network, and once a weapon is activated in the integrated fires modules systems mode, the impact point of the ammunition is displayed on all systems, giving friendly forces the ability to know if they are inadvertently being targeted and to take appropriate action. It also enables all networked systems to see where potential targets are and who is engaging them. The TASCS IFM is utilized primarily on systems that ordinarily require the user to have direct line of sight to the target, leaving them exposed. With TASCS IFM, they can engage from positions of cover and at longer distances, improving safety and survivability of the user. . •TASCS IFM can be developed for any weapon type; particualrly crew served direct and indirect firing systems such as Artillery, Mortars, Anti-Armour, Heavy and Medium Machine Guns, Sniper Systems, etc.

TASCS Networked Observation and Reconnaissance System ("TASCS NORS") •The TASCS NORS consists of a sensor package mounted to a soldier weapon and a display running a user interface program typically known as battlefield management system. The TASCS equips sniper weapons and spotters’ stations with sensor packages that allow them to be accurately located on the battlefield. TASCS NORS is equipped with cameras that allows viewing through the snipers’ sight or the spotters’ scope on the display device provided. The systems are networked through the user’s communication network to allow the sharing of target information and imagery. Target information can be shared between the sniper and the spotter, and to all TASCS equipped systems in the network. With the TASCS system, target information can readily be passed, including a picture of the target, helping reduce incidents of friendly fire and collateral damage.

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Critical Incident Management System Comprehensive Critical Incident Management System architecture and Solution: Native Cloud-based Microsoft environment (MS Azure) with Team Awareness Kit (TAK) Seamless INTEGRATION and FUSION of crucial real-time position location, imagery, and targeted time-sensitive emergency services data and information for the effective and coordinated delivery of emergency services Supporting stakeholders from Emergency Operations Centres (EOC), Incident Command Post (ICP), Incident Commanders, and all first responders whether mobile or dismounted Data managed and stored in compliance with NFPA 1600

Counter Threats

We offer the following proprietary next-generation counter-threat solutions to protect against hostile enemy lasers, electronic detection, and drones.

Phantom •Our Phantom is a compact portable multi-function device that includes the ability to emulate the electronic communications of any NATO country in order to spoof adversaries as to the location of NATO forces. •Our Phantom is a patented version of much larger vehicle-mounted Electronic Warfare systems.  Its small size means it can be deployed at the tactical level by ground personnel or by drones or mounted on light tactical vehicles.

Battlefield Laser Defense System •BLDS is a unique, proprietary system that detects and can locate lasers and alert ground personnel with KWESST’s networked Digitization applications. •We have three variant o BLDS: individual personnel-worn, squad version, and vehicle mounted for mobile operations.

Other products under development

In Q4 Fiscal 2021, we partnered with Alare in the United States to establish the technical feasibility of a kinetic system to neutralize small Unmanned Aircraft Systems ("UAS") and loitering munitions without collateral damage. The nature of our contract with Alare is of a short-term consulting agreement in which we agree to pay for engineering services as rendered. This drone project, referred as GhostNet, is currently paused while we assess market interest and focus on the commercialization of PARA OPS and pursue other Digitization sales opportunities for near-term revenue generation. We discontinued further investment in another drone project under development, referred as GreyGhost, which was a licensed technology with AerialX Drone Solutions Inc. ("AerialX") providing a kinetic interceptor that could use multiple methods to engage target drones. To date, AerialX has not successfully delivered a functioning prototype.

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We have also started the development of Shot Counter which is largely based on the same sensor technology as the TASCS, and which can be incorporated into a firearm in order to count the number of rounds fired by the weapon. It is a small device that fits inside the pistol grip of most weapons, and functions with no user input for up to ten years on a single battery. Today we have reached the proof of concept design; but, have not yet built a prototype. This project is on hold due to other priority projects.

Over the last three financial years we have made significant investment to further advance our product development and position ourselves with OEM partners for expected commercialization during Fiscal 2023. We also concluded two acquisitions, the PARA OPS and Phantom solutions. At the moment, only the ARWEN product line is considered to be in full production.

The following table provides an update of our current product development cycle by product line and estimated timeline by quarter (fiscal year ended September 30^th) to reach production:

	Concept & Design	Prototype(1)	Market Testing(2)	LRIP Production(3)	Commercialization(4)
PARA OPS– single shot device (5)			Q3	Q4 FY23	Q4 FY23
PARA OPS– Pro 5 Magnum (5)		Q4 FY22	Q4	Q4 FY23	Q4 FY23
PARA OPS – reciprocating devices	Q1 FY24	Q1 FY24	Q3FY24	Q3 FY24	Q4 FY24
TASCS IFM					Underway
BLDS					Underway
Phantom					To Be Determined

Notes:

(1)Includes prototype Version 1 (V1), integration, and testing.

(2)Includes field testing and prototype V2.

(3)Includes final product development, LRIP, and sales demonstration units. A product is not ready for pre-production until it reaches Technology Readiness Level (TRL) of 5 to 6.

(4)Subject to market demand for KWESST's product.

(5)Includes the cartridges for the devices.

We consider a product to have reached the commercialization phase when we have begun LRIP and we have a sales, marketing, and distribution plan for the product.

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Principal Markets

Our total revenues by category of activity and geographic market for each of the last three financial years and the six months ended March 31, 2023 were as follows:

		Six months ended March 31, 2023		Year ended September 30, 2022		Year ended September 30, 2021		Nine months ended September 30, 2020
Major products / service lines
Digitization	$	264,004	$	354,620	$	1,255,982	$	835,097
Non-Lethal		212,412		330,658		-		-
Training and services		1,080		34,590		-		-
Other		1,240		1,651		19,822		26,820
	$	478,736	$	721,519	$	1,275,804	$	861,917
Primary geographical markets
United States	$	27,319	$	389,210	$	1,238,063	$	835,097
Canada		451,417		332,309		37,741		26,820
	$	478,736	$	721,519	$	1,275,804	$	861,917

Market Opportunities

Non-Lethal

According to Fact.MR: Non-Lethal Weapons Market, April 2023, the global non-lethal weapons market was approximately USD$4.95 billion in 2023 and is projected to reach USD$7.6 billion in 2028 (a 4.3% compound annual growth rate). We plan to target the following two markets, with an initial focus in the United States:

• Professional market:

Our main focus in the short-term is the professional market in the United States and overseas as these represent a major opportunity for our non-lethal security products. According to the U.S. Bureau of Labor Statistics, in the United States there are nearly 917,000 police officers, detectives and criminal investigators. Cases involving police shootings and deaths related to the use of conductive energy devices have increased in the United States. According to The Washington Post, there have been over 6,300 shootings in the United States since 2017 involving police.

A Reuters report estimates that at least 1,000 people have died as a result of being stunned by conductive energy devices in the United States. In over 150 of those deaths, the conductive energy device was determined to be a cause or a contributing factor.

There are several other security-related occupations which we believe are potential customers for our non-lethal products. These include 800,000 private security guards, 346,000 corrections officers and 90,000 private detectives, according to the U.S. Bureau of Labor Statistics. We believe that our PARA OPS products could play a meaningful role in addressing the tragic increase in school shooting events. According to the Naval Postgraduate School's Center for Homeland Defense and Security, there have been approximately 460 shooting events in K-12 schools during the last five years. We believe our non-lethal security products offer school personnel important options to create a tactical advantage in school shootings without using lethal firearms.

According to the U.S. Department of Education, there are over 132,000 elementary and secondary schools and nearly 6,000 colleges and universities in the United States. We believe there is an opportunity to utilize our products to enhance school safety.

Other public spaces such as grocery stores, houses of worship, bars and nightclubs, concert venues, sporting arenas and public transportation centers are also confronted with increased security challenges. Each of these locations represents an opportunity for us as they could improve security without introducing lethal firearms into crowded civilian environments by equipping their employees and security personnel with our non-lethal products.

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Other market opportunities that we intend to further explore include the international professional market, realistic force-on-force training for military and police, realistic high-action gaming and animal control, both in the United States and internationally.

The principal market for the ARWEN product line of non-lethal systems is law enforcement, primarily in Canada and United States.

• Consumer market:

According to Gallup and the United States Census Bureau, as at January 2022, there are approximately 82 million gun owners in the United States. We believe our PARA OPS devices will offer gun owners and members of their households a safer, personal defense option, without the risk of loss of human life.

In addition to personal defense, we believe we have an opportunity to disrupt the recreational market - specifically for paintball guns, which are air-based devices rather than cartridge-based (see "Business Overview - Competitive Conditions"). According to market research by Statista, the paintball gun market size in the United States was $1.3 billion in 2020.

Digitization

The principal market for our digitization business lines is primarily among military and public safety agencies in countries that are members of NATO, as well as Australia and New Zealand. As the largest purchaser and user of military and public safety products, the United States is our primary focus, followed by the other NATO member countries, and to a lesser extent, the Middle and Far East.

In addition to increased military spending in the United States and other members of NATO, another important trend that we have observed is an increase in funding within the military for projects related to precision munitions for weapons already in use by the military (legacy weapons) to further enhance survivability of soldiers and their operational effectiveness. Our TASCS Integrated Fires Module (IFM) products are expected to benefit from these trends by transforming "dumb" legacy weapons into "smart" weapons (with better accuracy).

For our CIMS offering, our principal market is public safety agencies, primarily in Canada and United States. Public safety agencies across the United States are seeking to implement digital solutions that can improve responder safety and incident management. According to Accenture, digital transformation presents one of the biggest challenges for public safety agencies. Globally, the public safety and security market was USD$435 billion in 2021 and is expected to reach USD$868 billion by 2028, growing at a CAGR of 10.4%, according to Fortune Business Insights.

The major factors fueling the public safety market include rising instances of mass shooting, natural disasters, terrorist activities and security breaches as well as increasing law enforcement requirements for public safety and investments in public safety measures for smart cities.

Counter Threat

Our BLDS product was developed expressly to address the health and safety threats from weaponized and/or targeting laser devices utilized by adversaries in the field and to aid in the prevention of friendly fire incidents.

Our Phantom product was developed to provide additional protection to friendly forces by confusing adversaries' Electronic Warfare operators, preventing them from targeting our forces.

We are also exploring the counter unmanned aircraft system ("C-UAS") market including loitering munitions. The proliferation of small hostile drones continues to be a growing worldwide problem for military forces, sensitive facilities, and public security agencies. Most counter-drone systems are electronic, designed to detect, identify, track and, if possible, disrupt the communications protocols of drones to prevent completion of their mission. Increasingly, however, drones are being developed by adversaries that are difficult or impossible to disrupt electronically.  Military and Homeland Security agencies are therefore seeking alternatives for stopping drones kinetically but without collateral damage.  We have been working with Alare to develop a proprietary drone to address this opportunity.

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Competitive Conditions

Non-lethal

We expect our competition for non-lethal PARA OPS products will primarily be manufacturers of:

• handheld CO2- powered or air powered launchers of chemical irritant projectiles, including Byrna Technologies Inc. (which sells products under the Byrna® HD brand), United Tactical Systems, LLC (which sells products under the PepperBall brand), and FN Herstal;
• conductive energy devices, including Axon Enterprises, Inc. (which sells the TASER device); and
• remote restraint devices, including Wrap Technologies Inc.

Our competitive advantage is principally our proprietary system consisting of:

• a low energy cartridge system with a cartridge casing that generates spin to a projectile, a far more reliable platform than air-based launchers;
• inexpensive firing platforms in any design that fire only our PARA OPS cartridges;
• different payloads in the projectile for various applications;
• velocities and muzzle energy far below the "lethal" threshold;
• simple internal mechanisms with few components simplifying the manufacturing process; and
• specifically configured interior mates with projectile to generate self-stabilizing spin for accuracy and distance.

Our Executive Chairman was the inventor of PARA OPS. He was previously the founder of Simunition^TM, a manufacturer of non-lethal training ammunition, since sold to General Dynamics. Further, he was also the CEO and Executive Chairman of United Tactical Systems, LLC, a company offering public-safety products for law enforcement, military and personal defense (owns the PepperBall^TM brand). Accordingly, he brings a wealth of market knowledge to us. Additionally, our President and CEO has almost 20 years of firearms manufacturing experience. He was previously the General Manager of Colt Canada (the Canadian division of the American firearms manufacturer). In August 2021, we also hired a senior Technical Manager with over 17 years of firearms manufacturing, he previously held senior roles at Colt Canada including most recently R&D Manager and Product Support Engineering. While we do not build lethal firearms, this experience is very relevant for building our PARA OPS business.

Many air-powered (CO2-powered) devices are complex and less reliable, specifically:

• ambient temperature causes performance to vary, especially in colder weather;
• synthetic seals and "O" rings dry out and can cause catastrophic failures; and
• such devices entail long logistics tails (for example, heavy air tanks, compressors and spare parts).

We have filed a patent application with the U.S. Patent and Trademark Office ("USPO") for our proprietary cartridge-based firing system and are developing additional filings.

For the ARWEN's product line, our primary competitors are the following:

• DEFTEC / Safariland's 40 mm LTM launchers; and
• ALS (a Pacem Defense Company)'s single shot 37mm and 40mm launchers and 40mm multi-shot launchers.

A further market advantage is the access to the law enforcement market through our ownership of ARWEN, and the strength of its brand, which has been selling non-lethal systems to law enforcement agencies internationally for over 30 years. As a result of our acquisition of Police Ordnance, we believe there are synergies between our PARA OPS and ARWEN products such as access to law enforcement market for PARA OPS, providing a low-energy cartridge for ARWEN launchers and combining facilities and engineering.

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Digitization and Counter-Threat

Our competition for digitization and counter threat business lines is primarily:

• R&D labs funded by the U.S. Department of Defense for developing systems like TASCS;
• Fabrique Nationale Herstal S.A. for their remote weapon stations (although these do not offer high angular resolution like TASCS); and
• known developers of electronic decoy systems including Motorola (Tactical TV Decoys), Synchopated Engineering (Mockingbird RF Signal Emulator), and CACI Systemware (MAGPIE).

We are currently not aware of any major direct competitors for our BLDS technology.

Our competitive advantage is the significant experience that our team of engineers and technicians have in soldier systems (which we consider to be any device that a soldier carries onto the battlefield, ranging from a communications device to a sensor), weapons, and sensor fields. Our expertise in the field of networked weapons has been recognized by the United States military who requested that we participate in the NATO working group tasked with developing standards and requirements for these types of networked weapons.

We are also not aware of any major direct competitors for our CIMS.

Seasonality

We do not expect our non-lethal business line will be exposed to seasonality. While our Digitization and Counter-Threat business lines may be affected by national military budgets, as well as federal, state and local government spending, we expect the various customers having different spending cycles will mitigate our potential cyclicality exposure.

Manufacturing and Availability of Raw Materials

Non-lethal

We have currently outsourced the engineering work for the PARA OPS devices to a third party, with oversight by us. We plan to lease new office and lab space in the Kitchener-Waterloo area (Ontario) during the second quarter of Fiscal 2023, likely less than 10,000 square foot facility.  To achieve a scalable operating model with minimal capital expenditures, we plan to rely upon strategic alliances with OEMs for the manufacturing and distribution of our PARA OPS products.

For the ARWEN launchers, these are currently manufactured in Toronto (Ontario) area in a combined manufacturing and training facility of approximately 5,000 square feet (see "Property, Plants and Equipment").  The current lease is on a month-to-month basis. 

Today, we are not aware of material sourcing issues or pricing volatility of raw materials, except for price volatility for certain components to manufacture ARWEN ammunition that will be required for our non-lethal business line (see "Risk Factors - We Are Dependent on Key Suppliers for our ARWEN Product Line").

With the COVID-19 pandemic and global supply chain challenges, it is not possible to predict whether this could eventually materially impact our sourcing and pricing of our key raw materials for our non-lethal business line.

Digitization and Counter-Threat

Today we have assembled a team of engineers, technicians and advisors that have significant experience in soldier systems (which we consider to be any device that a soldier carries onto the battlefield, ranging from a communications device to a sensor), weapons, and sensor fields. It is this combination of disparate knowledge sets that enables us to integrate and develop innovative solutions. We leverage from this same pool of talent to deploy CIMS solutions for the public safety market.

All current product development is done at our facility in Ottawa (see "Property, Plants and Equipment"). For as long as market demand justifies a low rate of production quantities, we will internally produce these products. Once demand reaches quantities necessitating commercial-level production quantities, we will outsource our production to companies specifically suited to producing each particular product. We are not aware of any material regulatory approvals that are required for us to outsource production.

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Today, we are not aware of material sourcing issues or pricing volatility of key components for our Digitization and Counter-Threat business lines. However, with the COVID-19 pandemic, it is not possible to predict whether this could eventually materially impact our sourcing and pricing of our key raw materials.

Marketing Plans and Strategies

Non-lethal

Initially we plan to sell our PARA OPS to the professional market which includes law enforcement agencies and then to the consumer market through an e-commerce store and a network of distributors. We plan to hire sales and marketing resources during Q2 Fiscal 2023 for the commercialization of PARA OPS.

For the ARWEN launchers, we plan to continue direct sales to law enforcement agencies, with marketing via tradeshows and social media/web-based.

As part of our marketing efforts, we are planning to attend the following tradeshows:

Tradeshow	Location	Date of Event
SHOT Show	Las Vegas, Nevada	January 2024
IWA & Outdoor Classic	Nuremburg, Germany	March 2024
Canadian Tactical Conference	Collingwood, Ontario	May 2023
International Association Chiefs of Police	San Diego, USA	October 2023
NTOA LE Operations Conference	Milwaukee, USA	May 2023
Best Defense	London, Canada	November 2023

Digitization and Counter-Threat

For digitization and counter-threat products, we plan to market through direct customer contact, tradeshows, demonstrations, and web-based marketing. Currently, we are planning to attend the following tradeshows:

Tradeshow	Location	Date of Event
CANSEC	Ottawa, Ontario	May 2023
Modern Day Marine	Washington, D.C., USA	June 2023
Canadian Association of Chiefs of Police	Ottawa, Canada	August 2023
GVSETS	Novi, USA	August 2023
DSEI	London, UK	September 2023
AUSA	Washington, D.C., USA	October 2023
International Association of Chiefs of Police	San Diego, USA	October 2023

Proprietary Protection

Non-lethal

On February 11, 2022, we filed United States patent application No. 17/669,420 claiming priority to a provisional patent application serial 63/148,163 by the USPO for our PARA OPS system. On October 18, 2022, we were advised by USPO that a notice of publication of application had been issued in relation to our patent application.

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Additionally, we filed patent applications for our PARA OPS system with the Canadian Intellectual Property Office (Filing Certification pending) on October 24, 2022 and with the Australian Patent Office (Serial No. 2022259822) on October 27, 2022.

We have the following registered trademarks:

Trademark	Country	Application # / Registration #	Status / Registration Date
ARWEN	Canada	TMA657,575	January 31, 2006
ARWEN	Great Britain	UK00001247086	July 27, 1985
ARWEN	Singapore	T9105613J	June 8, 1991
ARWEN	United States	1,404,833	August 12, 1986

We have the following trademark and design mark pending applications:

Trademark	Country	File Date for Pending	Application # / Registration #	Status / Registration Date
PARA OPS	United States	February 2, 2022	97/248,319	Pending
EVERYONE GOES HOME ALIVE	Canada	August 10, 2022	2,203,009	Pending
EVERYONE GOES HOME ALIVE	United States	September 16, 2022	97/594,701	Pending
	Canada	November 5, 2021	2,145,500	Pending

We have the following patent pending applications:

Product line	Country	File Date for Pending	Application # / Registration #	Status / Registration Date
LOW ENERGY CARTRIDGE (PARA OPS)	Canada	October 25, 2022	3,179,723	Pending
LOW ENERGY CARTRIDGE (PARA OPS)	Australia	October 27, 2022	2022259822	Pending
LOW ENERGY CARTRIDGE (PARA OPS)	United States	November 2, 2022	17/669,420	Pending

Digitization

While we rely significantly on trade secrets to protect our internally developed technologies, we currently have the following patent pending application regarding our digitization business lines:

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Product line	Country	Application #	File Date	Title	Status
TASCS IFM	International	PCT/CA2021/050993	Filed on July 19, 2021 which claims the benefit of 63/054,435	Methods and Systems for Digital Image-Referenced Indirect Target Aiming	Published as W02022/016260 Pending Applicant is KWESST Inc.
TASCS IFM	Canada	3,186,490	Filed on July 19, 2021	Methods and Systems for Digital Image-Referenced Indirect Target Aiming	Pending Applicant is KWESST Inc.
TASCS IFM	Australia	2021312552	Filed on July 19, 2021	Methods and Systems for Digital Image-Referenced Indirect Target Aiming	Pending Applicant is KWESST Inc.
TASCS IFM	Europe	21845180.5	Filed on July 19, 2021	Methods and Systems for Digital Image-Referenced Indirect Target Aiming	Pending Applicant is KWESST Inc.
TASCS IFM	Israel	300031	Filed on July 19, 2021	Methods and Systems for Digital Image-Referenced Indirect Target Aiming	Pending Applicant is KWESST Inc.
TASCS IFM	India	202327004493	Filed on July 19, 2021	Methods and Systems for Digital Image-Referenced Indirect Target Aiming	Pending Applicant is KWESST Inc.
TASCS IFM	Jordan	PCT/JO/2023/14	Filed on July 19, 2021	Methods and Systems for Digital Image-Referenced Indirect Target Aiming	Pending Applicant is KWESST Inc.
TASCS IFM	Japan	2023-504725	Filed on July 19, 2021	Methods and Systems for Digital Image-Referenced Indirect Target Aiming	Pending Applicant is KWESST Inc.
TASCS IFM	South Korea	10-2023-7005420	Filed on July 19, 2021	Methods and Systems for Digital Image-Referenced Indirect Target Aiming	Pending Applicant is KWESST Inc.
TASCS IFM	New Zealand	NZ796573	Filed on July 19, 2021	Methods and Systems for Digital Image-Referenced Indirect Target Aiming	Pending Applicant is KWESST Inc.
TASCS IFM	Saudi Arabia	523442231	Filed on July 19, 2021	Methods and Systems for Digital Image-Referenced Indirect Target Aiming	Pending Applicant is KWESST Inc.
TASCS IFM	Singapore	11202300411W	Filed on July 19, 2021	Methods and Systems for Digital Image-Referenced Indirect Target Aiming	Pending Applicant is KWESST Inc.
TASCS IFM	United States	18/006,055	Filed on July 19, 2021	Methods and Systems for Digital Image-Referenced Indirect Target Aiming	Pending Applicant is KWESST Inc.
TASCS IFM	South Africa	2023/00978	Filed on July 19, 2021	Methods and Systems for Digital Image-Referenced Indirect Target Aiming	Pending Applicant is KWESST Inc.

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Counter Threat

While we rely significantly on trade secrets to protect our internally developed technologies, we currently have the following patent and pending patent applications regarding our counter-threat business lines:

Product line	Country	Application #	File Date	Title	Status
Phantom	United States	16/686,095	Filed on November 15, 2019 which claims the benefit of 62/657,706	Programmable Multi-Waveform RF Generator for Use as Battlefield Decoy	Issued as Patent No. 10,969,467 (assigned to KWESST Inc.)
Phantom	United States	16/116,914	Filed on August 30, 2018 which claims the benefit of 62/657,706	Programmable Multi-Waveform RF Generator for Use as Battlefield Decoy	Issued as Patent No. 11,096,243 (assigned to KWESST Inc.)
Phantom	United States	17/163,546	Filed on January 31, 2021 which claims benefit of 16/116,914	Programmable Multi-Waveform RF Generator for Use as Battlefield Decoy	Pending
Phantom	United States	17/405,021	Filed on August 17, 2021 which claims the benefit of 16/116,914	Programmable Multi-Waveform RF Generator for Use as Battlefield Decoy	Pending
Phantom	United States	18/138,071	Filed on April 22, 2023 which claims the benefit of 17/163,546	Programmable Multi-Waveform RF Generator for Use as Battlefield Decoy	Pending
Phantom	International	PCT/CA2021/050038	Filed on January 15, 2021	Programmable Multi-Waveform RF Generator for Use as Battlefield Decoy	Published as W02022/150901 Pending Applicant is KWESST Inc.
Phantom	Canada	3,106,716	Filed on January 21, 2021	Programmable Multi-Waveform RF Generator for Use as Battlefield Decoy	Pending (assigned to KWESST Inc.)
Phantom	Australia	2021200556	Filed on January 29, 2021	Programmable Multi-Waveform RF Generator for Use as Battlefield Decoy	Pending (assigned to KWESST Inc.)
BLDS	United States	63/523,726	Filed on June 28, 2023	Battlefield Laser Detection Equipment Module and System Comprising the Same	Pending

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We have the following pending trademark applications:

Trademark	Country	Application #	File Date	Status
Phantom	Canada	2,047,424	August 24, 2020	Pending
Phantom	United States	90/135,612	August 25, 2020	Pending

We also have the following corporate pending trademark applications:

Trademark	Country	Application #	File Date	Status
	Canada	2,063,763	November 12, 2020	Pending
	United States	90/518,212	February 8, 2021	Pending

Government Regulations

Non-lethal

United States

In February 2022, we retained the services of Orchid Advisors to assist us with the classification and ATF compliance for our PARA OPS devices.  Orchid Advisors is a FFL compliance solutions firm headquartered in Hartford, Connecticut.

Based on Orchid Advisor's interpretation of the ATF rules and regulations, we have self-classified the .67 caliber version of the PARA OPS devices as a "destructive device," providing us with the ability to go to market much sooner than waiting for ATF classification ruling. Under the ATF rules, a manufacturer must determine whether the device is a firearm and therefore be subject to ATF regulation and if it is a firearm whether it is subject to National Firearms Act of 1934 ("NFA") regulations.

To be considered a regulated firearm in the United States, the device must be: (i) a weapon that (ii) will or is designed to expel a projectile (iii) by the action of an explosive. Although primers in ammunition cartridges are exempt from control under the explosives regulations as administered by ATF, they are still considered an "explosive" for the purposes of the firearm definition.  Because we use primers in the ammunition cartridges for our PARA OPS devices, we have decided to self-classify our PARA OPS devices as a form of firearm in the United States pending any different eventual classification by the ATF. 

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As the PARA OPS product line is identified as a firearm in the United States, it must be determined whether an additional level of control is imposed by the NFA. Under NFA regulations, there are only two possible types of NFA firearm that PARA OPS could be defined as: (1) a "any other weapon" ("AOW") or (2) a "destructive device".  Sale of either of these to consumers is permissible but requires a lengthy approval process conducted by the ATF (the background check process on the consumer); whereas sale to law enforcement agencies, military bodies, or government agencies is a more expedient approval process (usually less than 7 days). Further, the AOW classification requires only a $5 transfer tax to consumers whereas a destructive device classification results in a $200 transfer tax to consumers (such tax being borne by the consumer). While our PARA OPS is non-lethal (the kinetic energy of our projectile is well below lethal threshold), we have determined that the current version of our PARA OPS devices are "destructive devices" because the measurement of the bore of our device is currently in excess of the one-half inch in diameter, the maximum size for AOW.

As a result, initial sales of our PARA OPS devices in the United States are expected to come primarily from law enforcement agencies until we reduce the bore of our device to less than one-half inch in diameter for the consumer market. In July 2022, we entered into a consulting agreement with an FFL engineering firm, Bachstein Consulting LLC, in the United States to finalize the prototype for the PARA OPS single and multi-shot devices, including LRIP during Q1 Fiscal 2023.  We are currently pursuing development through Fiscal 2023 of a non-pyrotechnic energy actuator for PARA OPS in conjunction with a smaller diameter cartridge and projectile which, together, we expect would result in a next-generation version of PARA OPS products that would be considered non-firearms in most jurisdictions. The distribution of our PARA OPS in the United States will be done directly with FFL distributors/firearm dealers for civilian sales.  Today, all 50 states of the United States allow civilians to own a firearm subject to the firearm laws of the state (which vary by state). We expect the sales of our PARA OPS devices will position us well for significant recurring revenues through the sale of subsequent ammunition over the next 12 months (see "Risk Factors - We have Significant Non-Recurring Revenue").

For the non-lethal ARWEN products, we maintain a firearm business license (the "Firearm Business License") issued by the Chief Firearms Office of the Ontario Ministry of the Solicitor General and we are also registered under the Controlled Goods Program in Canada. For further information, see "Digitization and Counter Threat". Additionally, we maintain a Federal Explosives License/Permit for the manufacturing of explosives and a FFL for manufacturer and sale of destructive devices, both issued by the ATF in the United States. These are currently under renewal.  All sales of our ARWEN launchers are made directly to law enforcement agencies.

Rest of the World

As our current focus is commercializing PARA OPS in the United States, we have not begun analyzing the related government regulations for the rest of the world.

Digitization and Counter-Threat

Firearm Business License

In Canada, we maintain a Firearm Business License with the Chief Firearms Officer of the Ontario Ministry of Solicitor General for our following business activities:

• Manufacture, modification and assembly: prohibited weapons, ammunition, restricted firearms, prohibited devices, prohibited ammunition, prohibited handguns, non-restricted firearms, prohibited firearms;
• Retail sales (including consignment sales): restricted firearms and non-restricted firearms;
• Consignment sales: prohibited firearms including prohibited handguns;
• Gunsmithing: prohibited firearms, prohibited handguns, non-restricted firearms, restricted firearms;
• Transportation of inventory: prohibited firearms, ammunition, prohibited handguns, non-restricted firearms, prohibited ammunition, prohibited devices, restricted firearms, prohibited weapons;
• Storage of firearms: restricted firearms, non-restricted firearms, prohibited firearms, prohibited handguns.
• Export: ammunition, prohibited handguns, non-restricted firearms, prohibited ammunition, prohibited firearms, prohibited weapons, prohibited devices;

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• Possession for the purpose of instruction: restricted firearms, ammunition, non-restricted firearms, prohibited handguns.
• Import: prohibited firearms, non-restricted firearms, prohibited devices, prohibited ammunition, ammunition, prohibited weapons, prohibited handguns and restricted firearms.

The Firearm Business License is delivered for the purposes of: (i) the performance of a contract entered into by the Government of Canada, the government of a province, the government of a municipality acting on behalf of a police force, or a police force, or by a person acting on behalf of such a government or a police force; and (ii) the development, modification or testing of a prohibited firearm, prohibited weapon, prohibited device or prohibited ammunition, or any component or part thereof, for the purpose of training, or supplying goods or training materials used in the training of, a public officer as defined in subsection 117.07(2) of the Criminal Code (Canada), who is acting in the course of his or her duties or employment.

As of the date of this Prospectus, we believe to be fully compliant with all the conditions under which the Firearm Business License is delivered and maintained.

We have applied for and received a Firearms Business License that covers off any potential scenario that we may from time to time be involved in which such a license would be required. We are currently not in the retail or consignment sale of firearms and do not expect to be in this type of business.

For greater clarity, we use real firearms in the development and testing of our products as well as in training users on their use. Any device such as the TASCS IFM or TASCS NORS must be developed and tested on the weapon platforms for which it is designed. The Shot Counter is designed to work on automatic weapons in military and police inventories. These types of weapons are classified as prohibited and are solely utilized in the development and testing of the product. Replica systems are utilized for static demonstration, trade shows and other non-firing events.

We procure ammunition such as those required for mortars, grenade launchers and others weapon types to conduct testing and evaluation. On occasion, we may need to export ammunition in support of demonstrations.

Controlled Goods Program

In Canada, an individual or organization must register in the Controlled Goods Program with the Public Services and Procurement Canada if they need to:

• examine, possess or transfer controlled goods (munitions);
• transfer controlled goods outside of Canada; or
• receive bid solicitation documents containing controlled goods or controlled technology.

We are registered in the Controlled Goods Program and believe we are in compliance as of the date of this Prospectus.

Economic Dependence

As an early-stage company, the revenue stream in Fiscal 2021 for the TASCS system was concentrated on one United States military customer. We recognized 98.3% of the total revenue (US $0.8 million) for this United States military customer during Fiscal 2021 (see "Operating and Financial Review and Prospects, Critical Accounting Estimates").  We have delivered the remaining milestone and recognized the remaining 2.7% of the total revenue during the first quarter of Fiscal 2022. While we expect follow-on orders for our TASCS IFM 81mm mortar system they are likely to be under multi-year "Joint Fires" programs beginning in Fiscal 2024, and there is no assurance of such orders  in Fiscal 2023.

Since September 30, 2021, we have further diversified our revenue base as a result of the Police Ordnance Acquisition.  Additionally, on December 1, 2021, we entered into a master professional services agreement (the "MPSA") with GDMS to support the development of digitization solutions for future Canadian land C41SR programs under Strong, Secure, Engaged: Canada's Defence Policy. This includes TAK integration and CIMS services over 12 months. The MPSA serves as the master agreement and governs the basic terms and conditions for all future statements of work ("SOW") but does not in itself give rise to financial rights or obligations for either GDMS or us nor does it ensure that a future SOW will be awarded. Accordingly, there are no material terms in the MPSA except for the termination provision. At its sole discretion, GDMS may terminate the MPSA and/or a SOW by written notice to us. Under such event, GDMS will be liable for work rendered or expenses incurred prior to the effective date of such termination for which payment has not been made to us.  GDMS may also terminate the MPSA immediately in the event of default (as defined in the GDMS). Concurrently with entering in the MPSA, we entered into a SOW with GDMS for the first phase of the project which was delivered by the end of Q3 Fiscal 2022 and fully collected.  GDMS accounted for 41% of our Fiscal 2022 consolidated revenue. During Q1 Fiscal 2023 we entered into another SOW with GDMS for USD$0.1 million, which we delivered by the end of the quarter. With the anticipated commercial launch of PARA OPS product line in Fiscal 2023 and continued product sales from the ARWEN launchers, we anticipate our total consolidated revenue will continue to diversify with various customers, resulting in less dependence on limited customers to drive positive cash flows and profitability.

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Foreign Operations

We established office space in Stafford, Virginia to conduct United States business development activities and anticipated light assembly and distribution for our non-lethal, Digitization, and Counter-Threat business lines.

History and Development of the Company

Corporate Overview

KWESST Micro Systems Inc. is a corporation domiciled in Canada and was incorporated under the BCBCA on November 28, 2017. We develop and commercialize next-generation tactical systems for military, security, and personal defense markets. Key market segments and solutions addressed by our proprietary solutions are:

(i)non-lethal products with broad application in the professional  and personal defense,

(ii)modernized digitization of tactical teams for shared real-time situational awareness in the military and civilian markets, and

(iii)counter-measures against threats such as drones, lasers and electronic detection for the military market.

Our business activities are carried on by our wholly-owned subsidiaries as listed in Intercorporate Relationships.

Our registered and head office is located at 2900 - 550 Burrard Street, Vancouver, British Columbia V6C 0A3 and our principal place of business is located at 155 Terence Matthews Crescent, Unit #1, Ottawa, Ontario, Canada, K2M 2A8.

Our Common Shares are listed and trading on Nasdaq under the symbol "KWE", the TSXV under the trading stock symbol "KWE.V" and the Frankfurt Stock Exchange under the stock symbol of "62U". Our U.S. IPO Warrants are listed and trading on Nasdaq under the symbol "KWESW" and our Canadian Warrants are listed and trading on TSXV under the symbol "KWE.WT.U"

Following the closing of the Qualifying Transaction on September 17, 2020 (as defined below) pursuant to the policies of the TSXV, we changed our fiscal year end from December 31^st to September 30^th.

The SEC maintains an internet site at http://www.sec.gov that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. Our internet site is https://www.kwesst.com; our telephone number is (613)319-0537.

Intercorporate Relationships

The following chart illustrates our wholly-owned subsidiaries:

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KWESST U.S. Holdings Inc.

On May 2, 2022, we incorporated a wholly-owned United States holding subsidiary in Delaware (United States). 

KWESST Public Safety Systems U.S. Inc.

On May 2, 2022, we incorporated a wholly-owned United States subsidiary in Delaware (United States), for the PARA OPS product line in the United States (see "Business Overview"). 

KWESST Defense Systems U.S. Inc. (formerly KWESST U.S., Inc.)

On January 28, 2021, we incorporated a wholly-owned United States subsidiary in Delaware (United States), named KWESST U.S., Inc., and established an office in Stafford, Virginia (United States) to further pursue Digitization and Counter-Threat business opportunities in the United States.  On June 3, 2022, we amended the certificate of incorporation of the subsidiary to change the name to KWESST Defense Systems U.S. Inc.

KWESST Public Safety Systems Canada Inc.

On April 6, 2022, we incorporated a wholly-owned subsidiary in Ontario (Canada), for the PARA OPS business line in Canada (see "Business Overview"). 

2720178 Ontario Inc. and Police Ordnance Company Inc.

On December 15, 2021, we acquired 2720178 Ontario Inc., which owns all of the issued and outstanding shares of Police Ordnance, a company incorporated in Ontario (Canada) (see "Principal Capital Expenditures and Divestitures").  These are wholly-owned subsidiaries of KWESST.

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KWESST Inc.

On April 24, 2017, we incorporated a company in Ontario (Canada) named KWESST Inc. for the Digitization and Counter-Threat business lines.

On September 17, 2020, pursuant to the Qualifying Transaction (as defined below), KWESST Inc. amalgamated with 2751530 Ontario Ltd. ("Subco"), with the amalgamated company retaining the name of "KWESST Inc."

Events in the Development of the Business

All share-related information presented in this section gives effect to the reverse split of the Company's Common Shares (the "Reverse Split").

Inception to 2019 Highlights

KWESST was formed in April 2017 by Jeffrey MacLeod, our President & CEO and director and promoter. KWESST was founded to pursue advanced projects within the defense and security fields. We opened our offices in Ottawa, Ontario in May of 2017 and began development of what would become our core technology, TASCS.  Our TASCS consists of a sensor package mounted to a soldier weapon and a display running a user interface program typically known as the Battlefield Management System ("BMS").

Between May and September of 2017, we developed the first-generation prototype of the sensor package forming part of TASCS, combined with a basic BMS. KWESST started to collaborate with a United States military drone supplier, AeroVironment, Inc. ("AeroVironment").

In March 2018, we successfully integrated AeroVironment's drone data feed into KWESST's TASCS.

From April 20, 2018 to December 14, 2018, KWESST completed several financings (collectively "KWESST 2018 Financing") in the amount of $940,255 by way of revenue sharing agreements, related party loans and 10% convertible debentures to fund our working capital requirements.

2019 Highlights

On April 12, 2019, we won our first contract with AeroVironment valued  at USD$100,000.  In August 2019, we were in discussions with AeroVironment for a further contract to integrate our TASCS IFM with AeroVironment's Augmented Weapon Sight technology for the preproduction development of 60mm and 81mm mortar and machine gun mounts.  This was delayed to April 2020 due to COVID-19 restrictions.

On October 1, 2019, we entered into an executive service agreement with DEFSEC Corporation ("DEFSEC") in which its CEO, David Luxton, agreed to serve as our Executive Chairman (refer to Compensation for remuneration information).

On October 24, 2019, we completed a private placement of Common Shares for gross proceeds of $1,015,000 at a price of $14 per share, resulting in the issuance of 72,500 Common Shares (the "October 2019 Private Placement").

On October 24, 2019, the revenue sharing agreements and convertible debentures that we issued as part of the KWESST 2018 Financing were settled by the issuance of: (i) 44,350 Common Shares, and (ii) $234,515 in principal amount of convertible notes, bearing interest at a rate of 10% per annum (the "KWESST 2019 Convertible Notes").

On November 18, 2019, we entered into a non-exclusive licensing agreement (the "AerialX Licensing Agreement") with AerialX and licensed a technology required to manufacture, operate and use a drone whose principal function and purpose is to act as a projectile to intercept aerial threats using kinetic force (the "Licensed Technology").

During the quarter ended December 31, 2019, we started developing proprietary laser defense products to protect ground forces from a portable laser attack weapon developed and produced by a foreign adversary.

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Fiscal 2020 Highlights

On January 30, 2020, we completed a private placement of 37,500 Common Shares at a price of $28 per Common Share for gross proceeds of $1,050,000.

On March 1, 2020, we entered into a consulting agreement with SageGuild to provide United States business development support to facilitate the integration of our solutions/services into the U.S. Department of Defense markets. The monthly consulting fee comprised of cash and 435 Common Shares at a price of $35 per share. In preparation for a go-public transaction, the Common Shares issuable in satisfaction of the consulting fee were amended to stock options starting from May 31, 2020, in which the exercise price was satisfied by services rendered by SageGuild.

On March 25, 2020, we completed a private placement of 12,082 Common Shares at a price of $35 per Common Shares for gross proceeds of $422,875.

On April 30, 2020, Foremost Ventures Corp. ("Foremost"), together with its wholly owned subsidiary, Subco, entered into an amalgamation agreement with KWESST Inc. pursuant to which Subco and KWESST Inc. agreed to amalgamate (the "Amalgamation") to complete an arm's length qualifying transaction, in accordance with the policies of the TSXV (the "Qualifying Transaction" or "QT").

On April 25, 2020, AeroVironment  issued an additional purchase order valued at USD$635,000 to provide increased capability to the AWS system. This generated approximately $530,000 of revenue in Fiscal 2020.

On May 8, 2020, we issued an aggregate amount of $1,115,034 in convertible notes comprised of (i) $1,081,504 in principal amount of convertible notes convertible at $31.50 per Common Share, bearing interest at a rate of 15% per annum ("KWESST May 2020 Private Placement Convertible Notes") and (ii) a convertible note with a principal amount of $33,530 issued to a third party for services rendered in connection with the private placement, all of which convertible notes (including accrued interest thereon) were automatically converted into 37,275 Common Shares upon closing of the Qualifying Transaction on September 17, 2020. Additionally, as an inducement, the note holders were entitled to receive 25% of the principal amount in the form of Common Shares based on a stock price of $31.50 per share, resulting in the issuance of 8,583 Common Shares concurrently with the above conversion event.

On June 12, 2020, we entered into a technology agreement (the "GhostStep Technology Purchase Agreement") with SageGuild pursuant to which KWESST acquired GhostStep technology. We have since rebranded it as Phantom. The total purchase consideration was valued at approximately $482,000. For further information, see Principal Capital Expenditures and Divestitures.

On July 9, 2020, KWESST issued 62,994 subscription receipts of KWESST at $49.01 per subscription receipt for aggregate gross proceeds of approximately $3,087,138, before share issuance costs. As part of the Qualifying Transaction, in September 2020, the 62,994 subscription receipts were converted into Common Shares of KWESST, which were subsequently cancelled, and Common Shares were issued in exchange therefor.

On July 20, 2020, we won a contract with a United States military customer valued at USD$405,000 to integrate our TASCS IFM with a mortar system.

On September 17, 2020, KWESST completed the Qualifying Transaction with Foremost. The Amalgamation was structured as a three-cornered amalgamation and, as a result, the amalgamated corporation, named "KWESST Inc.", became a wholly owned subsidiary of Foremost, which changed its name to "KWESST Micro Systems Inc.". Immediately following the completion of the Amalgamation, there were 589,516 Common Shares outstanding, and the former shareholders of KWESST Inc., along with the holders of the subscription receipts and convertible notes of KWESST Inc., owned approximately 97.8% of the issued and outstanding Common Shares. This constituted a reverse acquisition for accounting purposes under IFRS.

On September 22, 2020, the Common Shares began trading on the TSXV under the stock symbol "KWE".

Fiscal 2021 Highlights

On December 16, 2020, following successful trials, a United States military customer awarded a follow-on order of USD$799,000 with new hardware and software requirements coupled with additional military trials.

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On January 14, 2021, we entered into a definitive technology purchase agreement (the "DEFSEC Purchase Agreement") to acquire the Low Energy Cartridge ("LEC") technology from DEFSEC, a proprietary non-lethal cartridge-based firing system (rebranded as the "PARA OPS" system) for a total purchase consideration of approximately $2.9 million, subject to closing conditions. For further information, see "Principal Capital Expenditures and Divestitures."

On February 4, 2021, the Common Shares commenced quotation on the OTCQB under the stock symbol "KWEMF."

On April 5, 2021, KWESST and AerialX entered into an amended and restated license agreement in which we obtained exclusive rights to gain exclusive rights to manufacture, operate, and use its drone for the C-UAS  market, for the United States Department of Defense and DND. For further information, see Principal Capital Expenditures and Divestitures.

On April 29, 2021, we completed a private placement of 51,087 units at a price of $87.50 per unit for gross proceeds of $4,470,071 (the "April 2021 Private Placement"), as amended in August 2021. Each unit consisted of one Common Share and seventy Common Share purchase warrants, exercisable to acquire 1/70 of a Common Share at a price of $1.75 each (70 warrants for one Common Share) for a period of 24 months. Following this closing, we also closed the acquisition of the PARA OPS system on the same day.

On July 9, 2021, we held our first live demonstration of the PARA OPS system in Whistler, British Columbia. Following this successful live demonstration, on July 12, 2021, we announced details of our commercialization road map for the PARA OPS system, including the unveiling our products at the 2022 SHOT Show® in Las Vegas, Nevada to be held on January 18-21, 2022.

On July 21, 2021, we announced that Brandon Tatum agreed to be our strategic advisor and advocate for the LEC System. Mr. Tatum is a former Tucson Police Officer and runs a successful You-Tube channel called "The Officer Tatum", with over 1.9 million subscribers, as well as other social media platforms and a nationally syndicated radio show on the Salem Radio Network.

On August 31, 2021, the Common Share purchase warrants issued in the April 2021 Private Placement were listed for trading on the TSXV under the stock symbol "KWE.WT."

On September 16, 2021, we completed a private placement of 10,714 units at a price of $140 per unit for gross proceeds of $1,500,000. Each unit consisted of one Common Share and seventy Common Share purchase warrants, exercisable at a price of $2.35 for each 1/70 of a Common Share (70 warrants for one Common Share) for a period of 24 months.

On September 28, 2021, we announced our strategic partnership with Stryk Group USA for the commercialization of our PARA OPS system in the United States.

Fiscal 2022 Highlights

On October 4, 2021, we announced the introduction to market our Phantom electronic battlefield decoy, including advanced negotiation with a global defense contractor to provide Phantom units as part of the contractor tender for armored vehicles to a large NATO customer. There are only two bidders that have qualified for this opportunity.

On October 13, 2021, we announced that we are accelerating the readiness of deployable and man-wearable BLDS for first deliveries available by end of Q1 Fiscal 2022, following military interest from a number of NATO land and Special Operation Forces at the signature European defense show, DESI, which took place in London, UK, on September 13 to 18, 2021.  While no deliveries took place in Fiscal 2022, on November 2, 2022, we won our first customer order of USD$330,000 from Nordic Defence & Security AS of Oslo, Norway, a trading and consulting agency offering solutions for the army, navy, air force in addition to other professional users such as the police, fire departments and different security dependent organizations, for the provision of four BLDS to be delivered by May 2, 2023.  These BLDS units are to be mounted and integrated on the new combat patrol vehicles for Norwegian Special Operating Forces ("SOF") now in prototype build. Through this initial order, we are well positioned to supply a higher quantity of BLDS once the Norwegian SOF combat vehicle proceeds into full production in calendar year 2024.  There is no assurance on this timing or that we will receive additional orders for our BLDS from Norwegian SOF.

On November 12, 2021, we announced that GDLS selected KWESST's Phantom electronic battlefield decoy as part of its ongoing efforts to develop a next generation multi-million domain mobile capability at the tactical level. If GDLS wins the contract with their United States military customer, we have estimated the potential value for this contract to KWESST could be more than USD $40 million, depending on the number of Phantom units per military vehicle and final pricing based on volume. The United States military customer is expected to announce the winner of the tender for 400-500 next generation military vehicles in calendar 2023. Accordingly, there is no assurance that we will be awarded this contract or if we are, what the value of such contract will be to KWESST.

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On November 15, 2021, we conducted live fire demonstration of our initial non-lethal cartridge-based single shot device for investors near Toronto, Ontario, including an opportunity for these investors to use the devices. Further, on January 14, 2022, we announced the unveiling of our non-lethal cartridge-based products under the brand PARA OPS at the 2022 SHOT Show® in Las Vegas held on January 18^th to 21^st 2022.

On November 23, 2021, in connection with an updated capital markets strategy, we submitted our initial application to list our Common Shares on Nasdaq.

On December 2, 2021, we announced that we engaged the New York-based public relations firm AMW Public Relations to lead our public relations, brand strategy, and media communication initiatives.

On December 8, 2021, our United States military customer accepted the delivery of the final milestone of the US $0.8 million relating to the integration of our TASCS IFM with the 81 mortar system. Final payment was received in January 2022. While we expect follow-on customer orders for this solution during Fiscal 2023, there is no assurance of such orders.

On December 14 and 16, 2021, we announced that we signed a Master Services Agreement with GDMS - Canada  to support the development of digitization solutions for future Canadian land C4ISR programs. We estimate the contract's value to KWESST to be up to $1.0 million over the next 12 months.

On December 15, 2021, we completed the non-cash acquisition of Police Ordnance - see "Principal Capital Expenditures and Divestitures" for further details. On January 10, 2022, we announced that Police Ordnance Company Inc. received orders from law enforcement agencies for approximately $0.4 million in ARWEN products, all have since been delivered as of the date of this Prospectus. However, as most of the shipments related to open customer orders at the acquisition date, these were not recorded as revenue during the quarter but rather as a reduction of intangible assets in accordance with IFRS.

At the 2022 SHOT Show® held in Las Vegas from January 18^th to 21^st 2022, we showcased our initial PARA OPS single shot device. Since this event, we have continued to make further improvements to this device based on positive feedback from the SHOT Show®. As of the date of this Prospectus, we have finalized the design of the single shot device and are in the process of producing small quantities for market testing prior to commercial launch this summer. We are also in the process of optimizing the design of our multi-shot device for market testing in June 2022 and commercial launch soon after. Our initial sales focus will be law enforcements (see Proprietary Protection - Government Regulations).

On February 11, 2022, we filed United States patent application No. 17/669,420 claiming priority to a provisional patent application serial 63/148,163 by the USPO for our PARA OPS system.

On March 11, 2022, we closed a non-secured and non-convertible loan financing transaction with a syndicate of lenders for aggregate loan proceeds of $1.8 million and an additional $0.2 million on March 15, 2022, for a gross total of $2.0 million (the "Unsecured Loans"). The Unsecured Loans bear interest at a rate of 9.0% per annum, compounded monthly and not in advance, and have a maturity of thirteen months, with KWESST having the option to repay the whole or any part of the Unsecured Loans, without penalty or premium, at any time prior to the close of business on the maturity date. The principal amount is due only at maturity.  As part of the terms of the Unsecured Loans, we issued an aggregate of 14,286 bonus Common Shares to the lenders. These Common Shares were issued pursuant to prospectus exemptions of applicable Canadian securities laws and therefore subject to a four-month plus one day trading restriction. 

On March 29, 2022, the Common Shares commenced trading on the Frankfurt Stock Exchange under the stock symbol "62U." We believe this listing will provide us with the opportunity to further increase our investor base globally, improve our stock liquidity, and promote KWESST to the European financial markets.

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We announced on April 4, 2022, with the war in Ukraine, that we are currently actioning a number of NATO and non-NATO country requests for quotations of our Phantom electronic decoy and laser detection products.

On April 22, 2022, we issued 875 Common Shares to the selling shareholders of Police Ordnance as a result of achieving the performance milestone as defined in the share purchase agreement.

On April 25, 2022, we announced that we engaged RedChip Companies ("RedChip") to lead our investor relations efforts in the United States, in advance of our pending Nasdaq listing. Headquartered in Orlando, Florida, RedChip provides investor relations, financial media, and research for microcap and small-cap stocks.

On July 6, 2022, we won our first CIMS related contract and entered into a three-year contract with Counter-Crisis Technology Inc. to design, develop, and implement a significant component of a national Ground Search and Rescue Incident Command System for Public Safety Canada, with the Ontario Provincial Police as technical advisory stakeholder for this project. The total contract value is approximately $0.7 million, net of in-kind contributions of $76,000, over three years of services commencing in late July 2022.  Either party may, at any time and for any reason, terminate the contract for convenience upon at least 30 business days' notice.  In the event of termination for convenience, we may recover only the actual cost of work completed to the date of termination in approved units of work or percentage of completion.

On July 14, 2022, we closed a non-brokered private placement, resulting in the issuance of 22,857 units of KWESST, at a price of $15.05 per unit, for aggregate gross proceeds of $0.34 million. Each unit consisted of one Common Share and seventy one-half Common Share purchase warrants, exercisable at a price of $0.285 each per share for a period of 24 months. Each Warrant converts into 0.01428571 Common Shares or 70 warrants for one Common Share. Certain of our directors and officers participated in the amount of $87,500.

On August 16, 2022, we announced that we publicly filed a registration statement on Form F-1 with the SEC relating to a proposed public offering in the United States of common units (the "U.S. IPO Common Units"), consisting of one Common Share and a warrant to purchase one Common Share ("U.S. IPO Warrants"), and pre-funded units, consisting of a pre-funded warrant to purchase one Common Share and a warrant to purchase one Common Share (the "U.S. IPO").

On August 29, 2022, we announced that we closed two non-secured loans in the amount of USD$200,000 per loan with a third party lender for an aggregate amount of USD$400,000.  The first non-secured loan of USD$200,000 bears interest of 6% per annum and will mature on August 31, 2023.  In connection with the first non-secured loan, we issued 4,239 bonus shares to the lender. The second non-secured loan of USD$200,000 (the "Second Loan") bears interest of 6% per annum and will mature on August 31, 2023. For both loans, the repayment will be 110% of its principal and both loans are senior to our other unsecured indebtedness. The Second Loan contains certain provisions allowing us to apply to the TSXV to repay the principal amount by issuing Common Shares in accordance with the rules and regulations of the TSXV.

On September 13, 2022, we announced the commencement of an underwritten public offering in Canada of units (the "Canadian Units") consisting of one Common Share and one Common Share purchase warrant for gross proceeds of approximately USD$3 million (the "Canadian Offering") following the filing of a preliminary short form base PREP prospectus with the securities regulatory authorities in each of the provinces of Canada, except Québec.

Year-to-Date Fiscal 2023 Highlights

On October 28, 2022, in advance of the Nasdaq listing, we effected the Reverse Split of our Common Shares to meet Nasdaq's initial listing requirements.

On November 2, 2022, we won our first customer order from an overseas NATO country for our BLDS product (see Business Overview - Principal Products and Services). These BLDS are for Special Forces who will be battle-testing the system in operational conditions. The value of this order is estimated to be USD$330,000 and we expect to ship the order by June 30, 2023. Subject to successful testing, we expect follow-on requirements, though there is no assurance there will be any follow-on orders.

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On December 6, 2022, our Common Shares and the U.S. IPO Warrants were approved for trading on Nasdaq under the symbols "KWE" and "KWESW", respectively, and commenced trading on December 7, 2022. The SEC declared our Form F-1 Registration Statement effective on December 6, 2022.

On December 9, 2022, we announced the closing of the U.S. IPO and Canadian Offering, for aggregate gross proceeds of USD$14.1 million. In the U.S. IPO, we sold 2,500,000 U.S. IPO Common Units at a public offering price of USD$4.13 per unit. Each Common Unit consisted of one Common Share and one U.S. IPO Warrant. The U.S. IPO Warrants have a per share exercise price of USD$5.00, can be exercised immediately, and expire five years from the date of issuance. The U.S. IPO Warrants are listed on Nasdaq under the symbol "KWESW". In connection with the closing of the U.S. IPO, the underwriter partially exercised its over-allotment option to purchase an additional 199,000 pre-funded common share purchase warrants (the "U.S. IPO Pre-funded Warrants") and 375,000 U.S. IPO Warrants (the "U.S. IPO Option Warrants"). In the Canadian Offering, we sold 726,392 Canadian Units at a price to the public of USD$4.13 per unit. The Canadian Warrants have a per Common Share exercise price of USD$5.00, are exercisable immediately and expire five years from the date of issuance. The Canadian Warrants are not listed on any exchange. As consideration for the services provided in connection with the U.S. IPO, the underwriter's compensation included 134,950 warrants (the "U.S. IPO Underwriter Warrants"). Each U.S. IPO Underwriter Warrant is exercisable to acquire one common share at a price of US$5.1625, exercisable as of June 4, 2023 and expiring December 4, 2027. As consideration for the services provided in connection with the Canadian Offering, the underwriter's compensation included 50,848 compensation options (the "Canadian Compensation Options"). Each Canadian Compensation Option is exercisable to acquire one Canadian Unit at a price of US$4.13 for a period of two years after the closing of the Canadian Offering.

On December 13, 2022, we closed on share for debt arrangements with certain existing lenders, following TSXV's conditional approval.  This resulted in issuing 56,141 U.S. IPO Common Units to settle $12,000 of the March 2022 Loans and USD$223,321 (or CAD$302,197) of the August 2022 Loans, including unpaid accrued interest and 10% premium at maturity. The terms of the Units are the same as the Units issued in the Canadian Offering.

From December 9 to 21, 2022, we repaid the remaining $1,997,435 of the March 2022 Loans, including accrued unpaid interest, and USD$223,321 of the August 2022 Loans, including unpaid accrued interest and 10% premium at maturity.  We also repaid the CEBA Term Loans net of the total forgivable amount of $30,000. Following these loan repayments, we have no further outstanding loans.

From January 17 to 20, 2023, at the SHOT Show held in Las Vegas, U.S. we showcased PARA OPS single and Pro-5 magnum devices as well as our ARWEN non-lethal 37 mm launchers for law enforcement and government agencies and held strategic meetings with potential industry partners.

From February 20 to 24, 2023, at the IDEX tradeshow held in Abu Dhabi, United Arab Emirates, we showcased our BLDS as well as PARA OPS devices.

On March 1, 2023, we announced that Steven Archambault will be stepping down as Chief Financial Officer ("CFO") to pursue a new opportunity overseas and committed to remaining with KWESST as CFO until April 3, 2023, and to assist KWESST thereafter to ensure a smooth transition.  We have hired an executive search consultant to assist us with our CFO search. Following KWESST's annual general meeting on March 31, 2023, our Executive Chairman assumed the role of Interim CFO until a permanent CFO has been appointed.

On March 1, 2023, Rick Bowes stepped down as Vice President ("VP"), Operations of Digitization & Counter-Threat Products in order to transition to a full-time business development consultant for KWESST.  We have hired an executive search consultant to assist us with a new General Manager search.

From March 6 to 8, 2023, we were a presenting sponsor at the Future Soldier 2023 Technology Conference and expo in London, United Kingdom, an event attended by key U.K. Ministry of Defense, NATO, and industry stakeholders specifically focused on soldier modernization and tactical edge integration.

On April 3, 2023, we announced the results of our March 31, 2023 Annual General Meeting in which our shareholders approved all the resolutions detailed in our management information circular dated February 13, 2023.  We also announced that effective immediately our Executive Chairman also assumed the role of Interim CFO until a permanent CFO has been appointed.

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From April 19, 2023 to April 20, 2023, at the MDEX tradeshow held in Detroit, U.S., we showcased our BLDS vehicle applications to United States Army tank-automotive and armaments command program managers, OEMs, and suppliers.

On April 27, 2023, the TSXV approved the listing of the Canadian Warrants issued in the Canadian Offering in December 2022, commencing trading on May 1, 2023.

On May 2, 2023, we announced that DND awarded a CAD$136 million dollar five-year defense contract to the JV Group (KWESST, Akkodis (MODIS) Canada and Thales Canada).  KWESSTs workshare under the joint venture agreement is up to 20% which would represent approximately CAD$27.2M (or an average of CAD$5.4M per year) of the contract.  The contract is a professional services agreement whereby KWESST will provide qualified software and sustainment resources engineering (at rates agreed to in the contract) on a task-based (as-and-when requested basis) to develop specialized (Government of Canada owned) software applications for Land (Canadian Army) Command, Control, Communications, Computers Intelligence, Surveillance and Reconnaissance (LC4ISR) systems. The Company has estimated that the value of work it will perform over the 5-year term will be a minimum of CAD $4 million on average per year.  The timing and extent of work performed (and therefore revenue) is at the customer’s discretion and based on the issuance of task orders under the agreement as well as agreement with the JV partners on the division of tasks.

The contract award is subject to customary termination provisions for Government of Canada contracts of this nature which, among other things, allows the Government to terminate for convenience. While the Company has provided a conservative estimate of its value over the life of the contract, the program is critical to the operation of the Canadian Military and we expect that the customer will make use of the majority of the budget awarded under the contract over the 5-year term.  The contract also includes five one-year extension options which could extend the length of the contract to a total of up to ten years.

On May 30, 2023, we announced the appointment of Sean Homuth as our new CFO, effective June 12, 2023. Mr. Homuth will also serve as our Chief Compliance Officer.

On July 19, 2023, we announced the Private Placement and that we had entered into the Placement Agency Agreement with ThinkEquity, the Securities Purchase Agreement and the Registration Rights Agreement with the Selling Securityholders.

On July 21, 2023, we closed the Private Placement and sold 1,542,194 Common Shares at a price of USD$2.26 (CAD$2.98) per share and 930,548 Pre-Funded Warrants at a price of USD$2.259 (CAD$2.979) per warrant to the Selling Securityholders, with each Common Share and Pre-funded Warrant being bundled with one Warrant. Although the Common Shares and Pre-Funded Warrants were each bundled with a Warrant, each security was issued separately. 

Under the Placement Agency Agreement, ThinkEquity acted as sole placement agent for the Private Placement. As compensation for services rendered, we paid ThinkEquity a cash fee of USD$475,013.14 representing 8.5% of the aggregate gross proceeds of the Private Placement and issued 123,637 Warrants to purchase 123,637 Common Shares, representing 5% of the Common Shares and Pre-Funded Warrants sold in the Private Placement. The Warrants issued to ThinkEquity were exercisable, in whole or in part, immediately upon issuance and expire 60 months after July 21, 2023 and have an initial exercise price of USD$2.66 (CAD$3.50) per Common Share. In addition, we granted ThinkEquity a right of first refusal for a period of twelve (12) months beginning on May 19, 2023, to act as  sole investment banker, sole book-runner and/or sole placement agent for public and private equity and debt offerings.

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On July 25, 2023, we announced the filing of a U.S. patent application for the core module of our next-generation BLDS, branded "BLaDE" and will make the BLaDE module available as a plug-and-play offering to third-party OEMs for incorporation inter their new and legacy electro-optical systems on armored vehicles.

Principal Capital Expenditures and Divestitures

We made the following material capital expenditures over the last three financial years and year-to-date Fiscal 2023. All share-related information presented in this section gives effect to the Reverse Split.

Year-to-date Fiscal 2023

• None.

Fiscal 2022

• On December 15, 2021, we acquired 2720178 Ontario Inc., an Ontario (Canada) corporation, which owns all of the issued and outstanding shares of Police Ordnance (the "Police Ordnance Acquisition"). Located in Bowmanville, Ontario, with ancillary operations in Florida, Police Ordnance owns all intellectual properties to the ARWEN product line of non-lethal systems, and a proprietary line of 37 mm non-lethal cartridges designed for riot control and tactical teams.  Police Ordnance has law enforcement customers across Canada, the United States, and abroad. The Police Ordnance Acquisition provides us with a strategic opportunity to leverage its law enforcement customer base to accelerate growth within our specialty ordnance business (see Business Overview).

• On December 15, 2021, the closing date of the Police Ordnance Acquisition, the fair value of the purchase consideration was $0.6 million, which comprised of: (i) 3,965 Common Shares, (ii) 200,000 Common Share purchase warrants exercisable at a price of $1.72 per warrant (one warrant converts to 0.01428571 Common Share or 70 warrants for one Common Share) and expiring on December 15, 2024; and (iii) 875 Common Shares contingent on fulfilment of a financial milestone, which was met in April 2022 resulting in the issuance of these Common Shares. At this time the purchase price allocation remains preliminary as certain inventory and intangible asset valuation assessments are ongoing. We expect to finalize the allocation in Q4 2022. While this acquisition is expected to be accretive based on historical results, we do not expect it will have a material impact to our overall consolidated results of operations, financial condition, and/or cash flows over the next twelve months.

Fiscal 2021:

• On January 14, 2021, we entered into a purchase agreement with DEFSEC to acquire the LEC System. The transaction closed on April 29, 2021 (the "DEFSEC Closing Date"), following the April 2021 Private Placement. DEFSEC is an Ottawa-based based private company owned by David Luxton, our Executive Chairman. The purchase consideration was approximately $2.9 million comprising of 14,285 Common Shares, 500,000 Common Share purchase warrants, and the fair value of the minimum annual royalty payments over a ten-year period. Each Common Share purchase warrant entitles the holder to purchase one Common Share, at a price of $0.70 per 1/70 of a Common Share (70 warrants for one Common Share). These warrants will expire on April 29, 2026. Under the DEFSEC Purchase Agreement, we agreed to pay a 7% royalty on future annual sales of the PARA OPS products, subject to minimum annual royalty payments over a ten-year period. Refer to Note 4(a) of the audited financial statements for Fiscal 2021 for further details.

• On April 5, 2021, we entered into an amended and restated AerialX Licensing Agreement with AerialX in which we obtained exclusive rights to the Licensed Technology for the United States Department of Defense and DND for a period of two years from the date upon which AerialX will meet certain technical milestones (the "Technical Milestones"). In consideration for the exclusivity, we issued 1,428 Common Shares to AerialX. We also agreed to issue an additional 1,429 Common Shares and 4,286 Common Shares upon AerialX achieving the Technical Milestones and certain financial milestones, respectively. Additionally, we agreed to pay a variable 8%-15% royalty. Refer to Note 26 of the audited financial statements of Fiscal 2021 for further details.

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Fiscal 2020:

• On June 12, 2020, we entered into a technology purchase agreement with SageGuild pursuant to which we acquired the GhostStep® Technology (referred to hereinafter as "Phantom"). The Phantom technology is a portable, soldier or air deployable electronic battlefield decoy. The purchase consideration was $0.5 million, which was comprised of: (i) USD$0.1 million cash, (ii) 9,957 Common Shares, and (iii) 750,000 Common Share purchase warrants exercisable at a price of $0.50 per 0.01428571 of a Common Share (or 70 warrants for one Common Share) and expiring on January 15, 2023. Additionally, we agreed to pay a 20% royalty on the first USD$3.0 million of Phantom sales and 5% thereafter up to a maximum royalty payment of USD$20.0 million, with no minimum guaranteed annual royalty payment. Refer to Note 4 of the audited financial statements of Fiscal 2021 for further details.

Advisers

Our United States legal counsel is Dorsey & Whitney LLP, with a business address at 161 Bay Street, Suite 4310, Toronto, Ontario, Canada M5J 2S1.

Our Canadian legal counsel is Fasken Martineau DuMoulin S.E.N.C.R.L., s.r.l, with a business address at 800 Victoria Square, Suite 3500, Montréal, Québec, Canada, H4Z 1E9.

Auditors

KPMG LLP, Chartered Professional Accountants, are currently and have been our independent auditors since March 31, 2021. KPMG LLP audited our consolidated financial statements for the year ended September 30, 2022 and the year ended September 30, 2021. The business address of KPMG LLP is 150 Elgin Street, Suite 1800, Ottawa, Ontario, K2P 2P8. KPMG LLP are registered with both the Canadian Public Accountability Board and the United States Public Company Accounting Oversight Board.

Kreston GTA LLP, Chartered Professional Accountants, audited our consolidated financial statements for the nine months ended September 30, 2020. The business address of Kreston GTA LLP is 8953 Woodbine Avenue, Markham, Ontario, L3R 0J9. Kreston GTA LLP are registered with both the Canadian Public Accountability Board and the United States Public Company Accounting Oversight Board.

Organizational Structure

See History and Development of the Company - Intercorporate Relationships.

Property, Plants and Equipment

We do not own any real estate property. We operate from leased premises in different locations, as detailed in the following table:

Location	Area (approx.)	Premise Use	Expiry Date
155 Terence Matthews, Unit#1, Ottawa, Ontario, Canada	7,200 sq. ft.	Corporate offices and administration, R&D	April 30, 2026 (renewal extension of 5 years)
10 Center Street, Suite 201, Stafford, Virginia, United States	2,000 sq. ft.	Sales and Marketing	October 31, 2023
2370 Nash Road, Bowmanville, Ontario, Canada	5,000 sq. ft.	Manufacturing and distribution of non-lethal ARWEN products	September 30, 2023
557 Massey Road, Guelph,  Ontario, Canada (starting from August 1, 2023)	5,500 sq. ft.	Manufacturing and distribution of non-lethal ARWEN products, Para Ops engineering and sales	July 30, 2026 (renewal extension of 2 years to 2028)
70 Mosswood BVLD, Suite 100 Youngsville, NC 27596	1,500 sq. ft	Address and US facility of ATF/Federal Firearms license for Para Ops, ARWEN and KWESST serialized products. Also used for product testing and sales demonstrations, product development and support.	June 2026

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At September 30, 2022, the carrying value of our total tangible fixed assets was approximately $0.8 million held in Ottawa, Ontario, Canada.

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

Certain share-related information presented in this section gives effect to the Reverse Split.

The following discussion of our financial condition, changes in financial conditions and results of operations should be read in conjunction with our unaudited condensed consolidated interim financial statements as at and for the three and six months ended March 31, 2023, as well as our audited consolidated financial statements as at and for the year ended September 30, 2022, the year ended September 30, 2021 and the nine months ended September 30, 2020, in each case, together with the related notes (see "Financial Statements"). Our consolidated financial statements have been prepared in accordance with IFRS as issued by the IASB.

The following discussion contains forward-looking statements that involve inherent risks and uncertainties. Actual results may differ materially from those contained in such forward-looking statements. See the Forward-Looking Statements at the beginning of this Prospectus.

Operating Results

Overview and Outlook

We are an early-stage technology company that develops and commercializes next-generation tactical systems for military and security forces and public safety markets.  Our core mission is to protect and save lives and enhance operational effectiveness.  In the last three financial years we have significantly expanded our business through one business combination and two asset acquisitions to complement our product offerings (refer to "History and Development of the Company").

During the most recent fiscal year, we have made significant investments to position KWESST for future success including the following events:

• We acquired Police Ordnance, including its ARWEN product line of launchers and a proprietary line of 37mm cartridges designed for riot control and tactical teams. This added a complementary product line to our non-lethal business line.

• We entered into new strategic partnerships to accelerate our business growth strategies, including:

>GDMS: for future military digitization development;

>Thales and Modis: through a joint venture arrangement in June 2022, we bid on a multi-million dollar and multi-year Canadian defense contract opportunity for specialized software development and integration solutions for the Canadian Army as part of its digital modernization; as previously noted, on May 1, 2023 DND awarded the Canadian Government Contract to the JV Group;

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>GDLS: to provide them with our Phantom system as part a GDLS-C bid for several hundred next-generation vehicles for a prominent United States military customer. We expect the successful bidder to be announced in calendar 2023;

>Persistent Systems LLC: to team up with our respective products and services to offer integrated solutions to various customers to the DND;

>Counter Crisis-Technology Inc. ("CC-T"): to partner with them in developing and implementing a national Ground Search and Rescue Incident Command System for Public Safety Canada. This involves incorporating a Search and Rescue plug-in application the TAK, by leveraging our digitization and TAK integration capabilities with military customers.

Our OPEX grew materially in the first half of Fiscal 2023 and the last two fiscal years compared to Fiscal 2020 primarily due to making a significant investment throughout our organization to position ourselves for success. We expect our expenses will continue to grow in Fiscal 2023, particularly for commercializing our PARA OPS and marketing efforts in the United States to penetrate that market. In light of the recent global inflation pressures, we have experienced some increases in cost for certain raw materials that we source for the production of ARWEN ammunition, coupled with an increase of 6% to the annual payroll costs for our engineering group due to strong local demand for skilled, experienced engineers during Fiscal 2022. During Q2 Fiscal 2023, payroll increase for our engineering group was 15% or approximately $0.1 million annualized.  We also adjusted senior management and directors' compensation during the same quarter to be in line with market, resulting in an increase of $0.2 million per annum. As of the date of this Prospectus, our operations and business goals have not been materially affected by the current global supply chain disruptions nor from the disruption caused by Russia's invasion of Ukraine.  Except for the ARWEN product line, raw materials for our products are accessible from various suppliers and therefore we do not believe a persistent global supply chain dislocation will materially impact our operations over the next twelve months. It is difficult at this time to predict whether costs of raw materials will continue to increase in the light of the global supply chain disruptions; however, we expect to be able to pass on these incremental costs to customers. 

Our financial strategy to date has been to raise sufficient capital through securities offerings in order to fund our working capital requirements, product development, and business growth strategies. We completed our cross-border listing on Nasdaq and our Common Shares began trading on December 7, 2022, under the stock symbol "KWE" and the U.S. warrants under the symbol "KWESW" on the same day. On December 9, 2022, we closed our U.S. IPO and the Canadian Offering for aggregate gross proceeds of USD$14.1 million, before deducting underwriting and offering costs.

Results of Operations - Three and Six Months Ended March 31, 2023, and 2022

The following selected financial information is taken from the unaudited condensed consolidated interim financial statements for Q2 Fiscal 2023, see "Financial Information."

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		Three months ended March 31,						Six months ended March 31,					Change
		2023			2022			2023			2022		%
Revenue	$	161,403		$	166,251		$	478,736		$	183,716		161%
Cost of sales		(128,634	)		(142,012	)		(268,218	)		(167,491	)	60%
Gross profit		32,769			24,239			210,518			16,225		1197%
Gross margin %		20.3%			14.6%			44.0%			8.8%
Operating Expenses
General and administrative ("G&A")		1,665,971			1,033,017			2,644,458			2,088,157		27%
Selling and marketing ("S&M")		1,152,916			733,364			1,607,103			2,079,755		-23%
Research and development ("R&D")		306,680			465,344			569,509			1,259,756		-55%
Total operating expenses		3,125,567			2,231,725			4,821,070			5,427,668		-11%
Operating loss		(3,092,798	)		(2,207,486	)		(4,610,552	)		(5,411,443	)	-15%
Other expenses
Share issuance recovery (costs)		57,548			-			(1,309,545	)		-		N/A
Net finance costs		(11,107	)		(72,479	)		(554,684	)		(120,121	)	362%
Foreign exchange gain (loss)		(19,684	)		(9,044	)		(150,040	)		(299	)	50081%
Loss on disposals		-			(1,165	)		-			(1,165	)	-100%
Change in fair value of warrant liabilities		1,838,972			-			3,189,395			-		N/A
Total other income (expenses), net		1,865,729			(82,688	)		1,175,126			(121,585	)	-1067%
Net loss	$	(1,227,069	)	$	(2,290,174	)	$	(3,435,426	)	$	(5,533,028	)	-38%
EBITDA loss (1)	$	(978,395	)	$	(2,144,546	)	$	(2,556,864	)	$	(5,267,721	)	-51%
Adjusted EBITDA loss(1)	$	(2,703,250	)	$	(1,711,406	)	$	(4,009,627	)	$	(3,915,796	)	2%
Loss per share - basic and diluted	$	(0.29	)	$	(3.21	)	$	(1.17	)	$	(7.83	)	-85%
Weighted average common shares - basic		4,271,594			712,401			2,925,729			706,291		314%

^{(1)EBITDA and Adjusted EBITDA are non-IFRS measures. See "Non-IFRS Measures". See below for "Reconciliation of Non-IFRS Measure".}

In the following table, we have reconciled earnings before interest, taxes, depreciation, and amortization ("EBITDA") and Adjusted EBITDA to the most comparable IFRS financial measure.

		Three months ended March 31,						Six months ended March 31,
		2023			2022			2023			2022
Net loss as reported under IFRS	$	(1,227,069	)	$	(2,290,174	)	$	(3,435,426	)	$	(5,533,028	)
Net finance costs		11,107			72,479			554,684			120,121
Depreciation and amortization		237,567			73,149			323,878			145,186
EBITDA loss		(978,395	)		(2,144,546	)		(2,556,864	)		(5,267,721	)
Other adjustments:
Share issuance recovery (costs)		(57,548	)		-			1,309,545			-
Share-based compensation		151,981			422,931			277,047			1,350,461
Change in fair value of warrant liabilities		(1,838,972	)		-			(3,189,395	)		-
Foreign exchange loss (gain)		19,684			9,044			150,040			299
Loss on disposals		-			1,165			-			1,165
Adjusted EBITDA loss	$	(2,703,250	)	$	(1,711,406	)	$	(4,009,627	)	$	(3,915,796	)

For Q2 and year to date ("YTD") Fiscal 2023, KWESST's net loss was $1.2 million and $3.4 million, respectively. Q2 and YTD Fiscal 2023 Adjusted EBITDA loss was $2.7 million and $4.0 million, respectively, an increase of 58% and 2% over the comparable prior periods mainly due to increased OPEX driven by increased personnel costs, consulting costs, professional fees, regulatory and compliance costs, and tradeshows. The adjustments to EBITDA loss for Q2 and YTD Fiscal 2023 included share issuance costs relating to warrant liabilities, and the change in fair value of derivative liabilities, all of which are related to the warrants issued in the U.S. IPO and Canadian Offering (see Notes 12 and 13 of the Q2 Fiscal 2023 financial statements). Due to the lower volume of stock-based grants in the last 12 months immediately prior to March 31, 2023, compared to same prior period, this has resulted in a material reduction in stock-based compensation expense in the current quarter and YTD compared to Q2 and YTD Fiscal 2023.

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Revenue

Total revenue remained consistent with the comparable prior period in the three months ended March 31, 2023, and increased by $0.3 million in YTD Fiscal 2023 compared to YTD Fiscal 2022, mainly due to an additional $0.2 million generated from our digitization business line and $0.1 million from our non-lethal business line (driven from sale of ARWEN products).

We expect revenue to ramp up during Fiscal 2023 with the new Canadian Government Contract, coupled with the pending commercial launch of our PARA OPS, scheduled for end of Q3 Fiscal 2023, and full year revenue results from the ARWEN product line.

Gross Profit

Our gross profit was negligible in Q2 for both Fiscal 2023 and 2022.  For YTD Fiscal 2023, we earned $0.2 million or gross margin of 44%, compared to a negligible amount in the same period in 2022. As we are in the pre-revenue stage for most product lines, we expect continued fluctuation in gross profit / margin during Fiscal 2023 as we ramp up anticipated revenue through the fiscal year.

OPEX

Total OPEX increased by 40% or $0.9 million for the current quarter over the comparable prior period. Excluding the change in share-based compensation expense (non-cash item), total OPEX for the quarter increased by $1.2 million or 64%, primarily for the same reasons as noted below the YTD Fiscal 2023.

Total OPEX were $4.8 million for YTD Fiscal 2023 compared to $5.4 million in YTD Fiscal 2022. Excluding share-based compensation, total OPEX was $4.5 million compared to $4.1 million, an 11% increase over the comparable prior year due to the following factors:

• General and administrative ("G&A") increased by $0.6 million, or 27%, primarily due to the retention bonus earned by our former CFO, an increase in senior management and directors compensation to be in line with market, higher consulting fees and retention bonuses relating key personnel in the non-lethal business line. Additionally, we incurred an increase in D&O Insurance, professional fees, and compliance costs due to KWESST's Nasdaq listing in December 2022 and subsequent regulatory filing compliance.

• S&M decreased by $0.5 million, or 23%, primarily due to a $0.3 million decrease in share-based compensation expense, coupled with lower U.S. business development consulting costs in YTD Fiscal 2023.  This was partially offset by an increase in tradeshow spend to promote our products.

• R&D decreased by $0.7 million, or 55%, primarily due to $0.5 million decrease in share-based compensation expense in YTD Fiscal 2023 in comparison to the comparable prior period. R&D expenses further decreased due to reallocating most of our engineering resources to deliver on customer contracts. The related costs are reported as part of cost of sales (for delivered performance obligations to customers) and work-in-progress inventories.  These costs included an average increase in payroll costs of 15% per annum due to the strong local demand for skilled, experienced engineers.

Other income (expenses), net

For Q2 Fiscal 2023, our total other income was $1.8 million, compared to total other expenses of $0.1 million in Q2 Fiscal 2022. This change in other income (expenses), net is due to the same reason noted below for YTD Fiscal 2023.

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For YTD Fiscal 2023, our total other income was $1.1 million, compared to total other expenses of $0.1 million.  The change in other income (expenses), net was driven mainly by the $3.1 million favorable change in fair value of warrant liabilities as a result of the remeasurement of the warrant liabilities at March 31, 2023, driven by a decrease in the underlying common share price on March 31, 2022. Under IFRS, we are required to remeasure the warrant liabilities at each reporting date until they are exercised or expired.  This was partially offset by:

• $0.6 million increase in net finance costs is primarily due to the recognition of the remaining unamortized accretion costs and interest expense relating to the repayment of all outstanding loans, following the closing of the U.S. IPO and Canadian Offering during the quarter;

• $0.2 million increase in foreign exchange loss due to appreciation in the U.S. currency during the current quarter; and

• $1.3 million in share offering costs relating to the U.S. IPO and Canadian Offering.  Under IFRS, we are required to allocate proportionately the $4.2 million total underwriting and share offering costs (collectively "Share Offering Costs") between equity and warrant liabilities resulting from the U.S. IPO and Canadian Offering. The portion of the Share Offering Costs allocated to warrant liabilities were expensed.

SUMMARY OF QUARTERLY RESULTS

The following tables summarize selected results for the eight most recent completed quarters to March 31, 2023 (unaudited).

	2023				2022								2021
($ in thousands)	Q2		Q1		Q4		Q3		Q2		Q1		Q4		Q3
Revenue	161		317		255		282		166		17		160		522
Net loss	(1,227	)	(2,208	)	(2,345	)	(2,600	)	(2,290	)	(2,290	)	(2,884	)	(2,628	)

^{Note: due to preparing the table in thousands, there may be rounding differences.}

Quarterly Results Trend Analysis

There is no material change to our quarterly results trend from our disclosure in our annual MD&A dated January 27, 2023, except that we expect further volatility with our quarterly revenue during Fiscal 2023 due to the launch of PARA OPS products and anticipated new military contracts, coupled with an increase in OPEX as highlighted in the Results of Operations. Additionally, we expect further volatility with our quarterly net loss due to the remeasurement of warrant liabilities at each reporting period, with the change in fair value recorded through P&L.

FINANCIAL CONDITION, LIQUIDITY, AND CAPITAL RESOURCES

FINANCIAL CONDITION

The following table summarizes our financial position:

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		March 31,		September 30,
		2023		2022
Assets
Current	$	6,606,399	$	1,516,393
Non-current		6,230,088		5,807,070
Total assets	$	12,836,487	$	7,323,463
Liabilities
Current	$	4,431,602	$	6,925,880
Non-current		1,372,338		1,400,474
Total liabilities		5,803,940		8,326,354
Net assets	$	7,032,547	$	(1,002,891	)
Working capital (1)	$	2,174,797	$	(5,409,487	)

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

Our working capital was $2.2 million at March 31, 2023, an increase of $10.2 million from September 30, 2022. The increase was primarily due to net proceeds from the U.S. IPO and Canadian Offering, offset partially by repayment of all outstanding loans, payments of overdue accounts payables and certain accrued liabilities, and net operating loss for YTD Fiscal 2023.  Current liabilities include warrant liabilities, a non-cash liability item (see Note 12 of Q2 Fiscal 2023). Excluding warrant liabilities, working capital would be $4.8 million. These warrant liabilities will be extinguished when the warrants are exercised or expired.  If exercised, the proceeds will provide us with additional capital to fund our future working capital requirements.  There is no assurance that any warrants will be exercised.

Total assets increased by $5.5 million from September 30, 2022, mainly due to $5.1 million increase in currents assets from net proceeds of the U.S. IPO and Canadian Offering, offset partially by repayment of all outstanding loans, payments of overdue accounts payables and certain accrued liabilities.

Total liabilities decreased by $2.5 million from September 30, 2022, to $5.8 million at March 31, 2023, mainly due to a reduction in current liabilities. While we have significantly paid the outstanding accounts payable and fully repaid all outstanding loans during the current quarter, these were offset by the recognition of warrant liabilities at fair value as noted above.  As at March 31, 2023, we had $2.6 million of warrant liabilities.

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.

At March 31, 2023, our cash position was $4 million, an increase of $3.8 million since September 30, 2022 primarily due to net proceeds from the U.S. IPO and Canadian Offering, offset partially by repayment of all outstanding loans, payments of overdue accounts payables and certain accrued liabilities, and net operating loss for YTD Fiscal 2023.

On December 9, 2022, we closed both the U.S. IPO and Canadian Offering pursuant to which we received aggregate gross proceeds of USD$14.1 million (or CAD$19.4 million), before underwriting and offering costs (see below, "Capital Resources", for further details including our expected use of proceeds). With the remaining cash position at March 31, 2023, collections of outstanding receivables, the new Canadian Government Contract and other anticipated contracts, and the commercial launch of PARA OPS in Fiscal 2023, we believe we have sufficient liquidity and capital to timely fund our working capital and contractual obligations, over the next twelve months. However, we may require additional capital in the event we fail to implement our business plan, which could have a material adverse effect on our financial condition and/or financial performance. There is no assurance that we will be able to raise additional capital as they are required in the future. Potential sources of capital may include additional equity and/or debt financings. In our view, the availability of capital will be affected by, among other things, capital market conditions, the success of our PARA OPS system commercialization efforts, timing for winning new customer contracts, potential acquisitions, and other relevant considerations (see "Risk Factors"). In the event we raise additional funds by issuing equity securities, our existing shareholders will likely experience dilution, and any additional incurrence of indebtedness would result in increased debt service obligations and could require us to agree to operational and financial covenants that could further restrict our operations. Any failure to raise additional funds on terms favorable to us or at all may require us to significantly change or curtail our current or planned operations in order to conserve cash until such time, if ever, that sufficient proceeds from operations are generated, and could result in us not being in a position to advance our commercialization strategy or take advantage of business opportunities.

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Consolidated Statements of Cash Flows

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

		Six months ended March 31,
		2023			2022
Total cash provided by (used in):
Operating activities	$	(9,155,294	)	$	(2,880,326	)
Investing activities		(883,852	)		(332,997	)
Financing activities		13,852,292			2,042,380
Net cash outflows	$	3,813,146		$	(1,170,943	)
Cash, beginning of period		170,545			2,688,105
Cash, end of period	$	3,983,691		$	1,517,162

Cash used by operating activities

Cash flow used in operating activities increased by $6.2 million to $9.2 million for the six months March 31, 2023 primarily due to payments on overdue payables as well as unpaid voluntary deferred wages, consulting fees, and bonuses until we closed the U.S. IPO and Canadian Offering, coupled with significant prepaid expenses during the six months ended March 31, 2023. Prepaid expenses increased by $1.4 million mainly due to the renewal of D&O Insurance and commercial insurance coverage, royalties relating to future Phantom sales, capital market advisory services, and retention bonus for our head of PARA OPS (refundable in the event he voluntarily terminates prior to a specified date as set by us).

Cash used by investing activities

Cash flow used in investing activities was $0.9 million for the six months ended March 31, 2023, an increase of $0.6 million from the comparable period, mainly due to additional investment in the product development of our PARA OPS, coupled with additional LRIP equipment for PARA OPS.

Cash provided by financing activities

Cash flow provided by financing activities was $13.9 million in YTD Fiscal 2023 compared to $2 million in Fiscal 2022 primarily due to net proceeds generated from the U.S. IPO and Canadian Offering, partially offset by repayment of all outstanding borrowings during the six months ended March 31, 2023.

Capital Resources

Our objective in managing our capital is to safeguard our ability to continue as a going concern and to sustain future development of the business. Our senior management is responsible for managing the capital through regular review of financial information to ensure sufficient resources are available to meet operating requirements and investments to support its growth strategy. Our Board is responsible for overseeing this process. From time to time, we could issue new Common Shares or debt to maintain or adjust our capital structure. We are not subject to any externally imposed capital requirements.

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Our primary sources of capital to date have been from borrowings, security offerings, exercise of stock options and warrants, and, to a lesser extent, pre-commercial revenue.  The following is a breakdown of our capital:

		March 31,			September 30,
		2023			2022
Debt:
Lease obligations	$	241,907		$	275,621
Borrowings		-			2,278,774
Warrant liabilities		2,591,996			-
Equity:
Share capital		30,943,174			19,496,640
Warrants		2,089,388			1,959,796
Contributed surplus		3,424,644			3,551,330
Accumulated other comprehensive loss		(79,994	)		(101,418	)
Accumulated deficit		(29,344,665	)		(25,909,239	)
Total capital	$	9,866,450		$	1,551,504

During YTD Fiscal 2023, we fully repaid all outstanding loans following the closing of the U.S. IPO and Canadian Offering. 

Contractual Obligations and Commitments

At March 31, 2023, our contractual obligations and commitments were as follows:

Payment due:		Total		Within 1 Year		1 to 3 years		3 to 5 years
Minimum royalty commitments	$	2,350,000	$	-	$	350,000	$	2,000,000
Accounts payable and accrued liabilities		1,499,653		1,499,653		-		-
Lease obligations		424,418		127,287		255,423		41,708
Short-term rental obligations		67,933		67,933		-		-
Total contractual obligations	$	4,342,004	$	1,694,873	$	605,423	$	2,041,708

Shares Outstanding

At March 31, 2023, our authorized capital consists of an unlimited number of Common Shares with no stated par value.

The following table shows the outstanding Common Shares and dilutive securities at March 31, 2023:

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	March 31, 2023(1)		Average price (CAD $)		Proceeds if Exercised
Common shares	4,073,106
Founders' warrants	106,000	$	14.00	$	1,484,000
Broker warrants	643	$	139.97	$	90,000
Warrants	79,495	$	108.31	$	8,610,150
Pre-funded warrants	199,000	$	0.01	$	1,990
Warrant liabilities	3,282,533	$	6.77	$	22,222,748
Over-allotment warrants	375,000	$	6.77	$	2,538,750
U.S. Underwriter warrants	134,950	$	6.99	$	943,301
Stock options	51,338	$	4.10	$	210,486
Restricted stock units (RSUs)	6,571	$	-	$	-
Agents' compensation options:
Common shares	51,685	$	6.94	$	358,757
Warrants	52,812	$	11.04	$	582,830
Total common shares and dilutive securities	8,413,133			$	37,043,012

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

U.S. IPO and Canadian Offering

On December 9, 2022, we closed the U.S. IPO and Canadian Offering. In the U.S. IPO, we sold 2.5 million U.S. IPO Common Units at a public offering price of US$4.13 per unit, consisting of one Common Share and one U.S. IPO Warrant. The U.S. IPO Warrants have a per share exercise price of US$5.00, can be exercised immediately, and expire five years from the date of issuance. In connection with the closing of the U.S. IPO, the underwriter partially exercised its over-allotment option to purchase an additional 199,000 U.S. IPO Pre-funded Warrants and 375,000 U.S. IPO Option Warrants. All these warrants will expire on December 8, 2027.

In the Canadian Offering, we sold 726,392 units, each consisting of one Common Share and one warrant to purchase one Common Share, at a price to the public of US$4.13 per unit. The warrants will have a per Common Share exercise price of US$5.00, are exercisable immediately and expire five years from the date of issuance.

The closing of the U.S. IPO and Canadian Offering resulted in aggregate gross proceeds of US$14.1 million (CAD $19.4 million).  After underwriting discounts and offering expenses, the net proceeds were US$11.2 million (CAD $15.2 million).  See Note 13 of Q2 Fiscal 2023 financial statements for further details.

For the estimated use of proceeds from the U.S. IPO and Canadian Offering, refer to our annual MD&A for Fiscal 2022 dated January 27, 2023.

Shares for Debt Settlement

On December 13, 2022, we issued 56,141 Units to settle $12,000 of the March 2022 loans and USD$223,321 of the August 2022 loans, including unpaid accrued interest and 10% premium at maturity.  See Note 13(a) of Q2 Fiscal 2023 for further details.

Results of Operations - Fiscal Periods Ended September 30, 2022, 2021 and 2020

The following selected financial information is taken from the audited financial statements for Fiscal 2022, Fiscal 2021, and Fiscal 2020.

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		Year ended September 30,			Year ended September 30,			Nine months ended September 30,		Change 2022 vs 2021	Change 2021 vs 2020 (1)
		2022			2021			2020		%	%
Revenue	$	721,519		$	1,275,804		$	861,917		-43%	11%
Cost of sales		(536,735	)		(798,888	)		(247,113	)	-33%	142%
Gross profit		184,784			476,916			614,804		-61%	-42%
Gross margin %		25.6%			37.4%			71.3%
Operating Expenses
General and administrative		4,915,263			4,057,167			2,723,861		21%	12%
Selling and marketing		3,296,373			3,484,159			564,266		-5%	363%
R&D		2,064,493			2,138,138			817,584		-3%	96%
Total operating expenses		10,276,129			9,679,464			4,105,711		6%	77%
Operating loss		(10,091,345	)		(9,202,548	)		(3,490,907	)	10%	98%
Other expenses
Gain on derivatives		-			-			29,463		N/A	-100%
Net finance costs		(506,002	)		(107,751	)		(61,397	)	370%	32%
Foreign exchange gain (loss)		28,780			(3,742	)		(13,937	)	-869%	-80%
Loss on disposals		(1,165	)		(1,331	)		-		N/A	N/A
Total other expenses, net		(478,387	)		(112,824	)		(45,871	)	324%	84%
Loss before income taxes		(10,569,732	)		(9,315,372	)		(3,536,778	)	13%	98%
Deferred tax recovery		49,442			-			-		N/A	N/A
Net loss	$	(10,520,290	)	$	(9,315,372	)	$	(3,536,778	)	13%	-2%
EBITDA loss	$	(9,730,239	)	$	(9,066,631	)	$	(3,371,984	)	7%	102%
Adjusted EBITDA loss(2)	$	(7,297,670	)	$	(6,599,351	)	$	(1,589,723	)	11%	211%
Loss per share - basic and diluted	$	(14.41	)	$	(14.72	)	$	(8.03	)	-2%	-32%
Weighted average common shares - basic		730,302			632,721			440,631		15%	44%

(1)To calculate the change, we have annualized the results of operations for the nine months ended September 30, 2020

(2)EBITDA and Adjusted EBITDA are non-IFRS measures. See "Non-IFRS Measures".

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

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								Nine months
		Year ended			Year ended			ended
		September 30,			September 30,			September 30,
		2022			2021			2020
Net loss as reported under IFRS	$	(10,520,290	)	$	(9,315,372	)	$	(3,536,778	)
Net finance costs		506,002			107,751			61,397
Depreciation and amortization		326,491			140,990			103,397
Deferred tax recovery		(42,442	)		-			-
EBITDA loss		(9,730,239	)		(9,066,631	)		(3,371,984	)
Other adjustments:
Non-cash M&A costs(1)		-			-			1,514,703
Stock-based compensation		1,960,072			2,462,207			283,084
Professional fees relating to U.S. financing		500,112			-			-
Fair value adjustment on derivatives		-			-			(29,463	)
Foreign exchange loss (gain)		(28,780	)		3,742			13,937
Loss on disposals		1,165			1,331			-
Adjusted EBITDA loss	$	(7,297,670	)	$	(6,599,351	)	$	(1,589,723	)

Variance Analysis: Fiscal 2022 compared to Fiscal 2021

Revenue

We generated $0.7 million in revenue for Fiscal 2022, a decrease of 43% over last year's revenue. The decline in revenue was driven mainly due to the timing of expected contracts and a smaller contract awarded by GDMS-C and CC-T during the current year compared to the USD$0.8 million contract awarded by a United States military customer in Fiscal 2021. This was partially offset by $0.3 million from the ARWEN product line as a result of the Police Ordnance Acquisition made in late Q1 Fiscal 2022. The ARWEN revenue excludes $0.4 million for deliveries in relation to open customer orders at the closing of the Police Ordnance Acquisition which were recognized as a reduction of intangible assets.

We expect revenue to ramp up during Fiscal 2023 with new anticipated military contracts, coupled with the pending commercial launch of our PARA OPS, scheduled for Q2 Fiscal 2023, and full year revenue results from the ARWEN product line.

Gross Profit

Our gross profit was $0.2 million for Fiscal 2022, or gross margin of 25.6%, compared to $0.5 million in Fiscal 2021 with gross margin of 37.4%. The fluctuation in gross profit / margin is primarily due to our pre-commercialization phase.

OPEX

Total OPEX were $10.3 million for Fiscal 2022, a 6% increase over the prior year. Excluding share-based compensation (non-cash item), total OPEX was $8.3 million compared to $7.2 million over the prior year. This represents a 15% increase which was driven mostly by accrued bonuses to our employees and management (none in the prior year) for their significant contributions in positioning KWESST for future success, coupled with higher professional fees incurred relating to a brokered private placement financing effort during the Spring 2022 that did not close due to very challenging global equity market conditions where S&P 500 index and Nasdaq index declined by approximately 20.6% and 29.5%, respectively from January 1, 2022, to June 30, 2022. We subsequently completed a successful cross-border listing on Nasdaq with a U.S. IPO and Canadian Offering, which both closed in December 2022. Professional fees relating to this effort were capitalized and reported as deferred share offering costs in our consolidated statements of financial position at September 30, 2022.

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The above increase was partially offset by lower spend on advertising and promotion as well as no royalty and license costs in the current year compared to the previous year. We expect to incur royalty costs in Fiscal 2023 from expected sales of our PARA OPS and Phantom products.

In light of the current global inflationary pressure, we expect personnel costs to increase by approximately 10%-15% in Fiscal 2023, an increase that we plan to pass on to our customers.

Our R&D expenses during Fiscal 2022 comprised of costs incurred in performing R&D activities, including new product development, continued product enhancement, materials and supplies, salaries and benefits (including share-based compensation), engineering consulting costs, patent procurement costs, and estimated R&D-related facility costs. Where we qualify for Canadian investment tax credits ("ITC's") for qualified Scientific Research and Experimental Development Expenditures ("SR&ED"), we record this income as a reduction of R&D expenses. Additionally, in accordance with IFRS, we capitalize development costs only if development costs can be measured reliably, the product or process is technically or commercially feasible, future economic benefits are probable, and we have the intention and sufficient resources to complete the development and to use or sell the asset. Accordingly, we capitalized $1.2 million of development costs during Fiscal 2022 for PARA OPS and Phantom, compared to $83 thousand for Phantom during Fiscal 2021. See Note 9 of the audited consolidated financial statements for Fiscal 2022.

Finance Costs

Net finance costs were $0.5 million for Fiscal 2022, a 370% increase over Fiscal 2021 driven mainly by an increase in borrowings during Fiscal 2022 and full year accretion cost on the accrued royalties liability relating to the acquisition of the PARA OPS system.

Net Loss and Adjusted EBITDA Loss

We incurred a net loss of $10.5 million or $14.41 per basic share for Fiscal 2022, compared to the net loss of $9.3 million or $14.72 per basic share for Fiscal 2021. After adjusting for share-based compensation and other items (see table above), our Adjusted EBITDA loss was $7.3 million, compared to Adjusted EBITDA loss of $6.6 million in Fiscal 2021.

The increase in net loss and Adjusted EBITDA loss was primarily due to lower revenue and higher OPEX as noted above.

Variance Analysis: Fiscal 2021 compared to Fiscal 2020

Revenue

We earned $1.3 million in revenue for Fiscal 2021, compared to $0.9 million for Fiscal 2020. On an annualized basis, our total revenue increased by 11% over the prior year mainly due to one large contract with a United States military customer relating to our TASCS IFM system. At the end of Fiscal 2021, we estimated approximately 98.3% completion on this large contract and have fully delivered the remaining performance obligation since September 30, 2021.

For both Fiscal 2021 and 2020, our TASCS IFM revenue was concentrated with two United States military customers.

Gross Profit

Our gross profit was $0.5 million for Fiscal 2021, or gross margin of 37%, compared to $0.6 million for Fiscal 2020 with gross margin of 71%. The fluctuation in gross profit / margin is due to our pre-commercialization phase. Further, the contract that was awarded to us in Fiscal 2021 was significantly more complex in nature, requiring judgement during the bidding process in estimating the engineering labor hours to meet the customer requirements. We incurred more engineering labor hours than anticipated, which contributed to the lower gross margin in Fiscal 2021. Costs included enhancements to the technology for this particular customer.

OPEX

Total OPEX were $9.7 million for Fiscal 2021, compared to $4.1 million for Fiscal 2020. Excluding M&A costs, on an annualized basis total OPEX increased by 185% driven primarily by growth in G&A, S&M and R&D.

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• G&A increased by 12% on an annualized basis; however, excluding the M&A costs, our G&A increased by 161% primarily due to augmenting the senior management team with two executives and recruiting independent directors, which led to a significant increase in personnel costs, including share-based compensation. Further, as a result of becoming a public company in Canada late in Fiscal 2020, we are now incurring significantly more regulatory costs and director and officer insurance premium costs.

• S&M increased by 362% on an annualized basis primarily due to making an investment in promoting and increasing awareness about us and our product offerings, including the recruitment of Brandon Tatum, through his private company The Officer Tatum LLC, as our advisor and advocate for our PARA OPS non-lethal system for law enforcement and personal defense in the United States in advance of our commercial launch of the LEC System anticipated for January 2022. We compensate Officer Tatum primarily in non-cash consideration, RSUs and performance share units ("PSUs"). Additionally, we made further investments in business development by recruiting consultants in the United States and in Canada to promote our product offerings.

• Excluding the ITCs, R&D increased by 88% on an annualized basis primarily due to an increase in headcount to accelerate product development to ready products for market. We recognized $0.2 million and $0.1 million of ITCs in Fiscal 2021 and 2020, respectively, relating to qualified SR&ED projects. Recognition takes place only once we have completed our analysis on whether certain R&D projects qualify for SR&ED ITCs with the assistance of our external tax professionals. In accordance with IFRS, we capitalized $83 thousand of development costs for Phantom during Fiscal 2021, compared to $163 thousand capitalized development costs for our TASCS IFM system during Fiscal 2020, which was subsequently transferred to inventory during the first quarter of Fiscal 2021 as a result of winning a follow-on order from the United States military customer.

Finance Costs

Net finance costs increased marginally in Fiscal 2021 mainly due to the accretion cost on the accrued royalties liability relating to the acquisition of the PARA OPS System.

Net Loss and Adjusted EBITDA Loss

We incurred a net loss of $9.3 million or $14.72 per basic share for Fiscal 2021, compared to the net loss of $3.5 million or $8.03 per basic share for Fiscal 2020. After adjusting for share-based compensation, M&A costs, and other items (see table above), our Adjusted EBITDA loss was $6.6 million, compared to Adjusted EBITDA loss of $1.6 million in Fiscal 2020.

The increase in net loss was primarily due to investments made to drive marketing and promotional activities about us and our product offerings, accelerating product development, and recruiting talent to position ourselves for success.

Selected Annual Information

The following selected financial information is taken from the audited financial statements for Fiscal  2022, 2021, and 2020.

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		Year ended			Year ended			Nine months ended
		September 30,			September 30,			September 30,
		2022			2021			2020
Statement of Operations data:
Revenue	$	721,519		$	1,275,804		$	861,917
Gross profit	$	184,784		$	476,916		$	614,804
Gross margin %		25.6%			37.4%			71.3%
Operating loss	$	(10,091,345	)	$	(9,202,548	)	$	(3,490,907	)
Net loss	$	(10,520,290	)	$	(9,315,372	)	$	3,536,778
Loss per share - basic and diluted	$	(14.41	)	$	(14.72	)	$	(8.03	)
		September 30,			September 30,			September 30,
		2022			2021			2020
Financial Position data:
Cash	$	170,545		$	2,688,105		$	3,073,760
Total assets	$	7,323,463		$	8,717,846		$	5,312,777
Total non-current liabilities	$	1,400,474		$	1,434,628		$	307,909
Total shareholders' equity (deficit)	$	(1,002,891	)	$	6,123,728		$	3,884,864

See Results of Operations - Fiscal Periods Ended September 30, 2022, 2021 and 2020 for additional details and for the comparison discussion between the periods presented above.

Financial Condition

The following table summarizes our financial position:

		September 30,			September 30,		September 30,
		2022			2021		2020
Assets
Current	$	1,516,393		$	4,055,697	$	3,996,514
Non-current		5,807,070			4,662,149		1,316,263
Total assets	$	7,323,463		$	8,717,846	$	5,312,777
Liabilities
Current	$	6,925,880		$	1,159,490	$	1,120,004
Non-current		1,400,474			1,434,628		307,909
Total liabilities		8,326,354			2,594,118		1,427,913
Net assets	$	(1,002,891	)	$	6,123,728	$	3,884,864
Working capital (1)	$	(5,409,487	)	$	2,896,207	$	2,876,510

 ^{(2)Working capital is calculated as current assets less current liabilities.}

Our working capital was negative $5.4 million at September 30, 2022, a decrease of $8.3 million partly due to lower equity financing and higher net loss over the prior year.

Total assets decreased by 16% from September 30, 2021, mainly due to $2.5 million decrease in current assets for the same reason as noted above for working capital; offset partially by $1.1 million increase in non-current assets driven by capitalized development costs and to a lesser extent new intangible assets from the acquisition of Police Ordnance.

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Total liabilities increased by $5.8 million from September 30, 2021, mainly driven by additional short-term borrowings and an increase in accounts payable and accrued liabilities due to deferred payments with key vendors as well as accrued and unpaid wages for certain senior employees who voluntarily deferred their wages until we completed the U.S. IPO and Canadian Offering. We also accrued bonuses for staff and management at September 30, 2022 (none in the prior year).

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.

At September 30, 2022, our cash position was $0.2 million, a decrease of $2.5 million since September 30, 2021 primarily due to incurring a net operating loss for Fiscal 2022, which was partially offset by additional borrowings and to a lesser extent equity financing. Other than a small credit facility with Royal Bank of Canada for a corporate credit card program and foreign exchange line of credit, we do not have credit facilities in place.

On December 9, 2022, we closed both the U.S. IPO and Canadian Offering pursuant to which we received aggregate gross proceeds of USD$14.1 million, before underwriting and offering costs (see "Liquidity and Capital Resources" for further details including our expected use of proceeds). With this new capital, we believe we have sufficient liquidity and capital to timely fund our working capital and contractual obligations, including loan repayments, over the next twelve months. However, we may require additional capital in the event we fail to implement our business plan, which could have a material adverse effect on our financial condition and/or financial performance. There is no assurance that we will be able to raise additional capital as they are required in the future. Potential sources of capital may include additional equity and/or debt financings. In our view, the availability of capital will be affected by, among other things, capital market conditions, the success of our PARA OPS system commercialization efforts, timing for winning new customer contracts, potential acquisitions, and other relevant considerations (see "Risk Factors"). In the event we raise additional funds by issuing equity securities, our existing shareholders will likely experience dilution, and any additional incurrence of indebtedness would result in increased debt service obligations and could require us to agree to operational and financial covenants that could further restrict our operations. Any failure to raise additional funds on terms favorable to us or at all may require us to significantly change or curtail our current or planned operations in order to conserve cash until such time, if ever, that sufficient proceeds from operations are generated, and could result in us not being in a position to advance our commercialization strategy or take advantage of business opportunities.

Consolidated Statements of Cash Flows

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

		Year ended			Year ended			Nine months ended
		September 30,			September 30,			September 30,
		2022			2021			2020
Total cash provided by (used in):
Operating activities	$	(4,256,596	)	$	(6,255,213	)	$	(1,791,654	)
Investing activities		(1,113,793	)		(1,073,192	)		(390,972	)
Financing activities		2,852,829			6,942,750			5,234,771
Net cash outflows	$	(2,517,560	)	$	(385,655	)	$	3,052,145
Cash, beginning of period		2,688,105			3,073,760			21,615
Cash, end of period	$	170,545		$	2,688,105		$	3,073,760

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Cash used by operating activities

With the additional capital raised in the last three years, we continued to invest significantly across the organization and in product development. As an early-stage company with various products in the pipeline (pre-commercialization phase), our revenue remains low and insufficient to cover the increase in our overhead costs, professional fees, advertising and promotion costs, and R&D costs. As a result, cash flow used in operating activities was $4.3 million, $6.3 million, and $1.8 million for fiscal years 2022, 2021, and 2020, respectively.

Cash used by investing activities

Cash flow used in investing activities was $1.1 million for Fiscal 2022, consistent with prior year. In Fiscal 2022, we continued to make investments in the product development of our PARA OPS and Phantom systems. We also acquired Police Ordnance which resulted in assuming cash of $0.2 million at closing.

Cash flow used in investing activities for Fiscal 2021 was higher than for the nine months ended September 30, 2020, mainly due significant investments made in sales demonstration units for TASCS IFM, and to a lesser extent to a $0.15 million deposit made to DEFSEC as an advance on future royalties. The $0.4 million investment in Fiscal 2020 includes investments in capitalized developments projects and the cash consideration for the acquisition of the Phantom system from SageGuild.

Cash provided by financing activities

The $2.8 million cash provided by our financing activities for Fiscal 2022 was lower than the $6.9 million in the prior year primarily due to very challenging equity market conditions in the last nine months of Fiscal 2022. During Fiscal 2022, our financing was driven mainly from $2.5 million in borrowings, whereas in the prior year we raised $6 million in gross proceeds from selling Common Shares and warrants in private placements. Proceeds from exercise of warrants and stock options also declined by $1.5 million from last year due to the significant decline in the price of our common stock on the TSXV.

The $1.7 million increase in cash provided by financing activities in Fiscal 2021 over Fiscal 2020 was primarily driven by $1.8 million of proceeds from exercised stock options and warrants over the comparable period in light of the favorable movement in the price of the Common Shares since going public in Canada in late Fiscal 2020. In Fiscal 2021, we raised net proceeds of $5.4 million from equity offerings, slightly ahead of the $5.3 million raised in the prior period. We also repaid $0.2 million of related party loans during Fiscal 2021, compared to $0.08 million in the prior period.

Capital Resources

Our objective in managing our capital is to safeguard KWESST's ability to continue as a going concern and to sustain future development of the business. Our senior management is responsible for managing the capital through regular review of financial information to ensure sufficient resources are available to meet operating requirements and investments to support our growth strategy. Our Board 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 from borrowings, security offerings, exercise of stock options and warrants, and, to a lesser extent, pre-commercial revenue. The following is a breakdown of our capital:

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		September 30,			September 30,			September 30,
		2022			2021			2020
Debt:
Lease obligations	$	275,621		$	307,909		$	252,037
Related party loans		-			-			218,276
Borrowings		2,278,774			53,251			32,273
Equity:
Share capital		19,496,640			17,215,068			9,374,563
Warrants		1,959,796			1,848,389			277,170
Contributed surplus		3,551,330			2,458,211			306,708
Accumulated other comprehensive loss		(101,418	)		(8,991	)		-
Accumulated deficit		(25,909,239	)		(15,388,949	)		(6,073,577	)
Total capital	$	1,551,504		$	6,484,888		$	4,387,450

The following table shows a breakdown of our total borrowings:

Refer to Note 12, Borrowings, of our audited consolidated financial statements for Fiscal 2022 for further details on each of the above outstanding loans. Following the closing of the U.S. IPO and Canadian Offering, we have repaid all the above loans, net of shares for debt settlement as noted below. Accordingly, we have no outstanding borrowings as of the date of this Prospectus.

Contractual Obligations and Commitments

At September 30, 2022, our contractual obligations and commitments were as follows:

Payment due:		Total		Within 1 Year		1 to 3 years		3 to 5 years
Accounts payable and accrued liabilities	$	4,459,481	$	4,459,481	$	-	$	-
Borrowings		2,648,280		2,548,280		100,000		-
Minimum royalty commitments		2,500,000		150,000		350,000		2,000,000
Lease obligations		327,600		93,600		187,200		46,800
Total contractual obligations	$	9,935,361	$	7,251,361	$	637,200	$	2,046,800

Shares Outstanding

At September 30, 2022, our authorized capital consists of an unlimited number of Common Shares with no stated par value.

The following table shows the outstanding Common Shares and dilutive securities at September 30, 2022:

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	September 30,		Proceeds if		Average
	2022(1)		Exercised		price
Common shares	773,225
Founders' warrants	106,000	$	1,484,000	$	14.00
Broker warrants	643	$	$90,000	$	139.97
Warrants	83,067	$	8,610,150	$	103.65
Stock options	57,108	$	4,796,644	$	83.99
Restricted stock units (RSUs)	21,174	$	-	$	-
Performance stock units (PSUs)	170	$	-	$	-
Agents' compensation options:
Common shares	837	$	74,008	$	88.42
Warrants	1,964	$	240,623	$	122.52
Total dilutive securities	1,044,188	$	15,295,425

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

Since September 30, 2022, we have issued more Common Shares and warrants mainly as a result of the following material events.

U.S. IPO and Canadian Offering

On December 9, 2022, we closed the U.S. IPO and the Canadian Offering. In the U.S. IPO, we sold 2,500,000 units at a public offering price of USD $4.13 per unit, consisting of one Common Share and one U.S. IPO Warrant. The U.S. IPO Warrants have a per share exercise price of USD $5.00, can be exercised immediately, and expire five years from the date of issuance. In connection with the closing of the U.S. IPO, the underwriter partially exercised its over-allotment option to purchase an additional 199,000 U.S. IPO Pre-funded Warrants and 375,000 U.S. IPO Warrants.

In the Canadian Offering, we sold 726,392 Canadian Units, each consisting of one Common Share and one Canadian Warrant, at a price to the public of USD $4.13 per unit. The warrants will have a per Common Share exercise price of USD $5.00, are exercisable immediately and expire five years from the date of issuance.

The closing of the U.S. IPO and Canadian Offering resulted in aggregate gross proceeds of USD $14,145,000, before deducting underwriting discounts and offering expenses.

The Common Shares of KWESST and the U.S. IPO Warrants began trading on Nasdaq under the symbols "KWE" and "KWESW", respectively, on December 7, 2022.

ThinkEquity acted as sole book-running manager for the U.S. IPO and PI Financial acted as sole book-running manager for the Canadian Offering.

As consideration for the services provided in connection with the U.S. IPO, ThinkEquity received: (a) a broker-dealer cash commission of approximately USD$835,000 equal to 7.5% of the gross offering proceeds of the U.S. IPO and (b) U.S. IPO Underwriter Warrants to purchase up to 134,950 Common Shares equal to 5% of the Common Shares and U.S. IPO Pre-funded Warrants issued in the U.S. IPO. Each U.S. IPO Underwriter Warrant is exercisable to acquire one Common Share at a price of USD$5.1625, exercisable as of June 4, 2023, and expiring December 4, 2027.

As consideration for the services provided in connection with the Canadian Offering, PI Financial received: (a) a cash commission of approximately USD$210,000 equal to 7% of the gross proceeds of the Canadian Offering; and (b) 50,848 non-transferable options equal to 7% of the number of Canadian Units issued under the Canadian Offering. Each Canadian Compensation Option is exercisable to acquire one Canadian Unit at a price of USD$4.13 for a period of two years after the closing of the Canadian Offering.

The total estimated offering costs were approximately USD$2.1 million for the U.S. IPO and Canadian Offering, of which $0.6 million was incurred and deferred at September 30, 2022. 

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Accordingly, the estimated net proceeds from the U.S. IPO and Canadian Offering were $11 million.

Use of Proceeds

The following table illustrates the estimated use of the combined net proceeds from the U.S. IPO and Canadian Offering over the next 12 months:

Use of Net Proceeds (1)		In U.S. Dollars
Repayment of non-secured borrowings:
Issued in March 2022 (2)	$	1,460,000
Issued in August 2022 (3)	$	220,000
CEBA loans (4)	$	51,000
Product development	$	529,000
Corporate, general & administration, and working capital:
General and administrative	$	2,469,000
Selling and marketing	$	1,355,000
Research and development, net	$	296,000
Negative working capital at September 30, 2022 (excluding above loans)	$	2,286,226
Unallocated working capital	$	2,297,213
Total use of net proceeds	$	10,963,439

(1)For Canadian dollars denominated expenses, the amounts were converted at a rate of $1.37 to USD$1.00 on as reported by the Bank of Canada on December 16, 2022.

(2)The net proceeds were used to fund the Company's working capital.

(3)On December 13, 2022, one of the two non-secured loans issued in August 2022 was settled for KWESST Units (same terms as the Canadian Units).

(4)This is net of $23,077 forgivable amount as we have repaid the CEBA loans due to the Canadian Government the repayment deadline for the forgivable amount.

We may also use a portion of the net proceeds from the U.S. IPO and Canadian Offering for acquisitions or strategic investments in complementary businesses or technologies. We do not currently have any plans for any such acquisitions or investments and have not allocated specific amounts of net proceeds for any of these purposes.

The actual allocation of the net proceeds may vary depending on future developments in our business or unforeseen events. Pending such application of the net proceeds of the U.S. IPO and Canadian Offering, we may elect to invest such funds, in whole or in part, in short-term investment-grade securities or bank deposits. We intend to use the net proceeds as stated above; however, there may be circumstances where, for sound business reasons, a reallocation of proceeds may be deemed prudent or necessary.

Shares for Debt Settlement

On December 13, 2022, we issued 56, 141 Units to settle $12,000 of the March 2022 loans and USD$223,321 of the August 2022 loans, including unpaid accrued interest and 10% premium at maturity. The terms of the Units are the same as the Units issued in the Canadian Offering.

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Use of Proceeds from Prior Financings

The following table provides an approximate breakdown on the initial allocation of the use of funds for last year's brokered private placement and the actual use of proceeds:

		2021 Financing
				Estimated and
				Unaudited Actual		Proceeds
		Expected		Use of Funds from		Unspent as at
		Allocation of Net		April 29, 2021 to		September 30,
Use of Proceeds (1)		Proceeds		September 30, 2022		2022
Products development: (2)
TASCS IFM (3)	$	400,000	$	314,087	$	85,913
BLDS		200,000		305,788		(105,788	)
Phantom		500,000		793,852		(293,852	)
GreyGhost		200,000		15,840		184,160
ATAK		500,000		304,162		195,838
LEC		500,000		761,943		(261,943	)
Total products development		2,300,000		2,495,672		(195,672	)
Other specific allocations:
Repayment of CEO and employee loans		191,600		191,600		-
Repayment of unsecured borrowings		310,527		310,527		-
Prepaid royalties to DEFSEC (4)		150,000		150,000		-
Total allocated proceeds		2,952,127		3,147,799		(195,672	)
Unallocated proceeds for working capital		2,516,366		2,320,694		195,672
Transferred from 2020 Financing		235,345		235,345		-
Total use of proceeds	$	5,703,838	$	5,703,838	$	0

Notes:

(1)Excludes non-cash transactions settled in Common Shares.

(2)Includes concept & design, initial prototype, market testing, and pre-production including a few demo units. Costs includes internal labor costs, outsourced engineering costs, and materials (no overhead allocation).

(3)Net of customer funding of $1.0 million.

(4)In connection with the PARA OPS System acquisition.

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements that have or are reasonably likely to have, a current or future effect on our results of operations, financial condition, revenues or expenses, liquidity, capital expenditures or capital resources.

Research and Development, Patents and Licenses, etc.

Our R&D expenses are comprised of costs incurred in performing R&D activities, including new product development, continued product enhancement, materials and supplies, salaries and benefits (including share-based compensation), engineering consulting costs, patent procurement costs, and estimated R&D-related facility costs. Where we qualify for Canadian ITCs for qualified SR&ED, we record this income as a reduction of R&D expenses.

Additionally, we capitalize development costs only if development costs can be measured reliably, the product or process is technically or commercially feasible, future economic benefits are probable, and we have the intention and sufficient resources to complete the development and to use or sell the asset. This was case for our TASCS IFM development efforts during the nine months ended September 30, 2021. We subsequently transferred this capitalized development cost to inventory (work-in-process) during the first quarter of our fiscal 2021 as a result of winning a follow-on order from the United States military customer, which included delivery of our TASCS IFM prototype for 81mm mortar system. For Fiscal 2022, we capitalized development costs for our Phantom and PARA OPS systems (see Note 7 of the Fiscal 2022 financial statements in "Financial Statements").

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For a description of our patents and product development in progress, please see "Business Overview - Proprietary Protection."

Critical Accounting Estimates

The following is a summary of critical accounting policies, requiring management to make significant estimates and assumptions:

Revenue

Revenue is recognized upon transfer of control of products or services to customers at an amount that reflects the transaction price we expect to receive in exchange for the products or services. Our contracts with customers may include the delivery of multiple products and services, which are generally capable of being distinct and accounted for as separate performance obligations. The accounting for a contract or contracts with a customer that contain multiple performance obligations requires us to allocate the contract or contracts transaction price to the identified distinct performance obligations.

Revenue from contracts with customers is recognized, for each performance obligation, either over a period of time or at a point in time, depending on which method reflects the transfer of control of the goods or services underlying the particular obligation to the customer.

For performance obligations satisfied over time, we recognize revenue over time using an input method, based on costs incurred to date relative to total estimated costs at completion, to measure progress toward satisfying such performance obligation (for non-recurring engineering services, the input method is based on hours). Under this method, costs that do not contribute to our performance in transferring control of goods or services to the customer are excluded from the measurement of progress toward satisfying the performance obligation. In certain other situations, we might recognize revenue at a point in time, when the criteria to recognize revenue over time are not met. In any event, when the total anticipated costs exceed the total anticipated revenues on a contract, such loss is recognized in its entirety in the period it becomes known. Refer to Note 17 of the audited consolidated financial statements for Fiscal 2022 for tabular disclosure on timing of revenue recognition.

We may enter into contractual arrangements with a customer to deliver services on one project with respect to more than one performance obligation, such as non-recurring engineering, procurement, and training. When entering into such arrangements, we allocate the transaction price by reference to the stand-alone selling price of each performance obligation. Accordingly, when such arrangements exist on the same project, the value of each performance obligation is based on its stand-alone price and recognized according to the respective revenue recognition methods described above. For example, for non-recurring engineering services rendered over a contract period the revenue is recognized using the percentage of completion method; whereas for training services the revenue is recognized after the training is delivered (i.e. point in time).

We account for a contract modification, which consists of a change in the scope or price (or both) of a contract, as a separate contract when the remaining goods or services to be delivered after the modification are distinct from those delivered prior to the modification and the price of the contract increases by an amount of consideration that reflects our stand-alone selling price of the additional promised goods or services. When the contract modification is not accounted for as a separate contract, we recognize an adjustment to revenue on a cumulative catch-up basis at the date of contract modification. There was no contract modification in Fiscal 2022, Fiscal 2021 or Fiscal 2020.

The timing of revenue recognition often differs from performance payment schedules, resulting in revenue that has been earned but not billed. These amounts are included in unbilled receivables. At September 30, 2022, and December 31, 2022, we had an immaterial amount of unbilled receivable. Amounts billed in accordance with customer contracts, but not yet earned, are recorded and presented as part of contract liabilities. At December 31, 2022, we had $267 thousand of contract liabilities (September 30, 2022: $47 thousand).

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When a contract includes a significant financing component, the value of such component is excluded from the transaction price and is recognized separately as finance income or expense, as applicable.

Accounting for acquisitions and contingent consideration

During Fiscal 2022, we acquired Police Ordnance and accounted for it pursuant to IFRS 3, Business Combinations. Areas of significant estimation in connection with the accounting of this transaction included:

• the estimated fair value of raw and work-in-progress inventories and intangible assets for the purchase price allocation; and
• the volatility assumption used in the Black Scholes option model to estimate the fair value of the warrants issued to the selling shareholders given our short history as a public company.

During Fiscal 2021, we acquired the PARA OPS system and accounted for it pursuant to IFRS 2, Share-Based Payment. Areas of significant estimation in connection with the acquisition of the PARA OPS system included:

• the determination of the discount rate for the present value of the minimum annual royalty payments to DEFSEC; and
• the volatility assumption used in the Black Scholes option model to estimate the fair value of the warrants issued to DEFSEC given our short history as a public company (see "Critical Accounting Estimates - Accounting for share-based compensation").

For further details on the above acquisitions, refer to Note 4 of the audited consolidated financial statements of Fiscal 2022.

Impairment of long-lived assets

We review property and equipment for impairment whenever events or changes in circumstances indicate the carrying amount may not be recoverable. An impairment loss is recognized the carrying value of an asset exceeds its recoverable amount. The recoverable amount is the higher of an asset's fair value less costs to sell and value in use. For the purpose of assessing impairment, assets are grouped at the lowest levels for which there are separately identifiable cash flows, referred as the cash generating unit ("CGU").

In accordance with IFRS, if the sum of the undiscounted expected future cash flows from a long-lived asset is less than the carrying value of that asset, then we recognize an asset impairment charge. The impairment charge is determined based on the excess of the asset's carrying value over its fair value, which generally represents the discounted future cash flows from that asset.

Because we are an early-commercial stage technology company, management exercises significant judgment in establishing key assumptions and estimates to determine the recoverable amount of our CGU, including future cash flows based on historical and budgeting operating results, growth rates, tax rates, and appropriate after-tax discount rates. The actual results may vary and may cause significant adjustments in future periods.

Impairment of non-financial assets

We review non-financial assets for impairment whenever events or changes in circumstances indicate the carrying amount of the assets may be impaired. If the recoverable amount of the respective non-financial asset is less than our carrying amount, it is considered to be impaired. Management exercises significant judgement in estimating the recoverable amount for non-financial assets (see "Critical Accounting Estimates - Impairment of long-lived assets").

Accounting for share-based compensation

We measure share-based compensation at fair value. Key inputs in the Black Scholes option model is the volatility assumption, forfeiture rate, and expected life of our Common Shares. Due to our limited trading history, management has established a relevant peer group of listed companies and selected the weighted average of their volatilities over a period of three to five years, where available. Starting in Fiscal 2021, we have commenced to incorporate a percentage of our stock volatility in the overall calculation of the volatility assumption. We expect to solely rely on our stock volatility by the end of Fiscal 2023 to estimate the fair value of share-based compensation as well as for warrants. As a result of our limited trading history, we have assumed a forfeiture rate of 0%, which will be reassessed annually. The expected life is estimated based on our trading history.

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Accounting for Unsecured Loans

Due to the issuance of bonus Common Shares as part of the unsecured loans transactions during Fiscal 2022, we are required to allocate a percentage of the gross proceeds between the bonus Common Shares and the debt component based on their relative fair value. To measure the fair value of the unsecured loans, we used the income approach and estimated a market discount rate ranging from 22% - 24% to discount the future cash flows of the unsecured loans. Management selected a discount rate based on review of the debt cost for comparable public companies.

For further information on the unsecured loans, see Note 12 of the audited consolidated financial statements for Fiscal 2022.

Broker compensation options

As a result of the private placement in April 2021 and the Canadian Offering in December 2022, we issued broker compensation options. To measure the fair value of the broker compensation options, we used the Monte Carlo valuation model and exercised judgment in estimating the life, risk free rate, and volatility.

For further information on the broker compensation options see Note 15(c) of Fiscal 2022 and Note 13(c) of Q1 Fiscal 2023.

Accounting for warrant liabilities

In connection with the U.S. IPO and Canadian Offering, we issued warrants and pre-funded warrants with an exercise price denominated in U.S. dollars, which is different to our functional currency (Canadian dollars).  Accordingly, these are classified as financial liabilities under IFRS.  We measure these financial liabilities at fair value at each reporting period. Key inputs in the Black Scholes option model are the volatility assumption and expected life of the warrants and pre-funded warrants due to our limited trading history.  Refer to Note 12 of Q1 Fiscal 2023 for further information.

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DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

All share-related information presented in this section gives effect to the Reverse Split.

Directors and Senior Management

The following table sets forth the name of each of our directors and executive officers, as well as such individual's place of residence, position with us, principal business activities performed outside those with us and period of service as a director (if applicable).

Directors and Executive Officers

Name	Position With KWESST Micro	Age	Principal Business Activity Outside KWESST Micro	Director/Officer Since
David Luxton Ontario, Canada	Executive Chairman, Director	72	N/A	October 24, 2019(1)
Jeffrey MacLeod Ontario, Canada	President, CEO, Director and Promoter	63	N/A	April 24, 2017(1)
Sean Homuth Ontario, Canada	Chief Financial Officer, and  Chief Compliance Officer	45	N/A	June 12, 2023
Paul Mangano (2) Maine, United States	Director	65	Founder and Owner, Surculus Advisors LLC and General Manager, Steiner Optics Inc. (up to April 2022), CEO of OnPoint Systems, Inc. since August 2022	September 17, 2020
Paul Fortin (2) Ontario, Canada	Director	55	Senior Associate, David Pratt & Associates and Independent Advisor	September 17, 2020
John McCoach (2) British Columbia, Canada	Director	65	Director and Chairman of the Audit Committee, Xybion Digital Inc.; Vice Chairman, Royal Canadian Marine Search and Rescue	November 28, 2017(3)

Notes:

(1)Date on which the individual became a director of KWESST.

(2)A member of the Audit Committee. Mr. McCoach is Chair of the Audit Committee.

(3)Date on which the individual became a director of Foremost.

The following are brief biographies of our directors and executive officers.

David Luxton, Executive Chairman and Director

David Luxton is an entrepreneur in the defense and security industry. He is a former Canadian infantry officer, and former senior official with the Canadian and British governments. In 1990 he founded Simunition, a business that develops and sells simulated munitions for realistic close quarters combat training for military and law enforcement. Between 2003 and 2009, he led the expansion of the Allen-Vanguard Corporation, a company in the IED countermeasures business, from approximately $3,000,000 to a run rate of approximately $300,000,000 in annual revenues, then served as Chairman from 2010 to October 2021. Between 2015 and 2018, he was the Executive Chairman of United Tactical Systems, LLC, a company offering non-lethal products for law enforcement, military and personal defense. From 2003 to the date of this Prospectus, he has been President & Owner of DEFSEC, a company that specializes in strategic transactions in the defense and security industry. Furthermore, from 2016 to 2020, he was a Senior Strategic Advisor to the University of Ottawa. Since 2019, he has been the Executive Chairman of KWESST. He holds a SMDP postgraduate studies from the University of Oxford. He entered into a confidentiality and non-disclosure agreement through his consulting agreement with us on October 1, 2019.

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Jeffrey MacLeod, President, Chief Executive Officer, Director and Promoter

Jeffrey MacLeod is an experienced defense industry executive with over 20 years of experience in the small arms and advanced soldier system fields. By establishing us, he aimed to develop software and hardware systems, such as the TASCS, to take existing legacy weapons and fully integrate them into a soldier system. Prior to founding KWESST, from 2008 to 2017, Jeffrey was the General Manager of Colt, a company producing small firearms for the Canadian military. Jeffrey has a Bachelor's degree in mechanical engineering from the Technical University of Nova Scotia (now DalTech) and a Master's degree in Military Vehicle Technology from the Royal Military College of Science (U.K). He is a Professional Engineer registered in the Province of Ontario. He entered into a confidentiality and non-disclosure agreement with us through his employment contract on October 1, 2019.

Sean Homuth, Chief Financial Officer

Mr. Homuth is a senior financial executive with more than 20 years of experience working with both Canadian and U.S. public companies across a broad range of industries. He has experience with a variety of financing (equity, debt, royalty) and M&A transactions. Since 2008, he has spent the majority of his time in various senior executive roles with emerging companies. He leads KWESST's accounting and controllership, tax planning, financial planning and analysis, investor relations, treasury, human resources and IT functions at KWESST. He also serves as the Company's Chief Compliance Officer. Mr. Homuth is a Chartered Professional Accountant (CPA, CA Ontario) and a
Certified Public Accountant (Illinois).

Paul Mangano - Director

Prior to being invited to join our Board, Mr. Mangano founded and owned Surculus Advisors LLC since 2016, a boutique management consulting firm providing advice, leadership, specialized expertise and transaction consultation services to the industrial and high-tech sectors including aerospace, defense and security. Further, since August 2022, he is the CEO of Onpoint Systems, Inc. From August 2020 to April 2022, he was the General Manager of Steiner Optics Inc., a division of Beretta. Prior to forming Surculus Advisors LLC, from 2006 to 2015, he served as the President of L-3 Communication's Public Safety & Sporting business unit. Mr. Mangano graduated with a BA in Economics from Harvard University and an MBA in High Technology from Northeastern University.

Paul Fortin - Director

Prior to being invited to join our Board, Paul Fortin was the director of international business development at Borden Ladner Gervais LLP, a full-service law firm, from 2011 to 2019. Since March 2020, he has been working with David Pratt & Associates as a Senior Associate and is an independent advisor within the defense and security industry. Mr. Fortin graduated from Carleton University with a Bachelor's degree in Political Science and from Algonquin College with a specialization in Product Marketing Management.

John McCoach - Director

Prior to being invited to join our Board, John McCoach held multiple senior positions in various companies, including seven years as the President of the TSXV. John McCoach was a member of the Capital Markets Authority Implementation Organization Board of Directors from 2016 to 2021. Mr. McCoach is an independent director and the current Audit Committee Chairman of Xybion Digital Inc. since November 2021. He also served as Interim CEO and as a director of Foremost, a position he held from 2018 until the Qualifying Transaction with KWESST Inc.  Finally, Mr. McCoach is an active crew member, and Vice Chairman of, Royal Canadian Marine Search and Rescue.

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Compensation

Compensation for Fiscal 2022

The aggregate amount of compensation paid during the year ended September 30, 2022 (including accrued amount at September 30, 2022), directly and indirectly, including directors' fees, to our named executive officers and directors in their capacity as such, was $1.2 million (Fiscal 2021: $0.7 million).

This discussion describes our compensation program for each person who acted as President and CEO, CFO and the three most highly-compensated executive officers (or three most highly-compensated individuals acting in a similar capacity), other than the CEO and the CFO, whose total compensation was more than $150,000 in our last fiscal year and who was performing a policy-making function in respect of the Company (each a "NEO" and collectively the "NEOs"). This section addresses our philosophy and objectives and provides a review of the process that the Board follows in deciding how to compensate the NEOs. This section also provides discussion and analysis of the Board's specific decisions about the compensation of the NEOs for the fiscal year ended September 30, 2022. We had five (5) NEOs during the fiscal year ended September 30, 2022, namely David Luxton, Executive Chairman, Jeffery MacLeod, President and Chief Executive Officer, Steven Archambault, former Chief Financial Officer, VP, Corporate Services & Compliance, and interim Corporate Secretary, Paul Kania, former CFO, and Richard Bowes, VP, Operations of Digitization & Counter-Threat Products.

Compensation Philosophy and Objectives

Our current executive compensation program is designed to provide short and long-term rewards to our executives that are consistent with individual and corporate performance and their contribution to our short and long-term objectives. Our objectives with respect to compensation of executive officers are to provide compensation levels necessary to attract and retain high quality executives, and to motivate key executives to contribute to our interests. These objectives are to be met by the principal components of our executive compensation program, which has been focused on a combination of base compensation, cash bonus remuneration, and long-term incentives in the form of stock options or other security-based compensation.

The executive compensation program adopted by us and applied to our executive officers is designed to:

(a)attract and retain qualified and experienced executives who will contribute to our growth and success;

(b)ensure that the compensation of our executive officers provides a competitive base compensation package and a strong link between corporate performance and compensation; and

(c)motivate executive officers to enhance long-term shareholder value, with current compensation being weighted toward at-risk long-term incentives in the form of options and other security-based incentives so as to foster alignment with the interests of our shareholders and stakeholders.

We do not believe that our compensation programs encourage excessive or inappropriate risk taking because: (i) our employees receive both fixed and variable compensation, and the fixed portion (salary) provides a steady income regardless of Common Share value, which allows employees to focus on our business; and (ii) our LTIP encourages a long-term perspective due to the vesting provisions, which is generally at least over two (2) years. We believe that our compensation program is appropriately structured and balanced to motivate our employees and reward the achievement of annual performance goals, as well as the achievement of long-term growth in shareholder value.

Compensation Governance and Process

We have relied on the experience of our Board in setting our executive compensation philosophy and appropriate levels of compensation for our NEOs.

Today, we do not have a separate Compensation Committee. Our Board assumes responsibility as a whole for the oversight over the compensation of directors and executives, including:

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• review and approval our remuneration and compensation policies, including short and long-term incentive compensation plans and equity-based plans, bonus plans, pension plans (if any), our LTIP and grants, and benefit plans;
• sole authority to retain and terminate any compensation consultant to assist in the evaluation of director compensation, including sole authority to approve fees and other terms of the retention;
• review and approve at least annually all compensation arrangements for our senior executives;
• review and approve at least annually all compensation arrangements for our directors; and
• review the executive compensation sections disclosed in our management information circular distributed to shareholders in respect of our annual, and any special, meetings of shareholders.

While David Luxton and Jeffrey MacLeod work with our Board in making recommendations regarding our overall compensation policies and plan as well as specific level of compensation for the other NEOs, they are recused from any Board deliberations and decisions in respect to their own personal compensation. Their respective current fixed compensation was set prior to going public in Canada.

For Fiscal 2023, we plan to retain an independent consulting firm to conduct a peer review and recommend to the Board competitive compensation plans (short and long-term) for our NEOs and independent directors.  Accordingly, this may lead to significant changes to our compensation policies and practices.

Elements of Compensation

Our executive compensation program consists of three principal components: base salaries, annual incentive compensation and benefits, and long-term compensation.

Base Salaries

Base salaries are intended to reflect an executive officer's position within our corporate structure, his or her years of experience and level of responsibility, and salary norms in the sector and general marketplace. We have not formally conducted benchmarking against our peer group.  Further, as an early-stage company, we believe we have set the base salaries for the NEOs below current market to conserve cash in return for higher stock-based compensation awards. For Fiscal 2023 we plan to retain an independent consultant firm to formalize this process. Accordingly, decisions with respect to base salary levels for executive officers are not based on objective identifiable performance measures but for the most part are determined by reference to competitive market information for similar roles and levels of responsibility, coupled with subjective performance factors such as leadership, commitment, accountability, industry experience, and contributions. Our view is that a competitive base salary is a necessary element for retaining qualified executive officers, as it creates a meaningful incentive for individuals to remain with us and not be unreasonably susceptible to recruiting efforts by our competitors.

In determining the base salary compensation of each NEO, the Board considers: (i) recruiting and retaining executives critical to our success and the enhancement of shareholder value; (ii) providing fair and competitive compensation; (iii) balancing the interests of management and our shareholders; and (iv) rewarding performance, both on an individual basis and with respect to operations in general.

Annual Incentive Compensation and Benefits

Our Board will consider whether it is appropriate and in our best interests to award discretionary cash bonus to the NEOs for the most recently completed fiscal year and, if so, the amount. Discretionary cash bonuses are awarded to recognize the achievement of annual corporate objectives and to recognize contributions that enhance our intrinsic value.

The following is a summary of the maximum annual incentive compensation as a percentage of base salary / annual consulting fee, for the NEOs based on their respective employment / consulting agreements, at the sole discretion of the Board:

Position	Maximum Annual Incentive Compensation (Percentage of Base Salary)
Executive Chairman	200%
President and CEO	Not specified
CFO, VP, Corporate Services & Compliance, and Interim Corporate Secretary	50%
VP Operations - Digitization and Counter-Threat Products	50%

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We have not established explicit goals / milestones for our NEOs for Fiscal 2022 for the annual cash incentive compensation. However, we have set financial milestones for the vesting of 8,571 PSUs awarded to each of the Executive Chairman and the President & CEO on March 31, 2022. These financial milestones included achieving the following minimum floor:

• $5 million in customer orders for Fiscal 2022;

• $50 million in market capitalization for the Company at September 30, 2022; and

• $8 million of cash on hand at May 31, 2022.

As these financial milestones were not met, none of the above PSUs vested.

In July 2022, our Board approved a $100,000 retention bonus for the CFO, with $50,000 payable 30 days from completing the U.S. IPO, and the remaining $50,000 payable on December 31, 2022.

In December 2022, our Board approved USD$225,000 and USD$125,000 discretionary bonus to the Executive Chairman and the CFO, respectively, for their contributions during Fiscal 2022 and positioning the Company for future success including the successful closing of the U.S. IPO and Canadian Offering on December 9, 2022.

Long-Term Compensation

The long-term component of compensation for our NEOs, consists of (i) stock options ("Options"), (ii) RSUs, (iii) deferred share units ("DSUs"), (iv) SARs and/or (v) PSUs (collectively the "Security-Based Compensation Awards"). This component of compensation is intended to reinforce management's commitment to long-term improvements in our performance.

Our Board believes that incentive compensation in the form of Security-Based Compensation Awards which vest over time, is and has been beneficial and necessary to attract and retain NEOs. Furthermore, the Board believes Security-Based Compensation Awards are an effective long-term incentive vehicle because they are directly tied to our share price over a longer period and therefore motivates NEOs to deliver sustained long-term performance and increase shareholder value, and have a time horizon that aligns with long-term corporate goals. As such, our Board does not grant Security-Based Compensation Awards in excessively dilutive numbers or at exercise prices not reflective of the Company's underlying value.

In determining individual equity-based grants, the Board considers the experience, responsibilities and performance of each recipient of an award under the LTIP. Previous grants are also taken into consideration during the grant process.

Benefits Plans

The NEOs are entitled to life insurance, health and dental benefits.

We do not maintain a pension plan or retirement benefit plan for the NEOs.

External Compensation Consultants

During Fiscal 2022 and Fiscal 2021, we did not retain the services of executive compensation consultants to assist our Board in determining compensation for any of our NEOs or directors.  Further, the Board did not adjust the base salary for any NEOs during Fiscal 2022.

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Assessment of Risks Associated with Our Compensation Policies and Practices

Our Board has assessed the compensation plans and programs for our executive officers to ensure alignment with our business plan and to evaluate the potential risks associated with those plans and programs. Our Board has concluded that the compensation policies and practices do not create any risks that are reasonably likely to have a material adverse effect on the Company.

Our Board considers the risks associated with executive compensation and corporate incentive plans when designing and reviewing such plans and programs. We have not adopted a policy restricting our NEOs or directors from purchasing financial instruments that are designated to hedge or offset a decrease in market value of equity securities granted as compensation or held, directly or indirectly, by its NEOs or directors. To our knowledge, none of the NEOs or directors has purchased such financial instruments.

In connection with the U.S. IPO and Canadian Offerings, our directors and officers entered into lock-up agreements prohibiting them for trading in KWESST securities for three months from December 9, 2022.

Performance Graph

The following graph illustrates the cumulative return to our shareholders based on a $100 investment in the Common Shares from September 22, 2020, the date we went public in Canada, to September 30, 2022, as compared to the cumulative total return on the Standard & Poor's / TSXV Composite Index for the same period, assuming the reinvestment of cash distributions and/or dividends:

The trend in the above performance graph does not correlate to the trend of the compensation paid to the NEOs.  As described in Elements of Compensation, based salaries reflect each NEO's primary duties and responsibilities and are set at levels based on responsibility, experience and expertise as well as subjective factors such as leadership.  We believe that management must be compensated a minimum base salary for the value of the services provided, irrespective of our Common Share price performance.  Pursuant to our LTIP, we have granted Options, RSUs, and PSUs to our NEOs, each form a significant portion of compensation, and therefore the total compensation for the NEOs is directly affected by decreases or increases in the price of our Common Shares as the value of such Options, RSUs, and PSUs changes as our Common Share price changes.

Summary Compensation Table

The following table provides information concerning the total compensation paid to the NEOs for the years ended September 30, 2022, and 2021, and for the nine months ended September 30, 2020.

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								Non-equity incentive plan compensation
Name	Fiscal Year		Salary		Share- based Awards (1)		Option- based Awards (2)		Annual Incentive Plans (8)		Long- term Incentive Plans		Pension Value (3)		All Other Compensation		Total Compensation
David Luxton Executive Chairman and Director (4)	2022	$	180,000	$		$		$	308,408	$	-	$	-	$	-	$	488,408
	2021	$	180,000	$	237,300	$	58,000	$	-	$	-	$	-	$	-	$	475,300
	2020	$	110,769	$	-	$	-	$	5,000	$	-	$	-	$	-	$	115,769
Jeffrey MacLeod President & CEO and Director	2022	$	160,000	$		$		$	-	$	-	$	-	$	-	$	160,000
	2021	$	160,000	$	237,300	$	58,000	$	-	$	-	$	-	$	-	$	455,300
	2020	$	110,769	$	-	$	-	$	5,000	$	-	$	-	$	-	$	115,769
Steven Archambault Former CFO, VP, Corporate Services & Compliance, and Interim Corporate Secretary (5)	2022	$	155,000	$	115,660	$	12,334	$	171,338	$	-			$	-	$	454,332
	2021	$	192,733	$	24,999	$	301,000	$	-	$	-	$	-	$	-	$	518,732
	2020	$	-	$	-	$	-	$	-	$	-	$	-	$	-	$	-
Paul Kania Former CFO (6)	2022	$	-	$	-	$	-	$	-	$	-	$	-	$	-	$	-
	2021	$	-	$	-	$	-	$	-	$	-	$	-	$	-	$	-
	2020	$	50,000	$	-	$	38,750	$	-	$	-	$	-	$	-	$	88,750
Richard Bowes VP, Operations of Digitization & Counter-Threat Products(7)	2022	$	155,000	$	25,648	$	12,334	$	-	$	-	$	-	$	-	$	192,982
	2021	$	78,419	$	24,999	$	301,000	$	-	$	-	$	-	$	-	$	404,418
	2020	$	-	$	-	$	-	$	-	$	-	$	-	$	-	$	-

Notes:

(1)Represents the grant value of RSU awards, based the closing price of the Common Shares on the TSXV on the grant date.

(2)Represents the grant value of the option awards, using the Black-Scholes option model.  The Black-Scholes option model was selected by us as it is the most widely adopted and used option-valuation method. For the key inputs used in this valuation mode, refer to Note 15 (c) of the audited financial statements for Fiscal 2022.

(3)The Company does not have a retirement plan.

(4)Effective October 1, 2019, we entered into a professional services agreement with DEFSEC, a private company owned by Mr. Luxton. The compensation payable to Mr. Luxton is paid to his private company, DEFSEC.

(5)Mr. Archambault joined as our CFO on a part-time basis on October 1, 2020, transitioned to full-time on April 1, 2021. He also took on the role of VP, Corporate Services and Compliance in October 2021 and Interim Corporate Secretary in May 2022. Mr. Archambault resigned effective March 31, 2023.

(6)Through his private company, PLK Accounting and Finance Inc., Mr. Kania provided CFO services from November 4, 2019, to September 30, 2020.

(7)Through his private company, Cardinal Defense Consulting Inc, Mr. Bowes provided part-time virtual VP Operation services from January 25, 2021, to April 9, 2021. Effective April 12, 2021, Mr. Bowes joined as an executive officer.  Mr. Bowes resigned as an executive officer and, through Cardinal Defense Consulting Inc., he entered into a consulting agreement with KWESST on March 1, 2023 to provide business development services in Canada.

(8)In December 2022, the Board awarded a cash bonus of USD$225,000 to David Luxton and USD$125,000 to Steven Archambault in respect to their performance during Fiscal 2022, paid only after the closing of the U.S. IPO and Canadian Offering. For the above table, these amounts were converted to CAD using the daily average exchange rate on September 30, 2022, as reported by the Bank of Canada for the conversion of USD into CAD was USD$1.00 equals CAD$1.3707.

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Employment and Consulting Agreements

The following summarizes the key salient terms of the employment and consulting agreements between us and our NEOs in force as of September 30, 2022.

David Luxton: On October 1, 2019, we entered into a professional services agreement with DEFSEC, a private holding company owned by Mr. Luxton, in which he agreed to serve as our Executive Chairman for an annual fee of $120,000 per year and raising to $150,000 per year upon a going public transaction. This agreement was amended effective August 1, 2020, whereby the annual fee was adjusted to $180,000 per year. Mr. Luxton is entitled to an annual incentive bonus up to 200% of his annual fee at the Board's sole discretion. This agreement will expire on December 31, 2022. Subsequent to December 31, 2022, Mr. Luxton's compensation was amended to $360,000 per year with entitlement to an annual incentive bonus of up to 75% effective January 1, 2023.  We have the right to terminate his consulting agreement with six (6) month notice period, subject to termination benefits (see "Compensation - Potential Termination and Change of Control Benefits").

Jeffrey MacLeod: On October 1, 2019, we entered into an employment agreement with Mr. MacLeod to serve as our President and CEO with an initial base salary of $140,000 per year and raising to $160,000 upon a going public transaction. Because Mr. MacLeod's principal residence is based in West Montrose, Ontario, his employment agreement includes a $1,000 per month housing allowance for accommodations in Ottawa, Ontario while working at our corporate office. For Fiscal 2019, Mr. MacLeod collected a lower base salary to help us conserve cash to fund our working capital requirements. Further, he did not receive any housing allowance in the last three financial years. Mr. MacLeod is entitled to an annual incentive bonus at the Board's sole discretion and five weeks of vacation per year. His employment agreement will expire on September 30, 2022. We have the right to terminate his consulting agreement with six (6) month notice period, subject to termination benefits (see Compensation - Potential Termination and Change of Control Benefits).

Sean Homuth: On July 31, 2023 we entered into an amended and restated employment agreement, with effective date of June 12, 2023, with Mr. Homuth to serve as Chief Financial Officer and Chief Compliance Officer.  Mr. Homuth receives an annual base salary of CAD$300,000 with an annual incentive bonus of up to 50% of his annual base salary at the Board's sole discretion and four weeks of vacation per year.  Mr. Homuth will also receive an initial stock option grant with amount determined at the Board's discretion and vesting in accordance with the terms of the Company's LTIP plan. We may terminate Mr. Homuth's employment upon payment of a lump sum equal to 26 weeks salary plus accrued bonus.  This lump sum is increased by one week per completed year of service following the first anniversary of his employment with the Company to a maximum of 38 weeks.  In the event of a change of control, the forgoing is changed from 26 weeks to 52 weeks with the maximum changing from 38 weeks to 64 weeks.   

Outstanding Equity Awards at September 30, 2022

The following table sets forth information concerning all the outstanding equity awards held by each NEO as at September 30, 2022.

	Option-based awards							Share-based awards
		Number of securities underlying unexercised options		Option exercise price	Option expiration date		Value of unexercised in the-money options(1)	Number of shares or units of shares that have not vested		Market or payout value of share- based awards that have not vested (2)		Market or payout value of vested share- based awards not paid out or distributed
David Luxton (3)		1,428	$	87.50	7/2/2026	$	-	-	$	-	$	8,996
Jeffrey MacLeod (4)		1,428	$	87.50	7/2/2026	$	-	-	$	-	$	25,200
Steven Archambault (5)		1,429	$	14.70	7/24/2027	$	-	977	$	8,207	$	8,198
		2,857	$	136.50	8/25/2026	$	-	-	$	-	$	588
		714	$	49.00	11/20/2025	$	-	-	$	-	$	-
		3,571	$	52.50	10/1/2025	$	-	-	$	-	$	-
Richard Bowes (6)		1,429	$	14.70	7/24/2027	$	-	458	$	3,847	$	1,924
		1,428	$	136.50	8/25/2026	$	-	-	$	-	$	-
		4,285	$	90.30	4/29/2026	$	-	-	$	-	$	-
		1,428	$	120.40	1/25/2026	$	-	-	$	-	$	-
Total		19,997				$	-	1,435	$	12,054	$	44,906

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Notes:

(1)Based on the difference between the exercise price of the Option and $8.40, the closing price of the Common Shares on the TSXV on September 30, 2022.

(2)Based on $8.40, the closing price of the Common Shares on the TSXV on September 30, 2022.

(3)The grants were made to Mr. Luxton's private company, DEFSEC. His 2021 Option grant will vest over two (2) years and his RSU grant will vest over one (1) year.

(4)Mr. MacLeod's 2021 Option grant will vest over two (2) years and his RSU grant will vest over one (1) year.

(5)Mr. Archambault's 2022 Option and RSU grants vest 25% per quarter. His 2021 Option grants vest as follows: a) 2,857 options and 3,571 Options over (2) years, and b) 714 Options vested immediately and his 2021 RSU grant will vest over twelve (12) months, with 25% per quarter.

(6)Mr. Bowes' 2022 Option and RSU grants vest 25% per quarter. His 2021 Option grants vest as follows: a) 1,428 Options over one (1) year, and b) 4,285 Options and 1,428 Options over two (2) years.

There was no exercise of stock options during Fiscal 2022.

Value Vested or Earned During Fiscal 2022

The following table sets forth, for each NEO, the value of option-based awards and share-based awards which vested during the fiscal year ended September 30, 2022 and the value of non-equity incentive plan compensation earned during the fiscal year ended during the year ended September 30, 2022.

Name		Option-based awards - value vested during Fiscal 2022 (1)		Share-based awards - value vested during Fiscal 2022 (2)		Non-equity incentive plan compensation - value earned during Fiscal2022
David Luxton	$	36,236	$	46,731	$	308,408
Jeffrey MacLeod	$	36,236	$	13,127	$	-
Steven Archambault	$	189,753	$	36,254	$	171,338
Richard Bowes	$	237,978	$	22,294	$	-

Notes:

(1)Amounts represent the difference between the exercise price of the Options and the closing price of the Common Shares on the TSXV on the vesting date.

(2)Amounts represent the number of vested Share Units (as defined below) multiplied by the closing price of the Common Shares on the TSXV on the vesting date.

Potential Termination and Change of Control Benefits

All outstanding equity compensation is forfeited / cancelled if we terminate a NEO's employment / consulting agreement for cause. Further, in the event a NEO voluntarily resigns from his employment / consulting with us, any unpaid annual incentive and unvested equity compensation are forfeited in accordance with our LTIP.

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We have agreements with the NEOs that set out the terms of their employment / consulting and what they are entitled to in connection with a termination of employment or change of control. These agreements include non-solicitation, confidentiality, and ownership of intellectual property provisions to protect our interests.

The table below sets out the amount that would have been payable to each NEO had there been a change of control of the Company on September 30, 2022 and the severance payment that would have been payable to each NEO had the Company terminated employment of the NEO on September 30, 2022:

	Notice Period (months)		Termination Without Cause (pre-Change of Control)		Termination Without Cause in Connection with Change of Control
David Luxton
Base fee	6	$	180,000	$	270,000	(1)
Value of unvested options		$	-	$	-
Value of unvested RSUs		$	-	$	-
Value of vested RSUs not yet issued		$	8,996	$	8,996
TOTAL		$	188,996	$	278,996
Jeffrey MacLeod
Base pay	6	$	160,000	$	240,000	(1)
Value of unvested options		$	-	$	-
Value of unvested RSUs		$	-	$	-
Value of vested RSUs not yet issued		$	25,200	$	25,200
TOTAL		$	185,200	$	265,200
Steven Archambault
Base pay	1	$	90,000	$	90,000	(2)
Value of unvested options		$	-	$	-
Value of unvested RSUs		$	8,207	$	8,207
Value of vested RSUs not yet issued		$	8,786	$	8,786
TOTAL		$	106,993	$	106,993
Richard Bowes
Base pay	1	$	45,000	$	45,000	(2)
Value of unvested options		$	-	$	-
Value of unvested RSUs		$	3,847	$	3,847
Value of vested RSUs not yet issued		$	1,924	$	1,924
TOTAL		$	50,771	$	50,771

Notes:

(1)If within 24 months of, or in anticipation within 6 months of, change of control.

(2)If within 3 months of, or in anticipation within 3 months of, change of control.

A change of control is commonly defined in each of the respective agreements as:

a)the sale of all or substantially all of our outstanding Common Shares for cash or securities of an entity not managed by our management team and that are determined by our Board to be liquid for all of our shareholders ("Liquid Unrelated Issuer");

b)a merger, amalgamation, arrangement or other similar transaction involving us where the holders of our Common Shares receive cash or securities of a Liquid Unrelated Issuer, but do not immediately thereafter own securities of the successor corporation which entitle them to cash more than 50% of the votes attaching to all shares in the capital of the successor corporation;

c)the sale of all or substantially all of our assets followed by a liquidating distribution to the holders of our Common Shares of cash or securities of a Liquid Unrelated Issuer;

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provided that our Board shall have the right, in its absolute discretion, to deem any transaction not enumerated above to be a change of control. For greater clarity, a sale or transfer of founders shares between related parties, and/or an initial going public transaction of any kind shall not constitute a change of control.

Compensation of Independent Directors

In December 2020, our Board approved the following cash compensation for the independent directors effective October 1, 2020:

• $5,000 per quarter; and
• $2,500 per quarter for the Chair of the Audit Committee.

Prior to December 2020, did not pay cash compensation to directors.

The following table sets out the total compensation for our independent directors who served at any time during the year ended September 30, 2022.

Name		Fees Earned		Share-based Awards (1)		Option- based Awards (2)		Non- equity Incentive Plan Compensation		Pension Value(3)		All Other Compensation		Total Compensation
John McCoach	$	30,000	$	-	$	-	$	-	$	-	$	-	$	30,000
Paul Fortin	$	20,000	$	-	$	-	$	-	$	-	$	-	$	20,000
Paul Mangano(4)	$	20,000	$	-	$	-	$	-	$	-	$	41,121	$	61,121
Elisabeth Preston(5)	$	5,000	$	-	$	-	$	-			$	-	$	5,000

Notes

(1)Represents the grant value of RSU awards, based on the closing price of the Common Shares on the TSXV on the grant date.

(2)Represents the grant value of the option awards, using the Black-Scholes option model. The Black-Scholes option model was selected by the Company as it is the most widely adopted and used option-valuation method. For the key inputs used in this valuation mode, refer to Note 15 (c) of the audited financial statements for Fiscal 2022.

(3)The Company does not have a pension plan.

(4)Mr. Mangano earned consulting fee of USD$32,000 in connection with the product development for our PARA OPS.

(5)Mrs. Preston retired from the Board on May 18, 2022.

Subsequent to September 30, 2022 the fees for independent directors were increased to CAD $40,000 per year plus CAD $10,000 additional for the Audit Committee Chair effective October 1, 2023. 

Outstanding Equity Awards at September 30, 2022

We did not grant option-based or share-based awards to our independent directors during Fiscal 2022. The following table shows all compensation securities granted to our independent directors during Fiscal 2021.

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	Option-based awards							Share-based awards
	Fiscal Year award granted	Number of securities underlying unexercised options (1)		Option exercise price	Option expiration date		Value of unexercised in the money options(2)	Number of shares or units of shares that have not vested		Market or payout value of share-base awards that have not vested (3)		Market or payout value of vested share-based awards not paid out or distributed
John McCoach	2021	3,571	$	67.90	12/15/2025	$	250,000	-	$	-	$	-
	2018	306	$	32.90	6/15/2023	$	32,142	-	$	-	$	-
Paul Fortin	2021	3,571	$	67.90	12/15/2025	$	250,000	-	$	-	$	-
Paul Mangano	2021	3,571	$	67.90	12/15/2025	$	250,000	-	$	-	$	-
Elisabeth Preston	2021	4,285	$	124.60	2/23/2026	$	57,000	-	$	-	$	-
Total		15,304				$	839,142	-	$	-	$	-

Notes:

(1)The 2021 stock option grants to the directors vest over two (2) years. The 2018 stock option granted to Mr. McCoach has fully vested.

(2)Based on the difference between the exercise price of the option and $137.90, the closing price of the Common Shares on the TSXV on September 30, 2021.

(3)Based on $137.90, the closing price of the Common Shares on the TSXV on September 30, 2021.

There was no exercise of options during Fiscal 2022.

Value Vested or Earned During Fiscal 2022

The following table sets forth, for each independent director, the value of option-based awards and share-based awards which vested during the fiscal year ended September 30, 2022 and the value of non-equity incentive plan compensation earned during the fiscal year ended during the year ended September 30, 2022.  Note that no share-based awards have been granted to our directors since inception.

Name		Option-based awards - value vested during Fiscal 2022 (1)		Share-based awards - value vested during Fiscal 2022 (2)		Non-equity incentive plan compensation - value earned during Fiscal 2022
John McCoach	$	24,352	$	-	$	-
Paul Fortin	$	24,352	$	-	$	-
Paul Mangano	$	24,352	$	-	$	-
Elisabeth Preston(3)	$	-	$	-	$	-

Notes:

(1)Amounts represent the difference between the exercise price of the Options and the closing price of the Common Shares on the TSXV on the vesting date.

(2)Amounts represent the number of vested Share Units (as defined below) multiplied by the closing price of the Common Shares on the TSXV on the vesting date.

(3)Mrs. Preston retired from the Board on May 18, 2022.

Equity Compensation Plans

On February 10, 2021, our Board adopted a new LTIP, which was approved by our shareholders on March 31, 2021 and on April 9, 2021 by the TSXV.  Our LTIP was subsequently amended to conform with the new TSXV policy issued on November 24, 2021 in relation to security based compensation.  Our shareholders approved this amended LTIP on March 31, 2022, which was subsequently approved by the TSXV on April 14, 2022.

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The maximum number of Common Shares issuable under our LTIP for stock options is 10% of our issued and outstanding Common Shares, subject to adjustment or increase pursuant to the terms of the LTIP. Any stock options that have been cancelled, repurchased, expired, or exercised will again be available under the LTIP. At September 30, 2022, we had 57,108 outstanding stock options, leaving 19,833 stock options available for future grants.

Additionally, the maximum number of Common Shares issuable under our LTIP in respect of RSUs, DSUs, SARs, and PSUs (collectively "Share Units") is 60,381. At September 30, 2022, we had 23,487 outstanding Share Units, and 27,503 Share Units available for future grants.

The following is a summary of the salient terms of the equity-based awards available under our amended LTIP. For a more fulsome disclosure of our LTIP, a copy of our amended LTIP is available on SEDAR website at www.sedar.com.

Stock Options

Key Employees, Directors, Consultants and Persons performing Investor Relations Services (as such terms are defined in the LTIP) are eligible to receive grants of stock options to acquire Common Shares at the time of employment or contract, if applicable, and thereafter as determined by the Board.

Restricted Share Units

Key Employees, Directors and Consultants, are eligible to receive grants of RSUs, entitling the holder to receive one Common Share for each RSU, subject to restrictions as the Board may, in its sole discretion, establish in the applicable award agreement. The Board believes the granting of RSUs creates long-term incentive, a sense of ownership and an alignment of the recipients' interests with those of our shareholders and stakeholders. The granting of RSUs is intended to reward those executives who are responsible for our management and growth and to encourage such executives to develop a long-term vision for us to operate in a manner to maximize shareholder value. By using vesting periods for RSUs in addition to other restrictions, this compensation element is also designed to support long term retention of valuable Key Employees and Directors as well as provide an incentive for the achievement of specific milestones, if applicable.

Performance Share Units

Key Employees, Directors, and Consultants are eligible to receive grants of PSUs, entitling the holder to receive one Common Share for each PSU, subject to the achievement or attainment of specific performance criteria ("Performance Criteria") within a specific period ("Performance Cycle"). The number of PSUs and the Performance Criteria which must be satisfied in order for the PSUs to vest and the Performance Cycle in respect of such PSUs shall be specified in the applicable award agreement. The Board believes the granting of the PSUs incentivizes the attainment of specific goals which support our overall strategies and creates a sense of ownership and an alignment of the recipients' interests with those of our shareholders and stakeholders. The granting of PSUs is intended to reward those executives who are responsible for our management and growth and to encourage such executives to develop a long-term vision for us to operate in a manner to maximize shareholder value. By using vesting periods for PSUs in addition to other restrictions, this compensation element is also designed to support long-term retention of valuable employees as well as provide an incentive for the achievement of specific milestones, if applicable.

Deferred Share Units

Key Employees and Directors are eligible to receive grants of DSUs. Directors may elect to receive any part or all of their fees payable in respective of their position as a director as DSUs. Each holder of a DSU is entitled to receive one Common Share for each DSU. The Board believes the granting of DSUs creates long-term incentive, a sense of ownership and an alignment of the recipients' interests with those of our shareholders and Stakeholders. The granting of DSUs is intended to reward directors who are responsible for oversight of our management and growth and to encourage such directors to maintain a long-term vision for us to operate in a manner to maximize shareholder value.

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Stock Appreciation Rights

Key Employees, Directors, and Consultants are eligible to receive grants of SARs, entitling the recipient to receive a payment in Common Shares equal to the current market price less the grant price of the SAR as determined by the Board at the time of the grant for each SAR. Notwithstanding the foregoing, the Board may, in its sole discretion, satisfy payment of the entitlement in cash rather than in Common Shares. The granting of SARs is intended to reward those executives who are responsible for our management and growth and to encourage such executives to develop a long-term vision for us to operate in a manner to maximize shareholder value. By using vesting periods for SARs, this compensation element is also designed to support long-term retention of valuable employees as well as provide an incentive for the achievement of specific milestones, if applicable.

Vesting Provision

No award issued under the LTIP, other than Options, may vest before the date that is one year following the date it is granted or issued. Notwithstanding this provision, vesting may be accelerated for a Participant who dies or who ceases to be an eligible Participant under the LTIP in connection with a change of control, take-over bid, reverse takeover, or other similar transaction. 

For Options grants to Investor Relations service providers, vesting must be over a period of not less than one year, with no more than 25% of such options vesting in any three months.

Modification of an Award

Any adjustment, other than as noted in section 4.3 Anti-Dilution of the LTIP, to award granted or issued under our LTIP must be subject to the prior acceptance of the TSXV, including adjustments related to an amalgamation, merger, arrangement, reorganization, spin-off, dividend, or recapitalization.

Further, any decrease in the exercise price of or extension to stock options granted to individuals that are Insiders at the time of the proposed amendment is subject to disinterested shareholder approval.

Securities Authorized for Issuance Under Equity Compensation Plans

The following table sets forth the details as at September 30, 2022, the end of our most recently-completed fiscal year, with respect to compensation plans pursuant to which equity securities of the Company are authorized for issuance under our LTIP.

Equity Compensation Plans Information
Plan Category	Number of securities to be issued upon exercise of outstanding options, warrants and rights (a)	Weighted average exercise price of outstanding options, warrants and rights (b)	Number of securities remaining available for future issuance under Equity Compensation Plans (excluding securities listed in column (a)) (c)
Equity Compensation Plans approved by shareholders -  LTIP	Share Units: 24,001 Options: 57,108	Share Units: $nil Options: $83.87	Share Units: 27,503 Options: 19,833
Equity Compensation Plans not approved by shareholders	n/a	n/a	n/a

Board Practices

Each of our directors will hold office until the next annual general meeting of our shareholders or until his or her office is earlier vacated, in accordance with our Articles of Incorporation (the "Articles") and the BCBCA. Each of our officers serves at the pleasure of our Board. Please also refer to "Directors and Senior Management" above for further details regarding the periods of service of each of our current directors and officers.

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As of September 30, 2022, we did not have any service contracts with any of our independent directors.

Board Nomination

The identification of potential candidates for nomination as our directors is carried out by all directors, who are encouraged to participate in the identification and recruitment of new directors. Potential candidates are primarily identified through referrals and business contacts.

Audit Committee

The Audit Committee's Charter

Our directors have adopted a Charter for the Audit Committee, which sets out the Audit Committee's mandate, organization, powers and responsibilities. The full text of our Audit Committee Charter is available on request from us.

Composition of the Audit Committee

The members of the Audit Committee are John McCoach (Chairman), Paul Fortin, and Paul Mangano. All members are independent (as determined under Exchange Act Rule 10A-3 and Rule 5605(a)(2) of The Nasdaq Stock Market Rules and as defined in National Instrument 52-110 - Audit Committees ("NI 52-110") adopted by the Canadian Securities Administrators), and all members are financially literate (as defined in NI 52-110). The Audit Committee meets regularly on at least a quarterly basis. The members of the Audit Committee do not have fixed terms and are appointed and replaced from time to time by resolution of the Board.

The Board has determined that John McCoach qualifies as a financial expert (as defined in Item 407(d)(5)(ii) of Regulation S-K under the Exchange Act) and Rule 5605(c)(2)(A) of The Nasdaq Stock Market Rules; and (ii) is independent (as determined under Exchange Act Rule 10A-3 and Rule 5605(a)(2) of The Nasdaq Stock Market Rules).

Relevant Education and Experience

All of the Audit Committee members are senior-level professionals with experience in financial matters; each has a broad understanding of accounting principles used to prepare financial statements and varied experience as to general application of such accounting principles. Further, John McCoach has served on other Audit Committees of reporting issuers and was previously the President of the TSXV.

For further relevant education and experience of Messrs. McCoach, Fortin, and Mangano, refer to their respective biographies in "Directors, Senior Management and Employees."

Audit Committee Oversight

At no time during this past fiscal year have any recommendations by the Audit Committee respecting the appointment and/or compensation of our external auditors not been adopted by the Board.

Pre-Approval Policies and Procedures

Under its charter, the Audit Committee is required to pre-approve all non-audit services to be performed by the external auditors in relation to us, together with approval of the engagement letter for such non-audit services and estimated fees thereof. The pre-approval process for non-audit services will also involve a consideration of the potential impact of such services on the independence of the external auditors.

Employees

The following table sets forth the number of employees we had at the end of each fiscal period:

Year	Full Time	Part Time	Total
Fiscal 2020	10	Nil	10
Fiscal 2021	17	0.6	17.6
Fiscal 2022	17	1.2	18.2

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None of our employees are members in a labor union.

Share Ownership

As of June 30, 2023, our directors and executive officers, as a group, beneficially owned a total of 286,370 Common Shares, representing beneficial ownership of 3.47% of the Common Shares.

The table below sets forth the number of Common Shares beneficially owned by our directors and executive officers as of June 30, 2023. The persons listed below are deemed to be the beneficial owners of Common Shares underlying options, RSUs, and warrants that are exercisable within 60 days from the above date, including "out-of-the money"; options. The percentages shown below, for the beneficial owners, are based on 4,074,588 outstanding Common Shares as of June 30, 2023, plus 4,183,352 Common Shares underlying options, RSUs and warrants that are exercisable within 60 days for an aggregate total of 8,259,458.  The table below does not incorporate or give effect to the Private Placement.

Shareholdings of Directors and Executive Officers

Name of Beneficial Owner	Common Shares Held	Exercisable Options	RSUs	Common Shares Upon Exercise of Warrants	Number of Common Shares Beneficially Owned	Percent of Outstanding Common Shares
David Luxton (1)	70,628	1,429	-	39,005	111,062	1.34%
Jeffrey MacLeod (2)	144,361	1,429	-	12,000	157,790	1.91%
Sean Homuth	0	0	0	0	0	0
John McCoach	1,566	3,877	-	201	5,644	0.07%
Paul Mangano	4,610	3,571	-	11	8,192	0.10%
Paul Fortin	100	3,571	-	11	3,682	0.04%
Total	221,265	13,877	-	51,228	286,370	3.47%

Notes:

(1)Includes 68,032 Common Shares, 1,429 exercisable options, and exercisable warrants for 38,991 Common Shares held by his private company, DEFSEC.

(2)Common Shares are held by his private company, 2573685 Ontario Inc. Exercisable options and warrants are held by Mr. MacLeod.

Refer to section titled, Compensation, for the details of the options held by our directors and executive officers as at September 30, 2022. We have since not granted any further options.

We do not have any other equity arrangements for involving employees in our capital, except for the grant of Security-Based Compensation Awards pursuant to our LTIP at the discretion of the Board.

MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

Major Shareholders

To our knowledge, the following are our only shareholders that beneficially own, directly or indirectly, or exercise control over, shares carrying more than 5% of the outstanding voting rights attached to our Common Shares as at July 30, 2023. As of July 30, 2023, we had 5,616,782 Common Shares issued and outstanding.

Name of Shareholder	Number of Common Shares	Percentage of Common Shares
AIGH Capital (1)	556,175	9.90%
The Hewlett Fund LP (2)	559,000	9.95%

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Notes:

(1)Based on information provided by AIGH Capital in connection with the Private Placement and includes Common Shares subscribed for in the Private Placement.

(2)Based on information provided by The Hewlett Fund LP in connection with the Private Placement and includes Common Shares subscribed for in the Private Placement. 

Prior to the closing of our U.S. IPO and Canadian Offering in December 2022, the major changes in the last three years in the percentage ownership of persons who beneficially own 5% of the outstanding voting rights attached to our Common Shares were:

• Our Founder, President & CEO and director, through a holding company (2573685 Ontario Inc.), held 141,360 Common Shares or 18.2% of the total outstanding voting rights.
• DEFSEC increased its beneficial ownership to 68,579 Common Shares or 8.8% as a result of receiving 14,285 Common Shares (and warrants exercisable for 7,142 Common Shares) on April 29, 2021, for selling the PARA OPS technology to KWESST.
• On September 10, 2021, SOL Global Investments Corp. announced its equity ownership of our Common Shares for the first time, reporting 9.6% equity ownership and 10.3% on a partially diluted basis. On December 31, 2021, SOL Global Investments Corp held 77,142 Common Shares and warrants exercisable for an aggregate of 5,714 Common Shares. On March 9, 2022, SOL Global Investments announced that it had reduced their Common Share holdings in KWESST to less than 10% of our total outstanding Common Shares. Immediately prior to the closing of our U.S. IPO and Canadian Offering, SOL Global Investments Corp. held 119,250 Common Shares or 8.7%.

As a result of the U.S. IPO and Canadian Offering, all the above major shareholders now own less than 5% of the outstanding Common Shares.

Since the closing of the U.S. IPO and Canadian Offering, we now have three new institutional shareholders (as noted in the above table) with more than 5% beneficial ownership of the outstanding Common Shares. This major shareholder does not have different voting rights from other shareholders. At January 18, 2023, there were a total of 59 record holders of our Common Shares, of which ten record holders were resident in the United States, holding a total of 2,529,498 Common Shares, based on available information. This number represents approximately 62.1% of our total issued and outstanding Common Shares at that date.

We are a publicly owned company, and our Common Shares are owned by Canadian residents, United States residents, and residents of other countries. To our knowledge, we are not directly owned or controlled by another corporation, any foreign government or any other natural or legal person(s), whether severally or jointly. We are not aware of any arrangement, the operation of which may result in a change of control of us.

Related Party Transactions

To our knowledge, none of our directors or executive officers, nor any of our subsidiaries or insiders, nor any of our shareholders owning more than 10% of our voting shares, and no person with ties to any of the aforementioned, nor any member of the same group, has had or expects to have an interest in any transactions concluded since the beginning of Fiscal 2020 that has had or could have a material impact on us, or in any projected transactions, except as described below.

DEFSEC Purchase Agreement

The entering into the DEFSEC Purchase Agreement by us was considered to be a "related-party transaction" for purposes of Multilateral Instrument 61-101 - Protection of Minority Security Holders in Special Transactions ("MI 61-101") and Policy 5.9 - Protection of Minority Security Holders in Special Transactions of the TSXV. We relied on exemptions from the formal valuation and minority shareholder approval requirements available under MI 61-101. We were exempt from the formal valuation requirement in section 5.4 of MI 61-101 in reliance on sections 5.5(a) and (b) of MI 61-101 as the fair market value of the transaction was not more than the 25% of our market capitalization, and no securities of ours were listed or quoted for trading on prescribed stock exchanges or stock markets. Additionally, we were exempt from minority shareholder approval requirement in section 5.6 of MI 61- 101 in reliance on section 5.7(a) as the fair market value of the transaction was not more than the 25% of our market capitalization. The transaction was reviewed and approved by our independent directors and we obtained approval from over 51% of disinterested shareholders. Further, on February 19, 2021, the TSXV conditionally approved this asset acquisition. We closed the LEC Technology acquisition shortly after closing the April 2021 Private Placement.

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Employment and Consulting Agreements

We have entered into a professional services agreement with DEFSEC to obtain Executive Chairman services from David Luxton and employment agreements with Jeffrey MacLeod and Sean Homuth(see "Compensation - Employment and Consulting Agreements").

Related Party Loans

There were no related party loans in Fiscal 2022; in December 2022 we repaid $74,000 of Unsecured Loans provided by certain directors and officers (Messrs. Luxton, Mangano, Fortin, McCoach, and Archambault). During Fiscal 2021, we repaid all prior related party loans.

Other Related Party Transactions

From January 28, 2021, to June 24, 2022, the CEO and sole shareholder of SageGuild agreed to serve as director for our United States subsidiary, KWESST Defense Systems U.S. Inc, and as a result SageGuild was a related party to KWESST for this period. We previously entered into a consulting agreement with SageGuild in March 2020 to provide business development services in the United States. This consulting agreement, including compensation, was not modified as a result of the above. At the time, SageGuild was not a related party and the terms of this consulting agreement were negotiated at arm's length. From January 1, 2021, to September 30, 2021, the total compensation (cash and share-based) amounted to $339,309.  For the three and nine months ended June 30, 2022 the total compensation was $81,761 and $251,809 respectively.  Effective June 24, 2022, our Executive Chairman replaced SageGuild's CEO as the acting CEO and director for KWESST Defense Systems U.S. Inc. and therefore from this date SageGuild is no longer a related party.

For other immaterial related party transactions, refer to Note 11 of the audited consolidated financial statements for Fiscal 2022.

FINANCIAL INFORMATION

Consolidated Statements and Other Financial Information

Financial Statements

See section titled, Financial Statements.

Our unaudited condensed consolidated interim financial statements as at and for the three and six months ended March 31, 2023, as well as our audited consolidated financial statements as at and for the year ended September 30, 2022, the year ended September 30, 2021 and nine months ended September 30, 2020, as required under this section, are attached hereto and found immediately following the text of this Prospectus. The audit reports of Kreston GTA LLP and KPMG LLP are included therein immediately preceding the financial statements and schedules.

Legal Proceedings

We are not and have not been a party to any legal proceedings and are not aware of any such proceedings known to be contemplated, which could have a material impact to our financial condition and results of operations.

Dividend Policy

We have not, for any of the three most recently completed fiscal years or our current fiscal year, declared or paid any dividends on our Common Shares, and do not currently have a policy with respect to the payment of dividends. For the foreseeable future, we anticipate that we will not pay dividends but will retain future earnings and other cash resources for the operation and development of our business. The payment of dividends in the future will depend on our earnings, if any, our financial condition, and such other factors as our directors consider appropriate.

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Significant Changes

Except as otherwise disclosed in this Prospectus, there have been no significant changes in our financial condition since the most recent unaudited consolidated financial statements for the three and six months ended March 31, 2023.

MARKET FOR OUR COMMON SHARES

Our Common Shares are listed for trading on Nasdaq under the stock symbol "KWE";, listed for trading on the TSXV under the stock symbol "KWE.V";, and listed for trading on the Frankfurt Stock Exchange under the stock symbol of "62U";. Our U.S. IPO Warrants are listed for trading on Nasdaq under the trading symbol "KWESW"; and our Canadian warrants are listed for trading on TSXV under the trading symbol "KWE.WT.U";.

As of June 30, 2023, our authorized capital consisted of an unlimited number of Common Shares and consisted of 4,074,588 Common Shares outstanding, after giving effect to the Reverse Split, and there were approximately 61 record holders of our Common Shares. Our Common Shares are issued in registered form and the transfer of our Common Shares is managed by our transfer agent, TSX Trust Company, 301 - 100 Adelaide St. W., Toronto, ON, M5H 4H1 (Tel: (416) 342-1091).

For additional details regarding our Common Shares see "Share Capital."

PLAN OF DISTRIBUTION

Each Selling Securityholder of the securities and any of their pledgees, assignees and successors-in-interest may, from time to time, sell any or all of their securities covered hereby on Nasdaq or any other stock exchange, market or trading facility on which the securities are traded or in private transactions. These sales may be at fixed or negotiated prices. A Selling Securityholder may use any one or more of the following methods when selling securities:

● ordinary brokerage transactions and transactions in which the broker-dealer solicits purchasers;

● block trades in which the broker-dealer will attempt to sell the securities as agent but may position and resell a portion of the block as principal to facilitate the transaction;

● purchases by a broker-dealer as principal and resale by the broker-dealer for its account;

● an exchange distribution in accordance with the rules of the applicable exchange;

● privately negotiated transactions;

● settlement of short sales;

● in transactions through broker-dealers that agree with the Selling Securityholders to sell a specified number of such securities at a stipulated price per security;

● through the writing or settlement of options or other hedging transactions, whether through an options exchange or otherwise;

● a combination of any such methods of sale; or

● any other method permitted pursuant to applicable law.

The Selling Securityholders may also sell securities under Rule 144 or any other exemption from registration under the Securities Act, if available, rather than under this prospectus.

Broker-dealers engaged by the Selling Securityholders may arrange for other brokers-dealers to participate in sales. Broker-dealers may receive commissions or discounts from the Selling Securityholders (or, if any broker-dealer acts as agent for the purchaser of securities, from the purchaser) in amounts to be negotiated, but, except as set forth in a supplement to this Prospectus, in the case of an agency transaction not in excess of a customary brokerage commission in compliance with FINRA Rule 2121; and in the case of a principal transaction a markup or markdown in compliance with FINRA Rule 2121.

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In connection with the sale of the securities or interests therein, the Selling Securityholders may enter into hedging transactions with broker-dealers or other financial institutions, which may in turn engage in short sales of the securities in the course of hedging the positions they assume. The Selling Securityholders may also sell securities short and deliver these securities to close out their short positions, or loan or pledge the securities to broker-dealers that in turn may sell these securities. The Selling Securityholders may also enter into option or other transactions with broker-dealers or other financial institutions or create one or more derivative securities which require the delivery to such broker-dealer or other financial institution of securities offered by this prospectus, which securities such broker-dealer or other financial institution may resell pursuant to this prospectus (as supplemented or amended to reflect such transaction).

The Selling Securityholders and any broker-dealers or agents that are involved in selling the securities may be deemed to be "underwriters" within the meaning of the Securities Act in connection with such sales. In such event, any commissions received by such broker-dealers or agents and any profit on the resale of the securities purchased by them may be deemed to be underwriting commissions or discounts under the Securities Act. Each Selling Securityholder has informed the Company that it does not have any written or oral agreement or understanding, directly or indirectly, with any person to distribute the securities.

The Company is required to pay certain fees and expenses incurred by the Company incident to the registration of the securities. The Company has agreed to indemnify the Selling Securityholders against certain losses, claims, damages and liabilities, including liabilities under the Securities Act. The Company shall not be responsible for any of the Selling Securityholders' selling costs incurred pursuant to any available method provided hereunder for selling securities.

We agreed to keep this prospectus effective until the earlier of (i) the date on which the securities may be resold by the Selling Securityholders without registration and without regard to any volume or manner-of-sale limitations by reason of Rule 144, without the requirement for the Company to be in compliance with the current public information under Rule 144 under the Securities Act or any other rule of similar effect or (ii) all of the securities have been sold pursuant to this prospectus or Rule 144 under the Securities Act or any other rule of similar effect. The resale securities will be sold only through registered or licensed brokers or dealers if required under applicable state securities laws. In addition, in certain states, the resale securities covered hereby may not be sold unless they have been registered or qualified for sale in the applicable state or an exemption from the registration or qualification requirement is available and is complied with.

Under applicable rules and regulations under the Exchange Act, any person engaged in the distribution of the resale securities may not simultaneously engage in market making activities with respect to the Common Shares for the applicable restricted period, as defined in Regulation M, prior to the commencement of the distribution. In addition, the Selling Securityholders will be subject to applicable provisions of the Exchange Act and the rules and regulations thereunder, including Regulation M, which may limit the timing of purchases and sales of the Common Shares by the Selling Securityholders or any other person. We will make copies of this prospectus available to the Selling Securityholders and have informed them of the need to deliver a copy of this prospectus to each purchaser at or prior to the time of the sale (including by compliance with Rule 172 under the Securities Act).

Lock-Up Agreements

In connection with the Private Placement, we and our executive officers and directors have agreed pursuant to "lock-up" agreements not to, or are subject to other restrictions so that they may not, without the prior written consent of ThinkEquity, directly or indirectly, offer to sell, sell, pledge or otherwise transfer or dispose of any Common Shares (or enter into any transaction or device that is designed to, or could be expected to, result in the transfer or disposition by any person at any time in the future of), enter into any swap or other derivatives transaction that transfers to another, in whole or in part, any of the economic benefits or risks of ownership of our Common Shares, make any demand for or exercise any right or cause to be filed a registration statement, including any amendments thereto, with respect to the registration of any Common Shares or securities convertible into or exercisable or exchangeable for Common Shares or any other of our securities or publicly disclose the intention to do any of the foregoing for a period of 60 days from July 21, 2023. Notwithstanding the foregoing, prior written consent is not required for the following transactions assuming certain criteria are met: securities purchased in open market transactions after the Private Placement; transfers of securities as bona fide gifts, by will or intestacy or to a family member or trust for the benefit of a family member; transfers of securities to a charity or educational institution; certain transfers made by corporations, partnerships, limited liability company or other business entity; transfers to a trustee or beneficiary of a trust, if the lock-up party is a trust; receipt of Common Shares in connection with an employment arrangement or upon vesting or exercise of a security issued under an incentive plan of the Company or transfer of securities to cover tax obligations in connection with cashless vesting or exercise of securities; establishment of a Rule 10b5-1 trading plan; the exercise, exchange or conversion of securities for Common Shares; transfers by operation of law; transfers pursuant to a change in control transaction where an offer is made to all holders of Common Shares.

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SELLING SECURITYHOLDERS

The Common Shares being offered by the Selling Securityholders are those Common Shares previously issued to the Selling Securityholders, and those issuable to the Selling Securityholders, upon exercise of Pre-Funded Warrants or Warrants. For additional information regarding the issuances of the Shares, Pre-Funded Warrants and Warrants, see "Private Placement of Common Shares, Pre-Funded Warrants and Warrants";. We are registering the Common Shares, Warrant Shares and Pre-Funded Warrant Shares in order to permit the Selling Securityholders to offer the Common Shares, Warrant Shares and Pre-Funded Warrant Shares for resale from time to time. Except for the ownership of the Company’s securities, including the Common Shares, Pre-Funded Warrants and Warrants, and except for the Selling Securityholders that are the designees of ThinkEquity, which acted as the representative of the underwriters in our U.S. IPO, the Selling Securityholders have not had any material relationship with us within the past three years.

The table below lists the Selling Securityholders and other information regarding the beneficial ownership of Common Shares by each of the Selling Securityholders. The second column lists the total number of Common Shares beneficially owned by each Selling Securityholder, based on its ownership the Company's securities, including Common Shares sold in the Private Placement, Pre-Funded Warrants, Warrants and securities beneficially owned prior to the Private Placement, as of July 18, 2023, assuming the exercise of the Pre-Funded Warrants, Warrants and warrants beneficially owned prior to the Private Placement held by the Selling Securityholders as of July 18, 2023, without regard to any limitations on exercises. The third column lists the percentage ownership of Common Shares beneficially held, assuming the exercise of the Pre-Funded Warrants, Warrants and warrants beneficially owned prior to the Private Placement held by the Selling Securityholders as of July 18, 2023.

The fourth column lists the Common Shares being offered by this prospectus by the Selling Securityholders.

In accordance with the terms of a registration rights agreement with the Selling Securityholders, this prospectus generally covers the resale of the sum of (i) the number of Common Shares issued to the selling shareholders in the "Private Placement of Common Shares, Pre-Funded Warrants and Warrants" described above and (ii) the maximum number of Warrant Shares and Pre-Funded Warrant Shares, determined as if the outstanding Pre-Funded Warrants and Warrants were exercised in full as of the trading day immediately preceding the date this Registration Statement was initially filed with the SEC, each as of the trading day immediately preceding the applicable date of determination and all subject to adjustment as provided in the Registration Rights Agreement, without regard to any limitations on the exercise of the Pre-Funded Warrants or Warrants. The fifth column assumes the sale of all of the Common Shares offered by the Selling Securityholders pursuant to this Prospectus and the sixth column lists the percentage ownership of Common Shares beneficially held by the Selling Securityholders assuming the sale of all of the Common Shares offered by the Selling Securityholders pursuant to this Prospectus.

Under the terms of the Pre-Funded Warrants and Warrants, a Selling Securityholder may not exercise Pre-Funded Warrants or Warrants to the extent such exercise would cause such Selling Securityholder, together with its affiliates and attribution parties, to beneficially own a number of Common Shares which would exceed 4.99% or 9.99%, as applicable, of the Company’s then outstanding Common Shares following such exercise, excluding for purposes of such determination Warrant Shares issuable upon exercise of such Pre-Funded Warrants or Warrants which have not been exercised. The number of Common Shares in the second and fifth columns and the percentage of Common Shares in the third and sixth columns do not reflect this limitation. The Selling Securityholder may sell all, some or none of their Common Shares, Warrant Shares or Pre-Funded Warrant Shares in this Offering. See "Plan of Distribution.";

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Name of Selling Securityholder	Number of Common Shares Beneficially Owned Prior to This Offering	Percentage of Outstanding Common Shares Beneficially Owned Prior to This Offering	Maximum Number of Common Shares to be Sold Pursuant to this Offering	Number of Common Shares Owned After this Offering	Percentage of Outstanding Common Shares Beneficially Owned After this Offering
Walleye Opportunities Master Fund Ltd.(1)	1,892,305	27.29%	1,327,432	564,873	8.15%
Brio Capital Master Fund Ltd.(2)	515,916	8.79%	265,500	250,416	4.27%
AIGH Capital Management LLC(3)	2,200,371	27.29%	1,106,196	1,194,175	16.22%
The Hewlett Fund LP(4)	1,011,606	16.53%	619,468	392,138	6.41%
Iroquois Capital Management, LLC (5)	411,384	7.04%	353,984	57,400	0.98%
Tiger Trout Capital Puerto Rico LLC(6)	88,494	1.56%	88,494	0	0.00%
Warberg WF XI LP(7)	103,533	1.82%	90,000	13,533	0.24%
Warberg WF X LP(8)	90,000	1.54%	90,000	0	0.00%
Lytton-Kambara Foundation(9)	353,982	6.11%	353,982	0	0.00%
David S Nagelberg 2003 Revocable Trust(10)	44,246	0.78%	44,246	0	0.00%
Robert Forster(11)	46,746	0.83%	44,246	2,500	0.04%
Deane A Gilliam 2017 Irrevocable Family Trust(12)	22,122	0.39%	22,122	0	0.00%
Andrew Smukler(13)	44,246	0.78%	44,246	0	0.00%
Porter Partners LP(14)	88,494	1.56%	88,494	0	0.00%
Maria Molinsky(15)	22,122	0.39%	22,122	0	0.00%
The Joel Yanowitz & Amy Metzenbaum Revocable Living Trust(16)	44,246	0.78%	44,246	0	0.00%
David Dent(17)	30,972	0.55%	30,972	0	0.00%
Joseph Lucosky(18)	88,494	1.56%	88,494	0	0.00%
Lind Global Fund II LP(19)	221,240	3.86%	221,240	0	8.15%
Ramnarain Jaigobind(20)(21)	85,187	1.49%	42,408	42,779	0.75%
Chirag Choudhary(20)(22)	17,584	0.31%	8,407	9,177	0.16%
Eric Lord(20)(23)	38,123	0.67%	19,905	18,218	0.32%
Kevin Mangan(20)(24)	26,255	0.47%	14,466	11,789	0.20%
Nelson Baquet(20)(25)	4,776	0.08%	371	4,405	0.07%
Maria Robles(20)(26)	387	*	185	202	*
Craig Skop(20)(27)	13,317	0.24%	6,367	6,950	0.12%
Jeffrey Singer(20)(28)	776	0.01%	371	405	*
Scott Rothbaum(20)(29)	6,429	0.11%	6,429	0	0.00%
Robert Sagarino(20)(30)	4,137	0.07%	1,978	2,159	0.04%
William Baquet(20)(31)	33,459	0.59%	19,306	14,153	0.25%
Charles Giordano(20)(32)	3,439	0.06%	1,644	1,795	0.03%
Richard Adams(20)(33)	1,700	0.03%	800	900	0.02%
Phyllis Henderson(20)(34)	1,700	0.03%	800	900	0.02%
Kolinda Tomasic(20)(35)	400	*	200	200	*

** Less than 0.01%

⁽¹⁾The number of Common Shares beneficially owned prior to this Offering consists of: (i) 278,000 Common Shares purchased in the Private Placement, (ii) 385,716 Pre-Funded Warrant Shares, (iii) 663,716 Warrant Shares, (iv) 296,754 restricted Common Shares beneficially owned prior to the Private Placement and (v) 268,119 Common Shares underlying warrants beneficially owned prior to the Private Placement. The number of Common Shares beneficially owned does not reflect beneficial ownership limitations contain in any warrants. The address of Walleye Opportunities Master Fund Ltd. is 2800 Niagara Lane North, Plymouth, MN 55447.

⁽²⁾The number of Common Shares beneficially owned prior to this Offering consists of: (i) 132,750 Common Shares purchased in the Private Placement, (ii) 132,750 Warrant Shares, (iii) 130,416 Common Shares beneficially owned prior to the Private Placement and (iv) 120,000 Common Shares underlying warrants beneficially owned prior to the Private Placement. The number of Common Shares beneficially owned does not reflect beneficial ownership limitations contain in any warrants.  Shaye Hirsch directly or indirectly has the power to vote or dispose of the foregoing securities. The address of Brio Capital Master Fund Ltd. is c/o Brio Capital Management LLC, 100 Merrick Road, Suite 401W Rockville Centre, New York, NY 11570.

⁽³⁾The number of Common Shares beneficially owned prior to this Offering consists of: (i) 24,761 Common Shares purchased in the Private Placement by AIGH Investment Partners, LP ("AIGH Partners"), (ii) 393,098 Pre-Funded Warrant Shares beneficially owned by AIGH Partners, (iii) 417,859 Warrant Shares beneficially owned by AIGH Partners, (iv) 247,647 Common Shares beneficially owned by AIGH Partners prior to the Private Placement, (v) 650,647 Common Shares underlying warrants beneficially owned by AIGH Partners prior to the Private Placement, (vi) 106,201 Common Shares purchased in the Private Placement WVP Emerging Manager Onshore Fund LLC - AIGH Series ("WVP - AIGH"), (vii) 106,201 Warrant Shares beneficially owned by WVP - AIGH, (viii) 116,686 Common Shares beneficially owned by WVP - AIGH prior to the Private Placement, (iv) 114,786 Common Shares underlying warrants beneficially owned by WVP - AIGH prior to the Private Placement, (x) 29,038 Common Shares purchased in the Private Placement WVP Emerging Manager Onshore Fund LLC - Optimized Family Series ("WVP - Family Series"), (xi) 29,038 Warrant Shares beneficially owned by WVP - Family Series, (xiii) 31,842 Common Shares beneficially owned by WVP - Family Series prior to the Private Placement and (xiv) 32,567 Common Shares underlying warrants beneficially owned by WVP - Family Series prior to the Private Placement. The number of Common Shares beneficially owned does not reflect beneficial ownership limitations contain in any warrants. Orin Hirschman directly or indirectly has the power to vote or dispose of the foregoing securities. The address of AIGH Capital Management LLC is 6006 Berkeley Avenue, Baltimore MD 21209.

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⁽⁴⁾The number of Common Shares beneficially owned prior to this Offering consists of: (i) 158,000 Common Shares purchased in the Private Placement, (ii) 151,734 Pre-Funded Warrant Shares, (iii) 309,734 Warrant Shares, (iv) 350,000 Common Shares beneficially owned prior to the Private Placement and (v) 42,138 Common Shares underlying warrants beneficially owned prior to the Private Placement. The number of Common Shares beneficially owned does not reflect beneficial ownership limitations contain in any warrants. Martin Chopp directly or indirectly has the power to vote or dispose of the foregoing securities. The address of The Hewlett Fund LP is 100 Merrick Rd., 400W, Rockville Centre, NY 11570.

⁽⁵⁾The number of Common Shares beneficially owned prior to this Offering consists of: (i) 106,195 Common Shares purchased in the Private Placement by Iroquois Capital Investment Group LLC ("Iroquois Capital"), (ii) 106,195 Warrant Shares beneficially owned by Iroquois Capital, (iii) 22,000 Common Shares underlying warrants beneficially owned by Iroquois Capital prior to the Private Placement, (iv) 70,797 Common Shares purchased in the Private Placement by Iroquois Master Fund Ltd. ("Iroquois Master") (v) 70,797 Warrant Shares beneficially owned by Iroquois Master, (vi) 4,100 Common Shares beneficially owned by Iroquois Master and (vii) 31,300 Common Shares underlying warrants beneficially owned by Iroquois Master prior to the Private Placement. The number of Common Shares beneficially owned does not reflect beneficial ownership limitations contain in any warrants.  Richard Abbe directly or indirectly has the power to vote or dispose of the foregoing securities. The address of Iroquois Capital Management, LLC is 2 Over Hill Rd. Suite 400, Scarsdale, NY 10583.

⁽⁶⁾The number of Common Shares beneficially owned prior to this Offering consists of: (i) 44,247 Common Shares purchased in the Private Placement and (ii) 44,247 Warrant Shares. Alan Masley directly or indirectly has the power to vote or dispose of the foregoing securities. The address of Tiger Trout Capital Puerto Rico LLC is 1357 Ashford Ave STE 2-267 San Juan, PR 00907.

⁽⁷⁾The number of Common Shares beneficially owned prior to this Offering consists of: (i) 45,000 Common Shares purchased in the Private Placement, (ii) 45,000 Warrant Shares and (iii) 13,533 Common Shares underlying warrants beneficially owned prior to the Private Placement. Does not include the Common Shares beneficially owned by Warberg WF X LP otherwise reported herein. Jonathan Blumberg and Daniel Warsh directly or indirectly have the power to vote or dispose of the foregoing securities. The address of Warberg WF XI LP is 716 Oak St., Winnette, IL 60093.

⁽⁸⁾The number of Common Shares beneficially owned prior to this Offering consists of: (i) 45,000 Common Shares purchased in the Private Placement, (ii) 45,000 Warrant Shares and (iii) 175,500 Common Shares underlying warrants beneficially owned prior to the Private Placement. Does not include the Common Shares beneficially owned by Warberg WF XI LP otherwise reported herein. Jonathan Blumberg and Daniel Warsh directly or indirectly have the power to vote or dispose of the foregoing securities. The address of Warberg WF X LP is 716 Oak St., Winnette, IL 60093.

⁽⁹⁾The number of Common Shares beneficially owned prior to this Offering consists of: (i) 176,991 Common Shares purchased in the Private Placement and (ii) 176,991 Warrant Shares. The number of Common Shares beneficially owned does not reflect beneficial ownership limitations contain in any warrants.  Laurence Lytton directly or indirectly has the power to vote or dispose of the foregoing securities. The address of Lytton-Kambara Foundation is 467 Central Part West 17-A, New York, NY 10025.

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⁽¹⁰⁾The number of Common Shares beneficially owned prior to this Offering consists of: (i) 22,123 Common Shares purchased in the Private Placement and (ii) 22,123 Warrant Shares. The address of David S Nagelberg 2003 Revocable Trust is 939 Coast Blvd., Unit 21 DE La Jolla, CA 92037.

⁽¹¹⁾The number of Common Shares beneficially owned prior to this Offering consists of: (i) 22,123 Common Shares purchased in the Private Placement, (ii) 22,123 Warrant Shares and (iii) 2,500 Common Shares beneficially owned prior to the Private Placement. The address of Robert Forster is 54 Deeodale Dr., Great Neck, NY 11021.

⁽¹²⁾The number of Common Shares beneficially owned prior to this Offering consists of: (i) 11,061 Common Shares purchased in the Private Placement and (ii) 11,061Warrant Shares. Ari Raskees directly or indirectly has the power to vote or dispose of the foregoing securities. The address of Deane A Gilliam 2017 Irrevocable Family Trust is 805 Wilmot Road, Scarsdale, NY 10583.

⁽¹³⁾The number of Common Shares beneficially owned prior to this Offering consists of: (i) 22,123 Common Shares purchased in the Private Placement and (ii) 22,123 Warrant Shares. The address of Andrew Smukler is 404 Via Placita, Palm Beach Gardens, FL 33418.

⁽¹⁴⁾The number of Common Shares beneficially owned prior to this Offering consists of: (i) 44,247 Common Shares purchased in the Private Placement and (ii) 44,247 Warrant Shares. Jeffrey H. Porter directly or indirectly has the power to vote or dispose of the foregoing securities. The address of Porter Partners LP is 165 North Redwood Drive, Suite 204, San Rafael, CA 94903.

⁽¹⁵⁾The number of Common Shares beneficially owned prior to this Offering consists of: (i) 11,061 Common Shares purchased in the Private Placement and (ii) 11,061 Warrant Shares. The address of Maria Molinsky is 329 Chestnut Hill Road, Norwalk, CT 06851.

⁽¹⁶⁾The number of Common Shares beneficially owned prior to this Offering consists of: (i) 22,123 Common Shares purchased in the Private Placement and (ii) 22,123 Warrant Shares. Joel Yanowitz directly or indirectly has the power to vote or dispose of the foregoing securities.  The address of The Joel Yanowitz & Amy Metzenbaum Revocable Living Trust is 3 Stanton Way, Mill Valley, CA 94941.

⁽¹⁷⁾The number of Common Shares beneficially owned prior to this Offering consists of: (i) 15,486 Common Shares purchased in the Private Placement and (ii) 15,486 Warrant Shares. The address of David Dent is 6712 Arrow Head Pass, Edina, MN 55439.

⁽¹⁸⁾The number of Common Shares beneficially owned prior to this Offering consists of: (i) 44,247 Common Shares purchased in the Private Placement and (ii) 44,247 Warrant Shares. The address of Joseph Lucosky is 12 Utopia Dr., Colts Neck, NJ 07722.

⁽¹⁹⁾The number of Common Shares beneficially owned prior to this Offering consists of: (i) 110,620 Common Shares purchased in the Private Placement and (ii) 110,620 Warrant Shares. The number of Common Shares beneficially owned does not reflect beneficial ownership limitations contain in any warrants. The address of Lind Global Fund II LP is 444 Madison Ave., 41^st Floor, New York, NY 10022.

⁽²⁰⁾The Selling Securityholder is a principal of ThinkEquity LLC. ThinkEquity LLC acted as the placement agent for our July 2023 private placement. See "Private Placement of Common Shares, Pre-Funded Warrants and Warrants"; above. The address of the Selling Securityholder is c/o ThinkEquity LLC, 17 State Street, 41^st Floor, New York, New York 10004.

⁽²¹⁾The number of Common Shares beneficially owned prior to this offering consists of (i) 42,408 Warrant Shares and (ii) 42,779 Common Shares beneficially owned prior to the Private Placement.

⁽²²⁾The number of Common Shares beneficially owned prior to this offering consists of (i) 8,407 Warrant Shares and (ii) 9,177 Common Shares beneficially owned prior to the Private Placement.

⁽²³⁾The number of Common Shares beneficially owned prior to this offering consists of (i) 19,905 Warrant Shares and (ii) 18,218 Common Shares beneficially owned prior to the Private Placement.

⁽²⁴⁾The number of Common Shares beneficially owned prior to this offering consists of (i) 14,466 Warrant Shares and (ii) 11,789 Common Shares beneficially owned prior to the Private Placement.

⁽²⁵⁾The number of Common Shares beneficially owned prior to this offering consists of (i) 371 Warrant Shares and (ii) 4,405 Common Shares beneficially owned prior to the Private Placement.

⁽²⁶⁾The number of Common Shares beneficially owned prior to this offering consists of (i) 185 Warrant Shares and (ii) 202 Common Shares beneficially owned prior to the Private Placement.

⁽²⁷⁾The number of Common Shares beneficially owned prior to this offering consists of (i) 6,367 Warrant Shares and (ii) 6,950 Common Shares beneficially owned prior to the Private Placement.

⁽²⁸⁾The number of Common Shares beneficially owned prior to this offering consists of (i) 371 Warrant Shares and (ii) 405 Common Shares beneficially owned prior to the Private Placement.

⁽²⁹⁾The number of Common Shares beneficially owned prior to this offering consists of 6,429 Warrant Shares.

⁽³⁰⁾The number of Common Shares beneficially owned prior to this offering consists of (i) 1,978 Warrant Shares and (ii) 2,159 Common Shares beneficially owned prior to the Private Placement.

⁽³¹⁾The number of Common Shares beneficially owned prior to this offering consists of (i) 19,306 Warrant Shares and (ii) 14,153 Common Shares beneficially owned prior to the Private Placement.

⁽³²⁾The number of Common Shares beneficially owned prior to this offering consists of (i) 1,644 Warrant Shares and (ii) 1,795 Common Shares beneficially owned prior to the Private Placement.

⁽³³⁾The number of Common Shares beneficially owned prior to this offering consists of (i) 800 Warrant Shares and (ii) 900 Common Shares beneficially owned prior to the Private Placement.

⁽³⁴⁾The number of Common Shares beneficially owned prior to this offering consists of (i) 800 Warrant Shares and (ii) 900 Common Shares beneficially owned prior to the Private Placement.

⁽³⁵⁾The number of Common Shares beneficially owned prior to this offering consists of (i) 200 Warrant Shares and (ii) 200 Common Shares beneficially owned prior to the Private Placement.

DESCRIPTION OF SECURITIES

The Selling Securityholders are offering Common Shares in this Offering.

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Share Capital

Authorized Capital

We are authorized to issue an unlimited number of Common Shares, without par value. As of March 31, 2023, there were 4,073,106 Common Shares outstanding. Refer to Information on the Company - History and Development of the Company, for the equity offerings we have made over the last three financial years.

A reconciliation of the number of Common Shares outstanding at the beginning and end of Q3 Fiscal 2023 can be found in Note 13 of our unaudited condensed consolidated interim financial statements for Q3 Fiscal 2023.

We also have disclosed the rights, preferences and restrictions attached to our Common Shares under, Memorandum and Articles of Association.

Stock Options

As of March 31, 2023, there were options outstanding to purchase a total of 51,338 Common Shares, which have been issued to our directors, officers, employees, and consultants pursuant to the terms and conditions of our LTIP, which is described in detail under Compensation - Equity Compensation Plan. The number of options, expiry date and exercise prices of options granted to our directors and officers are presented in Share Ownership.

Escrowed Securities

Except as otherwise described below, to our knowledge and as of the date of this Prospectus, none of the Common Shares are being held in escrow. The holders of the escrowed Common Shares have voting power over such securities.  Once released by the TSX Trust Company, the holders also have dispositive power over such securities.

Designation of Class	Number of securities held in escrow(11)	Percentage of class(1)
Common Shares(2)	688 (3)	0.02%
Company 2024 Warrants(4)	2,000,000 (5)	0.70%
Common Shares(4)	82,498 (6) (7)	2.03%
Common Shares(8)	7,500 (9)	0.18%
Company 2024 Warrants(8)	525,000 (10)	0.18%

Notes:

(1)Based on the number of outstanding Common Shares as of June 30, 2023.

(2)Common Shares subject to escrow conditions pursuant to a CPC escrow agreement between Foremost and TSX Trust Company under TSXV Policy 2.4 - Capital Pool Companies dated May 2, 2018 (the "CPC Escrow Agreement").

(3)Deposited with TSX Trust Company, acting as escrow agent. These Common Shares will be released from escrow as to:

No. of Securities(11)	% of Escrowed Securities	Release Date
688	15% of the escrowed Common Shares	September 18, 2023
Includes 229 escrowed Common Shares held by a director.

(4)Securities deposited in escrow pursuant to a surplus security escrow agreement between us and TSX Trust Company dated September 17, 2020 as a result of the qualifying transaction following the Amalgamation (the "Surplus Security Escrow Agreement").

(5)Deposited with TSX Trust Company, acting as escrow agent. These Company 2024 Warrants will be released from escrow as to:

No. of Securities(11)	% of Escrowed Securities	Release Date
2,000,000	40% of the escrowed Company 2024 Warrants	September 18, 2023

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Includes 1,200,000 and 400,000 escrowed Warrants, after giving effect to the Reverse Split, to be released to DEFSEC (private company owned by our Executive Chairman), and President & CEO, respectively. Each warrant is exercisable for 1/70 of a Common Share.

(6)Deposited with TSX Trust Company, acting as escrow agent. These Common Shares will be released from escrow as to:

No. of Securities(11)	% of Escrowed Common Shares	Release Date
82,498	40% of the escrowed Common Shares	September 18, 2023

(7)Includes 20,373, 59,715, and 1,838 escrowed Common Shares to be released to DEFSEC, 2573685 Ontario Inc., and Paul Mangano (director), respectively, after giving effect to the Reverse Split.  For greater clarity, these are included in the beneficial ownership table in Directors, Senior Management, and Employees - Share Ownership.

(8)Securities deposited in escrow pursuant to a value security escrow agreement between us and TSX Trust Company dated September 17, 2020 as a result of the qualifying transaction following the Amalgamation (the "Value Security Escrow Agreement").

(9)Deposited with TSX Trust Company, acting as escrow agent. These securities have been or will be released from escrow as to:

No. of Securities(11)	% of Escrowed Securities	Release Date
7,500	15% of the escrowed Common Shares	September 18, 2023

(10)Deposited with TSX Trust Company, acting as escrow agent. These securities have been or will be released from escrow as to:

No. of Securities(11)	% of Escrowed Securities	Release Date
525,000	15% of the escrowed Company 2024 Warrants	September 18, 2023

 (11)Each warrant is exercisable for 1/70 of a Common Share, after giving effect to the Reverse Split. 

ADDITIONAL INFORMATION

Memorandum and Articles of Association

Incorporation

The Company was incorporated on November 28, 2017 pursuant to the provisions of the BCBCA under the name "Foremost Ventures Corp." On September 4, 2020, the Company changed its name to "KWESST Micro Systems Inc."

Our registered and records office address is located at Suite 1510 - 789 West Pender Street, Vancouver, British Columbia, V6C 1H2, Canada. Our head office is located at 155 Terence Matthews Crescent, Unit #1, Ottawa, Ontario, K2M 2A8, Canada.

Objects and Purposes

The Articles of the Company do not contain a limitation on objects and purposes.

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Directors

Article 17 of the Articles deals with a directors' disclosable interest (as defined in the BCBCA) in contracts or transactions into which the Company has entered or proposes to enter. Article 17.2 provides that a director who holds such a disclosable interest is not entitled to vote on any directors' resolution to approve such contract or transaction, unless all the directors have a disclosable interest in that contract or transaction, in which case any or all of those directors may vote on such resolution.

Pursuant to the BCBCA, a director holds a disclosable interest in a contract or transaction if (a) the contract or transaction is material to the Company, (b) the Company has entered, or proposes to enter, into the contract or transaction, and (c) the director has a material interest in the contract or transaction or the director is a director or senior officer of, or has a material interest in, a person who has a material interest in the contract or transaction. Pursuant to the BCBCA, a director does not have a disclosable interest in a number of prescribed situations, including without limitation in respect of a contract or transaction merely because the contract or transaction relates to the remuneration of the director in that person's capacity as a director of the Company.

The directors may act notwithstanding any vacancy in the board of directors, but if the Company has fewer directors in office than the number set pursuant to the Articles as the quorum of directors, the directors may only act for the purpose of appointing directors up to that number or of summoning a meeting of shareholders for the purpose of filling any vacancies on the board of directors or, subject to the BCBCA, for any other purpose. The quorum necessary for the transaction of the business of the directors may be set by the directors and, if not so set, is deemed to be set at two directors or, if the number of directors is set at one, is deemed to be set at one director, and that director may constitute a meeting.

Article 8 of the Articles deals with borrowing powers. The Company, if authorized by the directors, may: (i) borrow money in the manner and amount, on the security, from the sources and on the terms and conditions that they consider appropriate; (ii) issue bonds, debentures and other debt obligations either outright or as security for any liability or obligation of the Company or any other person and at such discounts or premiums and on such other terms as they consider appropriate; (iii) guarantee the repayment of money by any other person or the performance of any obligation of any other person; and (iv) mortgage, charge, whether by way of specific or floating charge, grant a security interest in, or give other security on, the whole or any part of the present and future assets and undertaking of the Company.

Qualifications of Directors

The Articles do not specify a retirement age for directors.

Directors are not required to own any Common Shares of the Company.

Section 124 of the BCBCA provides that an individual is not qualified to become or act as a director of a company if that individual is:

1.under the age of 18 years;

2.found by a court, in Canada or elsewhere, to be incapable of managing the individual's own affairs;

3.an undischarged bankrupt; or

4.convicted in or out of the Province of British Columbia of an offence in connection with the promotion, formation or management of a corporation or unincorporated business, or of an offence involving fraud, unless:

a.the court orders otherwise;

b.5 years have elapsed since the last to occur of:

i.the expiration of the period set for suspension of the passing of sentence without a sentence having been passed;

ii.the imposition of a fine;

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iii.the conclusion of the term of any imprisonment; and

iv.the conclusion of the term of any probation imposed; or

c.a pardon was granted or issued, or a record suspension ordered, under the Criminal Records Act (Canada) and the pardon or record suspension, as the case may be, has not been revoked or ceased to have effect.

A director who ceases to be qualified to act as a director of the Company must promptly resign.

Section 120 of the BCBCA provides that every company must have at least one director, and a public company must have at least three directors.

Rights, Preference and Restrictions

Holders of Common Shares are entitled to receive notice of any meeting of shareholders of the Company, to attend and to cast one vote per share at such meetings. Holders of Common Shares are also entitled to receive on a pro rata basis such dividends, if any, as and when declared by the Board at its discretion from funds legally available therefor and upon the liquidation, dissolution, or winding up of the Company are entitled to receive on a pro rata basis, the net assets of the Company after payment of debts and other liabilities, in each case subject to the rights, privileges, restrictions, and conditions attaching to any other series or class of shares ranking senior in priority. Common Shares do not carry any pre-emptive, subscription, redemption, conversion rights, sinking fund provisions, liability to further capital calls by the Company, or provisions discriminating against any existing or prospective holder of Common Shares as a result of such shareholder owning a substantial number of Common Shares.

The rights of shareholders of the Company may be altered only with the approval of the holders of two thirds or more of the Common Shares voted at a meeting of the Company's shareholders called and held in accordance with the Articles and applicable law.

Shareholder Meetings

The BCBCA provides that: (i) a general meeting of shareholders must be held in the Province of British Columbia, unless otherwise provided in the Company's Articles or as approved by ordinary resolution of shareholders; (ii) the Company must hold an annual general meeting of shareholders not later than 15 months after the last preceding annual general meeting and once in every calendar year; (iii) for the purpose of determining shareholders entitled to receive notice of or vote at a meeting of shareholders, the directors may set a date as the record date for that determination, provided that such date shall not precede by more than 2 months (or, in the case of a general meeting requisitioned by shareholders under the BCBCA, by more than 4 months) or be less than 21 days before the date on which the meeting is to be held; (iv) a quorum for the transaction of business at a meeting of shareholders of the Company is the quorum established by the Articles (Article 11.3 of the Articles provide that the quorum for the transaction of business at a meeting of shareholders is two persons who are, or who represent by proxy, shareholders who, in the aggregate, hold at least 5% of Common Shares entitled to vote at the meeting, are present in person; (v) the holders of not less than 5% of the issued shares entitled to vote at a meeting may requisition the directors to call a meeting of shareholders for the purpose of transacting any business that may be transacted at a general meeting; and (vi) the Court may, on its own motion or on the application of the Company, upon the application of a director or the application of a shareholder entitled to vote at the meeting: (a) order that a meeting of shareholders be called, held and conducted in a manner that the Court considers appropriate; and (b) give directions it considers necessary as to the call, holding and conduct of the meeting.

Limitations on Ownership of Securities

Except as provided in the Investment Canada Act, there are no limitations specific to the rights of non-Canadians to hold or vote the Common Shares under the laws of Canada or the Province of British Columbia or in the Company's constating documents.

Change in Control

There are no provisions in the Company's constating documents or under applicable corporate law that would have the effect of delaying, deferring or preventing a change in the control of the Company, or that would operate with respect to any proposed merger, acquisition or corporate restructuring involving the Company or any of its subsidiaries.

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Ownership Threshold

There are no provisions in the Company's constating documents or under applicable corporate law requiring share ownership to be disclosed. Securities legislation in Canada requires that shareholder ownership (as well as ownership of an interest in, or right or obligation associated with, a related financial instrument of a security of the Company) must be disclosed once a person beneficially owns or has control or direction over, directly or indirectly, securities of a reporting issuer carrying more than 10% of the voting rights attached to all the reporting issuer's outstanding voting securities. This threshold is higher than the 5% threshold under United States securities legislation at which shareholders must report their share ownership.

Changes to Capital

There are no conditions imposed by the Articles governing changes in the capital where such conditions are more significant than is required by the corporate laws of the Province of British Columbia for as long as the Company is a public company. Otherwise, Section 26.3 of the Articles provides that no share or designated security may be sold, transferred or otherwise disposed of without the consent of the directors and the directors are not required to give any reason for refusing to consent to any such sale, transfer or other disposition.

Description of Capital Structure

Our authorized share structure consists of an unlimited number of Common Shares without par value, of which 4,074,588 Common Shares were issued and outstanding as of June 30, 2023, after giving effect to the Reverse Split, and not including the Private Placement. All of the issued Common Shares are fully paid and non-assessable Common Shares in the capital of the Company. The Company does not own any of its Common Shares.

Exchange Controls

Canada has no system of exchange controls. There are no Canadian governmental laws, decrees, or regulations relating to restrictions on the repatriation of capital or earnings of the Company to non-resident investors. There are no laws in Canada or exchange control restrictions affecting the remittance of dividends or other payments made by the Company in the ordinary course to non-resident holders of the Common Shares by virtue of their ownership of such Common Shares, except as discussed below under section Material United States Federal Income Tax Consequences and Material Canadian Federal Income Tax Considerations.

There are no limitations under the laws of Canada or in the organizing documents of the Company on the right of foreigners to hold or vote securities of the Company, except that the Investment Canada Act may require that a "non-Canadian" not acquire "control" of the Company without prior review and approval by the Minister of Innovation, Science and Economic Development , where applicable thresholds are exceeded. The acquisition of one-third or more of the voting shares of the Company would give rise a rebuttable presumption of an acquisition of control, and the acquisition of more than fifty percent of the voting shares of the Company would be deemed to be an acquisition of control. In addition, the Investment Canada Act provides the Canadian government with broad discretionary powers in relation to national security to review and potentially prohibit, condition or require the divestiture of, any investment in the Company by a non-Canadian, including non-control level investments. "Non-Canadian" generally means an individual who is neither a Canadian citizen nor a permanent resident of Canada within the meaning of the Immigration and Refugee Protection Act (Canada) who has been ordinarily resident in Canada for not more than one year after the time at which he or she first became eligible to apply for Canadian citizenship, or a corporation, partnership, trust or joint venture that is ultimately controlled by non-Canadians.

MATERIAL CONTRACTS

We are a party to the following contracts which management currently considers to be material to the Company and our assets and operations.

• DEFSEC Purchase Agreement
• GhostStep Technology Purchase Agreement

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• CPC Escrow Agreement
• Surplus Security Escrow Agreement
• Value Security Escrow Agreement
• GDMS MPSA
• CounterCrisis Technology Subcontractor Agreement between KWESST Micro Systems Inc. and CounterCrisis Technology, dated July 6, 2022
• Professional Services Agreement among KWESST Inc., DEFSEC Corporation and David Luxton, dated October 1, 2019 (the "Luxton Agreement")
• Employment Contract between KWESST Inc. and Jeffrey MacLeod, dated September 1, 2019 (the "MacLeod Agreement")
• Canadian Government Contract
• Amended and Restated Employment Contract between KWESST Inc. and Sean Homuth, dated July 31, 2023 (the "Homuth Agreement")
• Placement Agency Agreement
• Securities Purchase Agreement
• Registration Rights Agreement

The terms and conditions of these material contracts are described below.

DEFSEC Purchase Agreement

See Note 4(b) of the audited consolidated financial statements for Fiscal 2022.

GhostStep Technology Purchase Agreement

See Note 4(b) of the audited consolidated financial statements for Fiscal 2022.

CPC Escrow Agreement

Upon completion of the initial public offering of Foremost on the TSXV on June 15, 2018, the Common Shares for the insiders of Foremost were subject to a three-year escrow period, to be released in in the manner described in Risk Factors - The release of securities currently held in escrow may adversely impact the price of our Common Shares, Warrants and/or other outstanding securities.

Surplus Security Escrow Agreement

Pursuant to the TSXV Policy 5.4, at the closing of the QT certain holders of our Common Shares were subject to a three-year escrow, to be released in in the manner described in Risk Factors - The release of securities currently held in escrow may adversely impact the price of our Common Shares, Warrants and/or other outstanding securities.

In the event we graduate from Tier 2 to Tier 1 on the TSXV, then the escrowed securities will be subject to accelerated releases in accordance with TSXV policy.

Value Security Escrow Agreement

Pursuant to the TSXV Policy 5.4, at closing of the QT certain holders of our Common Shares were subject to a three-year escrow, to be released in in the manner described in Risk Factors - The release of securities currently held in escrow may adversely impact the price of our Common Shares, Warrants and/or other outstanding securities.

In the event we graduate from Tier 2 to Tier 1 on the TSXV, then the escrowed securities will be subject to accelerated releases in accordance with TSXV policy.

GDMS MPSA

On December 1, 2021, we entered into a Master Professional Services Agreement with General Dynamic Mission Systems - Canada.

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See Business Overview - Economic Dependence.

Counter-Crisis Technology Subcontractor Agreement

On July 6, 2022, we entered into a three-year contract with CounterCrisis Technology to co-implement a national Ground Search and Rescue Incident Command System for Public Safety Canada, with the Ontario Provincial Police as technical advisory stakeholder for this project.

See "History and Development of the Company - Events in the Development of the Business Fiscal 2022 Highlights."

Luxton Agreement

See "Employment and Consulting Agreements - David Luxton."

MacLeod Agreement

See "Employment and Consulting Agreements - Jeffrey MacLeod."

Canadian Government Contract

On May 2, 2023, we announced that DND awarded a CAD$136 million dollar five-year defense contract to the JV Group (KWESST, Akkodis (MODIS) Canada and Thales Canada).  KWESSTs workshare under the joint venture agreement is up to 20% which would represent approximately CAD$27.2M (or an average of CAD$5.4M per year) of the contract.  The contract is a professional services agreement whereby KWESST will provide qualified software and sustainment resources engineering (at rates agreed to in the contract) on a task-based (as-and-when requested basis) to develop specialized (Government of Canada owned) software applications for Land (Canadian Army) Command, Control, Communications, Computers Intelligence, Surveillance and Reconnaissance (LC4ISR) systems.. See “Prospectus Summary.”

Homuth Agreement

See "Employment and Consulting Agreements - Sean Homuth."

Placement Agency Agreement

See "Private Placement of Common Shares, Pre-Funded Warrants and Warrants."

Securities Purchase Agreement

See "Private Placement of Common Shares, Pre-Funded Warrants and Warrants."

Registration Rights Agreement

See Private Placement of Common Shares, Pre-Funded Warrants and Warrants.

MATERIAL UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS

In the opinion of Dorsey & Whitney LLP, which is attached as Exhibit 8.1 to the Registration Statement of which this Prospectus forms a part, the following is a summary of the material U.S. federal income tax considerations applicable to a U.S. Holder (as defined below) arising from and relating to the acquisition, ownership and disposition of Common Shares acquired pursuant to this Offering.

This summary is for general information purposes only and does not purport to be a complete analysis or listing of all potential U.S. federal income tax considerations that may apply to a U.S. Holder as a result of the acquisition of Common Shares pursuant to this Offering. In addition, this summary does not take into account the individual facts and circumstances of any particular U.S. Holder that may affect the U.S. federal income tax consequences to such U.S. Holder, including specific tax consequences to a U.S. Holder under an applicable tax treaty. Accordingly, this summary is not intended to be, and should not be construed as, legal or U.S. federal income tax advice with respect to any particular U.S. Holder. This summary does not address the U.S. federal net investment income, U.S. federal alternative minimum, U.S. federal estate and gift, U.S. state and local, and non-U.S. tax consequences to U.S. Holders of the acquisition, ownership, and disposition of Common Shares acquired pursuant to this Offering. In addition, except as specifically set forth below, this summary does not discuss applicable tax reporting requirements. Each U.S. Holder should consult its own tax advisor regarding the U.S. federal, U.S. federal net investment income, U.S. federal alternative minimum, U.S. federal estate and gift, U.S. state and local, and non-U.S. tax consequences relating to the acquisition, ownership and disposition of Common Shares acquired pursuant to this Offering.

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No ruling from the Internal Revenue Service (the "IRS") has been requested, or will be obtained, regarding the U.S. federal income tax considerations applicable to U.S. Holders as discussed in this summary. This summary is not binding on the IRS, and the IRS is not precluded from taking a position that is different from, and contrary to, the positions taken in this summary. In addition, because the authorities on which this summary is based are subject to various interpretations, the IRS and the U.S. courts could disagree with one or more of the positions taken in this summary.

Scope of this Summary

Authorities

This summary is based on the Internal Revenue Code of 1986, as amended (the "Code"), Treasury Regulations (whether final, temporary, or proposed) promulgated under the Code, published rulings of the IRS, published administrative positions of the IRS, the current provisions of the Canada-United States Tax Convention (1980) (the "Convention"), and U.S. court decisions, that are in effect and available, as of the date of this document. Any of the authorities on which this summary is based could be changed in a material and adverse manner at any time, and any such change could be applied retroactively. This summary does not discuss the potential effects, whether adverse or beneficial, of any proposed legislation that, if enacted, could be applied on a retroactive or prospective basis.

U.S. Holder

For purposes of this summary, the term "U.S. Holder" means a beneficial owner of Common Shares acquired pursuant to this Offering that is for U.S. federal income tax purposes:

• a citizen or individual resident of the United States;

• a corporation (or other entity treated as a corporation for U.S. federal income tax purposes) organized under the laws of the United States, any state thereof or the District of Columbia;

• an estate whose income is subject to U.S. federal income taxation regardless of its source; or

• a trust that (1) is subject to the primary supervision of a court within the United States and the control of one or more U.S. persons for all substantial decisions or (2) has a valid election in effect under applicable Treasury Regulations to be treated as a U.S. person.

Transactions Not Addressed

This summary does not address the tax consequences of transactions effected prior or subsequent to, or concurrently with, any purchase of Common Shares pursuant to this Registration Statement (whether or not any such transactions are undertaken in connection with the purchase of Common Shares pursuant to this Registration Statement).

U.S. Holders Subject to Special U.S. Federal Income Tax Rules Not Addressed

This summary does not address the U.S. federal income tax considerations applicable to U.S. Holders that are subject to special provisions under the Code, including U.S. Holders that: (a) are tax-exempt organizations, qualified retirement plans, individual retirement accounts, or other tax-deferred accounts; (b) are financial institutions, underwriters, insurance companies, real estate investment trusts, or regulated investment companies; (c) are brokers or dealers in securities or currencies or U.S. Holders that are traders in securities that elect to apply a mark-to-market accounting method; (d) have a "functional currency" other than the U.S. dollar; (e) own Common Shares as part of a straddle, hedging transaction, conversion transaction, constructive sale, or other integrated transaction; (f) acquired Common Shares in connection with the exercise of employee stock options or otherwise as compensation for services; (g) hold Common Shares other than as a capital asset within the meaning of Section 1221 of the Code (generally, property held for investment purposes); (h) are partnerships and other pass-through entities (and investors in such partnerships and entities); (i) are S corporations (and shareholders thereof); (j) are subject to special tax accounting rules; (k) own, have owned or will own (directly, indirectly, or by attribution) 10% or more of the total combined voting power or value of our outstanding shares; (l) are U.S. expatriates or former long-term residents of the U.S.; (m) hold Common Shares in connection with a trade or business, permanent establishment, or fixed base outside the United States; or (n) are subject to the alternative minimum tax. U.S. Holders that are subject to special provisions under the Code, including U.S. Holders described immediately above, should consult their own tax advisors regarding the U.S. federal, U.S. federal net investment income, U.S. federal alternative minimum, U.S. federal estate and gift, U.S. state and local, and non-U.S. tax consequences relating to the acquisition, ownership and disposition of Common Shares acquired pursuant to this Offering.

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If an entity or arrangement that is classified as a partnership for U.S. federal income tax purposes holds Common Shares, the U.S. federal income tax consequences to such entity or arrangement and the owners of such entity or arrangement generally will depend on the activities of such entity or arrangement and the status of such owners. This summary does not address the tax consequences to any such entity or arrangement or owner. Owners of entities or arrangements that are classified as partnerships for U.S. federal income tax purposes should consult their own tax advisor regarding the U.S. federal income tax consequences arising from and relating to the acquisition, ownership, and disposition of Common Shares acquired pursuant to this Offering.

Passive Foreign Investment Company Rules

If the Company were to constitute a "passive foreign investment company" within the meaning of Section 1297 of the Code (a "PFIC") for any year during a U.S. Holder's holding period, then certain potentially adverse rules would affect the U.S. federal income tax consequences to a U.S. Holder resulting from the acquisition, ownership and disposition of Common Shares.  Based on current business plans and financial expectations, the Company expects that it should not be a PFIC for its current tax year and expects that it should not be a PFIC for the foreseeable future.  No opinion of legal counsel or ruling from the IRS concerning the status of the Company as a PFIC has been obtained or is currently planned to be requested.  PFIC classification is fundamentally factual in nature, generally cannot be determined until the close of the tax year in question, and is determined annually.  The Company's PFIC classification for its current or future tax years may depend on, among other things, the manner in which, and how quickly, the Company utilizes its cash on hand, as well as on changes in the market value of Common Shares. Additionally, the analysis depends, in part, on the application of complex U.S. federal income tax rules, which are subject to differing interpretations. Consequently, there can be no assurance that the Company has never been, is not, and will not become a PFIC for any tax year during which U.S. Holders hold Common Shares.

In addition, in any year in which the Company is classified as a PFIC, a U.S. Holder will be required to file an annual report with the IRS containing such information as Treasury Regulations and/or other IRS guidance may require, which filing obligation would generally commence in the first tax year in which the Company is classified as a PFIC and in which such U.S. Holder holds Common Shares.  In addition to penalties, a failure to satisfy such reporting requirements may result in an extension of the time period during which the IRS can assess a tax.  U.S. Holders should consult their own tax advisors regarding the requirements of filing such information returns under these rules, including the requirement to file an IRS Form 8621 annually.

In general, the Company will be a PFIC if, for a tax year, (a) 75% or more of the gross income of the Company for such tax year is passive income (the "income test") or (b) 50% or more of the value of the Company's assets either produce passive income or are held for the production of passive income (the "asset test"), based on the quarterly average of the fair market value of such assets.  "Gross income" generally includes all sales revenues less the cost of goods sold, plus income from investments and from incidental or outside operations or sources, and "passive income" generally includes, for example, dividends, interest, certain rents and royalties, certain gains from the sale of stock and securities, and certain gains from commodities transactions.  In addition, for purposes of the PFIC income test and asset test described above, if the Company owns, directly or indirectly, 25% or more of the total value of the outstanding shares of another corporation, the Company will be treated as if it (a) held a proportionate share of the assets of such other corporation and (b) received directly a proportionate share of the income of such other corporation.

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Under certain attribution rules, if the Company is a PFIC, U.S. Holders will be deemed to own their proportionate share of any subsidiary of the Company which is also a PFIC (a ''Subsidiary PFIC''), and will be subject to U.S. federal income tax on (i) a distribution on the shares of a Subsidiary PFIC or (ii) a disposition of shares of a Subsidiary PFIC, both as if the holder directly held the shares of such Subsidiary PFIC.

If the Company were a PFIC in any tax year and a U.S. Holder held Common Shares, such holder generally would be subject to special rules under Section 1291 of the Code with respect to "excess distributions" made by the Company on the Common Shares and with respect to gain from the disposition of Common Shares.  An "excess distribution" generally is defined as the excess of distributions with respect to the Common Shares received by a U.S Holder in any tax year over 125% of the average annual distributions such U.S. Holder has received from the Company during the shorter of the three preceding tax years, or such U.S. Holder's holding period for the Common Shares.  Generally, a U.S. Holder would be required to allocate any excess distribution or gain from the disposition of the Common Shares ratably over its holding period for the Common Shares.  Such amounts allocated to the year of the disposition or excess distribution would be taxed as ordinary income, and amounts allocated to prior tax years would be taxed as ordinary income at the highest tax rate in effect for each such year and an interest charge at a rate applicable to underpayments of tax would apply.

While there are U.S. federal income tax elections that sometimes can be made to mitigate these adverse tax consequences (including, without limitation, the "QEF Election" under Section 1295 of the Code and the "Mark-to-Market Election" under Section 1296 of the Code), such elections are available in limited circumstances and must be made in a timely manner.

U.S. Holders should be aware that, for each tax year, if any, that the Company is a PFIC, the Company can provide no assurances that it will satisfy the record keeping requirements of a PFIC, or that it will make available to U.S. Holders the information such U.S. Holders require to make a QEF Election with respect to the Company or any Subsidiary PFIC. Accordingly, U.S. Holders may not be able to make a QEF Election with respect to their Common Shares Shares. Each U.S. Holder should consult its own tax advisors regarding the availability of, and procedure for making, a QEF Election.

Certain additional adverse rules may apply with respect to a U.S. Holder if the Company is a PFIC, regardless of whether the U.S. Holder makes a QEF Election. These rules include special rules that apply to the amount of foreign tax credit that a U.S. Holder may claim on a distribution from a PFIC. Subject to these special rules, foreign taxes paid with respect to any distribution in respect of stock in a PFIC are generally eligible for the foreign tax credit. U.S. Holders should consult with their own tax advisors regarding the potential application of the PFIC rules to the ownership and disposition of Common Shares and the availability of certain U.S. tax elections under the PFIC rules.

General Rules Applicable to the Acquisition, Ownership, and Disposition of Common Shares

The following discussion describes the general rules applicable to the ownership and disposition of the Common Shares, but is subject in its entirety to the special rules described above under the heading Passive Foreign Investment Company Rules.

Distributions on Common Shares

A U.S. Holder that receives a distribution, including a constructive distribution, with respect to a Common Share will be required to include the amount of such distribution in gross income as a dividend (without reduction for any Canadian income tax withheld from such distribution) to the extent of the Company's current and accumulated "earnings and profits", as computed under U.S. federal income tax principles. A dividend generally will be taxed to a U.S. Holder at ordinary income tax rates if we are a PFIC for the tax year of such distribution or the preceding tax year. To the extent that a distribution exceeds our current and accumulated "earnings and profits", such distribution will be treated first as a tax-free return of capital to the extent of a U.S. Holder's tax basis in the Common Shares and thereafter as gain from the sale or exchange of such Common Shares (see "Sale or Other Taxable Disposition of Common Shares" below). However, the Company may not maintain the calculations of earnings and profits in accordance with U.S. federal income tax principles, and each U.S. Holder may be required to assume that any distribution by the Company with respect to the Common Shares will constitute ordinary dividend income. Dividends received on Common Shares generally will not be eligible for the "dividends received deduction" generally applicable to corporations.  Subject to applicable limitations and provided the Company is eligible for the benefits of the  Convention or the Common Shares are readily tradable on a United States securities market, dividends paid by us to non-corporate U.S. Holders, including individuals, generally will be eligible for the preferential tax rates applicable to long-term capital gains for dividends, provided certain holding period and other conditions are satisfied, including that we not be classified as a PFIC in the tax year of distribution or in the preceding tax year. The dividend rules are complex, and each U.S. Holder should consult its own tax advisor regarding the application of such rules.

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Sale or Other Taxable Disposition of Common Shares

Upon the sale or other taxable disposition of Common Shares, a U.S. Holder generally will recognize capital gain or loss in an amount equal to the difference between (a) the amount of cash plus the fair market value of any property received and (b) such U.S. Holder's tax basis in such Common Shares sold or otherwise disposed of. Gain or loss recognized on such sale or other taxable disposition generally will be long-term capital gain or loss if, at the time of the sale or other taxable disposition, the Common Shares have been held for more than one year.  Preferential tax rates may apply to long-term capital gain of a U.S. Holder that is an individual, estate, or trust. There are no preferential tax rates for long-term capital gain of a U.S. Holder that is a corporation. Deductions for capital losses are subject to significant limitations under the Code.

Additional Tax Considerations

Receipt of Foreign Currency

The amount of any distribution paid to a U.S. Holder in foreign currency or on the sale, exchange or other taxable disposition of Common Shares generally will be equal to the U.S. dollar value of such foreign currency based on the exchange rate applicable on the date of receipt (regardless of whether such foreign currency is converted into U.S. dollars at that time).  If the foreign currency received is not converted into U.S. dollars on the date of receipt, a U.S. Holder will have a tax basis in the foreign currency equal to its U.S. dollar value on the date of receipt. Any U.S. Holder who receives payment in foreign currency and engages in a subsequent conversion or other disposition of the foreign currency may have a foreign currency exchange gain or loss that would be treated as ordinary income or loss, and generally will be U.S. source income or loss for foreign tax credit purposes. Different rules apply to U.S. Holders who use the accrual method of tax accounting. Each U.S. Holder should consult its own U.S. tax advisor regarding the U.S. federal income tax consequences of receiving, owning, and disposing of foreign currency.

Foreign Tax Credit

Dividends paid on the Common Shares will be treated as foreign-source income, and generally will be treated as "passive category income" or "general category income" for U.S. foreign tax credit purposes. Any gain or loss recognized on a sale or other disposition of Common Shares generally will be United States source gain or loss. Certain U.S. Holders that are eligible for the benefits of the Convention may elect to treat such gain or loss as Canadian source gain or loss for U.S. foreign tax credit purposes. The Code applies various complex limitations on the amount of foreign taxes that may be claimed as a credit by U.S. taxpayers. In addition, Treasury Regulations that apply to foreign taxes paid or accrued (the "Foreign Tax Credit Regulations") impose additional requirements for Canadian withholding taxes to be eligible for a foreign tax credit, and there can be no assurance that those requirements will be satisfied. The Treasury Department has recently released guidance temporarily pausing the application of certain of the Foreign Tax Credit Regulations.

Subject to the PFIC rules and the Foreign Tax Credit Regulations, each as discussed above, a U.S. Holder that pays (whether directly or through withholding) Canadian income tax with respect to dividends paid on the Common Shares generally will be entitled, at the election of such U.S. Holder, to receive either a deduction or a credit for such Canadian income tax paid.  Generally, a credit will reduce a U.S. Holder's U.S. federal income tax liability on a dollar-for-dollar basis, whereas a deduction will reduce a U.S. Holder's income subject to U.S. federal income tax.  This election is made on a year-by-year basis and applies to all foreign taxes paid or accrued (whether directly or through withholding) by a U.S. Holder during a year.  The foreign tax credit rules are complex and involve the application of rules that depend on a U.S. Holder's particular circumstances.  Accordingly, each U.S. Holder should consult its own tax advisor regarding the foreign tax credit rules.

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Information Reporting; Backup Withholding Tax

Under U.S. federal income tax laws certain categories of U.S. Holders must file information returns with respect to their investment in, or involvement in, a foreign corporation. For example, U.S. return disclosure obligations (and related penalties) are imposed on U.S. Holders that hold certain specified foreign financial assets in excess of certain threshold amounts. The definition of specified foreign financial assets includes not only financial accounts maintained in foreign financial institutions, but also, unless held in accounts maintained by a financial institution, any stock or security issued by a non-U.S. person. U. S. Holders may be subject to these reporting requirements unless their Common Shares are held in an account at certain financial institutions. Penalties for failure to file certain of these information returns are substantial.  U.S. Holders should consult their own tax advisors regarding the requirements of filing information returns, including the requirement to file IRS Form 8938.

Payments made within the U.S., or by a U.S. payor or U.S. middleman, of dividends on, and proceeds arising from the sale or other taxable disposition of the Common Shares generally may be subject to information reporting and backup withholding tax, currently at the rate of 24%, if a U.S. Holder (a) fails to furnish its correct U.S. taxpayer identification number (generally on IRS Form W-9), (b) furnishes an incorrect U.S. taxpayer identification number, (c) is notified by the IRS that such U.S. Holder has previously failed to properly report items subject to backup withholding tax, or (d) fails to certify, under penalty of perjury, that it has furnished its correct U.S. taxpayer identification number and that the IRS has not notified such U.S. Holder that it is subject to backup withholding tax. However, certain exempt persons, such as U.S. Holders that are corporations, generally are excluded from these information reporting and backup withholding tax rules. Any amounts withheld under the U.S. backup withholding tax rules will be allowed as a credit against a U.S. Holder's U.S. federal income tax liability, if any, or will be refunded, if such U.S. Holder furnishes required information to the IRS in a timely manner.

The discussion of reporting requirements set forth above is not intended to constitute a complete description of all reporting requirements that may apply to a U.S. Holder. A failure to satisfy certain reporting requirements may result in an extension of the time period during which the IRS can assess a tax and, under certain circumstances, such an extension may apply to assessments of amounts unrelated to any unsatisfied reporting requirement. Each U.S. Holder should consult its own tax advisors regarding the information reporting and backup withholding rules.

THE ABOVE SUMMARY IS NOT INTENDED TO CONSTITUTE A COMPLETE ANALYSIS OF ALL TAX CONSIDERATIONS APPLICABLE TO U.S. HOLDERS WITH RESPECT TO THE ACQUISITION, OWNERSHIP, AND DISPOSITION OF COMMON SHARES. U.S. HOLDERS SHOULD CONSULT THEIR OWN TAX ADVISORS AS TO THE TAX CONSIDERATIONS APPLICABLE TO THEM IN LIGHT OF THEIR OWN PARTICULAR CIRCUMSTANCES.

MATERIAL CANADIAN FEDERAL INCOME TAX CONSIDERATIONS

The following is a general summary, as of the date hereof, of the principal Canadian federal income tax considerations generally applicable to the holding and disposition of Common Shares, Warrant Shares and Pre-Funded Warrant Shares (each a "Security";), as the case may be, acquired pursuant to this offering by a holder who, at all relevant times, (a) for the purposes of the Income Tax Act (Canada) (the "Tax Act";), (i) is not resident, or deemed to be resident, in Canada, (ii) deals at arm’s length with, and is not affiliated with, the Company, (iii) beneficially owns the Securities as capital property, (iv) does not use or hold the Securities in the course of carrying on, or otherwise in connection with, a business or a part of a business carried on or deemed to be carried on in Canada, and (v) is not a "registered non-resident insurer"; or "authorized foreign bank"; within the meaning of the Tax Act, or other holder of special status, and (b) for the purposes of the Canada-United States Income Tax Convention (1980), as amended (the "Convention";), is a resident of the U.S. and is a qualifying person or otherwise qualifies for the full benefits of the Convention. Securities will generally be considered to be capital property to a holder unless such Securities are held in the course of carrying on a business of buying or selling securities or an adventure or concern in the nature of trade. Holders who meet all the criteria in clauses (a) and (b) are referred to herein as a "U.S. Holder"; or "U.S. Holders.";

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This summary does not deal with special situations, such as the particular circumstances of traders or dealers or holders who have entered or will enter into a "derivative forward agreement"; or "synthetic disposition arrangement"; (in each case, as defined in the Tax Act) in respect of any of the Securities. Such holders and other holders who do not meet the criteria in clauses (a) and (b) should consult their own tax advisors.

This summary is based upon the current provisions of the Tax Act and the regulations thereunder (the "Regulations") and counsel's understanding of the current administrative policies and assessing practices of the Canada Revenue Agency (the "CRA") made publicly available prior to the date hereof. It also takes into account all proposed amendments to the Tax Act and the Regulations publicly released by the Minister of Finance (Canada) (the "Tax Proposals") prior to the date hereof, and assumes that all such Tax Proposals will be enacted as currently proposed. No assurance can be given that the Tax Proposals will be enacted in the form proposed or at all. This summary does not otherwise take into account or anticipate any changes in law, whether by way of legislative, judicial or administrative action or interpretation, nor does it take into account tax laws of any province or territory of Canada or of any other jurisdiction outside Canada.

This summary is of a general nature only and is not intended to be, nor should it be construed to be, legal or tax advice to any particular U.S. Holder and no representation with respect to the federal income tax consequences to any particular U.S. Holder or prospective U.S. Holder is made. The tax consequences to a U.S. Holder will depend on the holder's particular circumstances. Accordingly, U.S. Holders should consult with their own tax advisors for advice with respect to their own particular circumstances.

Currency Conversion

In general, for purposes of the Tax Act, all amounts relating to the acquisition, holding or disposition of the Securities must be converted into Canadian dollars based on the applicable exchange rate quoted by the Bank of Canada for the relevant day or such other rate of exchange that is acceptable to the CRA.

Dividends

Amounts paid or credited or deemed to be paid or credited as, on account or in lieu of payment, or in satisfaction of, dividends on the Securities to a U.S. Holder will be subject to Canadian withholding tax. Under the Convention, the rate of Canadian withholding tax on dividends paid or credited by the Company to a U.S. Holder that beneficially owns such dividends is generally 15% unless the beneficial owner is a company that owns at least 10% of the Company's voting stock at that time, in which case the rate of Canadian withholding tax is reduced to 5%.

Dispositions

Upon the disposition of a Security, a U.S. Holder will realize a capital gain in the taxation year of the disposition equal to the amount by which the U.S. Holder's proceeds of disposition, net of any reasonable costs of disposition, exceed the adjusted cost base to the U.S. Holder of the Security immediately before the disposition or deemed disposition.

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A U.S. Holder will not be subject to tax under the Tax Act in respect of any capital gain realized by such U.S. Holder on a disposition of a Security, unless such Security constitute "taxable Canadian property" (as defined in the Tax Act) of the U.S. Holder at the time of disposition and the U.S. Holder is not entitled to relief under the Convention.

Provided that the Security disposed of is listed on a designated stock exchange for purposes of the Tax Act (which currently includes the Nasdaq) at the time of the disposition, such Security will generally not constitute taxable Canadian property of a U.S. Holder, unless: (a) at any time during the 60-month period immediately preceding the disposition or deemed disposition of the Security (as applicable): (i) 25% or more of the issued shares of any class or series of the share capital of the Company were owned by, or belonged to, one or any combination of (x) the U.S. Holder, (y) persons with whom the U.S. Holder did not deal at arm's length (within the meaning of the Tax Act) and (z) partnerships in which the U.S. Holder or a person referred to in (y) holds a membership interest directly or indirectly through one or more partnerships; and (ii) more than 50% of the fair market value of the Security was derived directly or indirectly from one or any combination of: (A) real or immovable property situated in Canada, (B) Canadian resource property (as defined in the Tax Act), (C) timber resource property (as defined in the Tax Act), and (D) options in respect of, or interests in, or for civil law rights in, property described in any of (A) through (C) above, whether or not such property exists; or (b) the Security (as applicable) is deemed under the Tax Act to be taxable Canadian property.

If a Security is taxable Canadian property to a U.S. Holder, any capital gain realized on the disposition or deemed disposition of such Security may not be subject to Canadian federal income tax pursuant to the terms of the Convention.

U.S. Holders whose Securities may be taxable Canadian property should consult their own tax advisors for advice having regard to their particular circumstances.

LEGAL MATTERS

Dorsey & Whitney LLP, Toronto, Ontario, is acting as counsel to our Company regarding U.S. securities law and tax matters. Fasken Martineau DuMoulin LLP, Montréal, Québec, is acting as counsel to our Company regarding Canadian securities law matters and has provided an opinion on the validity of the securities being offered pursuant to this Prospectus.

EXPERTS

KPMG LLP, our current independent accountant, has consented to the inclusion of its reports with respect to KWESST Micro Systems Inc.'s consolidated financial statements as at and for the year ended September 30, 2022 and the year ended September 30, 2021, in this Prospectus, in the form and context in which they are included, and has authorized the contents of that part of the Registration Statement. The audit reports covering the September 30, 2021 and 2022, consolidated financial statements contains an explanatory paragraph that states that the Company's significant losses and negative operating cash flows raise substantial doubt about the entity's ability to continue as a going concern. The consolidated financial statements do not include any adjustments that might result from the outcome of that uncertainty. Further information regarding KPMG LLP is provided under the subheading titled Auditors.

Kreston GTA LLP, our previous independent accountant, has consented to the inclusion of its report with respect to KWESST Micro Systems Inc.'s consolidated financial statements as at and for nine months ended September 30, 2020, in this Prospectus, in the form and context in which they are included, and has authorized the contents of that part of the Registration Statement. Further information regarding Kreston GTA LLP is provided under the subheading titled Auditors.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to a number of financial risks arising through the normal course of business, including interest rate risk, foreign currency risk, credit risk, and liquidity risk. Refer to Note 20 of our audited consolidated financial statements for Fiscal 2022, Note 22 of our audited consolidated financial statements for Fiscal 2021 (for the year ended September 30, 2021) and Note 20 of our audited consolidated financial statements for Fiscal 2020 (for nine months ended September 30, 2020, and the year ended December 31, 2019).  There were no material changes in these risks for the three and six months ended March 31, 2023.

125

FINANCIAL STATEMENTS

Our consolidated financial statements are stated in Canadian dollars and are prepared in accordance with IFRS, as issued by the IASB. The following financial statements are attached hereto and found immediately following the text of this Prospectus.

• Unaudited condensed consolidated interim financial statements as at and for the three and six months ended March 31, 2023.
• Audited consolidated statements of financial position of KWESST Micro Systems Inc. as at September 30, 2022, 2021 and 2020, and the consolidated statements of net loss and comprehensive loss, consolidated statements of changes in shareholder's equity and cash flows for the periods then ended, and notes to the consolidated financial statements, including a summary of significant accounting policies.
• Report of KPMG LLP, Independent Registered Public Accounting Firm, on the consolidated statements of financial position of KWESST Micro Systems Inc. as of September 30, 2022 and September 30, 2021 and the related consolidated statements of loss and comprehensive loss, changes in shareholders' equity, and cash flows for the year ended September 30, 2022 and September 30, 2021, and the related notes the preceding financial statements, dated November 24, 2021.
• Report of Kreston GTA LLP, Independent Registered Public Accounting Firm, on consolidated statements of financial position of KWESST Micro Systems Inc. as of September 30, 2020 and the related consolidated statements of loss and comprehensive loss, changes in shareholders' equity, and cash flows for the nine month ended September 30, 2020, and the related notes the preceding financial statements, dated November 22, 2021.

CHANGE IN COMPANY'S CERTIFYING ACCOUNTANT

Shortly after going public in Canada in September 2020, the newly formed Audit Committee undertook a review of external audit services, including a tender for the Company's annual audit and interim quarterly reviews.  Following this tender review, our Audit Committee selected KPMG LLP as the Company's independent auditors and approved by our Board, subject to shareholder's approval at the March 31, 2021, Annual and Special Meeting of Shareholders.  Our shareholders approved the appointment of KPMG LLP on March 31, 2021 as well as their reappointment at the March 31, 2022 Annual and Special Meeting of Shareholders.

Accordingly, Kreston GTA LLP ("Kreston") was not proposed for reappointment and resigned, effective on March 31, 2021.

The audit report of Kreston did not contain any adverse opinion or disclaimer of opinion and did not express any reservation or modified opinion in its reports for the two (2) most recently completed fiscal years of the Corporation, nor for the period from the most recently completed period for which Kreston issued an audit report in respect of the Corporation and the date of this Notice.  Further, for the two (2) most recent fiscal years and any subsequent interim period preceding their resignation: there were no disagreements with Kreston on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure.

Additionally, for the two (2) most recent fiscal years and any subsequent interim period preceding their resignation:

• Kreston has not advised us that the internal controls necessary for us to develop reliable financial statements do not exist;

• Kreston has not advised us that information has to come to Kreston's attention that has led it to no longer be able to rely on management's representations, or that has made it unwilling to be associated with the financial statements prepared by management;

• Kreston has not advised us of the need to expand significantly the scope of its audit, nor that information has come to their attention during our two most recent fiscal years and any subsequent interim period preceding Kreston's resignation, that if further investigated may: (i) materially impact the fairness or reliability of either: a previously issued audit report or the underlying financial statements; or the financial statements issued or to be issued covering the fiscal period(s) subsequent to the date of the most recent financial statements covered by an audit report (including information that may prevent it from rendering an unqualified audit report on those financial statements); or (ii) cause it to be unwilling to rely on management's representations or be associated with our financial statements; and due to Kreston's resignation, or for any other reason, Kreston did not so expand the scope of its audit or conduct such further investigation; or

126

• Kreston has not advised us that information has come to their attention that it has concluded materially impacts the fairness or reliability of either (i) a previously issued audit report or the underlying financial statements, or (ii) the financial statements issued or to be issued covering the fiscal period(s) subsequent to the date of the most recent financial statements covered by an audit report (including information that, unless resolved to Kreston's satisfaction, would prevent it from rendering an unqualified audit report on those financial statements); and due to Kreston's resignation, or for any other reason, the issue has not been resolved to their satisfaction prior to its resignation.

KPMG LLP accepted the appointment effective April 6, 2021. Additionally, during the preparation of our consolidated financial statements for the fiscal year ended September 30, 2020, we sought advice from KPMG LLP between December 3, 2020, and January 14, 2021, on the application of the relevant IFRS standard for the acquisition of GhostStep® technology and the reverse acquisition relating to our Amalgamation with Foremost. However, KPMG LLP's role was limited to assisting management in interpreting the accounting guidance under IFRS 3, Business Combination and IFRS 2, Share-based Payment.  KPMG LLP did not provide an accounting opinion on these transactions; management was ultimately responsible for the accounting analysis and conclusion which was audited by its independent auditors then, Kreston.  Further, there was no matter that was either the subject of a disagreement or a reportable event in which we consulted with KPMG LLP.

INTERESTS OF EXPERTS AND COUNSEL

None of the named experts or legal counsel was employed on a contingent basis, owns an amount of shares in our Company which is material to that person, or has a material, direct or indirect economic interest in our Company or that depends on the success of the Offering.

DISCLOSURE OF COMMISSION POSITION ON INDEMNIFICATION FOR SECURITIES ACT LIABILITIES

Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers or persons controlling the registrant pursuant to the foregoing provisions, the registrant has been informed that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act and is therefore unenforceable.

WHERE YOU CAN FIND MORE INFORMATION

This Prospectus and the related exhibits are available for viewing at the offices of KWESST Micro Systems Inc., 155 Terence Matthews Crescent, Unit #1, Ottawa, Ontario, Canada, K2M 2A8, telephone: (613) 241-1849.

Additional information relating to us may be found in our reports filed with, and other information furnished to, the SEC which is available from the SEC's Electronic Data Gathering and Retrieval System (EDGAR) at www.sec.gov. These reports and other information may be inspected without charge at the locations described below. As a foreign private issuer, we are exempt from the rules under the Exchange Act related to the furnishing and content of proxy statements, and our officers, directors and principal shareholders are exempt from the reporting and short-swing profit recovery provisions contained in Section 16 of the Exchange Act. In addition, we are not required under the Exchange Act to file annual, quarterly and current reports and financial statements with the SEC as frequently or as promptly as United States companies who are not foreign private issuers under the Exchange Act. However, we will file with the SEC, within 120 days after the end of each fiscal year, or such applicable time as required by the SEC, an annual report on Form 20-F containing financial statements audited by an independent registered public accounting firm, and will furnish to the SEC, under cover of a current report on Form 6-K, unaudited quarterly financial information.

127

We have filed with the SEC a registration statement on Form F-1 under the Securities Act with respect to the securities offered hereby. This Prospectus does not contain all of the information set forth in the registration statement and the exhibits thereto, to which reference is hereby made. With respect to each contract, agreement or other document filed as an exhibit to the registration statement, reference is made to such exhibit for a more complete description of the matter involved. The registration statement and the exhibits thereto filed by us with the SEC may be inspected at the public reference facility of the SEC listed above.

128

INDEX TO FINANCIAL STATEMENTS

Condensed Consolidated Interim Financial Statements for the Three and Six Months Ended March 31, 2023 and 2022
Consolidated Statements of Financial Position	F-3
Consolidated Statements of Net Loss and Comprehensive Loss	F-4
Consolidated Statements of Changes in Shareholders' Equity	F-5
Consolidated Statements of Cash Flows	F-6
Notes to the Consolidated Financial Statements	F-7-F-24

Consolidated Financial Statements for the Year Ended September 30, 2022, the Year Ended September 30, 2021 and the Nine Months Ended September 30, 2020
Independent Auditors' Reports	F-27
Consolidated Statements of Financial Position	F-28
Consolidated Statements of Net Loss and Comprehensive Loss	F-29
Consolidated Statements of Changes in Shareholders' Equity	F-30
Consolidated Statements of Cash Flows	F-31
Notes to the Consolidated Financial Statements	F-32-F-74

129

Condensed Consolidated Interim Financial Statements of

KWESST MICRO SYSTEMS INC.

Three and six months ended March 31, 2023, and 2022

(Unaudited - Expressed in Canadian dollars)

KWESST MICRO SYSTEMS INC.

Table of contents for the three and six months ended March 31, 2023, and 2022

	Page
FINANCIAL STATEMENTS
Condensed Consolidated Interim Statements of Financial Position	F-3
Condensed Consolidated Interim Statements of Net Loss and Comprehensive Loss	F-4
Condensed Consolidated Interim Statements of Changes in Shareholders' Equity (Deficit)	F-5
Condensed Consolidated Interim Statements of Cash Flows	F-6
Notes to the Condensed Consolidated Interim Financial Statements	F-7-F-24

KWESST MICRO SYSTEMS INC.

Condensed Consolidated Interim Statements of Financial Position

At March 31, 2023 and September 30, 2022

(Unaudited)

In Canadian dollars	Notes		March 31, 2023			September 30, 2022
ASSETS
Cash and cash equivalents		$	3,983,691		$	170,545
Restricted short-term investment			30,000			30,000
Trade and other receivables	5		212,520			171,882
Inventories	6		872,520			393,538
Prepaid expenses and other			1,507,668			122,166
Deferred share offering costs			-			628,262
Current assets			6,606,399			1,516,393
Property and equipment			816,116			832,481
Right-of-use assets			179,089			208,131
Deposit			42,869			23,604
Intangible assets	7		5,192,014			4,742,854
Non-current assets			6,230,088			5,807,070
Total Assets		$	12,836,487		$	7,323,463
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Accounts payable and accrued liabilities	8 and 9	$	1,499,653		$	4,459,481
Accrued royalties liability			-			150,000
Lease obligations			72,681			69,150
Borrowings	10		-			2,199,978
Contract liabilities	11		267,272			47,271
Warrant liabilities	12 and 13(b)		2,591,996			-
Current liabilities			4,431,602			6,925,880
Accrued royalties liability			1,203,112			1,115,207
Lease obligations			169,226			206,471
Borrowings	10		-			78,796
Non-current liabilities			1,372,338			1,400,474
Total Liabilities			5,803,940			8,326,354
Shareholders' Equity (Deficit)
Share capital	13(a)		30,943,174			19,496,640
Warrants	13(b)		2,089,388			1,959,796
Contributed surplus	13(c)		3,424,644			3,551,330
Accumulated other comprehensive loss			(79,994	)		(101,418	)
Accumulated deficit			(29,344,665	)		(25,909,239	)
Total Shareholders' Equity (Deficit)			7,032,547			(1,002,891	)
Total Liabilities and Shareholders' Equity (Deficit)		$	12,836,487		$	7,323,463

See Note 2(a) Going concern and Note 19 Commitments and contingencies.

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

On behalf of the Board of Directors:

(signed) John McCoach, Director (signed) David Luxton, Director

F-3

KWESST MICRO SYSTEMS INC.

Condensed Consolidated Interim Statements of Net Loss and Comprehensive Loss

Three and six months ended March 31, 2023 and 2022

(Unaudited)

In Canadian dollars	Notes		Three Months Ended March 31, 2023			Three Months Ended March 31, 2022			Six Months Ended March 31, 2023			Six Months Ended March 31, 2022
Revenue	15	$	161,403		$	166,251		$	478,736		$	183,716
Cost of sales			(128,634	)		(142,012	)		(268,218	)		(167,491	)
Gross profit			32,769			24,239			210,518			16,225
Operating expenses
General and administrative			1,665,971			1,033,017			2,644,458			2,088,157
Selling and marketing			1,152,916			733,364			1,607,103			2,079,755
Research and development, net			306,680			465,344			569,509			1,259,756
Total operating expenses			3,125,567			2,231,725			4,821,070			5,427,668
Operating loss			(3,092,798	)		(2,207,486	)		(4,610,552	)		(5,411,443	)
Other income (expenses)
Share issuance recovery (costs)			57,548			-			(1,309,545	)		-
Net finance costs	16		(11,107	)		(72,479	)		(554,684	)		(120,121	)
Foreign exchange loss			(19,684	)		(9,044	)		(150,040	)		(299	)
Loss on disposals			-			(1,165	)		-			(1,165	)
Change in fair value of warrant liabilities	12		1,838,972			-			3,189,395			-
Total other income (expenses), net			1,865,729			(82,688	)		1,175,126			(121,585	)
Net loss		$	(1,227,069	)	$	(2,290,174	)	$	(3,435,426	)	$	(5,533,028	)
Other comprehensive income:
Items that are or may be reclassified subsequently to profit or loss:
Foreign currency translation differences			3,442			11,653			21,424			15,039
Total comprehensive loss		$	(1,223,627	)	$	(2,278,521	)	$	(3,414,002	)	$	(5,517,989	)
Net loss per share
Basic and diluted		$	(0.29	)	$	(3.21	)	$	(1.17	)	$	(7.83	)
Weighted average number of shares outstanding
Basic and diluted	14		4,271,594			712,401			2,925,729			706,291

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

F-4

KWESST MICRO SYSTEMS INC.

Condensed Consolidated Interim Statements of Changes in Shareholders' Equity (Deficit)

Six months ended March 31, 2023, and 2022

(Unaudited)

In Canadian dollars	Notes		Share capital			Contingent shares		Warrants			Contributed surplus			Translation reserve			Deficit			Total Shareholders' Equity (Deficit)
Balance, September 30, 2021		$	17,215,068		$	-	$	1,848,389		$	2,458,211		$	(8,991)			$      (15,388,949)		$	6,123,728
Shares issued to settle debt			19,000			-		-			-			-			-			19,000
Shares and warrants issued on acquisition	4		377,503			83,319		132,000			-			-			-			592,822
Warrants exercised			237,136			-		(61,136	)		-			-			-			176,000
Share-based compensation	13(c)		-			-		-			1,350,461			-			-			1,350,461
Shares for vested RSUs and PSUs			148,137			-		-			(148,137	)		-			-			-
Vested RSUs and PSUs repurchased for withholding taxes			-			-		-			(22,815	)		-			-			(22,815	)
Shares issued for unsecured loans			365,888			-		-			-			-			-			365,888
Share offering costs			(26,323	)		-		-			-			-			-			(26,323	)
Other comprehensive income			-			-		-			-			15,039			-			15,039
Net loss			-			-		-			-			-			(5,533,028	)		(5,533,028	)
Balance, March 31, 2022		$	18,336,409		$	83,319	$	1,919,253		$	3,637,720		$	6,048		$	(20,921,977	)	$	3,060,772
Balance, September 30, 2022		$	19,496,640		$	-	$	1,959,796		$	3,551,330		$	(101,418	)	$	(25,909,239	)	$	(1,002,891	)
Shares issued for public offering	13(a)		13,675,120			-		-			-			-			-			13,675,120
Share offering costs	13(a)		(3,050,278	)		-		189,592			125,086			-			-			(2,735,600	)
Shares issued for debt	13(a)		233,485			-		-			-			-			-			233,485
Warrants exercised	13(b) and 18		60,000			-		(60,000	)		-			-			-			-
Share-based compensation	13(c)		-			-		-			277,047			-			-			277,047
Shares for vested RSUs and PSUs	18		528,207			-		-			(528,207	)		-			-			-
Vested RSUs and PSUs repurchased for withholding taxes			-			-		-			(612	)		-			-			(612	)
Other comprehensive income			-			-		-			-			21,424			-			21,424
Net loss			-			-		-			-			-			(3,435,426	)		(3,435,426	)
Balance, March 31, 2023		$	30,943,174		$	-	$	2,089,388		$	3,424,644		$	(79,994	)	$	(29,344,665	)	$	7,032,547

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

F-5

KWESST MICRO SYSTEMS INC.

Condensed Consolidated Interim Statements of Cash Flows

Six months ended March 31, 2023, and 2022

(Unaudited)

In Canadian dollars	Notes		Six months ended March 31, 2023			Six months ended March 31, 2022
OPERATING ACTIVITIES
Net loss		$	(3,435,426)		$	(5,533,028)
Items not affecting cash:
Depreciation and amortization			323,878			145,186
Share-based compensation	13(c)		277,047			1,350,461
Change in fair value of warrant liabilities (including related foreign exchange gain)	12		(3,223,574	)		-
Net finance costs	16		554,684			120,121
Loss on disposals			-			1,165
Changes in non-cash working capital items	18		(3,534,350	)		1,051,854
Interest paid			(117,553	)		(16,085	)
Cash used in operating activities			(9,155,294	)		(2,880,326	)
INVESTING ACTIVITIES
Additions of property and equipment			(136,917	)		(118,703	)
Investments in intangible assets	7		(598,525	)		(441,074	)
Deposit for advanced royalties			(148,410	)		-
Recognition of open orders from acquisition	7		-			64,233
Cash acquired on acquisition	4		-			162,547
Cash flows used in investing activities			(883,852	)		(332,997	)
FINANCING ACTIVITIES
Proceeds from U.S. IPO and Canadian Offering, net	13(a)		16,346,768			-
Payments of share offering costs	13(a) and 18		(125,397	)		(26,323	)
Proceeds from borrowings	10		-			2,000,000
Payments of deferred financing fees			-			(74,055	)
Repayment of borrowings			(2,333,315	)		-
Repayments of lease obligations			(35,152	)		(10,427	)
Proceeds from exercise of warrants			-			176,000
Proceeds from exercise of stock options			-			-
Repurchase of vested RSUs and PSUs for withholding taxes			(612	)		(22,815	)
Cash flows provided by financing activities			13,852,292			2,042,380
Net change in cash during the period			3,813,146			(1,170,943	)
Cash, beginning of period			170,545			2,688,105
Cash, end of period		$	3,983,691		$	1,517,162
Cash and cash equivalents consist of the following:
Cash held in banks			953,741			1,517,162
Short-term guaranteed investment certificates			3,029,950			-
Cash and cash equivalents			3,983,691			1,517,162

See Note 18 Supplemental cash flow information.

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

F-6

KWESST MICRO SYSTEMS INC.

Notes to Unaudited Condensed Consolidated Interim Financial Statements

Three and six months ended March 31, 2023, and 2022

(Expressed in Canadian dollars, except share amounts)

 1.Corporate information

a)Corporate information

KWESST Micro Systems Inc. (the "Company", "KWESST", "we", "our", and "us") was incorporated on November 28, 2017, under the laws of the Province of British Columbia. Our registered office is located at 550 Burrard Street, Suite 2900, Vancouver, British Columbia, Canada and our corporate office is located at Unit 1, 155 Terrence Matthews Crescent, Ottawa, Ontario, Canada. We have representative offices in the following foreign locations: Washington DC (United States), London (United Kingdom), and Abu Dhabi (United Arab Emirates).

We develop and commercialize next-generation technology solutions that deliver a tactical advantage for military, public safety agencies and personal defense markets.  Our core mission is to protect and save lives.

KWESST's common stock is listed on the TSX-Venture Exchange ("TSX-V'') under the stock symbol of KWE, on the Nasdaq Capital Market ("Nasdaq") under the stock symbol of KWE and on the Frankfurt Stock Exchange under the stock symbol of 62U.  Additionally, warrants issued in the United States are also listed on the Nasdaq under the stock symbol of KWESW. Effective May 1, 2023, the warrants issued in Canada are listed on the TSX-V under the stock symbol of KWE.WT.U.

b)Reverse Stock Split

In August 2022, we submitted a Form F-1 Registration Statement to the U.S. Securities and Exchange Commission and applied to have its common shares listed on Nasdaq. In connection with KWESST's listing application on Nasdaq, we effected a one for seventy (1-for-70) reverse stock split of its common stock on October 28, 2022 (the "Reverse Split").  Accordingly, all shareholders of record at the opening of business on October 28, 2022, received one issued and outstanding common share of KWESST in exchange for seventy outstanding common shares of KWESST.  No fractional shares were issued in connection with the Reverse Split.  All fractional shares created by the Reverse Split were rounded to the nearest whole number of common shares, with any fractional interest representing 0.5 or more common shares entitling holders thereof to receive one whole common share. 

Effective on the date of the Reverse Split, the exercise price and number of common shares issuable upon the exercise of outstanding stock options were proportionately adjusted to reflect the Reverse Split. The restricted share units ("RSUs") and performance stock units ("PSUs") have also been adjusted for the Reverse Split.  While the number of warrants has not changed as a result of the Reverse Split; the conversion rate for each warrant was adjusted from one common share to 0.01428571 common share.  All information respecting outstanding common shares and other securities of KWESST, including net loss per share, in the current and comparative periods presented herein give effect to the Reverse Split.

2.Basis of preparation

(a)Going concern

These unaudited condensed consolidated interim financial statements have been prepared assuming we will continue as a going concern.

As an early-stage company, we have not yet reached commercial production for most of our products and have incurred significant losses and negative operating cash flows from inception that have primarily been funded from financing activities. We have incurred a $3.4 million net loss and negative operating cash flows of $9.2 million for the six months ended March 31, 2023 (2022 - $5.5 million net loss and negative operating cash flows of $2.9 million). At March 31, 2023, we had $2.2 million in working capital (September 30, 2022 - negative $5.4 million). 

F-7

KWESST MICRO SYSTEMS INC.

Notes to Unaudited Condensed Consolidated Interim Financial Statements

Three and six months ended March 31, 2023, and 2022

(Expressed in Canadian dollars, except share amounts)

Our ability to continue as a going concern and realize our assets and discharge our liabilities in the normal course of business is dependent upon closing timely additional sales orders, timely commercial launch of new products, and the ability to raise additional debt or equity financing, when required. There are various risks and uncertainties affecting our future financial position and our performance including, but not limited to:

• The market acceptance and rate of commercialization of our product offerings;
• Ability to successfully execute our business plan;
• Ability to raise additional capital at acceptable terms;
• General local and global economic conditions, including the ongoing COVID-19 pandemic and the global disruption from Russia's invasion of Ukraine.

Our strategy to mitigate these material risks and uncertainties is to execute timely a business plan aimed at continued focus on revenue growth, product development and innovation, improving overall gross profit, managing operating expenses and working capital requirements, and securing additional capital, as needed.

Failure to implement our business plan could have a material adverse effect on our financial condition and/or financial performance. There is no assurance that we will be able to raise additional capital as they are required in the future. Accordingly, there are material risks and uncertainties that may cast significant doubt about our ability to continue as a going concern.

These 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").  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 consolidated financial statements for the year ended September 30, 2022. However, selected explanatory notes are included to explain events and transactions that are significant to an understanding of the changes in our financial position and performance since the last annual consolidated financial statements as at and for the year ended September 30, 2022.

These unaudited condensed consolidated interim financial statements were authorized for issue by the Board of Directors on May 11, 2023.

(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.

F-8

KWESST MICRO SYSTEMS INC.

Notes to Unaudited Condensed Consolidated Interim Financial Statements

Three and six months ended March 31, 2023, and 2022

(Expressed in Canadian dollars, except share amounts)

At March 31, 2023, we have the following wholly-owned subsidiaries:

	Location	Equity %
KWESST Inc.	Ottawa, Canada	100%
2720178 Ontario Inc.	Bowmanville, Canada	100%
Police Ordnance Company Inc.	Bowmanville, Canada	100%
KWESST U.S. Holdings Inc.	Delaware, Canada	100%
KWESST Defense Systems U.S. Inc.	Virginia, United States	100%
KWESST Public Safety Systems U.S. Inc.	Virginia, United States	100%
KWESST Public Safety Systems Canada Inc.	Ottawa, Canada	100%

(d)Functional and presentation currency

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

(e)Basis of measurement

The consolidated financial statements have been prepared on the historical cost basis except for certain financial instruments measured at fair value. Historical cost is generally based on the fair value of the consideration given in exchange for assets.

(f)Use of estimates and judgments

The preparation of the 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 significant effects on the amounts recognized in these consolidated financial statements are the same as disclosed in Note 2(f) of the consolidated financial statements for the year ended September 30, 2022, except for the following new item:

• Note 12 - warrant liabilities: whether the determination of our stock volatility and the expected life of the warrant liabilities are reasonable considering our limited operating history, both are significant inputs in the valuation model to fair value the warrant liabilities issued in the U.S IPO and Canadian Offering.

Estimates

Information about assumptions and estimation uncertainties at March 31, 2023 that have a significant risk of resulting in a material adjustment to the carrying amounts of assets and liabilities in the next financial year are the same as disclosed in Note 2(f) of the consolidated financial statements for the year ended September 30, 2022.

F-9

KWESST MICRO SYSTEMS INC.

Notes to Unaudited Condensed Consolidated Interim Financial Statements

Three and six months ended March 31, 2023, and 2022

(Expressed in Canadian dollars, except share amounts)

COVID-19 Uncertainties

There is no change to our COVID-19 assessment from the disclosure provided in Note 2(f) of the consolidated financial statements for the year ended September 30, 2022.

3.Significant accounting policies

During the six months ended March 31, 2023, the accounting policies in these condensed consolidated interim financial statements are the same as those applied in KWESST's consolidated financial statements as at and for the year ended September 30, 2022.

4.Acquisition

On December 15, 2021, we acquired 2720178 Ontario Inc., an Ontario (Canada) corporation, which owns all of the issued and outstanding shares of Police Ordnance Company Inc., an Ontario (Canada) corporation (together, "Police Ordnance"), herein referred as the "Police Ordnance Acquisition". Located in Bowmanville, Ontario, with ancillary operations in Florida, Police Ordnance owns all intellectual properties to the ARWEN^TM product line of launchers, and a proprietary line of 37 mm cartridges designed for riot control and tactical teams.  Police Ordnance has law enforcement customers across Canada, the United States, and abroad. The Police Ordnance Acquisition provides us with a strategic opportunity to leverage its law enforcement customer base to accelerate growth within its specialty ordnance business.

We accounted for the acquisition of Police Ordinance pursuant to IFRS 3, Business Combinations.

Consideration Transferred:

The purchase consideration comprised of the following:

	Number		Fair Value
Common shares	3,965	$	377,503
Warrants	200,000	$	132,000
Contingent shares	875	$	83,319
Total fair value purchase consideration		$	592,822

The warrants are exercisable at $1.72 each and will expire on December 15, 2024. As a result of the Reverse Split (see Note 1(b)), each warrant converts into 0.01428571 common share or 70 warrants to receive one common share of KWESST.

We issued the 875 contingent common shares to the sellers in April 2022 following the fulfillment of the financial milestone as defined in the share purchase agreement.

We have estimated the fair value as follows:

• Common shares: based on KWESST's closing stock price on December 15, 2021.
• Warrants: based on using the Black Scholes option model with the following key inputs: a) exercise price of $1.72, 1/70 of the underlying stock price of $1.36, risk free rate of 1.04%, expected life of three years, and expected volatility of 84.7%.
• Contingent shares: based on KWESST's closing stock price on December 15, 2021, and high probability of achieving the financial milestone as defined in the share purchase agreement.

F-10

KWESST MICRO SYSTEMS INC.

Notes to Unaudited Condensed Consolidated Interim Financial Statements

Three and six months ended March 31, 2023, and 2022

(Expressed in Canadian dollars, except share amounts)

The net cash inflow as at the closing of the acquisition was as follows:

Cash assumed on acquisition	$	162,547
less: consideration paid in cash		-
Net cash inflow on acquisition	$	162,547

Net Assets Acquired:

The purchase consideration was allocated to Police Ordnance's net assets as follows:

Total purchase consideration at fair value	$	592,822
Police Ordnance's net assets:
Cash		162,547
Trade and other receivables		104,432
Inventories		352,685
Intangible assets:
Purchase orders		100,000
Customer relationships		50,000
ARWENTM tradename		44,000
Accounts payable and accrued liabilities		82,963
Corporate tax liability		32,338
Contract liabilities		29,861
Borrowings		26,238
Deferred tax liabilities		49,442
Net assets at fair value	$	592,822

As a result of the above purchase price allocation, we have recorded no goodwill for the Police Ordnance Acquisition.

Impact on KWESST's Results of Operations:

The results of operations of Police Ordnance are included in these unaudited condensed consolidated interim statements of net loss and comprehensive loss from December 16, 2021. If the acquisition had occurred on October 1, 2021, management estimates that Police Ordnance would have contributed approximately $128,600 and $282,300 of revenue and approximately $47,300 and $59,100 of net loss to KWESST's operating results for the three and six months ended March 31, 2022, respectively. In determining these amounts, management has assumed that the fair value adjustments that arose on the date of the acquisition would have been the same if the acquisition had occurred on October 1, 2021.

We incurred immaterial acquisition-related costs.

F-11

KWESST MICRO SYSTEMS INC.

Notes to Unaudited Condensed Consolidated Interim Financial Statements

Three and six months ended March 31, 2023, and 2022

(Expressed in Canadian dollars, except share amounts)

5.Trade and other receivables

The following table presents trade and other receivables for KWESST:

		March 31,  2023		September 30, 2022
Trade receivables	$	74,458	$	114,877
Unbilled revenue		5,673		8,881
Sales tax recoverable		128,895		48,124
Other receivable		3,494		-
Total	$	212,520	$	171,882

There was no impairment of trade and other receivables during the six months ended March 31, 2023 (2022 - $nil).

The following table presents changes in unbilled receivables:

		March 31,  2023			September 30, 2022
Balance, beginning of period	$	8,881		$	308,728
Revenue billed during the period		(3,670	)		(308,728	)
Revenue in excess of billings, net of amounts transferred to trade receivables		462			8,881
Balance, end of period	$	5,673		$	8,881
Current	$	5,673		$	8,881
Non-current	$	-		$	-

 6.Inventories

The following table presents a breakdown of inventories:

		March 31, 2023		September 30, 2022
Finished goods	$	44,673	$	49,643
Work-in-progress		353,240		21,350
Raw materials		474,607		322,545
Total	$	872,520	$	393,538

There was no impairment of inventories during the six months ended March 31, 2023 (2022 - $nil).

F-12

KWESST MICRO SYSTEMS INC.

Notes to Unaudited Condensed Consolidated Interim Financial Statements

Three and six months ended March 31, 2023, and 2022

(Expressed in Canadian dollars, except share amounts)

7.Intangible assets

The following table shows the movement in intangible assets since September 30, 2022:

Cost		PhantomTM System		PARA OPSTM System			PARA OPSTM Patent		ARWENTM Tradename			Customer Relationships			Purchase Orders			Total
Balance at September 30, 2022	$	1,149,585	$	3,469,215		$	28,783	$	37,032		$	46,041		$	12,198		$	4,742,854
Additions		19,855		570,414			8,256		-			-			-			598,525
Amortization		-		(134,654	)		-		(4,400	)		(2,500	)		-			(141,554	)
Recognition of open orders		-		-			-		-			-			(7,811	)		(7,811	)
Balance at March 31, 2023	$	1,169,440	$	3,904,975		$	37,039	$	32,632		$	43,541		$	4,387		$	5,192,014

At March 31, 2023, management concluded there was no impairment on the intangible assets (2022 - $nil). The development of PARA OPS^TM was substantially completed during the six months ended March 31, 2023 and amortization of $134,654 was recognized in General and administrative expenses. Management determined the estimated useful life to be five years.

8.Accounts payable and accrued liabilities

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

		March 31, 2023		September 30, 2022
Trade payable	$	450,334	$	2,292,954
Accrued liabilities		842,070		1,045,409
Salary and vacation payable		207,249		1,121,118
Total	$	1,499,653	$	4,459,481

 9. Related party transactions

At March 31, 2023, there was $177,500 (September 30, 2022 - $672,531) outstanding in accounts payable and accrued liabilities due to our officers and directors for unpaid wages, director fees, and expense reimbursements.

10.Borrowings

The following is a reconciliation of borrowings since September 30, 2022:

		CEBA Term Loans			March 2022 Loans			August 2022 Loans			Total Borrowings
Balance, September 30, 2022	$	78,796		$	1,764,630		$	435,348		$	2,278,774
Accrued interest and accretion expense		11,204			274,887			179,096			465,187
Interest paid		-			(39,517	)		(63,661	)		(103,178	)
Repayment of principal		(70,000	)		(1,988,000	)		(275,315	)		(2,333,315	)
Settled in equity (Notes 12 and 18)		-			(12,000	)		(275,468	)		(287,468	)
Forgivable amount		(20,000	)		-			-			(20,000	)
Balance, March 31, 2023	$	-		$	-		$	-		$	-

There were no changes to KWESST's RBC Credit Facility since September 30, 2022.

F-13

KWESST MICRO SYSTEMS INC.

Notes to Unaudited Condensed Consolidated Interim Financial Statements

Three and six months ended March 31, 2023, and 2022

(Expressed in Canadian dollars, except share amounts)

11.Contract liabilities

The following is a reconciliation of contract liabilities since September 30, 2022:

		March 31, 2023
Balance, beginning of period	$	47,271
Amounts invoiced and revenue deferred		267,529
Recognition of deferred revenue included in the  balance at the beginning of period		(47,528	)
Balance, end of period	$	267,272

12.Warrant liabilities

The following is a reconciliation of warrant liabilities since September 30, 2022:

		U.S. IPO and Canadian Offering									Debt Settlement
		2022 Warrants			Over-allotment Pre-Funded Warrants			Over-allotment Warrants			Warrants			Total
Balance, beginning of period	$	-		$	-		$	-		$	-		$	-
Initial recognition		4,617,451			832,698			536,681			80,617			6,067,447
Gain on revaluation of financial instruments		(2,889,992	)		(164,326	)		(335,070	)		(51,884	)		(3,441,272	)
Exchange gain on revaluation		(24,610	)		(5,878	)		(3,691	)		-			(34,179	)
Balance, end of period	$	1,702,849		$	662,494		$	197,920		$	28,733		$	2,591,996
Number of outsanding securities as at March 31, 2023		3,226,392			199,000			375,000			56,141			3,856,533

 U.S. IPO and Canadian Offering

On December 9, 2022, we closed an underwritten U.S. public offering (the "U.S. IPO") and an underwritten Canadian offering (the "Canadian Offering") for aggregate gross proceeds of CAD$19.4 million (US$14.1 million) (see Note 13(a)). As part of the U.S. IPO and Canadian Offering, we have issued 3,226,392 warrants (the "2022 Warrants") with an exercise price of US$5.00 per share.  Additionally, the U.S. underwriter exercised its over-allotment option to purchase:

• 199,000 Pre-Funded Warrants with an exercise price of US$0.01 per share for $3.81024 per pre-funded warrant (net of underwriter discount);
• 375,000 warrants with exercise price of US$5.00 per share for $0.0001 per warrant;

Refer to Note 13(a) for further information on the U.S. IPO and Canadian Offering.

Under IFRS, the above securities are classified as financial liabilities (referred herein as "warrant liabilities") because the exercise price is denominated in U.S. dollars, which is different to our functional currency (Canadian dollars). Accordingly, the ultimate proceeds in Canadian dollars from the potential exercise of the above securities are not known at inception. These financial liabilities are classified and measured at FVTPL (see Note 3(c) of the audited consolidated financial statements for the year ended September 30, 2022).  Gains on revaluation of the warrant liabilities are presented in Other income (expenses) on the condensed consolidated interim statements of net loss and comprehensive loss.

Warrant liabilities

While the warrants issued in the U.S. IPO were listed on Nasdaq and closed at US$0.90 per warrant on December 9, 2022, management concluded that this closing price was not reflective of an active market due to short trading window and therefore not representative of fair value. Accordingly, at inception, the 2022 Warrants were measured at fair value using the Black Scholes option pricing model (Level 2). We used the following assumptions:

F-14

KWESST MICRO SYSTEMS INC.

Notes to Unaudited Condensed Consolidated Interim Financial Statements

Three and six months ended March 31, 2023, and 2022

(Expressed in Canadian dollars, except share amounts)

		2022 Warrants		Over-allotment Pre-Funded Warrants (1)		Over-allotment Warrants (2)
Number of dilutive securities		3,282,533		199,000		375,000
Exercise price (in USD)	$	5.00	$	0.01
Share price (in USD)	$	4.13	$	3.08
Expected life		2.50
Dividend	$	-
Volatility		75%
Risk free rate		4.20%
Exchange rate (USD/CAD)	$	1.363
Fair value per warrant (CAD)	$	1.43	$	4.18	$	1.43

^{(1)Fair value is measured at the underlying common share closing price on Nasdaq on December 9, 2022, less US$0.01 exercise price.}

^{(2)Same fair value as calculated for Warrants.}

The share price (in USD) for the over-allotment pre-funded warrants was based on the estimated fair value of the common shares issued on December 9, 2022, by deducting the fair value of the warrants of US$1.05 from the US$4.13 Unit price and the exercise price of US$0.01 (see Note 13(a)).

Based on the above fair value, the issuance of the over-allotment pre-funded warrants and warrants to the underwriter resulted in a non-cash charge of $251,877, which is included in the change in fair value of warrant liabilities in the condensed consolidated interim statements of net loss and comprehensive loss.

At March 31, 2023, we remeasured the fair value of these warrants using the following assumptions:

		2022 Warrants (1)		Over-allotment Pre-Funded Warrants (2)		Over- allotment Warrants (1)
Number of securities		3,282,533		199,000		375,000
Nasdaq closing price (in USD)	$	0.39	$	2.47	$	0.39
Exchange rate (USD/CAD)	$	1.353	$	1.353	$	1.353
Fair value per warrant (CAD)	$	0.53	$	3.33	$	0.53

^{(1)Fair value is based on the Nasdaq closing pricing on March 31, 2023 for the warrants.}

^{(2)Fair value is measured at the Nasdaq closing price on March 31, 2023, for the underlying common stock less US$0.01 exercise price.}

Including the non-cash charge for the issuance of the over-allotment pre-funded warrants and warrants to the underwriter, we recognized $1,838,972 and  $3,189,395 as a change in fair value of warrant liabilities during the three and six months ended March 31, 2023, respectively, which was reported in the condensed consolidated net loss and comprehensive loss.

December 2022 Debt Settlement

On December 13, 2022, we have entered into share for debt arrangements with existing lenders (see Note 13(a)), which resulted in issuing 56,141 Units, same terms as the Units as issued in the Canadian Offering except that the underlying securities are subject to a four-month hold period. Accordingly, this resulted in issuing 56,141 common shares and 56,141 warrant liabilities with an exercise price of US$5.00 per share and maturing on December 13, 2027. We initially recorded the fair value of the warrant liabilities using the Black Scholes option pricing model with an underlying stock price equivalent to the unit price of US$4.13.

F-15

KWESST MICRO SYSTEMS INC.

Notes to Unaudited Condensed Consolidated Interim Financial Statements

Three and six months ended March 31, 2023, and 2022

(Expressed in Canadian dollars, except share amounts)

At March 31, 2023, we remeasured the fair value of these warrant liabilities using the Nasdaq closing price on March 31, 2023 of US$0.39. The remeasurement resulted in a change in fair value of warrant liabilities of $27,535 and $51,884 for the three and six months ended March 31, 2023, respectively, which was reported in the condensed consolidated net loss and comprehensive loss.

13.Share capital and Contributed Surplus

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, 2022:

	Number		Amount
Balance at September 30, 2022	773,225	$	19,496,640
Issued for U.S. IPO and Canadian Offering	3,226,392	$	13,675,120
Issued for debt settlements	56,134	$	233,485
Issued for conversion of stock units	13,784	$	528,207
Issued for warrant exercise	3,571	$	60,000
Less: share offering costs for the period		$	(3,050,278	)
Balance at March 31, 2023	4,073,106	$	30,943,174

U.S. IPO and Canadian Offering

On December 9, 2022, we closed the U.S. IPO and the Canadian Offering. In the U.S. IPO, we sold 2.5 million units at a public offering price of USD $4.13 per unit (the "Unit"), consisting of one share of common stock and one warrant to purchase one share of common stock ("Warrant"). The Warrants have a per share exercise price of USD $5.00, and can be exercised immediately. In connection with the closing of the U.S. IPO, the underwriter partially exercised its over-allotment option to purchase an additional 199,000 pre-funded common share purchase warrants ("Pre-Funded Warrants") at US$4.12 (before underwriter discount) and 375,000 option warrants to purchase common shares at US$0.0001 each. A Pre-Funded Warrant is a financial instrument that requires the holder to pay little consideration (exercise price of US$0.01) to receive the common share upon exercise of the Pre-Funded Warrant (see Note 14).  The holder of Pre-Funded Warrants has no voting rights. All of these warrants expire on December 9, 2027.

In the Canadian Offering, we sold 726,392 units, each consisting of one common share and one warrant to purchase one common share, at a price to the public of USD $4.13 per unit. The warrants will have a per common share exercise price of USD $5.00, are exercisable immediately and expire in five years on December 9, 2027. Effective May 1, 2023, the warrants are listed on the TSX-V under the stock symbol of KWE.WT.U.

The closing of the U.S. IPO and Canadian Offering resulted in aggregate gross proceeds of CAD$19.4 million (USD $14.1 million), before deducting underwriting discounts and offering expenses.

F-16

KWESST MICRO SYSTEMS INC.

Notes to Unaudited Condensed Consolidated Interim Financial Statements

Three and six months ended March 31, 2023, and 2022

(Expressed in Canadian dollars, except share amounts)

The common shares of KWESST and the Warrants sold in the U.S. IPO began trading on the Nasdaq Capital Market under the symbols "KWE" and "KWESW", respectively, on December 7, 2022.

ThinkEquity acted as sole book-running manager for the U.S. IPO and PI Financial acted as sole book-running manager for the Canadian Offering.

Accounting Treatment

Refer to Note 12 for the accounting of the warrants issued in the U.S. IPO and Canadian Offering.

Brokers' Compensation and Share Offering Costs

As consideration for the services provided in connection with the U.S. IPO, ThinkEquity received: (a) a broker-dealer cash commission of US$835,000 (or CAD$1,138,105) equal to 7.5% of the gross offering proceeds of the U.S. Offering and (b) underwriter warrants (the "U.S. Underwriter Warrants") to purchase up to 134,950 common shares equal to 5% of the common shares and pre-funded common share purchase warrants issued under the U.S. Offering. Each U.S. Underwriter Warrant is exercisable to acquire one common share at a price of US$5.1625, exercisable as of June 4, 2023, and expiring on December 9, 2027.

As consideration for the services provided in connection with the Canadian Offering, PI Financial received: (a) a cash commission of approximately US$210,000 (or CAD$286,230); and (b) 50,848 compensation options (the "Canadian Compensation Options"). Each Canadian Compensation Option is exercisable to acquire one Canadian Unit at a price of US$4.13 and expiring on December 9, 2024.

In addition to the above brokers' compensation, we also incurred US$2.1 million share offering costs (or CAD$2.8 million) for the U.S. IPO and Canadian Offering, of which CAD$628,262 was incurred and deferred at September 30, 2022.

The total brokers compensation (including fair value of U.S. Underwriter Warrants and Canadian Compensation Options) and share offering costs was US$3.2 million (or CAD$4.4 million). This total was allocated proportionately to the fair value of common shares and warrant liabilities. Accordingly, CAD$1.3 million allocated to warrant liabilities were expensed during the six months ended March 31, 2023.

Shares for Debt Settlement

We have entered into share for debt arrangements with existing lenders, which closed on December 13, 2022, following TSXV's conditional approval.  This resulted in issuing 56,141 Units to settle $12,000 of the March 2022 Loans and USD$223,321 (or CAD$302,197) of the August 2022 Loans, including unpaid accrued interest and 10% premium at maturity (the "Debt Settlements") - see Note 10. The terms of the Units are the same as the Units issued in the Canadian Offering.

F-17

KWESST MICRO SYSTEMS INC.

Notes to Unaudited Condensed Consolidated Interim Financial Statements

Three and six months ended March 31, 2023, and 2022

(Expressed in Canadian dollars, except share amounts)

b)Warrants

The following is a summary of changes in outstanding warrants since September 30, 2022:

	Number of warrants			Weighted average exercise price
Outstanding at September 30, 2022	13,417,156		$	0.78
Issued (Note 13(a))	3,991,483		$	6.44
Exercised	(250,000	)	$	0.50
Outstanding at March 31, 2023	17,158,639		$	2.10
Exercisable at March 31, 2023	16,648,689		$	2.09

U.S. Underwriter Warrants

In the U.S. IPO, we issued 134,950 warrants ("U.S. Underwriter Warrants").  Each U.S. Underwriter Warrant is exercisable to acquire one common share at US$5.1625 for a period of 5 years (expiring on December 9, 2027). Management estimated the fair value of these warrants using the Black Scholes option model with the following inputs:

Number of dilutive securities		134,950
Exercise price (in USD)	$	5.16
Share price (in USD)	$	3.08
Expected life		2.50
Dividend	$	-
Volatility		75%
Risk free rate		4.20%
Exchange rate (USD/CAD)	$	1.363
Fair value per warrant (CAD)	$	1.40

We have recorded $189,592 as the fair value for the U.S. Underwriter Warrants, with an equal offset to share offering costs (a non-cash transaction).

F-18

KWESST MICRO SYSTEMS INC.

Notes to Unaudited Condensed Consolidated Interim Financial Statements

Three and six months ended March 31, 2023, and 2022

(Expressed in Canadian dollars, except share amounts)

The following table provides additional information on the total outstanding warrants at March 31, 2023:

		Number outstanding	Conversion ratio to Common Shares		Book value	Expiry Date
Classified as Equity
Founders' warrants:
	Exercise price of $0.20	5,520,000	70 for 1	$	1,013	January 1, 2024
	Exercise price of $0.20	1,900,000	70 for 1	$	18,865	June 14, 2024
April 2021 equity financing:
	Exercise price of $1.75	3,274,657	70 for 1	$	785,918	April 29, 2023
	Exercise price of $1.75	40,000	70 for 1	$	9,600	August 25, 2023
LEC's warrants:
	Exercise price of $0.70	500,000	70 for 1	$	425,000	April 29, 2026
September 2021 equity financing:
	Exercise price of $2.35	750,000	70 for 1	$	390,000	September 16, 2023
Broker warrants:
	Exercise price of $1.75	137,499	70 for 1	$	33,000	April 29, 2023
	Exercise price of $2.00	45,000	70 for 1	$	32,400	September 16, 2023
Acquisition of Police Ordnance (Note 4):
	Exercise price of $1.72	200,000	70 for 1	$	132,000	December 15, 2024
July 2022 equity financing:
	Exercise price of $0.285	800,000	70 for 1	$	72,000	July 14, 2024
December 2022 U.S. Underwriter Warrants
	Exercise price of US$5.1625	134,950	1 for 1	$	189,592	December 6, 2024
		13,302,106		$	2,089,388
Classified as liability
December 2022 public offerings:
	Exercise price of US$5.00	3,226,392	1 for 1	$	1,702,849	December 9, 2027
December 2022 Pre-Funded Warrants
	Exercise price of US$0.01	199,000	1 for 1	$	662,494	No expiry
December 2022 Option Warrants
	Exercise price of US$5.1625	375,000	1 for 1	$	197,920	December 9, 2024
December 2022 debt settlement
	Exercise price of US$5.00	56,141	1 for 1	$	28,733	December 9, 2027
		3,856,533			2,591,996
	Total outstanding warrants	17,158,639		$	4,681,384

c)Contributed Surplus 

Broker Compensation Options

In the Canadian Offering, we issued 50,848 Canadian Compensation Options. Each Canadian Compensation Option is exercisable to acquire one Unit, as defined in Note 13(a), at a price equal to US$4.13 for a period of two years (expiring on December 9, 2024).  Based on the structure of the Compensation Option, management estimated its fair value using the Monte Carlo method (Level 2).  We used the following key inputs in the Monte Carlo model (100,000 simulations):

F-19

KWESST MICRO SYSTEMS INC.

Notes to Unaudited Condensed Consolidated Interim Financial Statements

Three and six months ended March 31, 2023, and 2022

(Expressed in Canadian dollars, except share amounts)

		Initial Recognition
Number of securities		50,848
Exercise price - compensation option (in USD)	$	4.13
1-Year CAD/USD Forward Exchange Rate	$	1.3560
Exercise price - compensation warrant (in USD)	$	5.00
2-Year CAD/USD Forward Exchange Rate	$	1.3483
Share price (in CAD)	$	4.20
Expected life - compensation option		1.00
Expected life - compensation warrant		2.50
Dividend	$	-
Volatility - compensation option		90%
Volatility - compensation warrant		75%
Risk free rate - compensation option		4.38%
Risk free rate - compensation warrant		3.15%
Fair value per compensation option (CAD)	$	2.46

We have recorded $125,086 of Canadian Compensation Options in contributed surplus, with an equal offset to share offering costs (a non-cash transaction).

Share-based compensation

On March 31, 2023, KWESST shareholders approved the renewal of the Long-Term Incentive Plan (the "LTIP").  Additionally, the disinterested shareholders of KWESST approved an amendment to the LTIP to increase the number of RSUs, PSUs, DSUs, and SARs (collectively "Share Units") authorized for issuance pursuant to the LTIP from 60,682 to 407,274 Share Units. Accordingly, we have 497,274 Share Units available for future grants.

Further, the disinterested shareholders of KWESST approved to revise the exercise price of 50,981 stock options to $3.60, the closing price of KWESST common shares on the TSX-V on March 31, 2023. In accordance with IFRS 2, this resulted in an immediate fair value increase of $77,001 included in share-based compensation, with an offset to contributed surplus for the three and six months ended March 31, 2022.

We did not grant any stock options, RSUs, PSUs, and SARs, pursuant to our LTIP during the six months ended March 31, 2023. Accordingly, we had 51,338 outstanding stock options at March 31, 2023. The remaining available stock option pool for future grants was 351,989 at March 31, 2023.

For the three and six months ended March 31, 2023, we recorded share-based compensation of $151,981 and $277,047, respectively (2022 - $422,931 and $1,350,461).

14.Earnings (loss) per share

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

F-20

KWESST MICRO SYSTEMS INC.

Notes to Unaudited Condensed Consolidated Interim Financial Statements

Three and six months ended March 31, 2023, and 2022

(Expressed in Canadian dollars, except share amounts)

	Three months ended March 31, 2023	Three months ended March 31, 2022	Six months ended March 31 2023	Six months ended March 31, 2022
Issued common shares,  beginning of period	4,265,984	707,271	773,225	699,509
Effect of shares issued from:
December 2022 U.S. IPO and Canadian Offering (Note 13)	-	-	1,985,472	-
Over-allotment Pre-Funded Warrants (Note 12)	-	-	122,462	-
Debt settlements (Note 13)	-	-	33,314	123
Conversion of stock units	5,610	1,007	9,490	545
Exercise of warrants	-	1,361	1,766	2,439
Acquisition of Police Ordnance (Note 4)	-	-	-	2,309
Issuance of bonus shares (Note 10)	-	2,762	-	1,366
Weighted average number of basic common shares	4,271,594	712,401	2,925,729	706,291
Dilutive securities:	-	-	-	-
Weighted average number of dilutive common shares	4,271,594	712,401	2,925,729	706,291

At March 31, 2023 and 2022, all dilutive securities were anti-dilutive because we incurred a net loss for the above periods.

As the $0.01 exercise price per Pre-Funded Warrant is non-substantive, the 199,000 Pre-Funded Warrants issued in the U.S. IPO are included in the basic net loss per share calculation.

15.Revenue

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

		Three months ended March 31, 2023		Three months ended March 31, 2022		Six months ended March 31, 2023		Six months ended March 31, 2022
Major products / service lines
Digitization	$	68,788	$	139,975	$	264,004	$	156,615
Non-lethal		92,615		26,166		213,492		26,166
Other		-		110		1,240		935
	$	161,403	$	166,251	$	478,736	$	183,716
Primary geographical markets
United States	$	21,398	$	4,411	$	27,319	$	21,051
Canada		140,005		161,840		451,417		162,665
	$	161,403	$	166,251	$	478,736	$	183,716
Timing of revenue recognition
Products and services transferred over time	$	68,788	$	155,649	$	264,004	$	172,289
Products transferred at a point in time		92,615		10,602		214,732		11,427
	$	161,403	$	166,251	$	478,736	$	183,716

At March 31, 2023, KWESST's contracted not yet recognized revenue was $1,029,889 (2022 - 157,901), of which 78.59% of this amount is expected to be recognized over the next 12 months with the remaining 21.41% expected to be recognized in 2 to 3 years.

F-21

KWESST MICRO SYSTEMS INC.

Notes to Unaudited Condensed Consolidated Interim Financial Statements

Three and six months ended March 31, 2023, and 2022

(Expressed in Canadian dollars, except share amounts)

For the three months ended March 31, 2023, two customers accounted for 31.84% and 13.45% (2022 - one customer accounted for 84.19%) of revenue. For the six months ended March 31, 2023, three customers accounted for 36.25%, 15.51%, and 10.56% (2022 - one customer accounted for 85.25%) of total revenue.

16.Net finance costs

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

			Three months ended March 31,			Three months ended March 31,			Six months ended March 31,			Six months ended March 31,
			2023			2022			2023			2022
Finance costs from:
	Unsecured loans	$	-		$	28,089		$	453,983		$	28,089
	Accretion cost - accrued royalties liability		42,626			35,322			86,315			73,506
	Lease obligations		6,332			8,396			13,085			16,028
	Other		-			1,334			63,204			4,959
Total financing costs			48,958			73,141			616,587			122,582
Interest income			(37,851	)		(662	)		(51,473	)		(2,461	)
Gain on debt settlement (Note 10)			-			-			(430	)		-
Gain on government grant (Note 10)			-			-			(10,000	)		-
Net finance costs		$	11,107		$	72,479		$	554,684		$	120,121

17.Financial instruments

For the three and six months ended March 31, 2023, there were no material changes to our financial risks as disclosed in Note 22 of the audited consolidated financial statements for the year ended September 30, 2022, except for the following:

Foreign currency risk

For the three and six months ended March 31, 2023, certain of our revenues were denominated in U.S. dollar and we also procure certain raw materials denominated in U.S. dollar for product development. Further, we raised gross proceeds of US$14.1 million in the U.S. IPO and Canadian Offering (see Note 13), including the issuance of warrants with exercise price denominated in U.S. dollar (see Note 12).  Accordingly, we are exposed to the U.S. dollar currency. Where a natural hedge cannot be achieved, a significant change in the U.S. dollar currency could have a significant effect on our financial performance, financial position and cash flows. Currently, we do not use derivative instruments to hedge its U.S. dollar exposure.

At March 31, 2023, we had the following net U.S. dollar exposure:

		Total USD
Net liabilities in U.S. subsidiary	$	(1,475	)
US denominated from other:
Assets	$	1,899,065
Liabilities		(1,748,249	)
		150,816
Total net US dollar exposure	$	149,341
Impact to profit  or loss if 5% movement in the US dollar	$	7,467

During the three and six months ended March 31, 2023, we recorded foreign exchange loss of $19,684 and $150,040, respectively (2022 - $9,044 and $299).

F-22

KWESST MICRO SYSTEMS INC.

Notes to Unaudited Condensed Consolidated Interim Financial Statements

Three and six months ended March 31, 2023, and 2022

(Expressed in Canadian dollars, except share amounts)

Liquidity risk

At March 31, 2023, our contractual obligations were as follows: 

Payment due:		Total		Within 1 Year		1 to 3 years		3 to 5 years
Minimum royalty commitments	$	2,350,000	$	-	$	350,000	$	2,000,000
Accounts payable and accrued liabilities		1,499,653		1,499,653		-		-
Lease obligations		424,418		127,287		255,423		41,708
Short-term rental obligations		67,933		67,933		-		-
Total contractual obligations	$	4,342,004	$	1,694,873	$	605,423	$	2,041,708

At March 31, 2023, we had $4.0 million in cash and $2.2 million in working capital (see Note 2(a)).

18.Supplemental cash flow information

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

		Six months ended March 31, 2023			Six months ended March 31, 2022
Trade and other receivables	$	(40,638	)	$	667,151
Inventories		(478,982	)		(11,059	)
Prepaid expenses		(1,385,502	)		247,534
Intangible assets		7,811			-
Accounts payable and accrued liabilities		(1,857,040	)		19,056
Contract liabilities		220,001			157,901
Corporate taxes payable		-			(28,729	)
	$	(3,534,350	)	$	1,051,854

In addition to the non-cash items noted in Note 13, we also had the following non-cash items that were excluded from the Statements of Cash Flows for the six months ended March 31, 2022:

• $2,924,880 non-cash share offering costs and $453,102 accounts payables as part of the net proceeds settlement at the closing of the U.S. IPO and Canadian Offering;
• 250,000 warrants exercised in connection with the GhostStep^TM acquisition in June 2020; and
• $528,207 of shares issued for vested RSUs and PSUs.

The following is a summary of non-cash items that were excluded from the Statements of Cash Flows for the six  months ended March 31, 2022:

• $19,000 debt settlement via common shares;
• $61,136 fair value of warrants exercised and transferred to share capital from warrants; and
• $125,000 for 250,000 warrants exercised in connection with the GhostStep^TM acquisition in June 2020.

19.Commitments and contingencies

Except as noted below, there was no material change to the commitments and contingencies as disclosed in Note 26 of the audited consolidated financial statements for the year ended September 30, 2022.

F-23

KWESST MICRO SYSTEMS INC.

Notes to Unaudited Condensed Consolidated Interim Financial Statements

Three and six months ended March 31, 2023, and 2022

(Expressed in Canadian dollars, except share amounts)

In March 2023, we committed to signing a three-year lease agreement in Guelph, Canada for our non-lethal operations. The lease will begin August 1, 2023 and expire on June 30, 2026, for a total commitment of $208,285. 

20.Segmented information

Our Executive Chairman has been identified as the chief operating decision maker. Our Executive Chairman evaluates the performance of KWESST and allocates resources based on the information provided by our internal management system at a consolidated level.  We have determined that we have only one operating segment.

At March 31, 2023, all of our property and equipment are located in Canada, including the right-of-use assets.

F-24

Consolidated Financial Statements of

KWESST MICRO SYSTEMS INC.

Years ended September 30, 2022, and 2021, and

Nine months ended September 30, 2020

(Expressed in Canadian Dollars)

F-25

KWESST MICRO SYSTEMS INC.

Table of contents for the years ended September 30, 2022, and 2021

and nine months ended September 30, 2020

	Page
Independent Auditor's Report	F-27
FINANCIAL STATEMENTS
Consolidated Statements of Financial Position	F-28
Consolidated Statements of Net Loss and Comprehensive Loss	F-29
Consolidated Statements of Changes in Shareholders' Equity (Deficit)	F-30
Consolidated Statements of Cash Flows	F-31
Notes to the Consolidated Financial Statements	F-32-F-74

F-26

Report of Independent Registered Public Accounting Firm

To the Shareholders and Board of Directors

KWESST Micro Systems Inc.:

Opinion on the Consolidated Financial Statements

We have audited the accompanying consolidated balance sheets of KWESST Micro Systems Inc. (the Company) as of September 30, 2022 and 2021, the related consolidated statements of net loss and comprehensive loss, shareholders' equity (deficit), and cash flows for each of the years in the two-year period ended September 30, 2022, and the related notes (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of September 30, 2022 and 2021, and its financial performances and its cash flows for each of the years in the two-year period ended September 30, 2022, in conformity with International Financial Reporting Standards as issued by the International Accounting Standard Board.

Going Concern

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2(a) to the consolidated financial statements, the Company has incurred significant losses and negative cash flows from operations since inception that raise substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 2(a). The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

Basis for Opinion

These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audit included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audit also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audit provides a reasonable basis for our opinion.

/s/ KPMG LLP

Chartered Professional Accountants, Licensed Public Accountants

We have served as the Company's auditor since 2021.

Ottawa, ON

January 27, 2023

F-27

KWESST MICRO SYSTEMS INC.

Consolidated Statements of Financial Position

At September 30, 2022 and 2021

			September 30,			September 30,
In Canadian dollars	Notes		2022			2021
ASSETS
Cash		$	170,545		$	2,688,105
Restricted short-term investment	12		30,000			30,000
Trade and other receivables	5		171,882			699,251
Inventories	6		393,538			90,299
Prepaid expenses and other			122,166			548,042
Deferred share offering costs	27(a)		628,262			-
Current assets			1,516,393			4,055,697
Property and equipment	7		832,481			903,649
Right-of-use assets	8		208,131			266,214
Deposit	8		23,604			21,367
Intangible assets	9		4,742,854			3,470,919
Non-current assets			5,807,070			4,662,149
Total Assets		$	7,323,463		$	8,717,846
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Accounts payable and accrued liabilities	10	$	4,459,481		$	1,127,202
Lease obligations	13		69,150			32,288
Accrued royalties liability	4(b)		150,000			-
Borrowings	12, 27(b)(c)		2,199,978			-
Contract liabilities	14		47,271			-
Current liabilities			6,925,880			1,159,490
Accrued royalties liability	4(b)		1,115,207			1,105,756
Lease obligations	13		206,471			275,621
Borrowings	12		78,796			53,251
Non-current liabilities			1,400,474			1,434,628
Total Liabilities			8,326,354			2,594,118
Shareholders' Equity (Deficit)
Share capital	15(a), 27(a)		19,496,640			17,215,068
Warrants	15(b), 27(a)		1,959,796			1,848,389
Contributed surplus	15(c)		3,551,330			2,458,211
Accumulated other comprehensive loss			(101,418	)		(8,991	)
Accumulated deficit			(25,909,239	)		(15,388,949	)
Total Shareholders' Equity (Deficit)			(1,002,891	)		6,123,728
Total Liabilities and Shareholders' Equity (Deficit)		$	7,323,463		$	8,717,846

See Note 2(a) Going concern and Note 26 Commitments and contingencies.

See accompanying notes to consolidated financial statements.

On behalf of the Board of Directors:

(signed) John McCoach, Director (signed) David Luxton, Director

F-28

KWESST MICRO SYSTEMS INC.

Consolidated Statements of Net Loss and Comprehensive Loss

Years ended September 30, 2022 and 2021 and nine months ended September 30, 2020

			Year ended			Year ended			Nine months ended
			September 30,			September 30,			September 30,
In Canadian dollars	Notes		2022			2021			2020
Revenue	17	$	721,519		$	1,275,804		$	861,917
Cost of sales			(536,735	)		(798,888	)		(247,113	)
Gross profit			184,784			476,916			614,804
Operating expenses
General and administrative			4,915,263			4,057,167			2,723,861
Selling and marketing			3,296,373			3,484,159			564,266
Research and development, net	21(a)		2,064,493			2,138,138			817,584
Total operating expenses	18		10,276,129			9,679,464			4,105,711
Operating loss			(10,091,345	)		(9,202,548	)		(3,490,907	)
Other income (expenses)
Fair value adjustments on derivatives			-			-			29,463
Net finance costs	20		(506,002	)		(107,751	)		(61,397	)
Foreign exchange gain (loss)			28,780			(3,742	)		(13,937	)
Loss on disposals			(1,165	)		(1,331	)		-
Total other expenses, net			(478,387	)		(112,824	)		(45,871	)
Loss before income taxes			(10,569,732	)		(9,315,372	)		(3,536,778	)
Income tax recovery
Deferred tax recovery	21		49,442			-			-
Net loss		$	(10,520,290	)	$	(9,315,372	)	$	(3,536,778	)
Other comprehensive loss:
Items that are or may be reclassified subsequently to profit or loss:
Foreign currency translation differences			(92,427	)		(8,991	)		-
Total comprehensive loss		$	(10,612,717	)	$	(9,324,363	)	$	(3,536,778	)
Net loss per share
Basic and diluted		$	(14.41	)	$	(14.72	)	$	(8.03	)
Weighted average number of shares outstanding
Basic and diluted	16		730,302			632,721			440,631

See accompanying notes to consolidated financial statements.

F-29

KWESST MICRO SYSTEMS INC.

Consolidated Statements of Changes in Shareholders' Equity (Deficit)

Years ended September 30, 2022 and 2021 and nine months ended September 30, 2020

In Canadian dollars																					Total
			Share			Contingent						Contributed			Translation						Shareholders'
	Notes		capital			shares			Warrants			surplus			reserve			Deficit			Equity (Deficit)
Balance, December 31, 2019			2,284,353						21,050			-			-			(2,536,799	)		(231,396	)
Shares and warrants issued for cash	15(a),(b)		4,568,013						76,120			-			-			-			4,644,133
Shares for converted debt and interest	15(a)		1,583,881						-			-			-			-			1,583,881
Shares issued for performance incentive	15(a)		731,500						-			-			-			-			731,500
Shares from Foremost's QT	4(c)		628,949						-			41,155			-			-			670,104
Shares and warrants issued on asset acquisition	4(c)		167,280						180,000			-			-			-			347,280
Stock options exercised	15(c)		78,080						-			(17,531	)		-			-			60,549
Shares for consulting services	15(a)		32,393						-			-			-			-			32,393
Share-based compensation	15(c)		-						-			283,084			-			-			283,084
Share offering costs	15(a)		(699,886	)					-			-			-			-			(699,886	)
Net loss			-						-			-			-			(3,536,778	)		(3,536,778	)
Balance, September 30, 2020		$	9,374,563		$	-		$	277,170		$	306,708		$	-		$	(6,073,577	)	$	3,884,864
Shares for debt settlements	15(a)		63,866			-			-			-			-			-			63,866
Warrants exercised	15(b)		815,307			-			(175,741	)		-			-			-			639,566
Shares and warrants issued on asset acquisition	4(b)		1,290,000			-			425,000			-			-			-			1,715,000
Shares for amended license	26		137,000			-			-			-			-			-			137,000
Shares and warrants issued for cash	15(a),(b)		4,721,818			-			1,280,654			-			-			-			6,002,472
Stock options and warrants exercised	15(c)		1,639,695			-			41,306			(531,263	)		-			-			1,149,738
Share-based compensation	15(c)		-			-			-			2,462,207			-			-			2,462,207
Restricted share units vested	15(c)		12,498			-			-			(12,498	)		-			-			-
Share offering costs	15(a)		(839,679	)		-			-			233,057			-			-			(606,622	)
Other comprehensive loss			-			-			-			-			(8,991	)		-			(8,991	)
Net loss			-			-			-			-			-			(9,315,372	)		(9,315,372	)
Balance, September 30, 2021		$	17,215,068		$	-		$	1,848,389		$	2,458,211		$	(8,991	)	$	(15,388,949	)	$	6,123,728
Shares issued to settle debt	15(a)		19,000			-			-			-			-			-			19,000
Shares and warrants issued on acquisition	4(a)		377,503			83,319			132,000			-			-			-			592,822
Shares and warrants issued for cash	15(a),(b)		272,000			-			72,000			-			-			-			344,000
Contingent shares converted to common shares	4(a)		83,319			(83,319	)		-			-			-			-			-
Warrants exercised	15(b)		277,098			-			(61,173	)		-			-			-			215,925
Warrants expired	15(b)		-			-			(31,420	)		31,420			-			-			-
Share-based compensation	15(c)		-			-			-			1,960,072			-			-			1,960,072
Shares for vested RSUs and PSUs	15(c)		874,840			-			-			(874,840	)		-			-			-
Vested RSUs and PSUs repurchased for
withholding taxes	15(c)		-			-			-			(23,533	)		-			-			(23,533	)
Shares issued for unsecured loans	12		411,692			-			-			-			-			-			411,692
Share offering costs	15(a)		(33,880	)		-			-			-			-			-			(33,880	)
Other comprehensive loss			-			-			-			-			(92,427	)		-			(92,427	)
Net loss			-			-			-			-			-			(10,520,290	)		(10,520,290	)
Balance, September 30, 2022		$	19,496,640		$	-		$	1,959,796		$	3,551,330		$	(101,418	)	$	(25,909,239	)	$	(1,002,891	)

See accompanying notes to consolidated financial statements.

F-30

KWESST MICRO SYSTEMS INC.

Consolidated Statements of Cash Flows

Years ended September 30, 2022 and 2021 and nine months ended September 30, 2020

			Year ended			Year ended			Nine months ended
			September 30,			September 30,			September 30,
In Canadian dollars	Notes		2022			2021			2020
OPERATING ACTIVITIES
Net loss		$	(10,520,290	)	$	(9,315,372	)	$	(3,536,778	)
Items not affecting cash:
Share-based compensation	15(c)		1,960,072			2,462,207			283,084
Net finance costs	20		506,002			107,751			61,217
Depreciation and amortization	7, 8, 19		326,491			140,990			103,397
Deferred tax recovery	21		(49,442	)		-			-
Loss on disposals			1,165			1,331			-
Impairment of intangible assets	9		-			55,376			-
Shares for amended license	26		-			137,000			-
Shares issued for M&A advisory and consulting services			-			-			763,893
Fair value adjustments on derivative liabilities			-			-			(29,463	)
Non-cash listing expense			-			-			814,703
Changes in non-cash working capital items	23		3,639,822			198,484			(245,095	)
Interest paid			(120,416	)		(42,980	)		(6,612	)
Cash used in operating activities			(4,256,596	)		(6,255,213	)		(1,791,654	)
INVESTING ACTIVITIES			(1,176,664	)
Investments in intangible assets	9					(83,228	)		(163,230	)
Acquisition of property and equipment	7		(187,478	)		(809,964	)		(133,927	)
Acquisition of technology asset			-			-			(134,192	)
Cash acquired on acquisition	4(a)		162,547			-			-
Recognition of open orders from acquisition	9		87,802			-			-
Deposit for advanced royalties	4(b)		-			(150,000	)		-
Deposit for long-term office lease			-			-			(38,212	)
Purchase of restricted short-term investment	12		-			(30,000	)		-
Cash acquired on closing of Foremost			-			-			78,589
Cash flows used in investing activities			(1,113,793	)		(1,073,192	)		(390,972	)
FINANCING ACTIVITIES			2,543,230
Proceeds from borrowings	12					326,000			40,000
Payments of deferred financing fees	12		(150,409	)		-			-
Proceeds from the issuance of common shares and warrants	15(a)		344,000			6,002,472			4,355,171
Payments of share offering costs	15(a)		(33,880	)		(606,622	)		(164,716	)
Proceeds from related party advances	11		60,000			-			-
Repayments to related party advances	11		(60,000	)		(218,276	)		(80,000	)
Proceeds from exercise of warrants	15(b)		215,925			680,872			-
Proceeds from convertible notes and converted to equity			-			-			1,081,504
Repayments of lease obligations	13		(42,504	)		(44,128	)		(58,188	)
Repurchase of vested RSUs and PSUs for withholding taxes			(23,533	)		-			-
Repayment of borrowings	12		-			(306,000	)		-
Proceeds from exercise of stock options	15(c)		-			1,108,432			61,000
Cash flows provided by financing activities			2,852,829			6,942,750			5,234,771
Net change in cash during the year			(2,517,560	)		(385,655	)		3,052,145
Cash, beginning of year			2,688,105			3,073,760			21,615
Cash, end of year		$	170,545		$	2,688,105		$	3,073,760

See Note 23 Supplemental cash flow information.

See accompanying notes to consolidated financial statements.

F-31

KWESST MICRO SYSTEMS INC.
Notes to Consolidated Financial Statements
Years ended September 30, 2022, and 2021 and nine months ended September 30, 2020
(Expressed in Canadian dollars, except share amounts)

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 and on the Frankfurt Stock Exchange under the stock symbol of 62U.  As a result of the U.S. IPO (see Note 28 (a), Subsequent Events - U.S. IPO and Canadian Offering), KWESST's common stock and warrants issued under the Form F-1 Registration Statement are also listed on the Nasdaq Capital Market ("Nasdaq") under the stock symbol of KWE and KWESW, respectively, as of December 7, 2022.

b)Reverse Stock Split

In August 2022, we submitted a Form F-1 Registration Statement to the U.S. Securities and Exchange Commission and applied to have its common shares listed on the Nasdaq Capital Market ("Nasdaq"). In connection with KWESST's listing application on Nasdaq, KWESST effected a one for seventy (1-for-70) reverse stock split of its common stock on October 28, 2022 (the "Reverse Split").  Accordingly, all shareholders of record at the opening of business on October 28, 2022, received one issued and outstanding common share of KWESST in exchange for seventy outstanding common shares of KWESST.  No fractional shares were issued in connection with the Reverse Split.  All fractional shares created by the Reverse Split were rounded to the nearest whole number of common shares, with any fractional interest representing 0.5 or more common shares entitling holders thereof to receive one whole common share. 

Effective on the date of the Reverse Split, the exercise price and number of common shares issuable upon the exercise of outstanding stock options were proportionately adjusted to reflect the Reverse Split.  The restricted share units ("RSUs") and performance stock units ("PSUs") have also been adjusted for the Reverse Split.  While the number of warrants has not changed as a result of the Reverse Split; the conversion rate for each warrant was adjusted from one common share to 0.01428571 common share.  All information respecting outstanding common shares and other securities of KWESST, including net loss per share, in the current and comparative periods presented herein give effect to the Reverse Split.

2.Basis of preparation

(a)Going concern

These consolidated financial statements have been prepared assuming we will continue as a going concern. The going concern basis of presentation assumes we will continue in operation for the foreseeable future and can realize our assets and discharge our liabilities and commitments in the normal course of business.

As an early-stage company, we not yet reached commercial production for most of our products and have incurred significant losses and negative operating cash flows from inception that have primarily been funded from financing activities. We have incurred a $10.5 million net loss and negative operating cash flows of approximately $4.3 million for the year ended September 30, 2022 (2021 - $9.3 million net loss and negative operating cash flows of $6.3 million). At September 30, 2022, we had $5.4 million in negative working capital (2021 - positive working capital of $2.9 million).

F-32

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Years ended September 30, 2022, and 2021 and nine months ended September 30, 2020

(Expressed in Canadian dollars, except share amounts)

Our ability to continue as a going concern and realize our assets and discharge our liabilities in the normal course of business is dependent upon closing timely additional sales orders, timely commercial launch of new products, and the ability to raise additional debt or equity financing, when required. There are various risks and uncertainties affecting our future financial position and our performance including, but not limited to:

• The market acceptance and rate of commercialization of our product offerings;

• Ability to successfully execute our business plan;

• Ability to raise additional capital at acceptable terms;

• General local and global economic conditions, including the ongoing COVID-19 pandemic and the global disruption from Russia's invasion of Ukraine.

Our strategy to mitigate these material risks and uncertainties is to execute timely a business plan aimed at continued focus on revenue growth, product development and innovation, improving overall gross profit, managing operating expenses and working capital requirements, and securing additional capital, as needed.

Failure to implement our business plan could have a material adverse effect on our financial condition and/or financial performance. There is no assurance that we will be able to raise additional capital as they are required in the future. Accordingly, there are material risks and uncertainties that may cast significant doubt about KWESST’s ability to continue as a going concern.

Subsequent to September 30, 2022, we closed our U.S. IPO and Canadian public offering on December 9, 2022, resulting in total gross proceeds of US$14.1 million or CAD$19.2 million (see Note 27(a)). 

These consolidated financial statements do not include any adjustments to the carrying amounts and classification of assets, liabilities and reported expenses that may otherwise be required if the going concern basis was not appropriate.

(b)Statement of compliance

These consolidated financial statements have been prepared in accordance with International Financial Reporting Standards ("IFRS") as issued by the International Accounting Standards Board ("IASB") and interpretations of the IFRS Interpretations Committee ("IFRIC"). 

The consolidated financial statements were authorized for issue by the Board of Directors effective on January 27, 2023.

(c)Principles of consolidation

These consolidated financial statements incorporate the financial statements of KWESST and the entities it controls.

Control is achieved where we have the power to govern the financial and operating policies of an entity so as to obtain benefits from its activities, are exposed to, or have rights to, variable returns from our involvement with the entity and have the ability to affect those returns through its power over the entity. Subsidiaries are fully consolidated from the date on which control is transferred to us until the date on which control ceases. Profit or loss of subsidiaries acquired during the year are recognized from the date of acquisition or effective date of disposal as applicable. All intercompany transactions and balances have been eliminated.

F-33

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Years ended September 30, 2022, and 2021 and nine months ended September 30, 2020

(Expressed in Canadian dollars, except share amounts)

At September 30, 2022, we have the following wholly-owned subsidiaries:

	Location	Equity %
KWESST Inc.	Ottawa, Canada	100%
2720178 Ontario Inc.	Bowmanville, Canada	100%
Police Ordnance Company Inc.	Bowmanville, Canada	100%
KWESST U.S. Holdings Inc.	Delaware, Canada	100%
KWESST Defense Systems U.S. Inc.	Virginia, United States	100%
KWESST Public Safety Systems U.S. Inc.	Virginia, United States	100%
KWESST Public Safety Systems Canada Inc.	Ottawa, Canada	100%

(d)Functional and presentation currency

The consolidated financial statements are presented in Canadian dollars ("CAD"), which is the functional currency of KWESST and its subsidiaries unless otherwise stated.

(e)Measurement basis

The consolidated financial statements have been prepared on the historical cost basis. Historical cost is generally based on the fair value of the consideration given in exchange for assets.

(f)Use of judgments and estimates

The preparation of the consolidated financial statements in accordance with IFRS requires management to make judgments, estimates, and assumptions that affect the application of accounting policies and the reported amounts of assets and liabilities, income, expenses, and disclosure of contingent liabilities. Actual results may differ from these estimates.

Estimates and underlying assumptions are reviewed on an ongoing basis. Revisions to estimates are recognized prospectively.

Judgments

Information about judgments made in applying accounting policies that have the most significant effects on the amounts recognized in these consolidated financial statements is included in the following notes:

• Note 4(a) - acquisition of Police Ordnance: whether the consideration transferred and purchase price allocation assumptions used as inputs in determining the fair value of net assets acquired is reasonable.

• Note 4(b) - acquisition of PARA OPS^TM System: whether the estimated discount rate used to discount the minimum royalty payments is reasonable, and the reasonability of the volatility assumption used in the Black Scholes option model to estimate the fair value of the warrants issued to DEFSEC.

• Note 10 - unsecured loans: whether the estimated market discount rate used to estimate the fair value of the unsecured loans is reasonable.

• Note 15(c) - share-based compensation: whether the determination of KWESST's stock volatility, forfeiture rate, and expected life are reasonable in light of its limited operating history, all significant inputs in the valuation model to fair value options granted; and

F-34

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Years ended September 30, 2022, and 2021 and nine months ended September 30, 2020

(Expressed in Canadian dollars, except share amounts)

• Note 15(c) - broker compensation options: whether the Monte Carlo valuation model and number of simulations, coupled with the volatility assumption, are reasonable to estimate the fair value of these options.

Estimates

Information about assumptions and estimation uncertainties at September 30, 2022, that have a significant risk of resulting in a material adjustment to the carrying amounts of assets and liabilities in the next financial year is included in the following notes:

• Note 9 - impairment test of intangible assets: key assumptions underlying recoverable amounts.

COVID-19 and Economic Uncertainties

While COVID-19 has not had a material impact to our business to date, the following is a summary of what we believe may impact our future business given the persistency of COVID-19: disruptions to business operations resulting from quarantines of employees, customers, manufacturers and other third-party service providers in areas affected by the outbreak; disruptions to business operations resulting from travel restrictions, including travel to industry tradeshows; and uncertainty around the duration of the virus' impact.

Despite the global vaccination efforts underway, the extent to which COVID-19 could impact our operations, financial condition, results of operations, and cash flows is highly uncertain and cannot be predicted. Negative financial results, uncertainties in the market, and a tightening of credit markets, caused by COVID-19, or a recession, could have a material adverse effect on our liquidity and ability to obtain financing in the future.

3.Significant accounting policies

(a)Revenue recognition

Revenue is recognized upon transfer of control of products or services to customers at an amount that reflects the transaction price we expect to receive in exchange for the products or services. Our contracts with customers may include the delivery of multiple products and services, which are generally capable of being distinct and accounted for as separate performance obligations. The accounting for a contract or contracts with a customer that contain multiple performance obligations requires us to allocate the contract or contracts transaction price to the identified distinct performance obligations based on the stand-alone selling price of each performance obligation.

Revenue from contracts with customers is recognized, for each performance obligation, either over a period of time or at a point in time, depending on which method reflects the transfer of control of the goods or services underlying the particular obligation to the customer.

For performance obligations satisfied over time, we recognize revenue over time using an input method, based on costs incurred to date relative to total estimated costs at completion, to measure progress toward satisfying such performance obligation (for non-recurring engineering services, the input method is based on hours). Under this method, costs that do not contribute to the performance of KWESST in transferring control of goods or services to the customer are excluded from the measurement of progress toward satisfying the performance obligation. In certain other situations, we might recognize revenue at a point in time, when the criteria to recognize revenue over time are not met. In any event, when the total anticipated costs exceed the total anticipated revenues on a contract, such loss is recognized in its entirety in the period it becomes known.

We may enter into contractual arrangements with a customer to deliver services on one project with respect to more than one performance obligation, such as non-recurring engineering, procurement, and training. When entering into such arrangements, we allocate the transaction price by reference to the stand-alone selling price of each performance obligation. Accordingly, when such arrangements exist on the same project, the value of each performance obligation is based on its stand-alone price and recognized according to the respective revenue recognition methods described above.  For example, for non-recurring engineering services rendered over a contract period the revenue is recognized using the percentage of completion method; whereas for training services the revenue is recognized after the training is delivered (i.e. point in time).

F-35

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Years ended September 30, 2022, and 2021 and nine months ended September 30, 2020

(Expressed in Canadian dollars, except share amounts)

We account for a contract modification, which consists of a change in the scope or price (or both) of a contract, as a separate contract when the remaining goods or services to be delivered after the modification are distinct from those delivered prior to the modification and the price of the contract increases by an amount of consideration to a price which reflects KWESST's stand-alone selling price of the additional promised goods or services. When the contract modification is not accounted for as a separate contract, we recognize an adjustment to revenue on a cumulative catch-up basis at the date of contract modification.

The timing of revenue recognition often differs from performance payment schedules, resulting in revenue that has been earned but not billed. These amounts are included in unbilled receivables. Amounts billed in accordance with customer contracts, but not yet earned, are recorded and presented as part of contract liabilities.

When a contract includes a significant financing component, the value of such component is excluded from the transaction price and is recognized separately as finance income or expense, as applicable.

(b)Business combinations

We account for business combinations using the acquisition method. Goodwill arising on acquisitions is measured as the fair value of the consideration transferred less the net recognized amount of the estimated fair value of identifiable assets acquired and liabilities assumed, all measured as of the acquisition date.  Transaction costs that we incur in connection with a business combination are expensed as incurred. We use our best estimates and assumptions to reasonably value assets acquired and liabilities assumed at the acquisition date as well as contingent consideration, where applicable, and these estimates are inherently uncertain and subject to refinement. As a result, during the measurement period, which may be up to one year from the acquisition date, we may record adjustments to the assets acquired and liabilities assumed with a corresponding offset to goodwill. Upon conclusion of the measurement period or final determination of the values of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recorded in profit or loss.

Where the total purchase consideration is less than the fair value of identifiable net assets, we recognize a gain on acquisition.

Acquisitions that do not meet the definition of a business are accounted for as asset acquisitions in accordance with the relevant IFRS standards and applicable to the type of asset acquired.

(c)Financial instruments

We recognize a financial asset or a financial liability when it becomes a party to the contractual provisions of the instrument.

Trade and other receivables without a significant financing component are initially measured at the transaction price. All other financial assets and financial liabilities are initially recognized at fair value. Transaction costs that are directly attributable to the acquisition or issue of financial assets and financial liabilities (other than financial assets and financial liabilities at fair value through profit or loss ("FVTPL")) are added to or deducted from the fair value of the financial assets or financial liabilities, as appropriate, on initial recognition. Transaction costs directly attributable to the acquisition of financial assets or financial liabilities at fair value through profit or loss are recognized immediately in profit or loss.

Financial assets

All financial assets are recognized and de-recognized on trade date.

F-36

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Years ended September 30, 2022, and 2021 and nine months ended September 30, 2020

(Expressed in Canadian dollars, except share amounts)

Financial assets are recognized at fair value and subsequently classified and measured at:

a)Amortized cost;

b)Fair value through other comprehensive income ("FVOCI"); or

c)Fair value though profit or loss ("FVTPL").

We determine the classification of our financial assets on the basis of both the business model for managing the financial assets and the contractual cash flows characteristics of the financial asset. Financial assets are not reclassified subsequent to their initial recognition unless we change our business model for managing financial assets.

A financial asset is measured at amortized cost if it is held within a business model whose objective is to hold assets to collect contractual cash flows, and its contractual terms give rise on specified dates to cash flows that are solely payments of principal and interest of the principal amount outstanding. Financial assets classified at amortized cost are measured using the effective interest method. At September 30, 2022, we classified the following as amortized cost:

• Cash

• Restricted short-term investment

• Trade and other receivables

• Lease deposit (non-current other asset)

All financial assets not classified and measured at amortized cost or FVOCI are measured at FVTPL. At September 30, 2022, we did not have financial assets classified as FVOCI or FVTPL.

Expected credit losses

We measure a loss allowance based on the lifetime expected credit losses. Lifetime expected credit losses are estimated based on factors such as our past experience of collecting payments, the number of delayed payments in the portfolio past the average credit period, observable changes in national or local economic conditions that correlate with default on receivables, financial difficulty of the borrower, and it becoming probable that the borrower will enter bankruptcy or financial re-organization.

Financial assets are written off when there is no reasonable expectation of recovery.

Financial liabilities

Financial liabilities are recognized at fair value and subsequently classified and measured at amortized cost or fair value though profit or loss ("FVTPL").

We determine the classification of our financial liabilities at initial recognition. We have classified the following as amortized costs:

• Accounts payable and accrued liabilities

• Corporate tax payable

• Borrowings

• Lease obligations

• Accrued royalties liability

Financial liabilities at amortized cost are measured using the effective interest rate method.

De-recognition of financial liabilities

KWESST de-recognizes financial liabilities when its obligations are discharged, cancelled or they expire.

F-37

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Years ended September 30, 2022, and 2021 and nine months ended September 30, 2020

(Expressed in Canadian dollars, except share amounts)

(d)Cash and cash equivalents

Cash and cash equivalents include cash investments in interest-bearing accounts and term deposits which can readily be redeemed for cash without penalty or are issued for terms of three months or less from dated of acquisition.

(e)Inventories

KWESST's inventories may consist of raw materials, work-in-progress ("WIP"), and finished goods. Inventories are measured at the lower of cost and net realizable value, with cost being determined using the weighted average cost method. The cost of WIP and finished goods includes the cost of raw materials, direct labour, and overhead. Net realizable value is the estimated selling price in the ordinary course of business, less the estimated costs of completion and selling expenses. At each reporting period, management estimates the provision for obsolete and slow-moving inventory which may be reversed in subsequent periods, should the value subsequently be recovered.

(f)Property and equipment

Property and equipment are measured at cost less accumulated depreciation and accumulated impairment losses. Cost comprises the fair value of consideration given to acquire or construct an asset and includes the direct charges associated with bringing the asset to the location and condition necessary for putting it into use along with the future cost of dismantling and removing the asset. These assets are depreciated over their estimated useful lives using the straight-line method as this most closely reflects the expected pattern of consumption of the future economic benefits. Depreciation methods, useful lives and residual values are reviewed at each financial year end and adjusted prospectively, if appropriate.

The following table provides a summary of estimated useful lives for our property and equipment:

	Rate
Computer equipment	3 years
Computer software	3 years
Office furniture and equipment	5 years
Low-rate initial production equipment	5 years
R&D equipment	5 years
Sales demo equipment	2 years
Leasehold improvements	Shorter of useful life or remaining term of lease

At the end of each reporting period, we review the carrying amounts of its property and equipment to determine whether there is any indication of impairment. If any such indication exists, the recoverable amount of the asset is estimated in order to determine the extent of the impairment loss (if any). The recoverable amount is the higher of fair value less costs to sell and value in use. In assessing value in use, the estimated future cash flows are discounted to their present value using a pre-tax discount rate that reflects current market assessments of the time value of money and the risks specific to the asset. For the purpose of impairment testing, assets that cannot be tested individually are grouped together into the smallest group of assets that generates cash inflows from continuing use that are largely independent of the cash flows of other assets or groups of assets (the "cash-generating unit, or CGU"). If the recoverable amount of an asset is estimated to be less than its carrying amount, the carrying amount of the asset is reduced to its recoverable amount. An impairment loss is recognized immediately in profit or loss.

Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.

F-38

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Years ended September 30, 2022, and 2021 and nine months ended September 30, 2020

(Expressed in Canadian dollars, except share amounts)

(g)Leases

At inception of a contract, we assess whether a contract is, or contains, a lease based on whether the contract conveys the right to control the use of an identified asset for a period of time in exchange for consideration.

We recognize a right-of-use asset and a lease liability at the lease commencement date. The lease obligation is measured at the present value of the lease payments that are not paid at the commencement date of the lease, discounted using its incremental borrowing rate at the inception of the lease (it was 10% for the current outstanding lease agreement). The right-of-use asset is initially measured based on the initial amount of the lease liability adjusted for any lease payments made at or before the commencement date, plus any initial direct costs incurred and an estimate of costs to dismantle and remove the underlying asset or to restore the underlying asset or the site on which it is located, less any lease incentives received. The assets are depreciated to the earlier of the end of the useful life of the right-of-use asset or the lease term using the straight-line method as this most closely reflects the expected pattern of consumption of the future economic benefits. The lease term includes periods covered by an option to extend if we are reasonably certain to exercise that option.  In addition, the right-of-use asset is periodically reduced by impairment losses, if any, and adjusted for certain remeasurements of the lease liability.

The lease liability is initially measured at the present value of the lease payments that are not paid at the commencement date, discounted using the interest rate implicit in the lease or, if that rate cannot be readily determined, our incremental borrowing rate. Variable lease payments that do not depend on an index or rate are not included in the measurement of the lease liability.

The lease liability is measured at amortized cost using the effective interest method. It is remeasured when there is a change in future lease payments arising from a change in an index or rate, if there is a change in our estimate of the amount expected to be payable under a residual value guarantee, or if we change our assessment of whether it will exercise a purchase, extension, or termination option. When the lease liability is remeasured in this way, a corresponding adjustment is made to the carrying value of the right-of-use asset or, is recorded in profit or loss if the carrying amount of the right-of-use asset has been reduced to zero.

We have elected to apply the practical expedient not to recognize right-of-use assets and lease liabilities for short-term leases that have a lease term of 12 months or less and leases of low-value assets. The lease payments associated with these leases are recognized as an expense on a straight-line basis over the lease term.

(h)Intangible assets

(i)Research and development ("R&D") costs

Expenditure on research activities, undertaken with the prospect of gaining new scientific or technical knowledge and understanding, is recognized in profit or loss when incurred.

Development expenditure is capitalized only if development costs can be measured reliably, the product or process is technically and commercially feasible, future economic benefits are probable, and we have the intention and sufficient resources to complete the development and to use or sell the asset. The expenditure capitalized in respect of development activities includes the cost of materials, direct labor and overhead costs that are directly attributable to preparing the asset for its intended use, and capitalized borrowing costs. Other development expenditures are recognized in profit or loss when incurred.

(ii)Subsequent expenditure

Subsequent expenditure is capitalized only when it increases the future economic benefits embodied in the specific asset to which it relates. All other expenditures, including expenditure on internally generated goodwill and brands, is recognized in profit or loss as incurred.

F-39

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Years ended September 30, 2022, and 2021 and nine months ended September 30, 2020

(Expressed in Canadian dollars, except share amounts)

(iii)Acquired intangible assets

Acquired intangible assets consist of open customer orders, tradenames, customer relationships, patents, and technology assets acquired either through an asset purchase or a business combination transaction. These intangible assets are recorded at their fair value at the acquisition date.

After initial recognition, except for open customer orders, intangible assets are measured at cost less any accumulated amortization and impairment losses.  For open customer orders, we reduce the amount when we have delivered under the customer contract, with an offset to accounts receivable (i.e. there is no revenue recognized for acquired open customer orders). Intangible assets with finite useful lives are amortized on a straight-line basis over their estimated useful lives. Amortization begins when the related acquired technology is commercialized.  We anticipate the estimated useful life for the current technology assets to be five years once commercialized.

(iv)Amortization

Amortization is a systematic allocation of the amortizable amount of an intangible asset of its useful life. The amortizable amount is the cost of the asset less its estimated residual value. We recognize in profit or loss on a sales-based rate over the estimated useful lives of the intangible assets from the date they are available for use, since this method most closely reflects the expected pattern of consumption of the future economic benefits embodied in each asset. Where a sales-based rate could not be determined, the straight-line approach is used.

Internally generated intangible assets are not systematically amortized as long as they are not available for use i.e. they are not yet  in working condition for their intended use. Accordingly, intangible assets such as development costs are tested for impairment at least once a year, until such date as they are available for use.

(v)Impairment

All intangible assets are periodically reviewed for impairment. The estimated present value of future cash flows associated with the intangible asset is determined and an impairment loss is recognized for the difference between this amount and the carrying amount as follows: the carrying amount of the asset is reduced to estimated present value of the future cash flows associated with the asset, discounted at the financial asset's original effective interest rate, and the resulting loss is directly recognized in profit or loss for the period.

(i)Provisions

A provision is recognized if, as a result of a past event, we have a present legal or constructive obligation that can be estimated reliably, and it is probable that an outflow of economic benefits will be required to settle the obligation. Provisions are determined by discounting the expected future cash flows at a pre-tax rate that reflects current market assessments of the time value of money and the risk specific to the liability. The accretion of the discount is recognized as a finance cost.

(j)Income taxes

Income tax expense comprises current income tax expense and deferred income tax expense. Current and deferred income taxes are recognized as an expense and included in profit or loss for the period, except to the extent that the tax arises from a transaction which is recognized in other comprehensive income or directly in shareholder's deficiency.

F-40

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Years ended September 30, 2022, and 2021 and nine months ended September 30, 2020

(Expressed in Canadian dollars, except share amounts)

Current income tax

Current tax expense is the amount of income taxes payable (recoverable) in respect of the taxable income (tax loss) for a period. Current liabilities (assets) for the current and prior periods are measured at the amount expected to be paid to (recovered from) the taxation authorities, using the tax rates that have been enacted or substantively enacted by the end of the reporting period.

Deferred income tax

Deferred tax assets and liabilities are recognized for the temporary differences between transactions and carrying amounts of assets and liabilities that have been included in the consolidated financial statements and the amounts used for taxation purposes. Deferred income taxes are provided for using the liability method. Under the liability method, deferred income taxes are recognized for all significant temporary differences between the tax and financial statement bases of assets and liabilities and for certain carry-forward items. Deferred income tax assets are recognized only to the extent that it is probable that the deferred income tax assets will be realized. Deferred tax assets are reviewed at each reporting date and are reduced to the extent it is no longer probable that the related tax benefit will be realized.

Deferred tax assets and liabilities are measured at the tax rates that are expected to apply in the year when the asset is realized or the liability is settled, based on tax rates (and tax laws) that have been enacted or substantively enacted at the reporting period. Deferred income tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of the enactment or substantive enactment. Deferred tax assets and liabilities are offset when there is a legally enforceable right to set off current tax assets against current tax liabilities and when they relate to income taxes levied by the same taxation authority and we intend to settle our current tax assets and liabilities on a net basis.

Investment tax credits

Investment tax credits relating to scientific research and experimental development expenditures are recorded in the fiscal period the qualifying expenditures are incurred based on management's interpretation of applicable legislation in the Income Tax Act of Canada. Credits are recorded provided there is reasonable assurance that the tax credit will be realized. Credits claimed are subject to review by the Canada Revenue Agency.

Credits claimed in connection with R&D activities are accounted for using the cost reduction method. Under this method, assistance and credits relating to the acquisition of equipment is deducted from the cost of the related assets, and those relating to current expenditures, which are primarily salaries and related benefits, are included in the determination of profit or loss as a reduction of the R&D expenses.

(k)Related party transactions

Parties are considered to be related if one party has the ability, directly or indirectly, to control the other party or exercise significant influence over the other party in making financial and operating decisions. Parties are also considered to be related if they are subject to common control or common significant influence. Related parties may be individuals or corporate entities. A transaction is considered to be a related party transaction when there is a transfer of resources or obligations between related parties. Related party transactions are in the normal course of business and have commercial substance.

(l)Share-based compensation

We have a Long-Term Incentive Plan ("LTIP") in which we may grant stock options, restricted share units ("RSUs"), performance stock units ("PSUs"), deferred stock units ("DSUs"), and stock appreciation rights ("SARs") to directors, employees and consultants. We measure share-based compensation at fair value for all share-based awards granted under the LTIP.

F-41

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Years ended September 30, 2022, and 2021 and nine months ended September 30, 2020

(Expressed in Canadian dollars, except share amounts)

Equity-settled service award

The grant date fair value of equity-settled share-based awards is recognized as an expense on a straight-line basis over the requisite service period, with a corresponding increase in equity, over the vesting period of the awards. For stock options, the grant date fair value is determined using the Black-Scholes option model. For share units, the grant date fair value is based on KWESST's closing stock price. Each tranche of an award is considered a separate award with its own vesting period and grand date fair value. The amount recognized as an expense is adjusted for estimated forfeitures.

Equity-settled performance award

The accounting for equity-settled performance award is the same as above, except compensation expense is subject to periodic adjustment based on the achievement of establishment performance criteria. 

Modified award

Where the terms of an equity-settled transaction award are modified, the minimum expense recognized is the expense as if the terms had not been modified and if the original terms of the award are met. An additional expense is recognized for any modification that increases the total fair value of the share-based payment transaction or is otherwise beneficial to the employees as measured at the date of acquisition.

(m)Foreign currency

Foreign currency transactions

The financial statements of KWESST and its Canadian wholly-owned subsidiaries are measured using CAD as the functional currency. Transactions in currencies other than in CAD are translated at the exchange rates prevailing at the dates of the transactions. At the end of each reporting period, monetary items denominated in foreign currencies are translated to the functional currency at the rates prevailing at that date. Exchange differences on monetary items are recognized in profit or loss in the period in which they arise. Non-monetary items carried at fair value that are denominated in foreign currencies are translated to the functional currency at the rates prevailing at the date when the fair value was determined. Non-monetary items that are measured in terms of historical cost in a foreign currency are translated using the rates at the date of the transaction and are not subsequently retranslated.

Foreign operations

The financial statements of KWESST's U.S. owned subsidiaries are measured using the United States dollar ("USD") as its functional currency. Assets and liabilities have been translated into USD using exchange rates prevailing at the end of each reporting period. Income and expense items are translated at the average exchange rates for the period, unless exchange rates fluctuate significantly during that period, in which cases the exchange rates at the dates of the transactions are used. Exchange differences arising, if any, are recognized in other comprehensive income and accumulated in shareholders' equity.

(n)Earnings (loss) per share

Basic earnings (loss) per share is computed using net earnings (loss) over the weighted average number of common shares outstanding during the period. We use the treasury stock method to compute the dilutive effect of options, warrants, and similar instruments. Under this method, the dilutive effect on earnings per share is calculated presuming the exercise of outstanding options, warrants, and similar instruments. It assumes that the proceeds of such exercise would be used to repurchase common shares at the average market price during the period.

However, the calculation of diluted loss per share excludes the effects of various conversions and exercises of convertible debt, options and warrants that would be anti-dilutive.

F-42

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Years ended September 30, 2022, and 2021 and nine months ended September 30, 2020

(Expressed in Canadian dollars, except share amounts)

4.Acquisitions

a)Police Ordnance

On December 15, 2021, we acquired 2720178 Ontario Inc., an Ontario (Canada) corporation, which owns all of the issued and outstanding shares of Police Ordnance Company Inc., an Ontario (Canada) corporation (together, "Police Ordnance"), herein referred as the "Police Ordnance Acquisition". Located in Bowmanville, Ontario, with ancillary operations in Florida, Police Ordnance owns all intellectual properties to the ARWEN^TM product line of launchers, and a proprietary line of 37 mm cartridges designed for riot control and tactical teams.  Police Ordnance has law enforcement customers across Canada, the United States, and abroad. The Police Ordnance Acquisition provides us with a strategic opportunity to leverage its law enforcement customer base to accelerate growth within its specialty ordnance business.

We accounted for the acquisition of Police Ordinance pursuant to IFRS 3, Business Combinations.

Consideration Transferred:

The purchase consideration comprised of the following:

	Number		Fair Value
Common shares	3,965	$	377,503
Warrants	200,000	$	132,000
Contingent shares	875	$	83,319
Total fair value purchase consideration		$	592,822

The warrants are exercisable at $1.72 each and will expire on December 15, 2024. As a result of the Reverse Split (see Note 1(b)), each warrant converts into 0.01428571 common share or 70 warrants to receive one common share of KWESST.

We issued the 875 contingent common shares to the sellers in April 2022 following the fulfillment of the financial milestone as defined in the share purchase agreement.

We have estimated the fair value as follows:

• Common shares: based on KWESST's closing stock price on December 15, 2021.

• Warrants: based on using the Black Scholes option model with the following key inputs: a) exercise price of $1.72, 1/70 of the underlying stock price of $1.36, risk free rate of 1.04%, expected life of three years, and expected volatility of 84.7%.

• Contingent shares: based on KWESST's closing stock price on December 15, 2021, and high probability of achieving the financial milestone as defined in the share purchase agreement.

The net cash inflow as at the closing of the acquisition was as follows:

Cash assumed on acquisition	$	162,547
less: consideration paid in cash		-
Net cash inflow on acquisition	$	162,547

F-43

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Years ended September 30, 2022, and 2021 and nine months ended September 30, 2020

(Expressed in Canadian dollars, except share amounts)

Net Assets Acquired:

The purchase consideration was allocated to Police Ordnance's net assets as follows:

Total purchase consideration at fair value	$	592,822
Police Ordnance's net assets:
Cash		162,547
Trade and other receivables		104,432
Inventories		352,685
Intangible assets:
Purchase orders		100,000
Customer relationships		50,000
ARWENTM tradename		44,000
Accounts payable and accrued liabilities		82,963
Corporate tax liability		32,338
Contract liabilities		29,861
Borrowings		26,238
Deferred tax liabilities		49,442
Net assets at fair value	$	592,822

As a result of the above purchase price allocation, we have recorded no goodwill for the Police Ordnance Acquisition.

Impact on KWESST's Results of Operations:

The results of operations of Police Ordnance are included in these consolidate statements of net loss and comprehensive loss from December 16, 2021. For the year ended September 30, 2022, Police Ordnance contributed revenue of $355,296 and net loss of $198,353 to our consolidated results.

If the acquisition had occurred on October 1, 2021, management estimates that Police Ordnance would have contributed approximately $846,600 of revenue and approximately $31,000 of net profit to our operating results for the year ended September 30, 2022, respectively. In determining these amounts, we have assumed that the fair value adjustments that arose on the date of the acquisition would have been the same if the acquisition had occurred on October 1, 2021.

We incurred immaterial acquisition-related costs.

b)LEC System

On April 29, 2021, we acquired the Low Energy Cartridge technology from DEFSEC, a proprietary non-lethal cartridge-based firing system (subsequently branded as PARA OPS^TM system). This technology acquisition includes all intellectual property rights for the PARA OPS^TM system.  With this acquisition, we will target the following four market segments that currently use a variety of dated "non-lethal" or "less-lethal" systems:

(i)public order (riots and control of dangerous subjects);

(ii)military and law enforcement training (realistic force-on-force training);

(iii)personal defence (home, car, boat, RV, camping, hiking); and

(iv)high-action gaming.

As DEFSEC is a private company owned by our Executive Chairman, this asset acquisition is a related party transaction.  We relied on exemptions from the formal valuation and minority shareholder approval requirements available under Multilateral Instrument 61-101, Protection of Minority Security Holders in Special Transactions.  However, we obtained approval from over 51% disinterested shareholders as well as from the TSX-V prior to closing the acquisition.

F-44

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Years ended September 30, 2022, and 2021 and nine months ended September 30, 2020

(Expressed in Canadian dollars, except share amounts)

We accounted for the acquisition of the PARA OPS^TM pursuant to IFRS 2, Share-Based Payment.

The purchase consideration consisted of:

• 14,286 common shares of KWESST; and

• 500,000 warrants to purchase our common shares at $0.70 each per 1/70 of a common share (70 warrants for one common share); 25% vesting on the first anniversary of the closing of the acquisition and 25% per annum thereafter. These warrants will expire on April 29, 2026.

Additionally, we will pay 7% royalty on annual sales of the PARA OPS^TM system to DEFSEC, net of taxes and duties, up to a maximum of $10 million, subject to minimum annual royalty payments starting in 2022. At closing of the acquisition, we made an upfront payment of $150,000 as an advance on future royalty payments. 

The minimum annual royalty payments are as follows:

Date		Amount
April 29 2023	$	150,000
April 29 2024	$	150,000
April 29 2025	$	200,000
April 29 2026	$	200,000
April 29 2027	$	250,000
April 29 2028	$	250,000
April 29 2029	$	300,000
April 29 2030	$	300,000
April 29 2031	$	350,000
April 29 2032	$	350,000
Total	$	2,500,000

The royalty payment obligation of the Purchase Agreement ("Agreement") will expire in 20 years unless terminated earlier under the terms set out in the Agreement.  At our sole discretion, we may terminate this Agreement for convenience, including if market conditions for sales of the PARA OPS^TM system become unfavorable subject 60 day's prior written notice.  Upon termination, we will be fully released and discharged by DEFSEC including the outstanding future royalties and any unvested warrants shall be immediately cancelled.  In return, we will return all intellectual property rights relating to the PARA OPS^TM system to DEFSEC.

The purchase price was determined as follows:

	Number		Fair Value
Common shares	14,286	$	1,290,000
Warrants	500,000	$	425,000
Minimum royalty payments		$	1,191,219
Total		$	2,906,219
Identifiable intangible assets
Technology asset		$	2,906,219

F-45

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Years ended September 30, 2022, and 2021 and nine months ended September 30, 2020

(Expressed in Canadian dollars, except share amounts)

We estimated the fair value as follows:

• Common shares: based on KWESST's closing stock price on April 29, 2021.

• Warrants: based on using the Black Scholes option model with the following key inputs: a) exercise price of $0.70, 1/70 of the underlying stock price of $1.29, risk free rate of 0.48%, expected life of three years, and expected volatility of 80%.

• Minimum royalty payments: based on the income approach, specifically discounted cash flows, using a discount rate of 13.7% per annum.

During the year ended September 30, 2022, we recorded $159,451 of accretion cost relating to the discounted minimum royalty payments, which is included in net finance costs in the consolidated statements of net loss and comprehensive loss (2021 - $64,537). As at September 30, 2022, $1,265,207 of accrued royalties liability was outstanding (2021 - $1,105,756).

c)Reverse acquisition

On September 17, 2020, Foremost Ventures Corp. ("Foremost") completed the Qualifying Transaction ("QT") with KWESST Inc. pursuant to the policies of the TSX-V. Prior to the completion of the QT, Foremost effected a consolidation of its outstanding common shares on the basis of one post-consolidation common share for every 326.9 pre-consolidation common shares. The QT was done by way of a three-cornered amalgamation (the "Amalgamation") pursuant to which, among other things:

(i)KWESST Inc. amalgamated with a wholly-owned subsidiary of Foremost, incorporated for the purposes of the Amalgamation, pursuant to the provisions of the Business Corporations Act (Ontario),

(ii)Foremost changed its name to KWESST Micro Systems Inc., and

(iii)all of the outstanding common shares of KWESST Inc. (the "KWESST Shares") were cancelled and, in consideration the holders thereof received post-consolidation common shares of KWESST Micro Systems Inc. on the basis of one KWESST Micro System Inc. share for each KWESST Share.

Immediately following the QT, there were 589,517 shares of KWESST outstanding, of which 576,681 were held by the former shareholders of KWESST Inc. (representing approximately 97.8% of the outstanding shares of the Company) and 12,836 were held by the shareholders of Foremost prior to the QT. Accordingly, this transaction was accounted for as a reverse acquisition where KWESST Inc. was deemed to be the acquirer for accounting purposes.

The reverse acquisition of Foremost was accounted for under IFRS 2, Share-based Payment. Accordingly, the fair value of the purchase consideration was accounted for at the fair value of the equity instruments granted by the shareholders of KWESST Inc. to the shareholders and option holders of Foremost.

The following represents management's estimate of the fair value of the net assets acquired and total consideration transferred at September 17, 2020, the closing date of the QT.

Number of common shares issued to
Foremost shareholders		12,836
KWESST's stock price at closing of reverse acquisition (1)	$	49.00
Common shares	$	628,949
Options		41,155
Total consideration transferred	$	670,104

(1)At closing, the subscription receipts issued by KWESST Inc. on July 9, 2020 pursuant to a brokered private placement (the "KWESST Subscription Receipts"), were automatically converted, into shares of KWESST. The private placement which was completed through PI Financial Corp. as agent, consisted of 62,994 KWESST Subscription Receipts issued at $49.00 per KWESST Subscription Receipt for gross proceeds of about $3.1 million before share issuance costs. See Note 16(a).

F-46

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Years ended September 30, 2022, and 2021 and nine months ended September 30, 2020

(Expressed in Canadian dollars, except share amounts)

The total fair value consideration was allocated to Foremost's net assets as follows:

Total fair value consideration	$	670,104
Foremost's net assets (liabilities):
Cash	$	78,589
Other receivables		1,900
Accounts payable and accrued liabilities		(225,088	)
Net assets (liabilities) at fair value		(144,599	)
Residual balance allocated to listing expense (included in M&A costs)		814,703
Total	$	670,104

The results of operations of Foremost are included in these consolidated statements of comprehensive loss from September 17, 2020.

The listing expense of $814,703 is a non-cash item - see consolidated statements of cash flows.

In addition, 14,286 common shares with fair value of $700,000 were issued to two M&A / capital market advisors for successfully assisting KWESST to complete the QT.

5.Trade and other receivables

The following table presents a breakdown of our trade and other receivables:

		September 30,		September 30,
		2022		2021
Trade receivables	$	114,877	$	-
Unbilled revenue		8,881		308,728
Sales tax recoverable		48,124		183,761
Investment tax credits refundable		-		206,762
Total	$	171,882	$	699,251

There was no impairment of trade and other receivables during the year ended September 30, 2022 (2021 - $nil).

The following table presents changes in unbilled receivables:

		September 30,			September 30,
		2022			2021
Balance, beginning of year	$	308,728		$	-
Revenue billed during the year		(308,728	)
Revenue in excess of billings, net of amounts transferred to trade accounts receivable		8,881			308,728
Amounts written off		-			-
Balance, end of year	$	8,881		$	308,728
Current	$	8,881		$	308,728
Non-current	$	-		$	-

F-47

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Years ended September 30, 2022, and 2021 and nine months ended September 30, 2020

(Expressed in Canadian dollars, except share amounts)

6.Inventories

The following table presents a breakdown of our inventories:

		September 30,		September 30,
		2022		2021
Finished goods	$	49,643	$	-
Work-in-progress		21,350		-
Raw materials		322,545		90,299
Total	$	393,538	$	90,299

There was no impairment of inventories during the year ended September 30, 2022 (2021 - $nil).

7.Property and equipment

The following is summary of changes in our property and equipment:

								Office			LRIP
		Computer			Computer			furniture and					R&D			Leasehold		Sales demo
Cost		equipment			software			equipment			equipment(1)		equipment			improvements		equipment		Total
Balance, September 30, 2020	$	32,807		$	8,145		$	81,841		$	-	$	53,634		$	59,090	$	-	$	235,517
Additions		30,778			-			11,211			-		165,030			58,147		548,626		813,792
Disposals		(3,828	)		(8,145	)		(2,936	)		-		(724	)		-		-		(15,633	)
Balance at September 30, 2021	$	59,757		$	-		$	90,116		$	-	$	217,940			117,237	$	548,626	$	1,033,676
Additions		50,849			5,129			10,817			77,559		21,864			19,800		1,460		187,478
Disposals		(3,800	)		-			-			-		-			-		-		(3,800	)
Balance at September 30, 2022	$	106,806		$	5,129		$	100,933		$	77,559	$	239,804		$	137,037	$	550,086		1,217,354

								Office
		Computer			Computer			furniture and			Moulding		R&D			Leasehold		Sales demo
Accumulated depreciation		equipment			software			equipment			equipment		equipment			improvements		equipment		Total
Balance, September 30, 2020	$	6,062		$	7,637		$	22,292		$	-	$	20,837		$	4,045		-	$	$60,873
Depreciation for the year		13,966			508			18,759			-		17,462			12,489		16,444		79,628
Disposals		(1,630	)		(8,145	)		(687	)		-		(12	)		-		-		(10,474	)
Balance at September 30, 2021	$	18,398		$	-		$	40,364		$	-	$	38,287		$	16,534		16,444	$	130,027
Depreciation for the year		26,762			1,254			19,067			7,002		46,219			27,915		129,262		257,481
Disposals		(2,635	)		-			-			-		-			-		-		(2,635	)
Balance at September 30, 2022	$	42,525		$	1,254		$	59,431		$	7,002	$	84,506		$	44,449	$	145,706	$	384,873
Carrying value at September 30, 2021	$	41,359		$	-		$	49,752		$	49,752	$	179,653		$	100,703	$	532,182	$	903,649
Carrying value at September 30, 2022	$	64,281		$	3,875		$	41,502		$	70,557	$	155,298		$	92,588	$	404,380	$	832,481

(1)Low-rate initial production equipment ("LRIP") includes moulds for developing PARA OPS^TM device samples.

8.Right-of-use assets

The following table presents our right-of-use assets:

		Offices			Printer			Total
Balance at September 30, 2020		324,297			3,279			327,576
Depreciation		(58,083	)		(3,279	)		(61,362	)
Balance at September 30, 2021	$	266,214		$	-		$	266,214
Depreciation		(58,083	)		-			(58,083	)
Balance at September 30, 2022	$	208,131		$	-		$	208,131

In connection with our current lease, we made a total deposit of $33,726 to be released only at the end of this lease. This was initially recorded at fair value, discounted using the implied interest rate in the lease. At September 30, 2022, $23,604 (2021 - $21,367) was the carrying value and reported as non-current deposit in the consolidated statements of financial position.

F-48

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Years ended September 30, 2022, and 2021 and nine months ended September 30, 2020

(Expressed in Canadian dollars, except share amounts)

9.Intangible assets

The following table shows a breakdown of our intangible assets:

		TASCS			PhantomTM		PARA OPSTM		PARA OPSTM		ARWENTM			Customer			Purchase
Cost		System			System		System		Patent		Tradename			Relationships			Orders			Total
Balance at September 30, 2020	$	163,230		$	481,472	$	-	$	-	$	-		$	-		$	-		$	644,702
Additions		-			83,228		-		-		-			-			-			83,228
Acquisition (Note 4(b))		-			-		2,906,219		-		-			-			-			2,906,219
Transferred to cost of sales		(107,854	)		-		-		-		-			-			-			(107,854	)
Impairment charge		(55,376	)		-		-		-		-			-			-			(55,376	)
Balance at September 30, 2021		-		$	564,700	$	2,906,219	$	-	$	-		$	-		$	-		$	3,470,919
Additions		-			584,885		562,996		28,783		-			-			-			1,176,664
Acquisition (Note 4(a))		-			-		-		-		44,000			50,000			100,000			194,000
Amortization		-			-		-		-		(6,968	)		(3,959	)		-			(10,927	)
Recognition of open orders		-			-		-		-		-			-			(87,802	)		(87,802	)
Balance at September 30, 2022	$	-		$	1,149,585	$	3,469,215	$	28,783	$	37,032		$	46,041		$	12,198		$	4,742,854

The balance at September 30, 2022 for Phantom^TM and PARA OPS^TM represents the acquired technology asset (i.e. intellectual properties), coupled with additional capitalized development costs. As both product lines have not yet reached commercialization, no amortization charge was recorded for the year ended September 30, 2022 (2021 - $nil).  Management anticipates the estimated useful life to be five years for both technology assets subsequent to the expected commercialization date and the estimated useful life of the patent will be determined subsequent to the approval of the patent.

In connection with Police Ordnance Acquisition (see Note 4(a)), we have recorded the following intangible assets at fair value: ARWEN^TM tradename, customer relationships and open purchase orders. During the year ended September 30, 2022, we have delivered on most open purchase orders resulting in a decrease of $87,802.  Management has estimated the useful lives of tradename and customer relationships of five years and ten years, respectively.

10.Accounts payable and accrued liabilities

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

		September 30,		September 30,
		2022		2021
Trade payable	$	2,292,954	$	620,041
Accrued liabilities		1,045,409		384,239
Salary, bonus and vacation payable		1,116,203		122,230
Interest payable		4,915		-
Payroll taxes payable		-		692
Total	$	4,459,481	$	1,127,202

11.Related party transactions

Key management personnel compensation

Key management personnel are those having authority and responsibility for planning, directing and controlling the activities of KWESST directly or indirectly, including any of our directors (executive and nonexecutive). Our key management personnel are the executive management team and Board of Directors, who collectively control approximately (28.3%) of the issued and outstanding common shares of KWESST at September 30, 2022 (2021 - 31.5%, 2020 - 38.0%).

F-49

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Years ended September 30, 2022, and 2021 and nine months ended September 30, 2020

(Expressed in Canadian dollars, except share amounts)

 

Key management personnel compensation comprised the following:

		Year ended		Year ended		Nine months ended
		September 30,		September 30,		September 30,
		2022		2021		2020
Wages and benefits	$	641,338	$	427,252	$	165,769
Consulting fees		529,529		180,000		145,000
Directors compensation		70,000		85,000		-
Share-based compensation		860,400		988,716		24,959
Total	$	2,101,267	$	1,680,968	$	335,728

The consulting fees relate to compensation to our Executive Chairman (via his private corporation, DEFSEC Corp), including a bonus for the year ended September 30, 2022, which was approved by our Board of Directors and paid only after the U.S. IPO and Canadian Offering (see Note 27(a)). It also includes consulting fees payable to an independent director for advisory services relating to PARA OPS^TM.

Related party loans

For the year ended September 31, 2022, we did not enter into any related party loans. The following table summarizes the changes in related party loans in the prior year.

		CEO			Employee
		loan			loan			Total
Balance, September 30, 2020	$	207,092		$	11,184		$	218,276
Accrued interest		4,513			68			4,581
Repayment of loans		(211,605	)		(11,252	)		(222,857	)
Balance, September 30, 2021	$	-		$	-		$	-

The CEO and employee loans accrued interest at TD Bank prime plus 1.55% and 5%, respectively.

Other related party transactions:

• In April 2021, two directors and the CFO of KWESST participated in the brokered private placement (see Note 15(a)); collectively, they purchased 1,029 Units for a total consideration of $90,000. This transaction was recorded at fair value.

• In March 2022, two directors, the Executive Chairman, and the CFO of KWESST participated in the March 2022 Loans for an aggregate amount of $74,000 and received a total of 529 bonus common shares (see Note 12).

• In July 2022, one director, the Executive Chairman, and the CFO of KWESST participated in the July 2022 Offering (see Note 15(a)); collectively, they purchased 5,813 Units for a total consideration of $87,500. This transaction was recorded at fair value.

• In August 2022, our Executive Chairman and CFO advanced a total of $60,000 to KWESST for employee payroll purposes. This advance was repaid on August 30, 2022.

At September 30, 2022 there was $672,531 outstanding amount in accounts payable and accrued liabilities due to our officers and directors for unpaid wages, bonuses, director fees and expense reimbursements.

F-50

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Years ended September 30, 2022, and 2021 and nine months ended September 30, 2020

(Expressed in Canadian dollars, except share amounts)

12.Borrowings

		CEBA Term			February 2021			March 2022			August 2022			Total
		Loans			Loan			Loans			Loans			Borrowings
Balance, September 30, 2020	$	32,273		$	-		$	-		$	-		$	32,273
Additional borrowings		20,000			306,000			-			-			326,000
Gain on government grant		(3,514	)		-			-			-			(3,514	)
Accrued interest		4,492			4,527			-			-			9,019
Repayment		-			(310,527	)		-			-			(310,527	)
Balance, September 30, 2021	$	53,251		$	-		$	-		$	-		$	53,251
Assumed from acquisition (Note 4)		26,238			-			-			-			26,238
Issuance at fair value		-			-			1,634,283			475,591			2,109,874
Deferred financing fees		-			-			(74,055	)		(76,354	)		(150,409	)
Net borrowings		79,489			-			1,560,228			399,237			2,038,954
Adjustment		(5,496	)		-			-			-			(5,496	)
Accrued interest and accretion expense		4,803			-			304,922			11,588			321,313
Foreign exchange loss		-			-			-			24,523			24,523
Interest paid		-			-			(100,520	)		-			(100,520	)
Balance, September 30, 2022	$	78,796		$	-		$	1,764,630		$	435,348		$	2,278,774
Current	$	-		$	-		$	1,764,630		$	435,348		$	2,199,978
Non-current		78,796			-			-					$	78,796
Total	$	78,796		$	-		$	1,764,630		$	435,348		$	2,278,774

August 2022 Loans

On August 25, 2022, we closed two unsecured loans in the amount of USD$200,000 per loan with a third-party lender ("Lender") for an aggregate amount of USD$400,000 (the "August 2022 Loans").

The August 2022 Loans bear interest at a rate of 6.0% per annum, compounded monthly and not in advance, and have a maturity of twelve months, with KWESST having the option to repay the whole or any part of the August 2022 Loans, without penalty or premium, at any time prior to the close of business on the maturity date. On repayment of the August 2022 Loans, we will pay 110% of the principal amount plus accrued interest on the August 2022 Loans. As part of the terms of one of the August 2022 Loans, we issued an aggregate of 4,239 common shares to the Lender (the "Bonus Shares"), being an amount equal to twenty percent (20%) of USD$200,000, converted to CAD$ at an exchange rate of $1.2983, divided by the market price of our common shares on the TSX-V at market close on August 24, 2022, being $12.25. The Bonus Shares were issued in accordance with applicable prospectus exemptions under Canadian securities laws.

As a result of issuing common shares and debt for the first loan of USD$200,000 (or $260,698), we allocated the gross proceeds to these two financial instruments based on their relative fair value.  To measure the fair value of the loan, we used the income approach and estimated a market discount rate of 24% to discount the future cash flows of the loan resulting in an estimated fair value of $214,893. Accordingly, we allocated $214,893 of the $260,698 to the first loan and $45,804 to share capital for the bonus common shares issued (see Note 15(a)).

Concurrently with the closing of the August 2022 Loans, our Executive Chairman and President and Chief Executive Officer (the "KWESST Principals") entered into call option agreements with the Lender whereby the Lender will have the option, pursuant to the terms and conditions of the call option agreements, to purchase 10,591 common shares held by the KWESST Principals at a price of $12.25 for a period of five years.  Additional free-trading common shares may be offered by the KWESST Principals to the Lender should we elect to proceed with a share-for-debt transaction in connection with one of the Loans. KWESST is not a party to the call option agreements.

In connection with the August 2022 Loans, we paid a cash finder's fee to a third-party intermediary in an amount of USD$32,000.

F-51

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Years ended September 30, 2022, and 2021 and nine months ended September 30, 2020

(Expressed in Canadian dollars, except share amounts)

March 2022 Loans

On March 11, 2022, we closed a unsecured loan financing with various lenders in an aggregate amount of $1,800,000 and an additional $200,000 on March 15, 2022, for a total of $2,000,000 (the "March 2022 Loans"). Certain directors and officers participated in this financing for an aggregate amount of $74,000. The March 2022 Loans bear interest at a rate of 9.0% per annum, compounded monthly and not in advance, and have a maturity of thirteen months, with KWESST having the option to repay the whole or any part of the March 2022 Loans, without penalty or premium, at any time prior to the close of business on the maturity date. The principal amount is due only at maturity.  As part of the terms of the March 2022 Loans, we issued an aggregate of 14,286 bonus common shares to the lenders.

As a result of issuing common shares and debt for a total combined cash consideration of $2,000,000, we allocated the gross proceeds to these two financial instruments based on their relative fair value.  To measure the fair value of the March 2022 Loans, we used the income approach and estimated a market discount rate of 22% to discount the future cash flows of the March 2022 Loans resulting in an estimated fair value of $1,634,112.  Accordingly, we allocated $1,634,112 of the $2,000,000 to March 2022 Loans and $365,888 to share capital for the bonus common shares issued (see Note 12(a)).

The total offering costs were $90,636, $74,055 of which was allocated to deferred financing fees and $16,581 allocated to share offering costs. The deferred financing fees are recognized as a reduction of the gross borrowings to be accreted over the life of the March 2022 Loans as a financing cost and the share offering costs were recognized as a reduction to common shares.

As the March 2022 Loans mature in April 2023, we presented these as current borrowings in the consolidated financial position.

February 2021 Loan

On February 24, 2021, we entered into an unsecured loan agreement with a private fund managed by a KWESST shareholder to borrow $306,000 for general corporate purposes. The interest rate on this loan was 0.5% per month. On May 27, 2021, we repaid the loan, including accrued interest, for a total of $310,527.

CEBA Term Loans

In December 2020, the Canadian Federal Government amended the CEBA Term Loan program to increase the loan amount by $20,000 to $60,000. We borrowed $40,000 during the nine-month period ended September 30, 2020, and an additional $20,000 during the fiscal year ended September 30, 2021.  As a result of the Police Ordnance Acquisition (see Note 4(a)), we assumed an additional CEBA Term Loan of $40,000 during fiscal year ended September 30, 2022.

The CEBA Term Loans are initially recorded at fair value, discounted based on our estimated incremental borrowing rate.  This resulted in recording a gain on government grant of $3,514 for the year ended September 30, 2021 (2020 - $9,096). 

Effective January 1, 2021, the CEBA Term Loans were automatically converted to a 2-year interest free term loan.  This was further amended on January 12, 2022, where the government of Canada announced the repayment deadline for the CEBA Term Loans to qualify for partial loan forgiveness is being extended from December 31, 2022, to December 31, 2023, for all eligible borrowers in good standing.  Repayment on or before the new deadline of December 31, 2023, will result in loan forgiveness of up to a third of the loans.  Due to our financial condition at September 30, 2022 and 2021, we have not recorded the potential forgivable amount in the event we repay the CEBA Term Loans prior to December 31, 2023.

F-52

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Years ended September 30, 2022, and 2021 and nine months ended September 30, 2020

(Expressed in Canadian dollars, except share amounts)

RBC Credit Facility

We maintain corporate credit cards for our key employees and a foreign exchange line of credit with Royal Bank of Canada ("RBC"). To provide security, we entered into a cash collateral agreement for $30,000 and a general security agreement providing a first lien on all assets. The $30,000 was invested in a short-term guaranteed investment certificate.

See Note 27(c), Subsequent Events - Loan Repayments.

13.Lease obligation

We have entered into a long-term office lease contract which expires on April 30, 2026. The office lease includes the right to renew for an additional five years following its expiry. Management has not included the renewal option because it was deemed too uncertain whether we would renew at September 30, 2022.

Under the current office lease agreement, we have benefited from the following lease inducements:

• Free rent from inception (March 1, 2020) to November 1, 2020; and

• Free rent from November 1, 2021, to March 1, 2022.

The following table presents the movement in our lease obligation for the respective periods:

					Current		Non-current
		Offices			Portion		portion
Balance, September 30, 2020	$	352,037		$	44,128	$	307,909
Lease payments (including interest)		(78,000	)		-		-
Interest expense		33,872			-		-
Balance at September 30, 2021	$	307,909		$	32,288	$	275,621
Lease payments (including interest)		(62,400	)		-		-
Interest expense		30,112			-		-
Balance at September 30, 2022	$	275,621		$	69,150	$	206,471

The following table presents the contractual undiscounted cash flows for the lease obligations:

		September 30,		September 30,
		2022		2021
Less than one year	$	93,600	$	62,400
One to five years		234,000		327,600
Total	$	327,600	$	390,000

14.Contract Liabilities

The following table presents the changes in contract liabilities:

		September 30,		September 30,
		2022		2021
Balance, beginning of fiscal year	$	-	$	7,053
Acquired in acquisition of POC (see Note 4(a))		29,759		-
Amounts invoiced and revenue deferred		17,512		-
Recognition of deferred revenue included in the balance at the beginning of period		-		(7,053	)
Balance, end of fiscal year	$	47,271	$	-

F-53

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Years ended September 30, 2022, and 2021 and nine months ended September 30, 2020

(Expressed in Canadian dollars, except share amounts)

15.Share capital and Contributed Surplus

As disclosed in Note 1(b), the 1-for-70 Reverse Split effected on October 28, 2022, has been applied retrospectively herein.

a)Share capital

Authorized

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

Issued Common Shares

	September 30, 2022				September 30, 2021				September 30, 2020
	Number		Amount		Number		Amount		Number		Amount
Balance, beginning of year	699,511	$	17,215,068		589,518	$	9,374,563		383,996	$	2,284,353
Issued in private placement	22,857	$	272,000		10,714	$	1,110,000		49,811	$	1,480,875
Issued for exercise of warrants	19,000	$	277,098		10,380	$	815,307		-	$	-
Issued for bonus shares relating to borrowings (Note 10)	18,525	$	411,692		-	$	-		-	$	-
Issued for conversion of share units	8,349	$	874,840		138	$	12,498		-	$	-
Issued for acquisition (Note 4(a))	3,965	$	377,503		-	$	-		-	$	-
Issued for conversion of contingent shares (Note 4(a))	875	$	83,319		-	$	-		-	$	-
Issued for debt settlements	143	$	19,000		1,305	$	63,866		-	$	-
Issued in brokered private placement	-	$	-		51,087	$	3,611,818		62,994	$	3,087,138
Issued for exercise of stock options	-	$	-		18,195	$	1,292,015		1,743	$	78,080
Issued for asset acquisition (Note 4(b))	-	$	-		14,286	$	1,290,000		9,957	$	167,280
Issued for exercise of broker compensation options	-	$	-		2,459	$	347,680		-	$	-
Issued for amended license (Note 26)	-	$	-		1,429	$	137,000		-	$	-
Issued for conversion of 15% 2020 converted notes	-	$	-		-	$	-		45,858	$	1,328,163
Issued for performance bonus	-	$	-		-	$	-		14,929	$	731,500
Shares from Foremost's QT (Note 4(c))	-	$	-		-	$	-		12,836	$	628,949
Issued for conversion of 10% 2019 converted notes	-	$	-		-	$	-		6,523	$	255,718
Issued for consulting services	-	$	-		-	$	-		871	$	32,393
Less: share offering costs for the year	-	$	(33,880	)	-	$	(839,679	)	-	$	(699,886	)
Balance, end of year	773,225	$	19,496,640		699,511	$	17,215,068		589,518	$	9,374,563

2022 Activities

Private Placement

On July 14, 2022, we closed a non-brokered private placement, resulting in the issuance of 22,857 units of KWESST ("July 2022 Units"), at a price of $15.05 per July 2022 Unit (the "Issue Price"), for aggregate gross proceeds of $344,000 (the "July 2022 Offering").

Each July 2022 Unit is comprised of one common share and seventy one-half common share purchase warrant (the "July 2022 Warrants"). Accordingly, we issued 800,000 Warrants exercisable at $0.285 each for a period of 24 months from the closing date. Each Warrant converts into 0.01428571 common shares or 70 warrants for one common share. There was no finder fee paid in this private placement.

Certain of our directors and officers (the "Insiders") purchased 5,814 Units for a total consideration of $87,500. The issuance of Units to the Insiders constitutes a related party transaction but is exempt from the formal valuation and minority approval requirements of Multilateral Instrument 61-101 - Protection of Minority Security Holders in Special Transactions ("MI 61-101") as KWESST's securities are not listed on any stock exchange identified in Section 5.5(b) of MI 61-101 and neither the fair market value of the units issued to the Insiders, nor the fair market value of the entire private placement, exceeds 25% of our market capitalization.

F-54

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Years ended September 30, 2022, and 2021 and nine months ended September 30, 2020

(Expressed in Canadian dollars, except share amounts)

The securities were issued in accordance with applicable prospectus exemptions under Canadian securities laws.

Police Ordnance Acquisition

As disclosed in Note 4(a), we issued 3,965 common shares to the selling shareholders in December 2021 at the closing of the acquisition and an additional 875 common shares in April 2022 following the achievement of  the financial milestone as defined in the share purchase agreement. 

2021 Activities

Brokered Private Placement

In April 2021, we closed our over-subscribed brokered private placement, resulting in the issuance of 51,087 units ("Units") of KWESST, at a price of $87.50 per Unit (the "Issue Price"), for aggregate gross proceeds of $4,470,071 (the "April 2021 Offering"), as amended in August 2021.

Under the April 2021 Offering, we sold a total of 51,087 units at a price of $87.50 per Unit. Each Unit is comprised of one common share of the Company and seventy common share purchase warrants ("April 2021 Warrant"). Each April 2021 Warrant is exercisable to acquire 1/70 of a common share at a price of $1.75 each (70 warrants for one common share) for a period of 24 months from the closing of the April 2021 Offering ("Closing Date"). If at any time after four (4) months and one (1) day following the Closing Date, the trading price of KWESST common stock on the TSX Venture Exchange is equal to or exceeds $210.00 for a period of 10 consecutive trading days, as evidenced by the price at the close of market, we will be entitled to notify the holders of the April 2021 Warrants of its intention to force the exercise of the April 2021 Warrants. Upon receipt of such notice, the holders of April 2021 Warrants shall have 30 days to exercise the April 2021 Warrants, failing which the April 2021 Warrants will automatically expire. Our directors and officers purchased 1,029 Units for a total consideration of $90,000.

In connection with this Offering, management has concluded the Unit qualified as an equity instrument under IAS 32, Financial Instruments: Presentation. Furthermore, management used the residual method to allocate the $87.50 consideration between common shares and the April 2021 Warrants. Because the April 2021 Warrants include an accelerator provision for expiration, management used the Barrier option model to estimate the fair value of these April 2021 Warrants at $0.24 each (70 warrants for one common share). As a result, $70.70 of the $87.50 consideration was allocated to common shares and is reflected in the above table of outstanding common shares.

The total cash and non-cash share offering costs were $630,680 for the Offering, including cash commission of $288,405 paid to the Agents and $233,057 of Compensation Options granted to the Agents (see part (c) Contributed Surplus).

Asset Acquisition

In April 2021, following the closing of the brokered private placement, KWESST closed on the acquisition of the PARA OPS^TM System technology resulting in the issuance of 14,286 common shares and 500,000 warrants (see Note 4(a)). Management estimated a fair value of $0.85 per warrant, using the Black-Scholes option model (see below - Warrants).

F-55

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Years ended September 30, 2022, and 2021 and nine months ended September 30, 2020

(Expressed in Canadian dollars, except share amounts)

Private Placement

In September 2021, we closed a non-brokered private placement, resulting in the issuance of 10,714 units ("September Units") of KWESST, at a price of $140.00 per September Unit (the "Issue Price"), for aggregate gross proceeds of $1,500,000 (the "September 2021 Offering").

Under the September 2021 Offering, each September Unit is comprised of one common share and seventy Warrant Shares at a price of $2.35 for each 1/70 of a common share (70 warrants for one common share) for a period of 24 months from September 16, 2021 ("September 2021 Warrants"). If at any time after four months and one day following September 16, 2021, the trading price of KWESST common stock on the TSX-V is equal to or exceeds $322.00 for a period of 3 consecutive trading days, as evidenced by the price at the close of market, we will be entitled to notify the holders of Warrants of its intention to force the exercise of the Warrants. Upon receipt of such notice, the holders of Warrants shall have 30 days to exercise the Warrants, failing which the Warrants will automatically expire.

We paid cash commissions to Haywood Securities Inc. in the amount of $90,000 and granted 45,000 broker warrants ("September 2021 Broker Warrants"). Each September 2021 Broker Warrant is exercisable to acquire 1/70 of a common share at a price of $2.00 for a period of 24 months from the closing of the September 2021 Offering. Management estimated a fair value of $0.72 per warrant, using the Black-Scholes option model (see below - Warrants).

In connection with this private placement, management has concluded the September Unit qualified as an equity instrument under IAS 32, Financial Instruments: Presentation. Furthermore, management used the residual method to allocate the $140.00 consideration between the common share and the Warrant. Because the warrant includes an accelerator provision for expiration, management used the Barrier option model to estimate the fair value of these September 2021 Warrants at $0.52 each (70 warrants for one common share). As a result, $103.60 of the $140.00 consideration was allocated to common shares and is reflected in the above table of outstanding common shares at September 30, 2021.

The total cash and non-cash share offering costs were $130,730 for this private placement.

Amended License

In April 2021, we issued 1,429 common shares for the exclusivity with AerialX as disclosed in Note 26.

Debt for Equity Settlement

During the year ended September 30, 2022, we settled $19,000 of legal fees for 143 common shares.

During the year ended September 30, 2021, we settled the following liabilities with our common shares:

• $47,000 of legal fees for 816 common shares; and

• $16,866 of online advertising services for 346 common shares.

2020 Activities

Brokered Private Placements

In September 2020, KWESST closed a brokered private placement led by PI Financial Corp., resulting in the issuance of 62,994, at $49.01 each, for aggregate gross proceeds of $3,086,687. The total share offering costs were $325,887, settled in cash and warrants.

F-56

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Years ended September 30, 2022, and 2021 and nine months ended September 30, 2020

(Expressed in Canadian dollars, except share amounts)

2020 Convertible Notes

In May 2020, KWESST Inc. closed on approximately $1.1 million gross proceeds from the issuance of unsecured convertible notes ("2020 Notes"), with automatic conversion upon a Liquidity Event including the listing of KWESST on the TSX-V.  In connection with these 2020 Notes, the note holders earned interest at a rate of 15% per annum. Additionally, as an inducement, the note holders also received 25% of the principal amount in the form of KWESST common shares based on a stock price of $31.50, resulting in the issuance 8,583 at the QT.

In light of KWESST going public in September 2020, resulting in the automatic conversion of these 2020 Notes, management concluded that under IAS 38 the recognition of these 2020 Notes should be accounted for as equity and not debt.  At the QT, these 2020 Notes were converted to 35,398 common shares. Because the 2020 Notes were treated as equity instruments, the total accrued interest of $59,112 was not recognized in the profit or loss. This accrued interest was converted to 1,877 common shares at QT. In connection with this private placement, KWESST incurred $58,065 of offering costs settled in cash and warrants.

Private Placements

In January 2020, KWESST closed a non-brokered private placement, resulting in the issuance of 37,500 common shares of KWESST, at $28.00 each, for aggregate gross proceeds of $1,050,000.

In March 2020, KWESST closed a non-brokered private placement, resulting in the issuance of 12,082 common shares of KWESST, at $35.00 each, for aggregate gross proceeds of $422,875.

In June 2020, KWESST closed a non-brokered private placement, resulting in the issuance of 229 common shares of KWESST, at $34.93 each, for aggregate gross proceeds of $8,000.

Performance Share Bonus

During the quarter ended September 30, 2020, KWESST settled performance bonuses in the form of 643 common shares. Additionally, KWESST awarded 7,143 common shares each to two M&A / capital market advisors for successfully assisting KWESST to complete a QT, in accordance with their respective consulting agreement.

Shares from Foremost

As part of the reverse acquisition, KWESST assumed 12,836 common shares previously issued by Foremost (see Note 4(b)).

2019 Convertible Notes

In September 2020, as a result of the completion of the QT (see Note 4 (c)) all the 2019 Convertible Notes and accrued interest were automatically converted to 6,523 common shares of KWESST.

Asset Acquisition

As disclosed in Note 4(c), KWESST issued 9,957 common shares to acquire the Phantom system technology.

b)Warrants

The following reflects the warrant activities:

F-57

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Years ended September 30, 2022, and 2021 and nine months ended September 30, 2020

(Expressed in Canadian dollars, except share amounts)

	September 30, 2022				September 30, 2021				September 30, 2020
				Weighted				Weighted			Weighted
	Number of			average	Number of			average exercise	Number of		average exercise
	warrants			exercise price	warrants			price	warrants		price
Outstanding, beginning of year	13,901,640		$	0.74	9,585,050		$	0.24	8,500,000	$	0.20
Issued	1,000,000		$	0.57	5,043,165		$	1.73	1,085,050	$	0.54
Exercised	(1,330,000	)	$	0.26	(726,575	)	$	1.05	-	$	-
Expired	(154,484	)	$	0.56	-		$	-	-	$	-
Outstanding, end of year	13,417,156		$	0.78	13,901,640		$	0.74	9,585,050	$	0.24
Exercisable, end of year	12,792,156		$	0.82	12,901,640		$	0.75	8,835,050	$	0.22

As a result of the Reverse Split (see Note 1(b)), the warrant holder must exercise 70 warrants to receive one common share.

The following table provides additional information on the total outstanding warrants at September 30, 2022:

	Number
	outstanding		Fair value (1)	Expiry Date
Founders' warrants:
Exercise price of $0.20	5,520,000	$	1,013	January 1, 2024
Exercise price of $0.20	1,900,000	$	18,865	June 14, 2024
GhostStep's warrants:
Exercise price of $0.50	250,000	$	60,000	January 15, 2023
April 2021 equity financing:
Exercise price of $1.75	3,274,657	$	785,918	April 29, 2023
Exercise price of $1.75	40,000	$	9,600	August 25, 2023
LEC's warrants (see Note 4(b)):
Exercise price of $0.70	500,000	$	425,000	April 29, 2026
September 2021 equity financing:
Exercise price of $2.35	750,000	$	390,000	September 16, 2023
Broker warrants:
Exercise price of $1.75	137,499	$	33,000	April 29, 2023
Exercise price of $2.00	45,000	$	32,400	September 16, 2023
Acquisition of Police Ordnance (Note 4(a)):
Exercise price of $1.72	200,000	$	132,000	December 15, 2024
July 2022 equity financing
Exercise price of $0.285	800,000	$	72,000	July 14, 2024
	13,417,156	$	1,959,796

(1) Fair value is calculated based on the grant date fair value and number outstanding at September 30, 2022. It does not represent the fair value at September 30, 2022.

The fair value for the warrants issued during the year ended September 30, 2022, was determined by the Black Scholes option pricing model using the following key inputs:

F-58

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Years ended September 30, 2022, and 2021 and nine months ended September 30, 2020

(Expressed in Canadian dollars, except share amounts)

		Acquisition of POC		July 2022 Warrants
Exercise Price	$	1.72	$	0.285
1/70 of stock price	$	1.36	$	0.215
Volatility		84.7%		90.5%
Dividend Yield		Nil		Nil
Risk-free interest rate		1.04%		3.12%
Expected life		3		2
Weighted average fair value per warrant	$	0.66	$	0.09

The fair value for the warrants issued during the year ended September 30, 2021, was determined by the following valuation models and key inputs:

		Barrier Option Model				Black-Scholes Option Model
		April 2021 warrants		September 2021 warrants		September 2021  broker warrants		LEC warrants
Exercise Price	$	1.75	$	2.35	$	2.00	$	0.70
1/70 of stock price	$	1.01	$	2.14	$	2.14	$	0.40
Volatility		80%		80%		80%		0%
Dividend Yield		Nil		Nil		Nil		Nil
Risk-free interest rate		0.31%		0.26%		0.26%		69.00%
Barrier (accelerator on life of warrants)	$	3.00	$	4.60		N/A		N/A
Rebate	$	1.25	$	2.00		N/A		N/A
Expected life		2		1		1		0.85
Weighted average fair value per warrant	$	0.24	$	0.52	$	0.72	$	0.85

The fair value for the warrants issued during nine months ended September 30, 2020, was determined using the Black-Scholes option model using the following inputs:

		Warrants @		Warrants @		Warrants
		$0.40		$0.45		@ $0.70
1/70 of stock price	$	0.40	$	0.50	$	0.70
Volatility		68%		68%		67%
Dividend Yield		Nil		Nil		Nil
Risk-free interest rate		1.47%		0.27%		0.29%
Expected life		2		2		2
Estimated fair value per warrant	$	0.15	$	0.20	$	0.26

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.

F-59

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Years ended September 30, 2022, and 2021 and nine months ended September 30, 2020

(Expressed in Canadian dollars, except share amounts)

Broker Compensation Options

The April 2021 Offering was completed by PI Financial Corp., the lead agent and sole bookrunner (the "Lead Agent"), and other dealers (the "Agents"). As consideration for the services provided by the Agents in connection with the April 2021 Offering, the Agents received: (a) a cash commission of $288,405; and (b) 3,296 compensation options (the "Compensation Options"). Each Compensation Option is exercisable to acquire one unit of KWESST (a "Compensation Option Unit") at a price equal to $87.50 for a period of two years after the closing of the Offering. Each Compensation Option Unit is comprised of one Common Share and seventy Common Share purchase warrants (a "Compensation Option Warrant"). Each Compensation Option Warrant is exercisable to acquire 1/70 of a Common Share (a "Compensation Option Warrant Share") at a price of $1.75 per Compensation Option Warrant Share (70 Compensation Option Warrant for one Compensation Option Warrant Share) for a period of 24 months from the closing of the Offering.

Based on the structure of the Compensation Option, management estimated its fair value using the Monte Carlo method. Management estimated a fair value of $77.00 per Compensation Option.  The following were key inputs used in the Monte Carlo simulation: estimated life of 2 years, underlying stock price of $90.30, exercise price of Compensation Option of $87.50, exercise price of 70 Compensation Option Warrants of $87.50, estimated volatility of 80%, risk free rate of 0.31%, and discount for lack of marketability of 0%.

Accordingly, we recorded $233,057 of Compensation Options in contributed surplus, with an equal offset to share offering costs (a non-cash transaction).

During the year ended September 30, 2021, the Agents have exercised 2,459 Compensation Option Units for total gross proceeds of $215,148. At September 30, 2022, the total outstanding Compensation Option Units was 837.

Share-based compensation

On March 31, 2022, our shareholders approved the amended Company's Long-Term Incentive Plan (the "LTIP") to retain a competitive compensation structure for its directors, executives, employees, consultants, and service providers. The LTIP allows for the issuance of stock options ("Options"), restricted share units ("RSUs"), deferred share units ("DSUs"), share appreciation rights ("SARs"), and performance stock units ("PSUs") - collectively referred as Compensation Securities.

Under the LTIP, the aggregate maximum number of common shares available for issuance from treasury at any given time shall not exceed 10% of the outstanding common shares as of the date of Compensation Securities, subject to adjustment or increase of such number pursuant to the terms of the LTIP. Any Options that have been cancelled, repurchased, expired, or exercised will again be available under the LTIP. The maximum number of common shares issuable under the LTIP in respect RSUs, DSUs, SARs, and PSUs (herein referred as "Share Units") shall not exceed 60,382 shares. The LTIP is subject to annual shareholder approval at the Annual General and Special Meeting.

(i)Stock Options

At September 30, 2022, there were 19,833 stock options available for grant under our LTIP.

The following is summary of changes in outstanding stock options for the respective periods:

F-60

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Years ended September 30, 2022, and 2021 and nine months ended September 30, 2020

(Expressed in Canadian dollars, except share amounts)

				Weighted
	Number of			average
	options			exercise price
Outstanding at December 31, 2019	-		$	-
Granted	29,357		$	45.50
Options from the Qualifying Transaction	1,224		$	32.90
Exercised	(1,743	)	$	35.00
Outstanding at September 30, 2020	28,838		$	45.50
Granted	52,988		$	104.30
Exercised	(18,194	)	$	50.40
Cancelled	(4,096	)	$	48.30
Outstanding at September 30, 2021	59,536		$	95.90
Granted	9,500		$	69.59
Cancelled	(11,928	)	$	131.76
Outstanding at September 30, 2022	57,108		$	83.87
Options exercisable at September 30, 2022	43,618		$	83.90

During the year ended September 30, 2022, we granted 9,500 (2021 – 52,988, 2020 – 29,357) options at a weighted average exercise price of $69.59 (2021 – $104.30, 2020 – $45.50). At September 30, 2022, the weighted average remaining vesting period was 0.88 years (2021 – 1.82 years, 2020 – 0.87).

For the options granted during the year ended September 30, 2022, the per share weighted-average fair value of stock options was $38.21 (2021 – $50.40, 2020 – $16.10), using the Black-Scholes option model with the following weighted-average assumptions:

		2022		2021		2020
	$	14.70 to	$	49.00 to	$	28.00 to
Stock price	$	126.70	$	159.60	$	49.00
	$	14.70 to	$	49.00 to	$	28.00 to
Exercise price	$	126.70	$	159.60	$	49.00
Volatility		90.48%		76.46%		67.71%
Dividend yield		Nil		Nil		Nil
Risk-free interest rate		2.04%		0.35%		65.00%
Expected life (years)		2.91		2.26		3.38
Weighted-average fair value per option	$	38.21	$	50.40	$	16.10

The following table summarizes information about stock options outstanding at September 30, 2022:

		Weighted
		average		Weighted		Remaining		Weighted
Range of		remaining		average		exercisable		average
exercise	Number	contractual		outstanding		contractual		exercisable
prices	outstanding	life		strike price	Exercisable	life		strike price
$14.70 to $41.16	4,592	4.54	$	15.91	306	0.71	$	32.90
$41.17 to $67.63	12,329	2.74	$	48.74	12,329	2.74	$	48.74
$67.64 to $94.10	20,973	3.47	$	78.02	17,080	3.38	$	75.79
$94.11 to 120.57	7,448	3.34	$	118.59	7,448	3.34	$	118.59
$120.58 to $147.00	11,766	3.95	$	135.66	6,455	3.97	$	134.87
	57,108	3.48	$	83.87	43,618	3.26	$	83.90

F-61

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Years ended September 30, 2022, and 2021 and nine months ended September 30, 2020

(Expressed in Canadian dollars, except share amounts)

Amendment to stock option grants

For the year ended September 30, 2022, we had no amended stock option grants.

During the year ended September 30, 2021, our Board of Directors approved the acceleration of vesting for 5,507 options and the cancellation of 3,571 options. This contributed an additional stock-based compensation charge of $65,813 (included in the above total share-based compensation expenses).

(ii)Share Units

At September 30, 2022, there were 27,503 Share Units available for grant under our LTIP.

The following table shows the changes in Share Units:

	RSUs		PSUs		SARs	Total
Outstanding at September 30, 2020	-		-		-	-
Granted	16,412		2,857		2,143	21,412
Vested and converted	(139	)	-		-	(139	)
Outstanding at September 30, 2021	16,273		2,857		2,143	21,273
Granted	10,726		17,942		514	28,668
Vested and converted to common shares	(5,681	)	(2,666	)	-	(8,347	)
Vested and repurchased for withholding taxes	(144	)	(249	)	-	(393	)
Expired / cancelled	-		(17,714	)	-	(17,714	)
Outstanding at September 30, 2022	21,174		170		2,657	24,001

RSUs:

Each RSU entitles the holder to receive one common share in the future, based on continued service during the applicable period.

During the year ended September 30, 2022, we granted 10,726 RSUs (2021 - 16,412), with a weighted-average grant date fair value of $43.50 per unit (2021 - $105.70). The weighted average vesting period for the outstanding RSUs was 0.18 years at September 30, 2022 (2021 - 0.69 years).

PSUs:

Each PSU entitles the holder to receive one common share in the future, based on the achievement of established performance criteria and continued service during the applicable performance period.

During the year ended September 30, 2022, we granted 17,942 PSUs (2021 - 2,857), with a weighted-average grant date fair value of $126.70 per unit (2021 - $105.00).  The outstanding PSUs were fully vested at September 30, 2022 (2021 - Weighted average vesting period was 0.40 years).

SARs:

Each SAR entitles the holder to receive cash or common share at our discretion in the future, based on continued service during the applicable period. The amount of the cash payment or the value of common shares is determined based on the increase of the share price of KWESST between the grant date and the exercise date. Because we intend to always settle in common shares, we account for SARs as equity-settled awards.

F-62

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Years ended September 30, 2022, and 2021 and nine months ended September 30, 2020

(Expressed in Canadian dollars, except share amounts)

During the year ended September 30, 2022, we granted 514 SARs (2021 - 2,143) at an exercise price of $126.70 (2021 - $115.50 each). The 514 SARs will expire on May 31, 2023 and 2,143 SARs will expire on January 22, 2024.

(iii) Share-based Compensation

For the year ended September 30, 2022, we recorded share-based compensation of $1,960,072 (2021 - $2,462,207, 2020 - $283,084).

The following table presents a breakdown of total share-based compensation expense by function:

		Year ended		Year ended		Nine months ended
		September 30,		September 30,		September 30,
		2022		2021		2020
General and administrative	$	1,104,858	$	1,425,111	$	160,267
Selling and marketing		552,627		754,167		42,700
Research and development, net		302,587		282,929		80,117
Total share-based compensation	$	1,960,072	$	2,462,207	$	283,084

16.Earnings (loss) per share

The following table summarizes the calculation of the weighted average basic number of basic and diluted common shares:

	Year ended	Year ended	Nine months ended
	September 30,	September 30,	September 30,
	2022	2021	2020
Issued common shares, beginning of year	699,511	589,518	383,996
Effect of shares issued from:
Exercise of warrants	10,593	4,383	-
Issuance of bonus shares (Note 10)	8,262	-	-
Private placements	4,571	21,810	45,665
Conversion of stock units	3,703	31	-
Acquisition of Police Ordnance (Note 4(a))	3,144	-	-
Conversion of contingent shares (Note 4(a))	386	-	-
Debt settlements	132	1,038	-
Exercise of options	-	9,118	447
Asset acquisitions (Note 4(b))	-	6,027	1,272
Amended license agreement (Note 26)	-	626	-
Exercise of broker options	-	170	-
Conversion of convertible notes, including interest	-	-	7,126
Services rendered	-	-	1,373
Foremost's QT	-	-	752
Weighted average number of basic common shares	730,302	632,721	440,631
Dilutive securities:
Stock options	-	-	-
Warrants	-	-	-
Weighted average number of dilutive common shares	730,302	632,721	440,631

At September 30, 2022 and 2021, all the stock options and warrants were anti-dilutive because of we incurred net loss for both fiscal years.

F-63

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Years ended September 30, 2022, and 2021 and nine months ended September 30, 2020

(Expressed in Canadian dollars, except share amounts)

17.Revenue

a)Revenue streams

KWESST generates revenue from the sale of products to its customers.

b)Disaggregation of revenue from contracts with customers

In the following table, revenue from contacts with customers is disaggregated by primary geographical market, major products and service lines, and timing of revenue recognition.

						Nine months
		Year ended		Year ended		ended
		September 30,		September 30,		September 30,
		2022		2021		2020
Major products / service lines
Digitization	$	354,620	$	1,255,982	$	835,097
Non-Lethal		330,658		-		-
Training and services		34,590		-		-
Other		1,651		19,822		26,820
	$	721,519	$	1,275,804	$	861,917
Primary geographical markets
United States	$	389,210	$	1,238,063	$	835,097
Canada		332,309		37,741		26,820
	$	721,519	$	1,275,804	$	861,917
Timing of revenue recognition
Products and services transferred over time	$	389,210	$	1,238,063	$	835,097
Products transferred at a point in time		332,309		37,741		26,820
	$	721,519	$	1,275,804	$	861,917

Revenue allocated to remaining performance obligations represents contracted revenue that has not yet been recognized ("contracted not yet recognized") and includes unearned revenue and amounts that will be invoiced and recognized as revenue in future periods. At September 30, 2022, our contracted not yet recognized revenue was $625,177 (2021 - $16,545, 2020 - $233,193), of which 43% of this amount is expected to be recognized over the next 12 months with the remaining 57% expected to be recognized in 2 to 3 years.

For the year ended September 30, 2022, one customer accounted for the 41% revenue (2021 - one customer accounted for 95%, 2020 - two customers accounted for 61% and 35%, respectively).

F-64

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Years ended September 30, 2022, and 2021 and nine months ended September 30, 2020

(Expressed in Canadian dollars, except share amounts)

18.Expenses by nature

The following table presents a breakdown of expenses by nature for the following periods:

		Year ended			Year ended			Nine months
		September 30,			September 30,			ended
		2022			2021			September 30,
Employee benefits	$	4,883,062		$	4,746,316		$	1,161,071
Advertising and promotion		1,352,750			1,914,630			220,946
Consulting fees		1,315,917			1,138,782			620,295
Professional fees		1,028,240			778,337			190,398
Travel and conferences		518,140			246,418			112,360
R&D consulting and material costs, net		420,378			482,348			100,483
Depreciation and amortization		326,491			140,990			103,397
Other expenses		266,822			252,961			106,006
Insurance		236,150			154,931			-
Transfer agent and listing fees		94,885			110,769			-
Royalty and license costs		-			287,000			-
M&A costs		-			-			1,561,860
Total expenses		10,442,835			10,253,482			4,176,816
Allocation to cost of sales:
Employee benefits		(166,706	)		(574,018	)		(71,105	)
Total operating expenses	$	10,276,129		$	9,679,464		$	4,105,711

19.Depreciation and Amortization

The following table presents total depreciation and amortization expense of property and equipment, intangible assets, and right-of-use assets by function:

		2022		2021		2020
General and administrative	$	123,960	$	95,310	$	89,307
Selling and marketing		129,265		16,443		-
Research and development		73,266		29,237		14,090
Total depreciation and amortization	$	326,491	$	140,990	$	103,397

F-65

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Years ended September 30, 2022, and 2021 and nine months ended September 30, 2020

(Expressed in Canadian dollars, except share amounts)

20.Net finance costs

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

		Year ended			Year ended			Nine months ended
		September 30,			September 30,			September 30,
		2022			2021			2020
Interest expense from:
Unsecured loan	$	321,313		$	4,527		$	-
Accretion cost - accrued royalties liability		159,451			64,537			-
Lease obligations		30,112			33,872			31,242
Related party loans		-			4,581			8,448
CEBA term loan		-			4,481			-
2019 convertible notes		-			-			44,899
Other		1,114			4,115			5,885
Total interest expense		511,990			116,113			90,474
Interest income		(5,988	)		(4,848	)		(2,454	)
Gain on termination of lease obligations		-			-			(17,527	)
Gain on government grant		-			(3,514	)		(9,096	)
Net finance costs	$	506,002		$	107,751		$	61,397

21.Income taxes

a)Income tax recovery

Income tax recovery is made up of the following components:

							Nine months
		Year end ended			Year ended		ended
		September 30,			September 30,		September 30,
		2022			2021		2020
Current income tax recovery (expense):	$	-		$	-	$	-
Deferred income tax (recovery) expense:		(49,442	)		-		-
	$	(49,442	)	$	-	$	-

b)Reconciliation of effective income tax rate

Our effective income tax rate differs from the statutory rate of 26.5% that would be obtained by applying the combined Canadian basic federal and provincial income tax rate to loss before income taxes. These differences result from the following:

F-66

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Years ended September 30, 2022, and 2021 and nine months ended September 30, 2020

(Expressed in Canadian dollars, except share amounts)

								Nine months
		Year ended			Year ended			ended
		September 30,			September 30,			September 30,
		2022			2021			2020
Loss before income taxes	$	(10,569,732	)	$	(9,315,372	)	$	(3,536,778	)
Expected statutory tax rate		26.5%			26.5%			26.5%
Expected tax recovery resulting from loss		(2,800,979	)		(2,468,574	)		(937,246	)
Increase (reduction) in income taxes resulting from:
Non-deductible expenses		563,842			654,956			275,273
Foreign operations subject to different tax rates		5,329			3,593			-
Unrecognized temporary differences		2,182,366			1,826,279			661,973
Prior year differences		-			(16,254	)		-
	$	(49,442	)	$	-		$	-

KWESST claims research and development deductions and related Investment Tax Credits ("ITC") for tax purposes based on management's interpretation of the applicable legislation in the Income Tax Act of Canada. These claims are subject to audit by the Canada Revenue Agency ("CRA") and any adjustments that results could affect ITCs recorded in the consolidated financial statements. The following table shows the breakdown of R&D expenses, net of ITCs:

		Year ended		Year ended			Year ended
		September 30,		September 30,			September 30,
		2022		2021			2020
R&D expenses	$	2,064,493	$	2,369,145		$	944,909
Less:
Investment tax credits		-		(231,007	)		(127,325	)
R&D expenses, net		2,064,493		2,138,138			817,584

c)Deferred tax balances

The following tables deferred tax assets (liabilities) have been recognized in the consolidated financial statements:

	Balance at	Arising on a			Balance at
	September 30,	business		Recognized in	September 30,
	2021	combination		profit or loss	2022
Deferred tax assets (liabilities):
Net operating loss carryforwards	-	-		26,459	26,459
Intangibles and development costs	-	(49,442	)	22,983	(26,459	)
	-	(49,442	)	49,442	-

F-67

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Years ended September 30, 2022, and 2021 and nine months ended September 30, 2020

(Expressed in Canadian dollars, except share amounts)

	Balance at					Balance at
	September 30,		Recognized in		Recognized in	September 30,
	2020		profit or loss		Equity	2021
Deferred tax assets (liabilities):
Net operating loss carryforwards	48,045		(48,045	)	-	-
Impairment provision	(48,045	)	48,045		-	-
	-		-		-	-
	Balance at					Balance at
	December 31,		Recognized in		Recognized in	September 30,
	2019		profit or loss		Equity	2020
Deferred tax assets (liabilities):
Net operating loss carryforwards	-		48,045		-	48,045
Impairment provision	-		(48,045	)	-	(48,045	)
	-		-		-	-

d)Unrecognized net deferred tax assets

Deferred taxes reflect the impact of loss carryforwards and of temporary differences between amounts of assets and liabilities for financial reporting purposes and such amounts as measured by enacted tax laws. However, KWESST has not recorded net deferred tax assets at September 30, 2022 and 2021 on the following deductible temporary differences, due to the uncertainty involved in determining whether these deferred tax assets will be realized upon expiration due to KWESST's limited history and cumulative operating losses since its inception.

The following is a summary of KWESST's unrecognized deductible temporary differences:

	Balance at	Balance at	Balance at
	September 30,	September 30,	September 30,
	2022	2021	2020
Net operating loss carryforwards	18,589,894	9,429,436	4,279,494
Share issuance costs	1,298,783	1,810,927	1,496,239
Intangibles and development costs	608,705	780,607	-
Scientific research and development expenditures	1,583,058	1,789,571	218,235
Other	46,300	104,793	46,891
	22,126,741	13,915,334	6,040,859

e)Available net operating losses

At September 30, 2022, KWESST has the following net operating losses in Canada available to reduce future year's taxable income which expire as follows:

F-68

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Years ended September 30, 2022, and 2021 and nine months ended September 30, 2020

(Expressed in Canadian dollars, except share amounts)

Year of Expiry		Amount
2036	$	512,163
2037		744,022
2038		1,174,797
2039		1,732,039
2040 and thereafter		14,526,720
	$	18,689,741

f) Available research and development investment tax credits

The Company has the following research and development investment tax credits available to reduce future years' income taxes payable which expire as follows:

Year of Expiry		Amount
2037	$	13,361
2038		6,742
2039		-
2040 and thereafter		328,480
	$	348,583

22. Financial instruments

Fair value of financial instruments

The fair values of our cash, restricted short-term investment, trade and other receivables, accounts payable and accrued liabilities, deposit (included in non-current other assets), and related party loans approximate carrying value because of the short-term nature of these instruments.

Under IFRS, the levels of fair value hierarchy is as follows:

Level 1: Unadjusted quoted prices in active markets for identical assets or liabilities;

Level 2: Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly (i.e. as prices) or indirectly (i.e. derived from prices); and

Level 3: inputs for the asset or liability that are not observable market data (unobservable inputs).

The lease deposit, lease obligations, accrued royalties liability, and borrowings were recorded at fair value at initial recognition.  The fair value measurement for these were Level 2. Subsequently, these were measured at amortized cost and accreted to their nominal value over their respective terms. At September 30, 2022, the fair value for accrued royalties liability determined using a discount rate of 24% (2021 - 13.7%) would be $869,219 (2021 - $1,105,756).  Using the same market discount rate, the fair value of the borrowings would be $68,750 at September 30, 2022 (2021 - $49,825).

Financial risk management

We are exposed to a number of financial risks arising through the normal course of business as well as through its financial instruments. Our overall business strategies, tolerance of risk and general risk management philosophy are determined by our Board of Directors in accordance with prevailing economic and operating conditions.

F-69

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Years ended September 30, 2022, and 2021 and nine months ended September 30, 2020

(Expressed in Canadian dollars, except share amounts)

 (a)Interest rate risk

Interest rate risk is the risk that the fair value of cash flows of a financial instrument will fluctuate because of changes in market interest rates. At September 30, 2022, our borrowings were all subject fixed interest rate and therefore these were not subject to interest rate risk.  At September 30, 2021, our borrowing was interest free.

(b)Foreign currency risk

Foreign currency risk is the risk that the future cash flows or fair value of our financial instruments that are denominated in a currency that is not our functional currency will fluctuate due to a change in foreign exchange rates.

For the years ended September 30, 2022 and 2021, our revenue was substantially denominated in U.S. dollar driven by contracts with U.S. prime contractors in the defense sector.  We also procure certain raw materials denominated in U.S. dollar for product development. Accordingly, we are exposed to the U.S. dollar currency. Where a natural hedge cannot be achieved, a significant change in the U.S. dollar currency could have a significant effect on our financial performance, financial position and cash flows. Currently, we do not use derivative instruments to hedge its U.S. dollar exposure.

At September 30, 2022, we had the following net U.S. dollar exposure:

		Total USD
Net liabilities in U.S. subsidiary	$	34,623
US denominated:
Assets	$	70,187
Liabilities		(1,015,090	)
Net U.S. dollar exposure	$	(979,526	)
Impact to profit or loss if 5% movement in the U.S.	$	(48,976	)

During the year ended September 30, 2022, we recorded foreign exchange gain of $28,780 (2021 - foreign exchange loss of $3,742; 2020 - foreign exchange loss of $13,937).

(c)Credit risk

Credit risk is the risk of financial loss to KWESST if a counterparty to a financial instrument fails to meet its contractual obligations. Our credit risk exposure is limited to cash, and trade and other receivables. Refer to Note 5 for the breakdown of our trade and other receivables.  We enter into contracts with either large, financially sound global general contractors or law enforcement agencies, which mitigates the credit risk. At September 30, 2022, our trade receivable was $114,877 (2021 - $nil), of which $53,233 was overdue by more than 60 days from law enforcement agencies.

(d)Liquidity risk

Liquidity risk is the risk that we will be unable to meet our financial obligations as they become due. Our objective is to ensure that we have sufficient cash to meet our near-term obligation when they become due, under both normal and stressed condition, without incurring unacceptable losses or risking reputational damage to KWESST. A key risk in managing liquidity is the degree of uncertainty in our cash flows due to our early stage in operations and the need for additional capital to fund our business strategies (see Note 2(a)).

F-70

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Years ended September 30, 2022, and 2021 and nine months ended September 30, 2020

(Expressed in Canadian dollars, except share amounts)

At September 30, 2022, our contractual obligations were as follows:

Payment due:		Total		Within 1 Year		1 to 3 years		3 to 5 years
Accounts payable and accrued liabilities	$	4,459,481	$	4,459,481	$	-	$	-
Borrowings		2,648,280		2,548,280		100,000		-
Minimum royalty commitments		2,500,000		150,000		350,000		2,000,000
Lease obligations		327,600		93,600		187,200		46,800
Total contractual obligations	$	9,935,361	$	7,251,361	$	637,200	$	2,046,800

At September 30, 2022, we had $170,545 in cash and $5,409,487 in negative working capital (current assets less current liabilities).  See Note 27 (a), Subsequent Events - U.S. IPO and Canadian Offering.

23.Supplemental cash flow information

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

		Year ended		Year ended			Nine months ended
		September 30,		September 30,			September 30,
		2022		2021			2020
Trade and other receivables	$	631,801	$	(218,334	)	$	(257,588	)
Inventories		49,446		17,555			-
Prepaid expenses and other		425,876		(106,205	)		(387,762	)
Accounts payable and accrued liabilities		2,515,289		(828,698	)		393,202
Contract liabilities		17,410		(7,053	)		7,053
Deposits		-		150,000			-
Accrued royalties liability		-		1,191,219			-
	$	3,639,822	$	198,484		$	(245,095	)

The following is a summary of non-cash items that were excluded from the consolidated statements of cash flows for the nine months ended September 30, 2022:

• $83,319 fair value of 875 contingent shares settled via common shares (see Note 4(a));

• $19,000 debt settlement via common shares;

• $61,173 fair value of warrants exercised and transferred to share capital from warrants; and

• $125,000 for 250,000 warrants exercised in connection with the GhostStep^TM acquisition in June 2020.

The following is a summary of non-cash items that were excluded from the consolidated statements of cash flows for the year ended September 30, 2021:

• $63,866 debt settlement via common shares;

• $125,000 for 250,000 exercised warrants in connection with the GhostStep^TM acquisition in June 2020;

• $102,991 fair value of warrants exercised and transferred to share capital;

• $203,516 fair value of options exercised and transferred to share capital from contributed surplus;

• $1,715,000 fair value of common shares and warrants issued for the acquisition of the LEC System (Note 4(b)),

• $137,000 fair value of common shares issued for the amended and restated license agreement with AerialX (Note 26);

• $169,832 share offering costs relating to the Broker Compensation Options (Note 15(a)); and

• $3,828 non-cash consideration for computer equipment acquired.

The following is a summary of non-cash items that were excluded from the consolidated statements of cash flows for the nine months ended September 30, 2020:

F-71

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Years ended September 30, 2022, and 2021 and nine months ended September 30, 2020

(Expressed in Canadian dollars, except share amounts)

• $358,178 of right-of-use asset and lease obligations relating to the new office lease;

• $139,787 of right-of-use asset and $157,315 lease obligations de-recognized from KWESST's consolidated financial position relating to the former lease office;

• $347,280 of KWESST's common shares and warrants for the asset acquisition of GhostStep^TM Technology;

• $255,718 of convertible notes, including accrued interest, settled in KWESST's common shares;

• $322,779 of share offering costs settled in KWESST's common shares;

• $41,155 of options adjustment due to QT (see note 4(c)); and

• $17,531 fair value of options exercised and transferred to KWESST's common shares.

24.Segmented information

Our Executive Chairman has been identified as the chief operating decision maker. Our Executive Chairman evaluates the performance of KWESST and allocates resources based on the information provided by our internal management system at a consolidated level. We have determined that we have only one operating segment.

At September 30, 2022 and 2021, all of our property and equipment are located in Canada, including the right-of-use assets.

25.Capital management

Our objective in managing our capital is to safeguard our ability to continue as a going concern and to sustain future development of the business. Our senior management is responsible for managing the capital through regular review of financial information to ensure sufficient resources are available to meet operating requirements and investments to support our growth strategy. Our Board of Directors is responsible for overseeing this process. From time to time, we could issue new common shares or debt to maintain or adjust our capital structure (see Note 27). KWESST is not subject to any externally imposed capital requirements.

KWESST's capital is composed of the following:

		September 30,			September 30,
		2022			2021
Debt:
Borrowings	$	2,278,774		$	53,251
Lease obligations		275,621			307,909
Equity:
Share capital		19,496,640			17,215,068
Warrants		1,959,796			1,848,389
Contributed surplus		3,551,330			2,458,211
Accumulated other comprehensive loss		(101,418	)		(8,991	)
Accumulated deficit		(25,909,239	)		(15,388,949	)
Total capital	$	1,551,504		$	6,484,888

26.Commitments and contingencies

AerialX Drone Solutions ("AerialX")

On April 5, 2021, we entered into an amended and restated licensing agreement with AerialX to gain exclusive rights to manufacture, operate, and use its drone for the C-UAS (Counter Unmanned Aerial Systems) market, specifically for the United States Department of Defense and Canada's Department of National Defence for a period of two years from the date upon which AerialX will meet certain technical milestones. In consideration for this exclusivity, we have issued 1,429 common shares to AerialX ("Exclusive License Shares"). Based on our closing stock price of $95.90 on April 23, 2021 (TSX-V approval date), the fair value for these shares was $137,000. We recorded the $137,000 fair value as a license cost for the year ended September 30, 2021, with an equal offset to our share capital.

F-72

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Years ended September 30, 2022, and 2021 and nine months ended September 30, 2020

(Expressed in Canadian dollars, except share amounts)

In addition to the Exclusive License Shares, we also agreed to issue an additional 1,429 common shares upon AerialX achieving the technical milestones. For the years ended September 30, 2022 and 2021, AerialX has not delivered on the technical milestones and therefore no recognition was made.

Additionally, we also agreed to issue up to 4,286 common shares subject to achieving the following performance milestones:

# of Common Shares	Milestones
1,071	$3 million in sales
1,429	$9 million in sales
1,786	$18 million in sales

The amended and restated licensing agreement also changed the terms of the annual minimum royalty payment to AerialX. The initial minimum royalty payment is not due prior to the first anniversary year of the Prototype Date, which is defined under the agreement as the date upon which a functioning prototype is received by us.

Under this agreement, we will pay a royalty ranging from 8% to 15% of sales of AerialX technology, subject to the following minimum payments:

• 1^st anniversary: $150,000

• 2^nd anniversary: $200,000

• 3^rd anniversary: $300,000

• 4^th anniversary: $400,000

• 5^th anniversary: $500,000

In accordance with the original agreement dated November 18, 2019, in the first quarter of Fiscal 2020 we made a payment of $150,000 as an advance for future royalty payments (the "Advance"). This Advance was recorded as a non-current deposit at December 31, 2019 and September 30, 2020. During the year ended September 30, 2021, management performed a recoverability review of all our financial assets, including this Advance. Management made the recoverability assessment on the Advance based on anticipated future sales of the licensed technology. Due to the lack of delivery of a functional prototype during the year ended September 30, 2021, management concluded the timing and volume of future sales of the licensed drone was too uncertain.  Accordingly, we took a charge to net loss for the year ended September 30, 2021. This charge is included in general and administrative expenses in the consolidated statements of net loss and comprehensive loss.  As at September 30, 2022, ArielX has not delivered a functional prototype and no further royalties have been paid.

Under the amended and restated licensing agreement, we will continue to have non-exclusive worldwide license. This agreement will expire on April 30, 2026.

27.Subsequent Events

a)U.S. IPO and Canadian Offering

On December 9, 2022, we closed an underwritten U.S. public offering (the "U.S. IPO") and an underwritten Canadian offering (the "Canadian Offering"). In the U.S. IPO, we sold 2,500,000 units at a public offering price of USD $4.13 per unit (the "Unit"), consisting of one share of common stock and one warrant to purchase one share of common stock ("Warrant"). The Warrants have a per share exercise price of USD $5.00, can be exercised immediately, and expire five years from the date of issuance. In connection with the closing of the U.S. IPO, the underwriter partially exercised its over-allotment option to purchase an additional 199,000 pre-funded common share purchase warrants and 375,000 warrants to purchase common shares. The underwriter has the right to exercise the balance of its over-allotment option within the 45-day period.

F-73

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Years ended September 30, 2022, and 2021 and nine months ended September 30, 2020

(Expressed in Canadian dollars, except share amounts)

In the Canadian Offering, we sold 726,392 units, each consisting of one common share and one warrant to purchase one common share, at a price to the public of USD $4.13 per unit. The warrants will have a per common share exercise price of USD $5.00, are exercisable immediately and expire five years from the date of issuance.

The closing of the U.S. IPO and Canadian Offering resulted in aggregate gross proceeds of USD $14,145,000, before deducting underwriting discounts and offering expenses.

The common shares of KWESST and the Warrants sold in the U.S. IPO began trading on the Nasdaq Capital Market under the symbols "KWE" and "KWESW", respectively, on December 7, 2022.

ThinkEquity acted as sole book-running manager for the U.S. IPO and PI Financial acted as sole book-running manager for the Canadian Offering.

As consideration for the services provided in connection with the U.S. IPO, ThinkEquity received: (a) a broker-dealer cash commission of approximately US$835,000 equal to 7.5% of the gross offering proceeds of the U.S. Offering and (b) underwriter warrants (the "Underwriter Warrants") to purchase up to 134,950 common shares equal to 5% of the common shares and pre-funded common share purchase warrants issued under the U.S. Offering. Each Underwriter Warrant is exercisable to acquire one common share at a price of US$5.1625, exercisable as of June 4, 2023, and expiring December 4, 2027.

As consideration for the services provided in connection with the Canadian Offering, PI Financial received: (a) a cash commission of approximately US$210,000 equal to 7% of the gross proceeds of the Offering; and (b) 50,848 compensation options (the "Compensation Options") equal to 7% of the number of Units issued under the Canadian Offering. Each Compensation Option is exercisable to acquire one Canadian Unit at a price of US$4.13 for a period of two years after the closing of the Canadian Offering.

In addition to the above brokers' compensation, we also incurred US$2.3 million share offering costs for the U.S. IPO and Canadian Offering, of which $628,262 was incurred and deferred at September 30, 2022.

b)Shares for Debt Settlement

We have entered into share for debt arrangements with existing lenders, which closed on December 13, 2022, following TSXV's conditional approval.  This resulted in issuing 56,141 Units to settle $12,000 of the March 2022 Loans and USD$223,321 of the August 2022 Loans, including unpaid accrued interest and 10% premium at maturity (the "Debt Settlements") - see Note 12. The terms of the Units are the same as the Units issued in the Canadian Offering (see part (a)).

The Units, as well as the common shares and Warrants, to be issued pursuant to the Debt Settlements will be subject to a four-month hold period pursuant to applicable securities regulations and the policies of the TSXV.

c)Loan Repayments

In December 2022, we have repaid the remaining $1,997,435 of the March 2022 Loans, including accrued unpaid interest, and USD$223,321 of the August 2022 Loans, including unpaid accrued interest and 10% premium at maturity.  Following these loan repayments, there were no further outstanding loans.

In December 2022, we have repaid the CEBA Term Loans net of the total forgivable amount of $30,000. 

F-74

Consolidated Financial Statements of

KWESST MICRO SYSTEMS INC.

Nine months ended September 30, 2020, and

Twelve months ended December 31, 2019

(Expressed in Canadian Dollars)

F-75

KWESST MICRO SYSTEMS INC.

Table of Contents for the Nine months Ended September 30, 2020 and twelve months ended December 31, 2019

	Page
Independent Auditor's Report	F-77
FINANCIAL STATEMENTS
Consolidated Statements of Financial Position	F-79
Consolidated Statements of Net Loss and Comprehensive Loss	F-80
Consolidated Statements of Changes in Shareholders' Equity	F-81
Consolidated Statements of Cash Flows	F-82
Notes to the Consolidated Financial Statements	F-83

F-76

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of KWESST Micro Systems Inc.

Opinion on the Consolidated Financial Statements

We have audited the accompanying consolidated statements of financial position of KWESST Micro Systems Inc. (the "Company") as of September 30, 2020 and December 31, 2019, and the related consolidated statements of loss and comprehensive loss, changes in shareholders' equity, and cash flows for the nine month ended September 30, 2020 and twelve months ended December31, 2019, and the related notes (collectively referred to as the "consolidated financial statements").

In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of September 30, 2020 and December 31, 2019, and its financial performance and its cash flows for the periods then ended, in conformity with the International Financial Reporting Standards as issued by the International Accounting Standards Board.

Correction in the application of IFRS 16 Leases

As discussed in Note 8, the consolidated financial statements for the nine months ended September 30, 2020 have been adjusted for a correction in the application of IFRS 16 Leases.

Material Uncertainty Related to Going Concern

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2(a) to the consolidated financial statements, the Company has incurred significant losses and negative cash flows from operations since inception that raise substantial doubt about its ability to continue as a going concern. Management's plans regarding these matters are also described in Note 2(a). The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. Our opinion is not modified in respect of this matter.

Basis for Opinion

These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

Kreston GTA LLP | 8953 Woodbine Avenue, Markham, Ontario, Canada, L3R 0J9, T. 905.474.5593 | www.krestongta.com
A member of Kreston International | A global network of independent accounting firms

F-77

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion.

Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.

Emphasis of Matter

As discussed in Note 26(b) to the consolidated financial statements, subsequent to the fiscal year 2020, the Company has completed an asset acquisition transaction with a related party under common control by issuance of common shares and share purchase warrants of the Company. Our opinion is not modified in respect of this matter.

We served as the Company's auditor since 2019.

Chartered Professional Accountants

Licensed Public Accountants

November 22, 2021, except for Note 1 as to which the date is November 14, 2022

Markham, Canada

Kreston GTA LLP | 8953 Woodbine Avenue, Markham, Ontario, Canada, L3R 0J9, T. 905.474.5593 | www.krestongta.com
A member of Kreston International | A global network of independent accounting firms

F-78

KWESST MICRO SYSTEMS INC.

Consolidated Statements of Financial Position

At September 30, 2020 and December 31, 2019

In Canadian dollars	Note		September 30,  2020			December 31, 2019
			(Adjusted - See Note 8)			(As restated - see Note 25)
ASSETS
Cash		$	3,073,760		$	21,615
Trade and other receivables	5		480,917			219,803
Prepaid expenses and other			441,837			54,075
Current assets			3,996,514			295,493
Property and equipment	6		174,644			70,122
Right-of-use assets	8		327,576			184,472
Deposits	8		19,341			-
Intangible assets	7		644,702			-
Other assets	25		150,000			150,000
Non-current assets			1,316,263			404,594
Total Assets		$	5,312,777		$	700,087
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Liabilities
Accounts payable and accrued liabilities	9	$	818,274		$	198,687
Lease obligations	12		44,128			85,468
Related party loans	10		218,276			289,828
Borrowings	11		32,273			-
Deferred revenue	13		7,053			-
Financial derivative liabilities	14		-			29,463
Current liabilities			1,120,004			603,446
Lease obligations	12		307,909			117,218
Convertible notes	15		-			210,819
Non-current liabilities			307,909			328,037
Total Liabilities			1,427,913			931,483
Shareholders' Equity (Deficit)
Share capital	16		9,374,563			2,284,353
Contributed surplus	16		583,878			21,050
Accumulated deficit			(6,073,577	)		(2,536,799	)
Total Shareholders' equity (deficit)			3,884,864			(231,396	)
Total Liabilities and Shareholders' Equity (Deficit)		$	5,312,777		$	700,087

See Note 2(a) Going concern and Note 24 Commitments and contingencies.
See accompanying notes to consolidated financial statements.
On behalf of the Board of Directors:
(signed) John McCoach, Director	(signed) David Luxton, Director

F-79

KWESST MICRO SYSTEMS INC.

Consolidated Statements of Net Loss and Comprehensive Loss

For the nine months ended September 30, 2020 and the twelve months ended December 31, 2019

In Canadian dollars	Note		Nine Months ended  September 30, 2020			Twelve months ended December 31, 2019
			(Adjusted  - see Note 8)			(As restated - see Note 25)
Revenue	18	$	861,917		$	509,148
Cost of sales			(247,113	)		(85,101	)
Gross profit			614,804			424,047
Operating expenses
General and administrative	4, 10, 16		2,723,861			397,990
Selling and marketing			564,266			36,681
Research and development, net			817,584			1,003,705
Total operating expenses			4,105,711			1,438,376
Operating loss			(3,490,907	)		(1,014,329	)
Other income (expenses)
Fair value adjustments on derivatives	14		29,463			113,178
Net finance costs	10, 12, 15		(61,397	)		(245,147	)
Foreign exchange gain (loss)			(13,937	)		(982	)
Total other income (expenses)			(45,871	)		(132,951	)
Loss before income taxes			(3,536,778	)		(1,147,280	)
Income tax recovery:	19
Current tax recovery			-			-
Deferred tax recovery			-			-
Net loss and comprehensive loss		$	(3,536,778	)	$	(1,147,280	)
Net Loss per share
Basic and diluted		$	(8.03	)	$	(4.61	)
Weighted average number of shares outstanding
Basic and diluted	17		440,631			249,001

See accompanying notes to consolidated financial statements.

F-80

KWESST MICRO SYSTEMS INC.
Consolidated Statements of Changes in Shareholders' Equity
For the nine months ended September 30, 2020 and the twelve months ended December 31, 2019

In Canadian dollars		Common Shares					Contributed Surplus								Total Shareholders' Equity
[Refer to Note 16]	Other Notes	Number Issued		Share Capital			Warrants		Options			Deficit
Balance, December 31, 2018		3	$	200		$	-	$	-		$	(1,389,519	)	$	(1,389,319	)
Shares issued for cash		72,500		1,014,948			-		-			-			1,014,948
Shares issued for debt		311,493		1,269,205			1,192		-			-			1,270,397
Warrants issued for debt		-		-			19,858		-			-			19,858
Net loss	25	-		-			-		-			(1,147,280	)		(1,147,280	)
Balance, December 31, 2019		383,996	$	2,284,353		$	21,050	$	-		$	(2,536,799	)	$	(231,396	)
Shares and warrants issued in a brokered private placement		62,994		3,087,138			60,340		-			-			3,147,478
Shares for converted debt and interest		52,381		1,583,881			-		-			-			1,583,881
Shares and warrants issued in non-brokered private placements		49,811		1,480,875			15,780		-			-			1,496,655
Shares issued for performance incentive		14,929		731,500			-		-			-			731,500
Shares from Foremost's qualifying transaction	4(a)	12,836		628,949			-		41,155			-			670,104
Shares and warrants issued on acquisition of technology asset	4(b)	9,957		167,280			180,000					-			347,280
Stock options exercised		1,743		78,080			-		(17,531	)		-			60,549
Shares for consulting services		871		32,393			-					-			32,393
Share-based payments		-		-					283,084			-			283,084
Share offering costs		-		(699,886	)		-					-			(699,886	)
Net loss		-		-			-					(3,536,778	)		(3,536,778	)
Balance, September 30, 2020		589,518	$	9,374,563		$	277,170	$	306,708		$	(6,073,577	)	$	3,884,864

See accompanying notes to consolidated financial statements.

F-81

KWESST MICRO SYSTEMS INC.
Consolidated Statements of Cash Flows
For the nine months ended September 30, 2020 and the twelve months ended December 31, 2019

In Canadian dollars	Note		Nine months ended September 30, 2020			Twelve months ended December 31, 2019
			(Adjusted - See Note 8)			(As restated - see Note 25)
OPERATING ACTIVITIES
Net loss		$	(3,536,778	)	$	(1,147,280	)
Items not affecting cash:
Depreciation and amortization	6, 8		103,397			102,142
Share-based compensation	17		283,084			-
Shares for M&A advisory and consulting services			763,893			-
Fair value adjustments on derivative liabilities	14		(29,463	)		(113,178	)
Non-cash listing expense (included in M&A costs)	4(a)		814,703			-
Net finance costs			61,217			230,858
Changes in non-cash working capital items	21		(245,095	)		(141,575	)
Interest paid			(6,612	)		(24,523	)
Cash used in operating activities			(1,791,654	)		(1,093,556	)
INVESTING ACTIVITIES
Acquisition of property and equipment	6		(133,927	)		(20,190	)
Acquisition of technology asset	4(b)		(134,192	)		-
Deposit for long-term office lease			(38,212	)		-
Investments in development projects	7		(163,230	)		-
Cash acquired on closing of Foremost	4(a)		78,589			-
Cash flows used in investing activities			(390,972	)		(20,190	)
FINANCING ACTIVITIES
Proceeds from the issuance of common shares	16		4,355,171			1,014,948
Proceeds from convertible notes and converted to equity	17		1,081,504			-
Payments of share offering costs	17		(164,716	)		-
Proceeds from borrowings	11		40,000			-
Repayment of borrowings			-			(10,747	)
Repayments to related party loans	10		(80,000	)		(70,513	)
Proceeds from related party loans	10		-			310,684
Repayments of lease obligations	12		(58,188	)		(77,367	)
Repayments of convertible notes	15		-			(31,644	)
Proceeds from exercise of stock options	16		61,000			-
Cash flows provided by financing activities			5,234,771			1,135,361
Net change in cash during the period			3,052,145			21,615
Cash, beginning of period			21,615			-
Cash, end of period		$	3,073,760		$	21,615

See Note 21 for supplemental cash flow information
See accompanying notes to consolidated financial statements.

F-82

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Nine months ended September 30, 2020 and twelve months ended December 31, 2019

(Expressed in Canadian dollars, except share and per share amounts)

1.Corporate information

KWESST Micro Systems Inc. (the "Company" or "KWESST"), formerly Foremost Ventures Corp. (''Foremost''), was incorporated on November 28, 2017, under the laws of the Province of British Columbia. The Company's registered office is located at 550 Burrard Street, Suite 2900, Vancouver, British Columbia, Canada. Its corporate office is located at Unit 1, 155 Terrence Matthews Crescent, Ottawa, Ontario, Canada.

On September 17, 2020, Foremost completed a Qualifying Transaction ("the QT") with KWESST Inc., a private company, was incorporated under the laws of the Province of Ontario on April 24, 2017. The QT constituted a reverse acquisition in accordance with IFRS as the shareholders of KWESST Inc. took control of Foremost (Note 4(a)). At the time of the QT, Foremost did not constitute a business as defined under IFRS 3 - Business Combinations, and therefore the QT was accounted for as an asset acquisition. As KWESST Inc. was deemed to be the acquirer for accounting purposes, the resulting consolidated statements of financial position was presented as a continuance of KWESST Inc.'s operations at their historical carrying values, and the comparative figures presented are those of KWESST Inc. The results of operations, the cash flows, and the assets and liabilities of Foremost have been included in these consolidated financial statements since September 17, 2020.

Following the QT, KWESST, pursuant to Section 4.8(2) of National Instrument 51-102, provided notice that KWESST has changed its fiscal year end to September 30th from December 31st. Accordingly, these consolidated financial statements presented herein are as at and for the nine months ended September 30, 2020 with comparatives as at and for the twelve months ended December 31, 2019.

KWESST develops and markets innovative products to create ''intelligent tactical systems'' and proprietary technology for game-changing applications in the military and homeland security market. KWESST's core technology has multiple applications based on its micro integrated sensor software technology, or MISST, a proprietary integration of miniaturized sensors, optics, ballistics and software that provides an advancement in affordable smart systems and mission capability.

KWESST's common stock is listed on the TSX-Venture Exchange (''TSX-V'') under the stock symbol of KWE.

KWESST effected a one for seventy (1-for-70) reverse stock split of its common stock on October 28, 2022 (the "Reverse Split"). The Reverse Split has been retroactively applied to these consolidated financial statements.

To retroactively apply this Reverse Split, the exercise price and number of common shares issuable upon the exercise of outstanding stock options were adjusted accordingly. The restricted share units ("RSUs") and performance stock units ("PSUs") have also been adjusted. While the number of warrants has not changed as a result of the Reverse Split; the conversion rate for each warrant was adjusted from one common share to 0.01428571 of a common share.

All information respecting outstanding common shares and other securities of KWESST, including net loss per share, in the current and comparative periods presented are on a Reverse Split basis.

2.Basis of preparation

(a)Going concern

These consolidated financial statements have been prepared assuming KWESST will continue as a going concern.

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KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Nine months ended September 30, 2020 and twelve months ended December 31, 2019

(Expressed in Canadian dollars, except share and per share amounts)

As an early-stage company, KWESST has incurred significant losses and negative operating cash flows from inception that have primarily been funded from financing activities. The Company incurred approximately $3.5 million net loss and negative operating cash flows of approximately $1.8 million for the nine months period ended September 30, 2020 (2019 - $1.1 million net loss and negative operating cash flows of $1.1 million for 12 months). At September 30, 2020, KWESST had a working capital of $2.9 million (December 31, 2019 - working capital deficiency of $0.3 million).

The Company's ability to continue as a going concern and realize its assets and discharge its liabilities in the normal course of business is dependent upon closing timely additional sales orders, achieving sustained profitability and the ability to raise additional debt or equity financing, if required, to fund its working capital requirements. There are various risk and uncertainties affecting KWESST's operating including, but not limited to:

• The market acceptance and rate of commercialization of the KWESST's offerings;
• Ability to successfully execute its business plan;
• Ability to raise additional capital at acceptable terms;
• General local and global economic conditions, including the ongoing COVID-19 pandemic, certain of which are beyond the Company's control.

KWESST's strategy to mitigate these risks and uncertainties is to execute timely a business plan aimed at continued focus on revenue growth, product development and innovation, improving overall gross profit, managing operating expenses and working capital requirements, and securing additional capital, as needed. There are no guarantees that the funds raised will be sufficient to sustain KWESST's ongoing operations beyond twelve months or that additional debt or equity financing will be available to the Company or available at acceptable terms. Failure to implement the Company's business plan could have a material adverse effect on the Company's financial condition and/or financial performance. Accordingly, there are material risks and uncertainties that cast significant doubt about KWESST's ability to continue as a going concern.

These consolidated financial statements do not include any adjustments or disclosures that would be required if assets are not realized and liabilities and commitments are not settled in the normal course of operations. If KWESST is unable to continue as a going concern, then the carrying value of certain assets and liabilities would require revaluation to a liquidation basis, which could differ materially on the values presented in the financial statements.

(b)Statement of compliance

These consolidated financial statements have been prepared in accordance with International Financial Reporting Standards (''IFRS'') as issued by the International Accounting Standards Board ("IASB") and interpretations of the IFRS Interpretations Committee ("IFRIC''). 

The consolidated financial statements were authorized for issue by the Board of Directors on November 22, 2021 except for Note 1 and the related changes, as to which the date is November 14, 2022.

(b)Principles of consolidation

These consolidated financial statements incorporate the financial statements of KWESST and the entity it controls.

Control is achieved where KWESST has 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 the Company's 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 the Company 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.

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Notes to Consolidated Financial Statements

Nine months ended September 30, 2020 and twelve months ended December 31, 2019

(Expressed in Canadian dollars, except share and per share amounts)

At September 30, 2020, the Company has one wholly-owned subsidiary: KWESST Inc.

(c)Functional and presentation currency

The consolidated financial statements are presented in Canadian dollars ("CAD"), which is the functional currency of KWESST and its subsidiary.

(d)Measurement basis

The consolidated financial statements have been prepared on the historical cost basis except for certain financial instruments measured at fair value. Historical cost is generally based on the fair value of the consideration given in exchange for assets.

(e)Comparative figures

Certain comparative figures in the consolidated statements of net loss and comprehensive loss have been reclassified to conform with the current period's presentation.

(f)Use of estimates and judgments

The preparation of the consolidated financial statements in accordance with IFRS requires management to make judgments, estimates, and assumptions that affect the application of accounting policies and the reported amounts of assets and liabilities, income, expenses, and disclosure of contingent liabilities. Actual results may differ from these estimates.

The continuing uncertainty around the outbreak of the novel coronavirus ("COVID-19"') pandemic required the use of judgements and estimates in the preparation of the consolidated financial statements for the nine months ended September 30, 2020. The future impact of COVID-19 uncertainties could generate, in future reporting periods, a significant impact to the reported amounts of assets, liabilities, revenue and expenses in these and any future financial statements.

Critical judgments that management has made in applying KWESST's accounting policies that the most significant effect on the amounts recognized in the consolidated financial statements include: assessment of KWESST's ability to continue as a going concern (Note 2(a)); and determination of the functional currency of the principal operations of KWESST(Note 2(c)).

Significant areas having estimation uncertainty in applying accounting policies that have the most significant effect on the amounts recognized in the financial statements:

Revenue recognition

To date, substantially all of the Company's revenue arise from providing customized tactical system solutions to customers at an amount that reflects the consideration KWESST expects to receive in exchange for the system offering.

The timing of revenue recognition often differs from contract payment milestones, resulting in revenue that has been earned but not billed. These amounts are included in unbilled receivables. Amounts billed in accordance with customer contracts, but not yet earned, are recorded and presented as part of deferred revenue. At September 30, 2020, management determined there was no unbilled receivables.

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Notes to Consolidated Financial Statements

Nine months ended September 30, 2020 and twelve months ended December 31, 2019

(Expressed in Canadian dollars, except share and per share amounts)

Fair value of acquired intangible assets

As disclosed in Note 1, the 1-for-70 Reverse Split effected on October 28, 2022 has been applied retrospectively herein.

KWESST estimates the fair value of technology acquired based on observable market inputs. Because KWESST Inc. was a private company at the time of closing the GhostStep® Technology acquisition (see Note 4(b)), the common shares issued under this transaction were not actively trading on a stock exchange. Accordingly, management measured the fair value of the common shares based on the cash versus shares election available under the purchase agreement. Specifically, KWESST Inc. had the sole discretion to pay USD $100,000 (CAD $134,192) or issue 7,957 common shares to SageGuild. This implies a fair value of $16.80 per common share of KWESST Inc. at the time of closing the transaction.

Accordingly, for the purpose of estimating the fair value of the warrants issued under this transaction (see contingent consideration below), management used $0.24 as 1/70 of the underlying stock price for one of the key inputs in the Black-Scholes pricing model.

Contingent consideration

As disclosed in Note 1, the 1-for-70 Reverse Split effected on October 28, 2022 has been applied retrospectively herein.

The GhostStep® Technology acquisition included contingent consideration in which KWESST Inc. issued 750,000 warrants (exercisable to acquire 10,714 common shares) to SageGuild which are cancellable if service condition is not met (see Note 4(b)). The rights granted under warrants shall vest and be exercisable as to 250,000 warrants on each of December 31, 2020, 2021, and 2022 if service condition is met. Subject to the service condition being met, on each of these three vesting dates, SageGuild shall be deemed to have exercised 250,000 warrants for an aggregate purchase price of $125,000.

Under IFRS, the contingent consideration is classified as either a financial liability or equity based on the feature of the contingent consideration and how the number of shares to be issued is determined. Where a fixed number of shares either will or will not be issued depending on future events, the contingent consideration meets the definition of equity. The SageGuild warrants were classified as equity and the subsequent settlement will also be accounted for within equity. The contingent consideration is required to be recognized at the acquisition date fair value even if it is not deemed to be probable of payment at the date of the acquisition.

Treatment of development costs

Costs to develop products are capitalized to the extent that the criteria for recognition as intangible assets in IAS 38, Intangible Assets are met. Those criteria require that the product is technically and economically feasible, which management assessed based on the attributes of the development project, perceived user needs, industry trends, and expected future economic conditions. Management considers these factors in aggregate and applies significant judgment to determine whether the product is feasible.

Impairment of intangible assets

At September 30, 2020, the intangible assets relates primarily the GhostStep® Technology recorded at its fair value at the acquisition date (see Note 8). Because the GhostStep® Technology is pre-commercial stage with no similar technology in the current marketplace, there is significant management judgement in projecting anticipated global market demand, pricing, and gross profit for this electronic decoy technology; all key inputs in management's discounted cash flow model to determine the recoverable amount. An impairment loss is recognized if the recoverable amount of the asset is less than the carrying amount.

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KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Nine months ended September 30, 2020 and twelve months ended December 31, 2019

(Expressed in Canadian dollars, except share and per share amounts)

Useful lives of property and equipment

As KWESST is an early-stage company, it has limited operating history to estimate the useful lives of property and equipment. Management made estimates based on anticipated use. Further, management has determined the residual value of these assets to be nil. At September 30, 2020, management concluded there was no evidence of a change in the useful lives of property and equipment.

Fair value of share-based payments and warrants

Because KWESST Inc. has limited operating history and was a private company at the time of granting stock options and issuing warrants during the nine months ended September 30, 2020, management exercised significant judgement in estimating the fair value of stock options and warrants. Fair value is estimated using the Black-Scholes pricing model, which requires management to make significant judgment principally on the following key inputs: expected life of the stock option and volatility of the underlying share price. For share-based payment, management must also apply an estimated forfeiture rate to the calculated fair value, which is subject to significant judgement due to the Company's limited history.

3.Significant accounting policies

KWESST used the following significant accounting policies for the preparation of the consolidated financial statements. These policies have been applied to the comparative period.

(a)Revenue recognition

KWESST determines the amount of revenue to be recognized through application of the following five-step process:

(i)Identification of the contract, or contracts with a customer;

(ii)Identification of the performance obligations in the contract;

(iii)Determination of the transaction price;

(iv)Allocation of the transaction price to the performance obligations in the contract; and

(v)Recognition of revenue when or as the Company satisfies the performance obligations.

For contracts with payment milestones, Management estimates the percentage of completion and records unbilled revenue.

KWESST also recognizes an asset for the incremental costs of obtaining a contract with a customer if it expects the costs to be recoverable. Management has determined that sales commissions meet the requirements to be capitalized. Capitalized contract acquisition costs are amortized consistent with the pattern of transfer to the customer for the goods and services to which the asset relates. KWESST applies the practical expedient available under IFRS 15 and does not capitalize incremental costs of obtaining contracts if the amortization period is one year or less.

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KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Nine months ended September 30, 2020 and twelve months ended December 31, 2019

(Expressed in Canadian dollars, except share and per share amounts)

(b)Financial instruments

KWESST recognizes a financial asset or a financial liability when it becomes a party to the contractual provisions of the instrument.

Trade and other receivables without a significant financing component are initially measured at the transaction price. All other financial assets and financial liabilities are initially recognized at fair value. Transaction costs that are directly attributable to the acquisition or issue of financial assets and financial liabilities (other than financial assets and financial liabilities at fair value through profit or loss (''FVTPL'')) are added to or deducted from the fair value of the financial assets or financial liabilities, as appropriate, on initial recognition. Transaction costs directly attributable to the acquisition of financial assets or financial liabilities at fair value through profit or loss are recognized immediately in profit or loss.

Financial assets

All financial assets are recognized and de-recognized on trade date.

Financial assts are recognized at fair value and subsequently classified and measured at:

a)Amortized cost;

b)Fair value through other comprehensive income (''FVOCI''); or

c)Fair value though profit or loss (''FVTPL'').

KWESST determines the classification of its financial assets on the basis of both the business model for managing the financial assets and the contractual cash flows characteristics of the financial asset. Financial assets are not reclassified subsequent to their initial recognition unless the Company changes its business model for managing financial assets.

A financial asset is measured at amortized cost if it is held within a business model whose objective is to hold assets to collect contractual cash flows, and its contractual terms give rise on specified dates to cash flows that are solely payments of principal and interest of the principal amount outstanding. At September 30, 2020, KWESST classified the following as amortized cost:

• Cash
• Trade and other receivables
• Lease deposit (non-current other asset)

All financial assets not classified and measured at amortized cost or FVOCI are measured at FVTPL. At September 30, 2020, KWESST did not have financial assets classified as FVOCI or FVTPL.

Expected credit losses

KWESST measures a loss allowance based on the lifetime expected credit losses. Lifetime expected credit losses are estimated based on factors such as KWESST's past experience of collecting payments, the number of delayed payments in the portfolio past the average credit period, observable changes in national or local economic conditions that correlate with default on receivables, financial difficulty of the borrower, and it becoming probable that the borrower will enter bankruptcy or financial re-organization.

Financial assets are written off when there is no reasonable expectation of recovery.

Financial liabilities

Financial liabilities are recognized at fair value and subsequently classified and measured at amortized cost or fair value though profit or loss (''FVTPL'').

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KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Nine months ended September 30, 2020 and twelve months ended December 31, 2019

(Expressed in Canadian dollars, except share and per share amounts)

KWESST determines the classification of its financial liabilities at initial recognition. The Company has classified the following as amortized costs:

• Accounts payable and accrued liabilities
• Related party loans
• Borrowings
• Lease obligations
• Convertible notes

Financial liabilities at amortized cost are measured using the effective interest rate method.

At September 30, 2020 and December 31, 2019, KWESST classified financial derivative liabilities as FVTPL.  Accordingly, fair value is remeasured at each reporting period with the fair value adjustment recognized in profit or loss. There was no outstanding financial derivative liability at September 30, 2020.

De-recognition of financial liabilities

KWESST de-recognizes financial liabilities when its obligations are discharged, cancelled or they expire.

(c)Property and equipment

Property and equipment are measured at cost less accumulated depreciation and accumulated impairment losses. Cost comprises the fair value of consideration given to acquire or construct an asset and includes the direct charges associated with bringing the asset to the location and condition necessary for putting it into use along with the future cost of dismantling and removing the asset. These assets are depreciated over their estimated useful lives using the straight-line method as this most closely reflects the expected pattern of consumption o the future economic benefits. Depreciation methods, useful lives and residual values are reviewed at each financial year end and adjusted prospectively, if appropriate.

The following table provides a summary of estimated useful lives for KWESST's property and equipment:

Property and equipment	Rate
Computer equipment	5 years
Computer software	3 years
Office furniture and equipment	5 years
R&D equipment	5 years
Leasehold improvements	Shorter of useful life or remaining term of lease

At the end of each reporting period, KWESST reviews the carrying amounts of its property and equipment to determine whether there is any indication of impairment. If any such indication exists, the recoverable amount of the asset is estimated in order to determine the extent of the impairment loss (if any). The recoverable amount is the higher of fair value less costs to sell and value in use. In assessing value in use, the estimated future cash flows are discounted to their present value using a pre-tax discount rate that reflects current market assessments of the time value of money and the risks specific to the asset. For the purpose of impairment testing, assets that cannot be tested individually are grouped together into the smallest group of assets that generates cash inflows from continuing use that are largely independent of the cash flows of other assets or groups of assets (the ''cash-generating unit, or CGU''). If the recoverable amount of an asset is estimated to be less than its carrying amount, the carrying amount of the asset is reduced to its recoverable amount. An impairment loss is recognized immediately in profit or loss.

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KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Nine months ended September 30, 2020 and twelve months ended December 31, 2019

(Expressed in Canadian dollars, except share and per share amounts)

Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.

(d)Leases

At inception of a contract, KWESST assesses whether a contract is, or contains, a lease based on whether the contract conveys the right to control the use of an identified asset for a period of time in exchange for consideration.

KWESST recognizes a right-of-use asset and a lease liability at the lease commencement date. The lease obligation is measured at the present value of the remaining lease payments as of January 1, 2018, discounted using its incremental borrowing rate of 10%. The right-of-use asset is initially measured based on the initial amount of the lease liability adjusted for any lease payments made at or before the commencement date, plus any initial direct costs incurred and an estimate of costs to dismantle and remove the underlying asset or to restore the underlying asset or the site on which it is located, less any lease incentives received. The assets are depreciated to the earlier of the end of the useful life of the right-of-use asset or the lease term using the straight-line method as this most closely reflects the expected pattern of consumption of the future economic benefits. The lease term includes periods covered by an option to extend if KWESST is reasonably certain to exercise that option.  Lease terms range from 3 to 6 years for offices and printer. In addition, the right-of-use asset is periodically reduced by impairment losses, if any, and adjusted for certain remeasurements of the lease liability.

The lease liability is initially measured at the present value of the lease payments that are not paid at the commencement date, discounted using the interest rate implicit in the lease or, if that rate cannot be readily determined, KWESST's incremental borrowing rate. Variable lease payments that do not depend on an index or rate are not included in the measurement of the lease liability.

The lease liability is measured at amortized cost using the effective interest method. It is remeasured when there is a change in future lease payments arising from a change in an index or rate, if there is a change in KWESST's estimate of the amount expected to be payable under a residual value guarantee, or if KWESST changes its assessment of whether it will exercise a purchase, extension, or termination option. When the lease liability is remeasured in this way, a corresponding adjustment is made to the carrying value of the right-of-use asset or, is recorded in profit or loss if the carrying amount of the right-of-use asset has been reduced to zero.

KWESST has elected to apply the practical expedient not to recognize right-of-use assets and lease liabilities for short-term leases that have a lease term of 12 months or less and leases of low-value assets. The lease payments associated with these leases are recognized as an expense on a straight-line basis over the lease term.

(e)Intangible assets

(i)Research and development ("R&D'') costs

Expenditure on research activities, undertaken with the prospect of gaining new scientific or technical knowledge and understanding, is recognized in profit or loss when incurred.

Development activities involve a plan or design for the production of new or substantially improved products and processes. Development expenditure is capitalized only if development costs can be measured reliably, the product or process is technically and commercially feasible, future economic benefits are probable, and KWESST has the intention and sufficient resources to complete the development and to use or sell the asset. The expenditure capitalized in respect of development activities includes the cost of materials, direct labor and overhead costs that are directly attributable to preparing the asset for its intended use, and capitalized borrowing costs. Other development expenditures are recognized in profit or loss when incurred.

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KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Nine months ended September 30, 2020 and twelve months ended December 31, 2019

(Expressed in Canadian dollars, except share and per share amounts)

(ii)Subsequent expenditure

Subsequent expenditure is capitalized only when it increases the future economic benefits embodied in the specific asset to which it relates. All other expenditures, including expenditure on internally generated goodwill and brands, is recognized in profit or loss as incurred.

(iii)Amortization

Amortization is a systematic allocation of the amortizable amount of an intangible asset of its useful life. The amortizable amount is the cost of the asset less its estimated residual value. KWESST recognizes in profit or loss on a sales-based rate over the estimated useful lives of the intangible assets from the date they are available for use, since this method most closely reflect the expected pattern of consumption of the future economic benefits embodied in each asset. Where a sales-based rate could not be determined, the straight-line approach is used.

Internally generated intangible assets are not systematically amortized as long as they are not available for use i.e. they are not yet on site or in working condition for their intended use. Accordingly, intangible assets such as development costs are tested for impairment at least once a year, until such date as they are available for use.

(iv)Impairment

All intangible assets are periodically reviewed for impairment. The estimated present value of future cash flows associated with the intangible asset is determined and an impairment loss is recognized for the difference between this amount and the carrying amount as follows: the carrying amount of the asset is reduced to estimated present value of the future cash flows associated with the asset, discounted at the financial asset's original effective interest rate, and the resulting loss is directly recognized in profit or loss for the period.

(f)Provisions

A provision is recognized if, as a result of a past event, KWESST has a present legal or constructive obligation that can be estimated reliably, and it is probable that an outflow of economic benefits will be required to settle the obligation. Provisions are determined by discounting the expected future cash flows at a pre-tax rate that reflects current market assessments of the time value of money and the risk specific to the liability. The unwinding of the discount is recognized as a finance cost.

(g)Convertible notes

KWESST's convertible notes are segregated into their debt and equity components or derivative liability components at the date of issue, in accordance with the substance of the contractual agreements.

The conversion feature of the convertible notes is presumed to be classified as a derivative financial liability unless it meets all the criteria to recognize as equity instrument under IAS 32, Financial Instruments: Presentation. One of the criteria is that the conversion option exchanges a fixed amount of shares for a fixed amount of cash ("fixed for fixed").

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KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Nine months ended September 30, 2020 and twelve months ended December 31, 2019

(Expressed in Canadian dollars, except share and per share amounts)

If the conversion feature meets the fixed for fixed criteria, the conversion option will be classified as equity components. Equity instruments are instruments that evidence a residual interest in the assets of an entity after deducting all of its liabilities. Therefore, when the initial carrying amount of the convertible notes is allocated to its equity and liability components, the equity component is assigned the residual amount after deducting from the fair value of the instrument as a whole the amount separately determined for the liability component. The sum of the carrying amounts assigned to the liability and equity components on initial recognition is always equal to the fair value that would be ascribed to the instrument as a whole. No gain or loss arises from initially recognizing the components of the instrument separately.

If the conversion feature does not meet the fixed for fixed criteria, the conversion option will be recorded as derivative financial liability, which must be separately accounted for at fair value on initial recognition. The carrying amount of the debt component, on initial recognition, is recalculated as the difference between the proceeds of the convertible notes as a whole and the fair value of the derivative financial liabilities. Subsequent to initial recognition, the derivative financial liability is re-measured at fair value at the end of each reporting period with changes in fair value recognized in the consolidated statements of comprehensive loss for each reporting period, while the debt component is accreted to the face value of the debt using the effective interest method.

Incremental costs incurred in respect of raising capital or debt are charged against the equity or debt proceeds raised, unless the instrument to which the transaction costs relate is classified as held for trading, in which case the incremental costs are expensed to profit or loss immediately.

(h)Income taxes

Income tax expense comprises current income tax expense and deferred income tax expense. Current and deferred income taxes are recognized as an expense and included in profit or loss for the period, except to the extent that the tax arises from a transaction which is recognized in other comprehensive income or directly in shareholder's deficiency.

Current income tax

Current tax expense is the amount of income taxes payable (recoverable) in respect of the taxable income (tax loss) for a period. Current liabilities (assets) for the current and prior periods are measured at the amount expected to be paid to (recovered from) the taxation authorities, using the tax rates that have been enacted or substantively enacted by the end of the reporting period.

Deferred income tax

Deferred tax assets and liabilities are recognized for the temporary differences between transactions that have been included in the consolidated financial statements or income tax returns. Deferred income taxes are provided for using the liability method. Under the liability method, deferred income taxes are recognized for all significant temporary differences between that the tax and financial statement bases of assets and liabilities and for certain carry-forward items. Deferred income tax assets are recognized only to the extent that, in the opinion of management, it is probable that the deferred income tax assets will be realized.

Deferred tax assets and liabilities are measured at the tax rates that are expected to apply in the year when the asset is realized or the liability is settled, based on tax rates (and tax laws) that have been enacted or substantively enacted at the reporting period. Deferred income tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of the enactment or substantive enactment. Deferred tax assets and liabilities are offset when there is a legally enforceable right to set off current tax assets against current tax liabilities and when they relate to income taxes levied by the same taxation authority and KWESST intends to settle its current tax assets and liabilities on a net basis.

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KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Nine months ended September 30, 2020 and twelve months ended December 31, 2019

(Expressed in Canadian dollars, except share and per share amounts)

Investment tax credits

Investment tax credits relating to scientific research and experimental development expenditures are recorded in the fiscal period the qualifying expenditures are incurred based on management's interpretation of applicable legislation in the Income Tax Act of Canada. Credits are recorded provided there is reasonable assurance that the tax credit will be realized. Credits claimed are subject to review by the Canada Revenue Agency.

Credits claimed in connection with R&D activities are accounted for using the cost reduction method. Under this method, assistance and credits relating to the acquisition of equipment is deducted from the cost of the related assets, and those relating to current expenditures, which are primarily salaries and related benefits, are included in the determination of profit or loss as a reduction of the R&D expenses.

(i)Related party transactions

Parties are considered to be related if one party has the ability, directly or indirectly, to control the other party or exercise significant influence over the other party in making financial and operating decisions. Parties are also considered to be related if they are subject to common control or common significant influence. Related parties may be individuals or corporate entities. A transaction is considered to be a related party transaction when there is a transfer of resources or obligations between related parties. Related party transactions are in the normal course of business and have commercial substance.

(j)Share-based payments

KWESST records share-based compensation related to its stock options and certain warrants granted from the Company. Stock-based compensation for stock options and warrants are measured at fair value using a Black Scholes option-pricing model. The market value of KWESST's shares on the date of the grant is used to determine the fair value of options and warrants. Each tranche of an award is considered a separate award with its own vesting period and grand date fair value. Compensation cost is recognized as employee benefits expense over the vesting period in which employees unconditionally become entitled to the award. The amount recognized as an expense is adjusted to reflect only the number of awards for which related service conditions are expected to be met, such that the amount ultimately recognized as an expense is based on the number of awards that meet the related service conditions at the vesting date.

Where the terms of an equity-settled transaction award are modified, the minimum expense recognized is the expense as if the terms had not been modified and if the original terms of the award are met. An additional expense is recognized for any modification that increases the total fair value of the share-based payment transaction or is otherwise beneficial to the employees as measured at the date of acquisition.

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KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Nine months ended September 30, 2020 and twelve months ended December 31, 2019

(Expressed in Canadian dollars, except share and per share amounts)

(k)Foreign currency

Transactions in foreign currencies are translated to the respective functional currencies of KWESST at the exchange rate in effect at the transaction date. Monetary assets and liabilities denominated in other than the functional currency are translated at the exchange rates in effect at the reporting date. Non-monetary items that are measured in terms of historical cost in other than the functional currency are translated using the exchange rate at the date of the transaction. The resulting exchange gains and losses are recognized in profit or loss.

(l)Earnings (loss) per share

Basic earnings (loss) per share is computed using the weighted average number of common shares outstanding during the period. KWESST uses the treasury stock method to compute the dilutive effect of options, warrants, and similar instruments. Under this method, the dilutive effect on earnings per share is calculated presuming the exercise of outstanding options, warrants, and similar instruments. It assumes that the proceeds of such exercise would be used to repurchase common shares at the average market price during the period.

However, the calculation of diluted loss per share excludes the effects of various conversions and exercises of convertible debt, options and warrants that would be anti-dilutive.

(m)Reverse acquisition

KWESST was a capital pool company, which did not constitute a business as defined under IFRS 3 - Business Combination at the time of the QT and is therefore not within the scope of IFRS 3. However, the QT has some features of a reverse acquisition under IFRS 3. In the absence of a Standard that specifically applies to the QT, KWESST applied by analogy the guidance in IFRS 3 for reverse acquisitions in accordance with IAS 8 accounting policies, changes in accounting estimates and errors.

Application of the reverse acquisitions guidance by analogy results in the private operating entity KWESST Inc. being identified as the accounting acquirer, and the listed non-operating entity KWESST being identified as the accounting acquiree. The accounting acquirer is deemed to have issued shares to obtain control of the accounting acquiree KWESST. Because the QT is not within the scope of IFRS 3, KWESST accounted for it as an asset acquisition and the consideration as a share-based payment transaction which was accounted for in accordance with IFRS 2 - Share-based Payment.

According to IFRS 2, any difference in the fair value of the shares deemed to have been issued by the accounting acquirer and the fair value of the accounting acquiree's identifiable net assets represents a service received by the accounting acquirer. Regardless of the level of monetary or non-monetary assets owned by the non-listed operating entity, the entire difference was considered to be payment for a service of a stock exchange listing for its shares, and that no amount should be considered a cost of raising capital. The service received in the form of a stock exchange listing does not meet the definition of an intangible asset because it is not identifiable in accordance with IAS 38 Intangible Assets (it is not separable) and does not meet the definition of an asset that should be recognized in accordance with other Standards and the Conceptual Framework, therefore the services received was recognized as listing expense (included in merger & acquisition costs in the consolidated statements of net loss and comprehensive loss).

F-94

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Nine months ended September 30, 2020 and twelve months ended December 31, 2019

(Expressed in Canadian dollars, except share and per share amounts)

New accounting standards issued but not yet in effect

Classification of liabilities as current or non-current (Amendments to IAS 1)

The IASB has published Classification of Liabilities as Current or Non-Current (Amendments to IAS 1), which clarified the guidance on whether a liability should be classified as either current or non-current. The amendments were as follows:

(i)Clarified that the classification of liabilities as current or non-current should only be based on rights that are in place at the end of the reporting period.

(ii)Clarified that classification is unaffected by expectations about whether an entity will exercise its right to defer settlement of a liability; and

(iii)Made clear that settlement includes transfers to the counterparty of cash, equity instruments, other assets or services that result in extinguishment of the liability.

This new guidance is effective for annual periods beginning on or after January 1, 2022. Earlier application is permitted. KWESST has not yet assessed the impact of adoption of this guidance. Further, there is currently a proposal outstanding that would defer the effective date until January 1, 2023.

4.Acquisitions

As disclosed in Note 1, the 1-for-70 Reverse Split effected on October 28, 2022 has been applied retrospectively herein.

a)Reverse acquisition

On September 17, 2020, Foremost completed the QT with KWESST Inc. pursuant to the policies of the TSX Venture Exchange (''TSX-V''). Prior to the completion of the QT, Foremost effected a consolidation of its outstanding common shares on the basis of one post-consolidation common share for every 326.9 pre-consolidation common shares. The QT was done by way of a three-cornered amalgamation (the "Amalgamation") pursuant to which, among other things:

(i)KWESST Inc. amalgamated with a wholly-owned subsidiary of Foremost, incorporated for the purposes of the Amalgamation, pursuant to the provisions of the Business Corporations Act (Ontario),

(ii)Foremost changed its name to KWESST Micro Systems Inc., and

(iii)all of the outstanding common shares of KWESST Inc. (the "KWESST Shares") were cancelled and, in consideration therefor, the holders thereof received post-consolidation common shares of KWESST Micro Systems Inc. on the basis of one KWESST Micro System Inc. share for each KWESST Share.

Immediately following the QT, there were 589,517 shares of KWESST outstanding, of which 576,681 were held by the former shareholders of KWESST Inc. (representing approximately 97.8% of the outstanding shares of the Company) and 12,836 were held by the shareholders of Foremost prior to the QT. Accordingly, this transaction was accounted for as a reverse acquisition where KWESST Inc. is deemed to be the acquirer for accounting purposes.

The reverse acquisition of Foremost was accounted for under IFRS 2, Share-based Payment. Accordingly, the fair value of the purchase consideration was accounted for at the fair value of the equity instruments granted by the shareholders of KWESST Inc. to the shareholders and option holders of Foremost.

F-95

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Nine months ended September 30, 2020 and twelve months ended December 31, 2019

(Expressed in Canadian dollars, except share and per share amounts)

The following represents management's estimate of the fair value of the net assets acquired and total consideration transferred at September 17, 2020, the closing date of the QT.

Number of common shares issued to Foremost shareholders		12,836
KWESST's stock price at closing of reverse acquisition (1)	$	49.00
Common shares	$	628,949
Options		41,155
Total consideration transferred	$	670,104

(1)At closing, the subscription receipts issued by KWESST Inc. on July 9, 2020 pursuant to a brokered private placement (the "KWESST Subscription Receipts"), were automatically converted into shares of KWESST. The private placement which was completed through PI Financial Corp. as agent, consisted of 62,994 KWESST Subscription Receipts issued at $49.00 per KWESST Subscription Receipt for gross proceeds of about $3.1 million before share issuance costs. See Note 16.

The total fair value consideration was allocated to Foremost's net assets as follows:

Total fair value consideration	$	670,104
Foremost's net assets (liabilities):
Cash	$	78,589
Other receivables		1,900
Accounts payable and accrued liabilities		(225,088	)
Net assets (liabilities) at fair value		(144,599	)
Residual balance allocated to listing expense (included in M&A costs)		814,703
Total	$	670,104

The results of operations of Foremost are included in these consolidated statements of comprehensive loss from September 17, 2020.

The listing expense of $814,703 is a non-cash item - see consolidated statements of cash flows.

In addition, 14,286 common shares with fair value of $700,000 were issued to two M&A / capital market advisors for successfully assisting KWESST to complete the QT. One of the two advisors is a related party (Note 16).

b)Asset acquisition

On June 12, 2020, KWESST Inc. entered into the GhostStep Technology Purchase Agreement (the "Purchase Agreement") with SageGuild LLC ("SageGuild") pursuant to which KWESST Inc. acquired the GhostStep® Technology.  Management determined that this transaction did not meet the definition of a business under IFRS 3 and therefore this transaction was accounted for as an asset acquisition.

The total purchase consideration ("Purchase Price") comprised of:

(i)a cash payment made on June 12, 2020 in the amount of USD $100,000 (CAD $134,192);

(ii)the issuance on June 12, 2020 of 2,000 common shares of KWESST; and

F-96

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Nine months ended September 30, 2020 and twelve months ended December 31, 2019

(Expressed in Canadian dollars, except share and per share amounts)

(iii)either the payment of USD $100,000 in cash or the issuance of 7,957 common shares of KWESST at a deemed price of $35.00 per common share (CAD $278,500), at KWESST's sole discretion, upon the completion of KWESST's QT.

As a result of completing the QT, KWESST Inc. has elected to issue 7,957 common shares to SageGuild.

In addition to the Purchase Price, pursuant to the Purchase Agreement KWESST Inc. has:

(i)agreed to make annual payments ("Yearly Payments") to SageGuild of $125,000 on each of December 31, 2020, 2021 and 2022, subject to certain conditions; and

(ii)issued 750,000 warrants to SageGuild exercisable at $0.50 per warrant for 1/70 of a common share and expiring on January 15, 2023 (the "Warrants") - see Notes 16.

The Warrants will vest in equal tranches of 250,000 warrants on each of December 31, 2020, 2021 and 2022. KWESST has the right to apply the Yearly Payments against the exercise price of the Warrants.

Accordingly, the total purchase consideration amounted to:

Cash consideration	$	134,192
Share issuance with no condition		33,600
Elected share issuances		133,680
Contingent consideration		180,000
Total purchase consideration	$	481,472

The above total purchase consideration was recognized as intangible assets (see Note 8).

In addition to the above total purchase consideration, KWESST Inc. has agreed to pay SageGuild royalties at a rate of 20% on amounts received in consideration of the grant of licenses and on sales of the GhostStep® Technology until KWESST has paid SageGuild a total of USD $3 million in royalties. Once KWESST has paid SageGuild a total of USD $3 million in royalties, the royalty rate will decrease to 5%. The obligation to pay royalties will terminate automatically once KWESST has paid SageGuild a total of USD $20 million in royalties. The Purchase Agreement became effective on June 12, 2020 and will continue in full force and effect until the earliest of (i) June 12, 2040 or (ii) the date of the expiration of the last of the patents or any of the patents (which are expected to be valid for a period of seventeen years from the date of issuance) related to improvements of the GhostStep® Technology to which SageGuild, or its principal Mr. Jeffrey M. Dunn, materially contributes, unless the terminated earlier in accordance with the terms and conditions of the agreement.

In the event KWESST is in default of payment of any royalty payment as outlined above for a period of 30 days, SageGuild may terminate the agreement and KWESST will be required to, among other things, transfer the GhostStep® Technology back to SageGuild.

KWESST Inc. did not have any sales during the nine months ended September 30, 2020 that would have triggered royalty payments payable to SageGuild.

F-97

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Nine months ended September 30, 2020 and twelve months ended December 31, 2019

(Expressed in Canadian dollars, except share and per share amounts)

5. Trade and other receivables

The following table presents trade and other receivables for KWESST:

		September 30, 2020		December 31, 2019
Trade receivables	$	210,795	$	1,191
Sales tax recoverable		142,797		55,684
Investment tax credits refundable		127,325		162,928
Total	$	480,917	$	219,803

There was no impairment of trade and other receivables during the nine months ended September 30, 2020 (2019 - $nil).

6. Property and equipment

The following is summary of changes in property and equipment for KWESST:

Cost		Computer equipment		Computer software		Office furniture and equipment		R&D equipment		Leasehold improvements			Total property and equipment
Balance at December 31, 2018	$	-	$	8,145	$	31,873	$	41,379	$	8,607		$	90,004
Additions		14,073		-		908		5,209		-			20,190
Disposals		-		-		-		-		-			-
Balance at December 31 2019	$	14,073	$	8,145	$	32,781	$	46,588	$	8,607		$	110,194
Additions		18,734		-		49,060		7,046		59,090			133,930
Disposals		-		-		-		-		(8,607	)		(8,607	)
Balance at September 30, 2020	$	32,807	$	8,145	$	81,841	$	53,634	$	59,090		$	235,517
Accumulated depreciation		Computer equipment		Computer software		Office furniture and equipment		R&D equipment		Leasehold improvements			Total property and equipment
Balance at December 31, 2018	$	-	$	3,396	$	9,587	$	5,257	$	2,497		$	20,737
Amortization for 12 months		241		2,715		6,556		8,102		1,721			19,335
Balance at December 31, 2019	$	241	$	6,111	$	16,143	$	13,359	$	4,218		$	40,072
Amortization for 9 months		5,821		1,526		6,149		7,478		8,434			29,408
Disposals		-		-		-		-		(8,607	)		(8,607	)
Balance at September 30, 2020	$	6,062	$	7,637	$	22,292	$	20,837	$	4,045		$	60,873
Carrying value at December 31, 2019	$	13,832	$	2,034	$	16,638	$	33,229	$	4,389		$	70,122
Carrying value at September 30, 2020	$	26,745	$	508	$	59,549	$	32,797	$	55,045		$	174,644

F-98

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Nine months ended September 30, 2020 and twelve months ended December 31, 2019

(Expressed in Canadian dollars, except share and per share amounts)

7.Intangible assets

The following table presents intangible assets for KWESST:

		Development Costs		Technology Asset		Total
Cost
Balance at December 31, 2019	$	-	$	-	$	-
Additions		163,230		-		163,230
Additions through acquisition (Note 4)		-		481,472		481,472
Balance at September 30, 2020	$	163,230	$	481,472	$	644,702

During the nine months ended September 30, 2020, KWESST capitalized development costs of $163,230 in connection with a funded development project to support a U.S. military customer, featuring KWESST's signature Tactical Awareness and Situational Control System ("TASCS") - see Note 26 (a).

As disclosed in Note 4(b), KWESST acquired technology assets of $481,472, comprising intellectual property rights, including trademark rights, of the GhostStep® Technology, an electronic decoy system. Management has estimated a useful life of five years; however, as this technology has not yet reached commercialization, no amortization charge was recorded for the nine months period ended September 30, 2020.

8.Right-of-use assets

The following table presents right-of-use assets for KWESST:

		Offices			Printer			Total
Balance at December 31, 2018	$	254,159		$	13,120		$	267,279
Depreciation		(76,248	)		(6,559	)		(82,807	)
Balance at December 31, 2019	$	177,911		$	6,561		$	184,472
Additions		571,604			-			571,604
Termination		(139,787	)		-			(139,787	)
Depreciation		(92,567	)		(3,282	)		(95,849	)
Balance at September 30, 2020 (as previously reported)		517,161			3,279			520,440
Correction of an error		(192,864	)		-			(192,864	)
Balance at September 30, 2020 (as adjusted)	$	324,297		$	3,279		$	327,576

During the nine months ended September 30, 2020, KWESST terminated an office lease agreement due to breach of contract by the former landlord and de-recognized the related right-of-use asset and lease obligations (see Note 12). As a result, KWESST entered into a new office lease agreement with a 74-month lease term starting from March 1, 2020. In connection with this new lease, KWESST made a total deposit of $33,726 to be released only at the end of this lease. This deposit was initially recorded at fair value, discounted using the implied interest rate in the lease. At September 30, 2020, $19,341 was the carrying value and reported as non-current deposit in the consolidated statements of financial position.

Subsequently, during the year ended September 30, 2021, management made an adjustment for a correction in the application of IFRS 16, Leases, to the new office lease entered in the prior year, whereby future variable payments were erroneously included in the calculation of the lease obligations. The following summarizes the effects of this correction to the prior year's comparatives.

F-99

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Nine months ended September 30, 2020 and twelve months ended December 31, 2019

(Expressed in Canadian dollars, except share and per share amounts)

Consolidated statements of financial position as at September 30, 2020:

		Previously Reported			Adjustment			Adjusted
Trade and other receivables	$	479,291		$	1,626		$	480,917
Right-of-assets	$	520,440		$	(192,864	)	$	327,576
Deposit (non-current)	$	22,337		$	(2,996	)	$	19,341
Total assets	$	5,507,011		$	(194,234	)	$	5,312,777
Lease obligations (current)	$	78,358		$	(34,230	)	$	44,128
Lease obligations (non-current)	$	496,394		$	(188,485	)	$	307,909
Total liabilities	$	1,650,628		$	(222,715	)	$	1,427,913
Deficit	$	(6,102,058	)	$	28,481		$	(6,073,577	)

 Consolidated statements of changes in shareholders' equity (deficit) for the nine months ended September 30, 2020:

		Previously Reported			Adjustment		Adjusted
Deficit	$	(6,102,058	)	$	28,481	$	(6,073,577	)
Total shareholders' equity (deficit)	$	3,856,383		$	28,481	$	3,884,864

9. Accounts payable and accrued liabilities

The following table presents the accounts payable and accrued liabilities for KWESST:

		September 30, 2020		December 31, 2019
Trade payable	$	493,027	$	126,481
Accrued liabilities		188,265		29,822
Payroll taxes payable		67,229		-
Salary and vacation payable		65,722		29,343
Other		4,031		13,041
Total	$	818,274	$	198,687

10.Related party transactions

As disclosed in Note 1, the 1-for-70 Reverse Split effected on October 28, 2022 has been applied retrospectively herein.

Key management personnel compensation

Key management personnel are those having authority and responsibility for planning, directing and controlling the activities of KWESST directly or indirectly, including any directors (executive and nonexecutive) of KWESST. The key management personnel of KWESST are the executive management team and Board of Directors, who collectively control approximately 38% of the issued and outstanding common shares of KWESST at September 30, 2020.

F-100

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Nine months ended September 30, 2020 and twelve months ended December 31, 2019

(Expressed in Canadian dollars, except share and per share amounts)

Key management personnel compensation comprised the following:

		Nine months ended  September 30, 2020		Twelve months Year ended December 31, 2019
Wages and benefits	$	165,769	$	48,343
Consulting fees		145,000		30,000
Directors compensation		-		-
Share-based compensation		24,959		-
Total	$	335,728	$	78,343

The consulting fees relate to compensation paid to KWESST's Executive Chairman (via his private corporation, DEFSEC Corporation), including a one-time $15,000 payment for prior year expenses in accordance with the consulting agreement.

Related party loans

The following table summarizes the related party loans.

		Loans from CEO(1)			Employee loan (2), (5)			Loans from investors (3), (4)			Total
Balance at December 31, 2018	$	612,171		$	81,253		$	191,789		$	885,213
Additions		309,912			-			772			310,684
Transferred to convertible debentures		-			-			(192,561	)		(192,561	)
Converted into common shares		(649,500	)		-			-			(649,500	)
Converted into warrants		(19,858	)		-			-			(19,858	)
Repayment of loans		(45,513	)		(25,000	)		-			(70,513	)
Accrued interest		22,706			3,657			-			26,363
Balance at December 31, 2019	$	229,918		$	59,910		$	-		$	289,828
Repayment of loans		(30,000	)		(50,000	)		-			(80,000	)
Accrued interest		7,174			1,274			-			8,448
Balance at September 30, 2020	$	207,092		$	11,184		$	-		$	218,276

(1)In prior years, KWESST's CEO and his spouse (major shareholders) advanced funds to KWESST to fund its working capital requirements. The loans are due on demand and accrue annual interest at TD Bank prime plus 1.55%.

(2)In prior years, KWESST borrowed funds from an employee to fund its working capital requirements. The loan bears interest at 5% per annum and is due upon demand. This loan was fully repaid during the first quarter of fiscal 2021.

(3)On April 20, 2018, KWESST issued two Subscriptions for Revenue Sharing in the principal amount of $50,000 each to an investor. An additional amount of $26,961 was invested to the Company on December 14, 2018. The total loan of $126,960 and was subsequently reclassified as convertible notes on October 23, 2019 (see Note 15).

(4)On June 5, 2018, KWESST issued a Subscription for Revenue Sharing in the principal amount of $64,829 (USD$50,000) to one of KWESST's officer. This loan was subsequently reclassified as convertible debentures on October 23, 2019 (see Note 15).

F-101

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Nine months ended September 30, 2020 and twelve months ended December 31, 2019

(Expressed in Canadian dollars, except share and per share amounts)

Other related party transactions during the nine months ended September 30, 2020:

• Two directors of KWESST were investors in the 2019 convertible notes (see Note 15), in which KWESST incurred interest expense of $6,585 on these two convertible notes. This interest expense was converted to KWESST common shares.
• KWESST hired a consulting firm to provide capital markets advisory services, including assistance to complete KWESST's Qualifying Transaction with Foremost (see Note 4 (a)) and to raise capital. This consulting firm is also a significant shareholder and holds 1,500,000 warrants (each warrant is exercisable into 1/70 of a common share) and 2,857 options of KWESST, including securities held by the owner of this firm. Total cash and share-based remuneration amounted to $494,325.
• The lease for the 3-D printer was with a private company owned by KWESST's President and CEO and his spouse (see Note 12).

At September 30, 2020 and December 31, 2019, there was no outstanding amount in accounts payable and accrued liabilities due to officers and directors of KWESST.

11.Borrowings

In April 2020, KWESST was approved and received a $40,000 term loan with TD Bank under the Canada Emergency Business Account (''CEBA Term Loan'') program funded by the Government of Canada. The CEBA Term Loan is non-interest and can be repaid at any time without penalty. KWESST has recorded a fair value of $30,904 at inception, discounted using its incremental borrowing rate of 10%. The difference of $9,096 between the fair value and the total amount of CEBA Term Loan received has been recorded as a gain on government grant for the nine months period ended September 30, 2020. See Note 26(a).

12.Lease obligations

During the nine months ended September 30, 2020, KWESST terminated an office lease and entered into a long-term office lease contract. The office lease includes the right to renew for an additional five years following its expiry on April 30, 2026. Management has not included the renewal option because it was deemed too uncertain whether KWESST would renew at this time.

Under the new office lease, KWESST benefits from the following lease inducements:

• Free rent from inception (March 1, 2020) to November 1, 2020; and

• Free rent from November 1, 2021, to March 1, 2022.

When measuring the lease obligation, the Company discounted the remaining lease payments using the incremental estimated borrowing rate of Company of 10% per annum at the time of closing the new lease agreement.

F-102

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Nine months ended September 30, 2020 and twelve months ended December 31, 2019

(Expressed in Canadian dollars, except share and per share amounts)

The following table presents lease obligations for KWESST:

		Offices			Printer			Total			Current   Portion		Non-current portion
Balance, December 31, 2018	$	266,292		$	13,761		$	280,053		$	77,367	$	202,686
Lease payments (including interest)		(94,270	)		(7,620	)		(101,890	)		-		-
Interest expense		23,441			1,082			24,523			-		-
Balance, December 31, 2019	$	195,463		$	7,223		$	202,686		$	85,468	$	117,218
Addition		347,640			-			347,640
Termination		(157,315	)		-			(157,315	)
Lease payments (including interest)		(62,816	)		(7,620	)		(70,436	)
Interest expense		29,065			397			29,462
Balance, September 30, 2020 (as adjusted)	$	352,037		$	-		$	352,037		$	44,128	$	307,909

Refer to Note 7 regarding the correction of an error in the application of IFRS 16.

The termination of the former lease resulted in the de-recognition of the lease obligation and related unamortized book value of the right-of-use asset, resulting in a gain of $17,527. This was included in the net finance costs for the nine months ended September 30, 2020.

The following table presents the contractual undiscounted cash flows for the lease obligations:

		September 30, 2020		December 31, 2019
Less than one year	$	78,000	$	101,890
One to five years		390,000		125,693
Total	$	468,000	$	227,583

13.Deferred revenue

The following table presents the changes in deferred revenue:

		September 30, 2020		December 31, 2019
Balance, beginning of period	$	-	$	-
Amounts invoiced and revenue deferred		7,053		-
Recognition of deferred revenue included in the balance at the beginning of period		-		-
Balance, end of period	$	7,053	$	-

14.Financial derivative liabilities

In connection with the issuance of the 2019 Convertible Notes (see Note 15), management determined that the conversion feature was a financial derivative liability which is remeasured at fair value at each reporting period (see Note 20).

F-103

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Nine months ended September 30, 2020 and twelve months ended December 31, 2019

(Expressed in Canadian dollars, except share and per share amounts)

The following table summarizes the financial derivative liabilities:

		Total
Balance at December 31, 2018	$	111,953
Fair value adjustment when notes were converted into common shares		(111,953	)
Fair value of financial derivative liabilities on initial recognition		30,688
Fair value adjustment		(1,225	)
Balance at December 31, 2019		29,463
Fair value adjustment		(29,463	)
Balance at September 30, 2020	$	-

15.Convertible notes

As disclosed in Note 1, the 1-for-70 Reverse Split effected on October 28, 2022 has been applied retrospectively herein.

The following table presents the convertible notes for KWESST:

Balance at December 31, 2018	$	521,515
Related party loans transferred to convertible notes (Note 10)		192,561
Converted into common shares (Note 16)		(620,897	)
Repayment of debt		(31,644	)
Less fair value of conversion feature		(30,688	)
Accrued interest		74,707
Accretion expenses		105,265
Balance at December 31, 2019		210,819
Accrued interest		16,769
Accretion expenses		28,130
Converted in common shares (Note 16)		(255,718	)
Balance at September 30, 2020	$	-

Activities in 2019

During the year ended December 31, 2018, KWESST issued convertible notes to investors in the total principal amount of $601,961 bearing an interest of 10% per annum.

On October 23, 2019, KWESST converted $560,007 of debt and $60,890 of interest into 44,350 common shares at a price of $14.00 relating to all debts noted above and repaid $31,644 debt by cash. The remaining $234,515 was issued as new convertible debentures at a rate of 10% per annum and due on October 23, 2021. Upon the occurrence of a Liquidity Event, the new convertible note will automatically convert into common shares of KWESST at a conversion rate equal to a 20% discount to the value assigned to the common shares of KWESST under such Liquidity Event for the entire amount of the principal amount plus all accrued interest.

"Liquidity Event" means either (1) the completion of an initial public offering which results in the common shares of KWESST being listed and posted for trading or quoted on any of the Toronto Stock Exchange, the TSX Venture Exchange, the New York Stock Exchange, the American Stock Exchange, the Nasdaq National Market, the London Stock Exchange or any successor exchange or market thereto; or (2) the closing of a merger, amalgamation plan of arrangement or other transaction or series of related transactions resulting in the holders of common shares receiving consideration in securities listed on a Qualified Exchange.

F-104

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Nine months ended September 30, 2020 and twelve months ended December 31, 2019

(Expressed in Canadian dollars, except share and per share amounts)

The conversion feature of convertible debentures is presumed to be classified as a derivative financial liability unless it meets all the criteria to recognize as equity instrument under IAS 32 - Financial Instruments: Presentation. One of criteria is that the conversion feature exchanges a fixed amount of shares for a fixed amount of cash ("fixed for fixed"). The convertible debentures are convertible to % of the shares of the Company on a fully diluted basis which is not a fixed amount of shares, therefore the fixed for fixed criteria is not met. As such, the conversion feature was classified as financial derivative liabilities instead of an equity instrument. KWESST separated the convertible debentures into two components at initial recognition, with the debt carried at amortized cost, and the conversion feature carried at fair value as financial derivative liabilities.

Activities in 2020

As disclosed in Note 4(a), a Liquidity Event occurred which resulted in the conversion of the $255,718 outstanding convertible note, including accrued interest up to Liquidity Event, into 6,523 common shares.

16.Share capital and Contributed Surplus

As disclosed in Note 1, the 1-for-70 Reverse Split effected on October 28, 2022 has been applied retrospectively herein.

Share capital

Authorized

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

F-105

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Nine months ended September 30, 2020 and twelve months ended December 31, 2019

(Expressed in Canadian dollars, except share and per share amounts)

Issued Common Shares

	Number		Issued Price		Amount
Outstanding at December 2018	3	$	66.67	$	200
Issued for directors converted loans (1)	92,857	$	0.34		31,308
Issued for parent company converted loans (2)	152,857	$	3.06		467,000
Issued for directors converted loans (3)	21,429	$	7.00		150,000
Issued for converted debt and accrued interest (4)	44,350	$	14.00		620,897
Issued in private placement (5)	72,500	$	14.00		1,014,948
Outstanding at December 31, 2019	383,996			$	2,284,353
Issued in private placement (6)	37,500	$	28.00		1,050,000
Issued in private placement (6)	12,082	$	35.00		422,875
Issued in asset acquisition (7)	9,957	$	16.80		167,280
Issued for converted debt and accrued interest (8)	6,523	$	39.20		255,718
Issued for new converted debt and accrued interest (9)	45,858	$	28.96		1,328,163
Issued in private placement (10)	229	$	34.93		8,000
Issued for consulting services (11)	871	$	37.19		32,393
Issued for exercise of stock options (12)	1,743	$	44.80		78,080
Issued for performance bonus (13)	14,929	$	49.00		731,500
Issued in brokered private placement (14)	62,994	$	49.01		3,087,138
Shares from Foremost's QT  (15)	12,836	$	49.00		628,949
Outstanding at September 30, 2020	589,518			$	10,074,449
Less: share offering costs					(699,886	)
Total share capital at September 30, 2020				$	9,374,563

2019 Activities

(1)During the first quarter of 2019, the directors converted $32,500 of loans into 92,857 of units of KWESST Inc. (''Units''). Each Unit is comprised of one common share and one common share purchase warrant. Each warrant entitles the holder to acquire 1/70 of a common share at a price of $14.00 per share and with an expiry date of June 14, 2024.

(2)During the first quarter of 2019, the corporate shareholder of KWEEST Inc. converted $467,000 of loans into 152,857 common shares.

(3)During the third quarter of 2019, the directors converted $150,000 of loans into 21,429 common shares.

(4)During the third quarter of 2019, KWESST Inc. converted $560,007 of debt and $60,890 of interest into 44,350 common shares.

(5)During the third quarter of 2019, KWESST Inc. closed a non-brokered private placement raising $1,014,948 at a value of $14.00 per share by issuing 72,500 common shares.

2020 Activities

(6)During the first quarter of 2020, KWESST Inc. closed a non-brokered private placement, raising gross proceeds of $1,050,000 at $28.00 per share and another non-brokered private placement raising gross proceeds of $422,875 at $35.00 per share. Total share offering costs amounted to $45,283.

(7)See Note 4(b).

(8)See Note 15.

(9)During the second quarter of fiscal 2020, KWESST Inc. closed on approximately $1.1 million gross proceeds from a non-brokered private placement for unsecured convertible notes, with automatic conversion upon a Liquidity Event including the listing of the Company on the TSX-V.  In light of the Company going public during the third quarter of fiscal 2020, resulting in the automatic conversion of these notes, management concluded that under IAS 38 the recognition of these notes should be equity and not debt.  At the QT, these convertible notes were converted to 35,398 common shares. In connection with these notes, the note holders earned interest at a rate of 15% per annum. Because the notes were treated as equity instruments, the total accrued interest of $59,112 was not recognized in the profit or loss. This accrued interest was converted to 1,877 common shares at QT. Additionally, as an inducement, the note holders also received 25% of the principal amount in the from KWESST common shares based on a stock price of $31.50, resulting in the issuance 8,583 common shares. In connection with this private placement, KWESST incurred $58,065 of offering costs settled in cash and warrants.

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KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Nine months ended September 30, 2020 and twelve months ended December 31, 2019

(Expressed in Canadian dollars, except share and per share amounts)

(10)During the second quarter of fiscal 2020, KWESST issued 229 common shares under a non-brokered private placement.

(11)During the second quarter of fiscal 2020, KWESST issued 871 common shares as settlement for consulting services rendered.

(12)See below - Stock Options.

(13)During the third quarter, KWESST settled performance bonuses in the form of 643 common shares. Additionally, KWESST awarded 7,143 common shares each to two M&A / capital market advisors for successfully assisting KWESST to complete a QT, in accordance with their respective consulting agreement. One of the two advisors is a related party (see Note 10).

(14)During the third quarter and as part of the QT, KWESST closed a brokered private placement led by PI Financial Corp., resulting in gross proceeds of $3,086,687 before share offering costs of $325,887 settled in both cash and warrants.

(15)See Note 4(a).

Warrants

The following reflects the warrant activities for KWESST:

	# of Warrants		Exercise Price		Fair  Value	Weighted average remaining life (years)	Expiry Date
Warrants outstanding at December 31 2018	-	$	-	$	-	-
Granted	6,500,000	$	0.20	$	1,192	3.25	January 1 2024
Granted	2,000,000	$	0.20	$	19,858	3.71	June 14 2024
Warrants outstanding at December 31, 2019	8,500,000			$	1,192
Issued in private placement	15,000	$	0.40	$	2,265	1.33	January 30 2022
Issued in private placement	84,622	$	0.45	$	13,515	1.60	May 8 2022
Issued in asset acquisition (see Note 4)	750,000	$	0.50	$	180,000	2.29	June 12 2022
Issued in private placement	235,428	$	0.70	$	60,340	1.77	July 9 2022
Warrants outstanding at September 30, 2020	9,585,050			$	257,312	3.22

2019 Activities:

Warrants were issued to major shareholders, which a portion was subsequently reallocated to the Executive Chairman's controlling company (DEFSEC) and strategic advisor (See Note 10). Management determined that the estimated fair value for 6.5 million warrants issued on January 1, 2019, was insignificant. For the remaining two million warrants, management estimated the fair value for these warrants using the Black-Sholes pricing model with the following inputs:

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KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Nine months ended September 30, 2020 and twelve months ended December 31, 2019

(Expressed in Canadian dollars, except share and per share amounts)

		Warrants @ $0.20
1/70 of stock price	$	0.044
Volatility		66.75%
Dividend Yield		Nil
Risk-free interest rate		1.40%
Expected life		5
Weighted average fair value per warrant	$	0.0099

2020 Activities:

In connection with private placements, warrants were issued as compensation to brokers and consultants. Additionally, KWESST issued 750,000 warrants to SageGuild LLC in connection with the technology acquisition.

Management estimated fair value of the warrants using the Black-Scholes pricing model with the following key inputs:

		Warrants   @ $0.40		Warrants @ $0.45		Warrants @ $0.70
1/70 of stock price	$	0.40	$	0.50	$	0.70
Volatility		68%		68%		67%
Dividend Yield		Nil		Nil		Nil
Risk-free interest rate		1.47%		0.27%		0.29%
Expected life		2		2		2
Estimated fair value per warrant	$	0.15	$	0.20	$	0.26

Stock options

KWESST has a rolling stock option plan (the ''Plan'') that authorizes the Board of Directors to grant incentive stock options to directors, officers, consultants and employees, whereby a maximum of 10% of the issued common shares are reserved for issuance under the Plan. Under this Plan, the exercise price of each option may not be less than the market price of KWESST's shares at the date of grant. The maximum term for options is five years. Options are granted periodically and generally vest over two years.

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KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Nine months ended September 30, 2020 and twelve months ended December 31, 2019

(Expressed in Canadian dollars, except share and per share amounts)

The following table shows the status of the Plan:

	Number of options			Weighted average exercise price
Options outstanding at December 31, 2019	-		$	-
Granted	29,357			45.50
Options from the Foremost qualifying transaction	1,224			32.90
Exercised	(1,743	)		35.00
Options outstanding at September 30, 2020	28,838		$	45.50
Options exercisable at September 30, 2020	7,474		$	42.00

The following table presents information about stock options outstanding at September 30, 2020:

Range of exercise prices	Number outstanding	Weighted average remaining contractual life	Number exercisable
$33.00	1,224	2.71	1,224
$35.00	2,614	0.67	-
$46.00	13,214	4.41	3,304
$49.00	11,786	4.79	2,946
	28,838	4.15	7,474

At September 30, 2020, there were 30,113 stock options available for grant under the Plan.

During 2020, KWESST granted 29,357 options (2019 - nil) and recorded stock-based compensation expenses of $283,084 (2019 - $nil) related to the vesting of options. The per share weighted-average fair value of stock options granted in 2020 was $16.10 on the date of grant using the Black-Scholes option model with the following weighted-average assumptions:

Stock price	$28.00 to $49.00
Exercise price	$28.00 to $49.00
Volatility	67.71%
Dividend Yield	Nil
Risk-free interest rate	0.65%
Expected life (years)	4.15
Weighted-average fair value per option	$             16.10

Management estimated a forfeiture rate of nil%, except for an option grant of 7,143 at $49.00 each where forfeiture rate was set at 50% based information available subsequent to September 30, 2020.

F-109

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Nine months ended September 30, 2020 and twelve months ended December 31, 2019

(Expressed in Canadian dollars, except share and per share amounts)

17. Earnings (loss) per share

As disclosed in Note 1, the 1-for-70 Reverse Split effected on October 28, 2022 has been applied retrospectively herein.

The following table summarizes the calculation of the weighted average basic number of basic and diluted common shares:

	Nine months ended September 30, 2020	Twelve months ended December 31, 2019
Issued common shares,  beginning of period	383,996	3
Effect of shares issued from:
Conversion of directors converted loans	-	101,174
Conversion of parent company converted loans	-	126,055
Exercise of options	447	-
Conversion of convertible notes, including  interest	7,126	21,769
Issuance for services	1,373	-
Issuance for technology acquisition (Note 4 (b))	1,272	-
Issuance of for equity private placements	45,665	-
Qualifying transaction (Note 4(a))	752	-
Weighted average number of basic common shares	440,631	249,001
Dilutive securities:
Stock options	-	-
Warrants	-	-
Weighted average number of dilutive common shares	440,631	249,001

At September 30, 2020 and December 31, 2019, all the stock options and warrants were anti-dilutive because of KWESST's net loss for both periods.

F-110

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Nine months ended September 30, 2020 and twelve months ended December 31, 2019

(Expressed in Canadian dollars, except share and per share amounts)

18.Revenue

The following table presents the key streams of revenue for KWESST:

		Nine months ended September 30, 2020		Twelve months ended December 31, 2019
Systems	$	835,097	$	472,749
Other		26,820		36,399
	$	861,917	$	509,148

Revenue allocated to remaining performance obligations represents contracted revenue that has not yet been recognized ("contracted not yet recognized") and includes unearned revenue and amounts that will be invoiced and recognized as revenue in future periods. At September 30, 2020, KWESST's contracted not yet recognized revenue was $233,193, of which 100% of this amount is expected to be recognized over the next 12 months.

19.Income tax recovery

a)Reconciliation of effective income tax rate

KWESST's effective income tax rate differs from the statutory rate of 26.5% that would be obtained by applying the combined Canadian basic federal and provincial income tax rate to loss before income taxes. These differences result from the following:

		Nine months ended September 30, 2020			Twelve months ended December 31, 2019
		(Adjusted  - see Note 8)			(Restated - see Note 25)
Loss before income taxes	$	(3,536,778	)		(1,147,280	)
Expected statutory tax rate		26.5%			26.5%
Expected tax recovery resulting from loss		(937,246	)		(304,029	)
Increase (reduction) in income taxes resulting from:
Non-deductible expenses		275,273			28,115
Unrecognized temporary differences		661,973			275,914
	$	-		$	-

KWESST claims research and development deductions and related Investment Tax Credits ("ITC") for tax purposes based on management's interpretation of the applicable legislation in the Income Tax Act of Canada. These claims are subject to audit by the Canada Revenue Agency ("CRA") and any adjustments that results could affect ITCs recorded in the consolidated financial statements. During the nine months ended September 30, 2020, KWESST recognized estimated investment tax credits of $127,325 for the current period and the twelve months ended December 31, 2019. This was presented as a reduction to R&D consulting and material costs in the consolidated statements of net loss and comprehensive loss.

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KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Nine months ended September 30, 2020 and twelve months ended December 31, 2019

(Expressed in Canadian dollars, except share and per share amounts)

b)Deferred tax balances

The following tables deferred tax assets (liabilities) have been recognized in the consolidated financial statements:

		Balance at December 31, 2019		Recognized in profit or loss			Recognized in equity		Balance at September 30, 2020
Deferred tax assets (liabilities):
Net operating loss carryforwards	$	-	$	48,045		$	-	$	48,045
Intangible assets		-		(48,045	)				(48,045	)
	$	-	$	-		$	-	$	-

c)Unrecognized net deferred tax assets

Deferred taxes reflect the impact of loss carryforwards and of temporary differences between amounts of assets and liabilities for financial reporting purposes and such amounts as measured by enacted tax laws. However, KWESST has not recorded net deferred tax assets at September 30, 2020 and December 31, 2019, due to the uncertainty involved in determining whether these deferred tax assets will be realized upon expiration due to KWESST's limited history and operating losses since its inception.

The following is a summary of KWESST's unrecognized deductible temporary differences:

		Balance at		Balance at
		September 30,		December 31,
		2020		2019
Net operating loss carryforwards	$	4,279,494	$	2,111,531
Share issuance costs		1,496,239		17,281
Scientific research and development expenditures		218,235		170,940
Other		46,891		22,106
	$	6,040,859	$	2,321,858

F-112

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Nine months ended September 30, 2020 and twelve months ended December 31, 2019

(Expressed in Canadian dollars, except share and per share amounts)

d)Available net operating losses

At September 30, 2020, KWESST has the following net operating losses in Canada available to reduce future year's taxable income which expire as follows:

Year of expiry		Amount
2036	$	512,163
2037		611,677
2038		1,174,797
2039		1,829,518
2040		332,641
	$	4,460,796

20.Financial instruments

Fair value of financial instruments

The fair values of KWESST's cash, trade and other receivables, accounts payables and accrued liabilities, lease deposits (included in non-current other assets), related parties, and convertible notes approximate carrying value because of the short-term nature of these instruments.

The lease deposits, convertible notes, and lease obligations were recorded at fair value at initial recognition. Subsequently, these were measured at amortized cost and accreted to their nominal value over their respective terms.

Financial derivative liabilities are the only instruments classified as a Level 2 in the fair value hierarchy, as a result of measuring its fair value at each reporting date using the Black-Scholes pricing model. Under IFRS, the levels of fair value hierarchy is as follows:

Level 1: Unadjusted quoted prices in active markets for identical assets or liabilities;

Level 2: Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly (i.e. as prices) or indirectly (i.e. derived from prices); and

Level 3: inputs for the asset or liability that are not observable market data (unobservable inputs).

Financial risk management

The Company is exposed to a number of financial risks arising through the normal course of business as well as through its financial instruments. The Company's overall business strategies, tolerance of risk and general risk management philosophy are determined by the directors in accordance with prevailing economic and operating conditions.

(a)Interest rate risk

Interest rate risk is the risk that the fair value of cash flows of a financial instrument will fluctuate because of changes in market interest rates. KWESST's related party loans have fixed interest rate terms and therefore KWESST is not exposed to interest rate risk.

(b)Foreign currency risk

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KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Nine months ended September 30, 2020 and twelve months ended December 31, 2019

(Expressed in Canadian dollars, except share and per share amounts)

Foreign currency risk is the risk that the future cash flows or fair value of the Company's financial instruments that are denominated in a currency that is not KWESST's functional currency will fluctuate due to a change in foreign exchange rates.

For the nine months ended September 30 2020, KWESST's revenue was substantially denominated in US dollar driven by contracts with U.S. prime contractors in the defense sector. Accordingly, KWESST is exposed to the US dollar currency. A significant change in the US dollar currency could have a significant effect on KWESST's financial performance, financial position and cash flows. Currently, KWESST does not use derivative instruments to hedge its US dollar exposure.

At September 30, 2020, KWESST had the following net US dollar exposure:

		Total USD
Assets	$	222,262
Liabilities		(88,019	)
Net exposure at September 30, 2020	$	134,243
Impact to profit  or loss if 5% movement in the US dollar	$	6,712

During the nine months ended September 30, 2020, KWESST recorded foreign exchange loss of $13,937 (12 months in 2019: $982 loss)

(c)Credit risk

Credit risk is the risk of financial loss to the Company if a counterparty to a financial instrument fails to meet its contractual obligations. KWESST's credit risk exposure is limited to cash, and trade and other receivables. Refer to Note 5 for the breakdown of KWESST's trade and other receivables. KWESST enters into contracts with large, financially sound US general contractors, which mitigates the credit risk. Since September 30, 2020, KWESST has fully collected from the U.S. customer. The remaining receivable is due from the Canadian Federal and Provincial Government for sales tax recoverable and investment tax credits.

(d)Liquidity risk

Liquidity risk is the risk that KWESST will be unable to meet its financial obligations as they become due. KWESST's objective is to ensure that it has sufficient cash to meet its near term obligation when they become due, under both normal and stressed condition, without incurring unacceptable losses or risking reputational damage to KWESST. A key risk in managing liquidity is the degree of uncertainty in KWESST's cash flows due to its early stage in operations and the need for additional capital to fund its business strategies (see Note 2(a)).

At September 30, 2020, KWESST had approximately $3.1 million cash and $2.9 million in working capital (current assets less current liabilities).

F-114

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Nine months ended September 30, 2020 and twelve months ended December 31, 2019

(Expressed in Canadian dollars, except share and per share amounts)

21.Supplemental cash flow information

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

		Nine months ended September 30, 2020			Twelve months ended December 31, 2019
					(As restated - see Note 25)
Trade and other receivables	$	(257,588	)	$	(41,465	)
Prepaid expenses and other		(387,762	)		(36,629	)
Other assets		-			(150,000	)
Accounts payable and accrued liabilities		393,202			86,519
Deferred revenue		7,053			-
	$	(245,095	)	$	(141,575	)

The following is a summary of non-cash items that were excluded from the consolidated statements of cash flows for the nine months ended September 30, 2020:

• $358,178 of right-of-use asset and lease obligations relating to the new office lease;
• $139,787 of right-of-use asset and $157,315 lease obligations de-recognized from KWESST's consolidated financial position relating to the former lease office;
• $347,280 of KWESST's common shares and warrants for the asset acquisition of GhostStep® Technology;
• $255,718 of convertible notes, including accrued interest, settled in KWESST's common shares;
• $322,779 of share offering costs settled in KWESST's common shares;
• $41,155 of options adjustment due to QT (see note 4(a)); and
• $17,531 fair value of options exercised and transferred to KWESST's common shares.

The following is a summary of non-cash items that were excluded from the consolidated statements of cash flows for the twelve months ended December 31, 2019:

• $1,290,255 common shares and warrants for loans.

22.Segmented information

KWESST's Executive Chairman has been identified as the chief operating decision maker. The Executive Chairman evaluates the performance of the Company and allocates resources based on the information provided by KWESST's internal management system at a consolidated level. KWESST has determined that it has only one operating segment.

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KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Nine months ended September 30, 2020 and twelve months ended December 31, 2019

(Expressed in Canadian dollars, except share and per share amounts)

Geographic information

The following table presents external revenue on a geographic basis:

		Nine months ended September 30, 2020		Twelve months ended December 31, 2019
United States	$	835,097	$	472,749
Canada		26,820		36,399
	$	861,917	$	509,148

All of KWESST's property and equipment are located in Canada, including the right-of-use assets.

Concentration of customers information

For the nine months ended September 30, 2020, two customers accounted for the revenue based in the United States. For the twelve months ended December ended December 31, 2019, one customer accounted for the revenues based in United States.

23.Capital management

KWESST's objective in managing its capital is to safeguard its ability to continue as a going concern and to sustain future development of the business. The Company's senior management is responsible for managing the capital through regular review of financial information to ensure sufficient resources are available to meet operating requirements and investments to support its growth strategy. The Board of Directors is responsible for overseeing this process. From time to time, KWESST could issue new common shares or debt to maintain or adjust its capital structure. KWESST is not subject to any externally imposed capital requirements.

KWESST's capital is composed of the following:

		September 30, 2020			December 31, 2019
		(Adjusted - See Note 8)
Debt:
Related party loans	$	218,276		$	289,828
Borrowings		32,273			-
Lease obligations		352,037			202,686
Convertible notes		-			210,819
Equity:
Share capital		9,374,563			2,284,353
Contributed surplus		583,878			21,050
Accumulated deficit		(6,073,577	)		(2,536,799	)
	$	4,487,450		$	471,937

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KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Nine months ended September 30, 2020 and twelve months ended December 31, 2019

(Expressed in Canadian dollars, except share and per share amounts)

24.Commitments and contingencies

a)Minimum royalties

On November 18, 2019, KWESST entered into a non-exclusive license agreement with a third party for its product named DroneBullet, a drone whose principal function and operation is acting as a projectile to intercept aerial threats using kinetic force.  Under this license agreement, KWESST will pay 8% royalty on annual sales of the DroneBullet to the third party, subject to the following minimum annual payments.

• $150,000 for March 31, 2020 to December 31, 2020;
• $200,000 for January 1, 2021 to December 31, 2021;
• $300,000 for January 1, 2022 to December 31, 2022;
• $400,000 for January 1, 2023 to December 31, 2023; and
• $500,000 for January 1, 2024 to December 31, 2024.

In accordance with this license agreement, KWESST paid $150,000 advanced royalty to the third party in 2019 (see Note 25). Due to delays in completing a fully functional DroneBullet, the third party delayed its minimum annual royalty payment. In light of this delay, KWESST and the third party are currently renegotiating the contract to amend certain terms, including the timing for the first minimum annual payment.

This agreement will expire on March 31, 2025. The agreement was amended subsequent to September 30, 2020 (see Note 26(c)).

25.Restatement of previously reported audited financial statements

Subsequent to the issuance of the previously reported audited financial statements for the year ended December 31, 2019, management discovered an error with the accounting for a $150,000 advanced royalty paid to a third party. This advanced royalty payment was an advance on future royalty payments under the licencing agreement (see Note 24) and therefore this payment should have been recognized as non-current other asset rather than a charge to profit or loss. It is classified as non-current because the application of the advanced royalty is limited to sales royalties in excess of the minimum annual royalties, subject to a maximum of $50,000 per year.

The following tables summarizes the effects of the adjustments described above.

Line item on the consolidated statements of financial position and consolidated statement of changes in shareholders' equity:

		As at					As at
		December 31, 2019			Adjustment		December 31, 2019
		(Previously Reported)					(As restated)
Other assets	$	-		$	150,000	$	150,000
Non-current assets	$	254,594		$	150,000	$	404,594
Total assets	$	550,087		$	150,000	$	700,087
Deficit	$	(2,686,799	)	$	150,000	$	(2,536,799	)
Total shareholders' equity (deficit)	$	(381,396	)	$	150,000	$	(231,396	)
Total liabilities and shareholders' equity (deficit)	$	550,087		$	150,000	$	700,087

F-117

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Nine months ended September 30, 2020 and twelve months ended December 31, 2019

(Expressed in Canadian dollars, except share and per share amounts)

Line item on the consolidated statements of net loss and comprehensive loss:

		Year ended						Year ended
		December 31, 2019			Adjustment			December 31, 2019
		(Previously Reported)						(As restated)
General and administrative expenses	$	547,990		$	(150,000	)	$	397,990
Total operating expenses	$	1,588,376		$	(150,000	)	$	1,438,376
Operating loss	$	(1,164,329	)	$	150,000		$	(1,014,329	)
Loss before income taxes	$	(1,297,280	)	$	150,000		$	(1,147,280	)
Net loss and comprehensive loss	$	(1,297,280	)	$	150,000		$	(1,147,280	)
Net loss per share	$	(5.21	)	$	150,000		$	(4.61	)

Line item on the consolidated statements of cash flows:

		Twelve months ended						Twelve months ended
		December 31, 2019			Adjustment			December 31, 2019
		(Previously Reported)						(As restated)
Net loss per share	$	(1,297,280	)	$	150,000		$	(1,147,280	)
Changes in non-cash working capital items	$	8,425		$	(150,000	)	$	(141,575	)

This non-current asset of $150,000 was subsequently written off.

26.Subsequent Events

As disclosed in Note 1, the 1-for-70 Reverse Split effected on October 28, 2022 has been applied retrospectively herein.

a)Borrowings

In December 2020, the Canadian Federal Government amended the CEBA Term Loan program to increase the loan amount by $20,000 to $60,000. KWESST has increased its borrowings accordingly. Additionally, effective January 1, 2021, the outstanding balance of the CEBA Term Loan was automatically converted to a 2-year interest free term loan.

The CEBA Term Loan may be repaid at any time without notice or the payment of any penalty. If 75% of the CEBA Term Loan is repaid on or before December 31, 2022, the repayment of the remaining 25% shall be forgiven. If on December 31, 2022, KWESST exercises the option for a 3-year term extension, a 5% annual interest will be applied on the any balance remaining during the extension period.

b)Technology acquisition

On April 29, 2021, KWESST acquired the Low Energy Cartridge technology from DEFSEC, a proprietary non-lethal cartridge-based firing system (herein referred as the "LEC System"). This technology acquisition includes all intellectual property rights for the LEC System. As DEFSEC is a private company owned by KWESST's Executive Chairman, this asset acquisition is a related party transaction.

F-118

KWESST MICRO SYSTEMS INC.

Notes to Consolidated Financial Statements

Nine months ended September 30, 2020 and twelve months ended December 31, 2019

(Expressed in Canadian dollars, except share and per share amounts)

The purchase consideration consisted of:

• 14,286 common shares of KWESST; and
• 500,000 warrants to purchase KWESST's common shares at $0.70 per 1/70 of a common share; 25% vesting on the first anniversary of the closing of the LEC Technology acquisition and 25% per annum thereafter. These warrants will expire on April 29, 2026.

Additionally, KWESST will pay 7% royalty on annual sales of the LEC System to DEFSEC, net of taxes and duties, up to a maximum of $10 million, subject to minimum annual royalty payments starting in 2023.

The royalty payment obligation of the Purchase Agreement ("Agreement") will expire in 20 years unless terminated earlier under the terms set out in the Agreement.

c)Amended and restated licensing agreement

As disclosed in Note 24(a), KWESST entered into a licensing agreement with a third party, AerialX Drone Solutions ("AerialX").

Subsequently on April 5, 2021, KWESST entered into an amended and restated licensing agreement with AerialX for a period of two years from the date upon which AerialX will meet certain technical milestones. In consideration, KWESST has issued 1,429 common shares to AerialX ("Exclusive License Shares"). Based on KWESST's closing stock price of $95.90 on April 23, 2021 (TSX-V approval date), the fair value for these shares was $137,000.

d)Share capital activities

In April 2021, KWESST closed a brokered private placement, resulting in the issuance of 51,087 units of KWESST, at a price of $87.50 per unit for aggregate gross proceeds of $4,470,071. Each issued unit is comprised of one common share of the Company and seventy common share purchase warrant. Each Warrant is exercisable to acquire 1/70 of a common share at a price of $1.75 each (70 warrants for one common share) for a period of 24 months from the closing date. If at any time after four (4) months and one (1) day following the closing date, the trading price of KWESST common stock on the TSX Venture Exchange is equal to or exceeds $21.00 for a period of 10 consecutive trading days, as evidenced by the price at the close of market, KWESST shall be entitled to notify the holders of the Warrants of its intention to force the exercise of the Warrants. Upon receipt of such notice, the holders shall have 30 days to exercise the Warrants, failing which the Warrants will automatically expire.

The following provides a summary of share capital activities since September 30, 2020:

	Number		Amount
Outstanding at September 30, 2020	589,518	$	9,374,563
Issued in brokered private placement	51,087	$	3,611,818
Issued for exercise of stock options	18,195	$	1,292,015
Issued for asset acquisition	14,286	$	1,290,000
Issued in private placement	10,714	$	1,110,000
Issued for exercise of warrants	10,380	$	815,307
Issued for exercise of broker compensation options	2,459	$	347,680
Issued for amended license	1,429	$	137,000
Issued for debt settlements	1,305	$	63,866
Issued for share units	138	$	12,498
Less: share offering costs for the year	-	$	(839,679	)
Outstanding at September 30, 2021	699,511	$	17,215,068

KWESST Micro Systems Inc.

Up to 5,069,121 Common Shares

PRELIMINARY PROSPECTUS

        , 2023

130

PART II

INFORMATION NOT REQUIRED IN PROSPECTUS

Item 6. Indemnification of Directors and Officers.

Section 160 of the BCBCA authorizes companies to indemnify past and present directors, officers and certain other individuals for the liabilities incurred in connection with their services as such (including costs, expenses and settlement payments) in an eligible proceeding, unless such individual did not act honestly and in good faith with a view to the best interests of the company or, in the case of an eligible proceeding other than a civil proceeding, if such individual did not have reasonable grounds for believing his or her conduct in respect of which the proceeding was brought was lawful. In the case of a suit by or on behalf of the corporation or an associated corporation, a court must approve the indemnification.

Our Notice of Articles provide that we shall indemnify past and present directors against all eligible penalties to which such person is or may be liable, and we will, after the final disposition of an eligible proceeding, pay the expenses actually and reasonable incurred by such person in respect of that proceeding.

On February 25, 2022, we entered into agreements with our directors and certain officers (each an "Indemnitee" under such agreements) to indemnify the Indemnitee, to the fullest extent permitted by law and subject to certain limitations, against all liabilities, costs, charges and expenses reasonably incurred by an Indemnitee in an action or proceeding to which the Indemnitee was made a party by reason of the Indemnitee being an officer or director of (i) our Company or (ii) an organization of which our Company is a shareholder or creditor if the Indemnitee serves such organization at our request.

We maintain insurance policies relating to certain liabilities that our directors and officers may incur in such capacities.

Item 7. Recent sales of unregistered securities.

The following information relates to all securities issued or sold by us within the past three years and not registered under the Securities Act, adjusted for the Reverse Split. The issuances of securities described below were exempt from registration under the Securities Act in reliance on Regulation S promulgated under the Securities Act regarding sales by an issuer in offshore transactions, Regulation D under the Securities Act, Rule 701 under the Securities Act and/or pursuant to Section 4(a)(2) of the Securities Act regarding transactions not involving a public offering.

	Party	Principal Agent's name	Principal Agent's commission	Nature of Transaction	Security Type	Proceeds	Security or Exercise Price	Total number of securities
Fiscal 2023
2023-21-07	Investors	ThinkEquity LLC	USD$326,855	Private placement	Common Shares	USD $3,485,358	N/A	1,542,194
2023-21-07	Investors	ThinkEquity LLC	N/A	Private placement	Warrant	N/A	USD$2.66	2,472,742
2023-21-07	Investors	ThinkEquity LLC	USD$178,679	Private placement	Pre-funded Warrant	USD $2,103,038	USD$0.001	930,548
2023-21-07	Broker	ThinkEquity LLC	N/A	Private placement	Broker Warrants	N/A	USD$2.66	123,637
2022-12-09	Investors	PI Financial	USD$210,000	Canadian Offering	Broker Options	N/A	USD$4.13	50,848
2022-12-09	Investors	ThinkEquity LLC	N/A	U.S. IPO	U.S. IPO Option Warrants	N/A	USD$5.00	375,000

II-2

2022-12-09	Investors	ThinkEquity LLC	N/A	U.S. IPO	U.S. IPO Pre-funded Warrants	N/A	USD$0.01	199,000
2022-12-09	Broker	ThinkEquity LLC	USD$836,017	U.S. IPO	U.S. IPO Underwriter Warrants	N/A	USD$5.1625	124,950
2022-12-09	Investors	N/A	N/A	Non-cash debt settlement	Warrant	N/A	USD$5.00	56,141
2022-12-09	Investors	N/A	N/A	Non-cash debt settlement	Common	N/A	USD$5.00	56,141
Fiscal 2022
2022-08-25	Investors	ThinkEquity LLC	USD$ 32,000	Private placement	Common	$          51,932	$      12.25	4,239
2022-07-14	Investors	N/A	N/A	Private placement	Common	$          344,000	$      15.05	22,857
2022-07-14	Investors	N/A	N/A	Private placement	Warrant	N/A	$      19.95	11,428
2022-04-22	Police Ordnance	N/A	N/A	Non-cash M&A: contingent consideration earned	Common	N/A	$      95.20	875
2022-04-19	Investors	N/A	N/A	Exercise of warrants	Common	$          40,000	$    14.00	2,857
2022-03-30	Investors	N/A	N/A	Exercise of warrants	Common	$          40,000	$    14.00	2,857
2022-03-29	Investors	N/A	N/A	Exercise of warrants	Common	$            8,000	$    14.00	571
2022-03-28	Investors	N/A	N/A	Exercise of warrants	Common	$            8,000	$    14.00	571
2022-03-18	Investors	N/A	N/A	Exercise of warrants	Common	$          95,000	$    14.00	6,785
2022-03-15	Investors	N/A	N/A	Exercise of warrants	Common	$          25,000	$    14.00	1,785
2022-03-15	Investors	PI Financial	$          7,020	Private placement	Common	$        237,827	$    25.61	9,285
2022-03-11	Investors	PI Financial	$          3,780	Private placement	Common	$        128,061	$    25.61	5,000
2021-12-31	SageGuild	N/A	N/A	Exercise of warrants	Common	$        125,000	$    35.00	3,571
2021-12-15	Police Ordnance	N/A	N/A	Non-cash M&A	Common	N/A	$    95.20	3,965
2021-12-15	Police Ordnance	N/A	N/A	Non-cash M&A	Warrant	N/A	$  120.40	2,857
2021-10-25	Vendor (accredited)	N/A	N/A	Non-cash debt settlement	Common	N/A	$  133.00	142
Fiscal 2021
2021-09-22	Broker	N/A	N/A	Exercise of compensation options	Common	$          43,261	$    87.50	494
2021-09-22	Broker	N/A	N/A	Exercise of warrants	Common	$          60,566	$  122.50	494

II-3

2021-09-20	Investors	N/A	N/A	Exercise of warrants	Common	$        151,200	$  122.50	1,234
2021-09-17	Investors	N/A	N/A	Exercise of warrants	Common	$        218,400	$  122.50	1,782
2021-09-16	Investors	N/A	N/A	Exercise of warrants	Common	$          87,850	$  122.50	717
2021-09-16	Investors	Haywood Financial	$        90,000	Private placement	Common	$      1,500,000	$  140.00	10,714
2021-09-16	Investors	Haywood Financial	N/A	Private placement	Warrant	N/A	$  164.50	10,714
2021-09-16	Broker	Haywood Financial	N/A	Private placement	Warrant	N/A	$  140.00	642
2021-09-08	Broker	N/A	N/A	Exercise of compensation options	Common	$          19,964	$    87.50	228
2021-08-31	Broker	N/A	N/A	Exercise of compensation options	Common	$          29,339	$    87.50	335
2021-08-30	Broker	N/A	N/A	Exercise of compensation options	Common	$        122,571	$    87.50	1,400
2021-08-25	Broker	N/A	N/A	Exercise of warrants	Common	$                929	$    49.01	18
2021-08-25	Investors	N/A	N/A	Private placement	Common	$          50,000	$    87.50	571
2021-08-25	Investors	N/A	N/A	Private placement	Warrant	N/A	$    122.50	571
2021-08-17	Broker	N/A	N/A	Exercise of warrants	Common	$            2,730	$      49.00	55
2021-07-13	Broker	N/A	N/A	Exercise of warrants	Common	$            1,008	$      49.00	20
2021-04-29	DEFSEC	N/A	N/A	Non-cash asset acquisition	Common	N/A	$    90.30	14,285
2021-04-30	DEFSEC	N/A	N/A	Non-cash asset acquisition	Warrant	N/A	$      35.00	7,142
2021-04-29	Investors	PI Financial	$      288,405	Brokered private placement	Common	$      4,420,071	$      87.50	50,515
2021-04-29	Investors	PI Financial	N/A	Brokered private placement	Warrant	N/A	$    122.50	50,515
2021-04-29	Broker	PI Financial	N/A	Brokered private placement	Compensation option	N/A	$      87.50	3,296
2021-04-23	AerialX	N/A	N/A	Non-cash asset acquisition	Common	N/A	$      95.90	1,428
2021-02-23	Broker	N/A	N/A	Exercise of warrants	Common	$          41,654	$      49.00	850
2021-02-23	Broker	N/A	N/A	Exercise of warrants	Common	$            9,006	$      49.00	183
2021-02-22	Advisor	N/A	N/A	Exercise of warrants	Common	$            6,000	$      28.00	214

II-4

2021-02-12	Broker	N/A	N/A	Exercise of warrants	Common	$            1,499	$      49.00	30
2021-02-08	Broker	N/A	N/A	Exercise of warrants	Common	$          25,479	$      49.00	519
2021-02-04	Broker	N/A	N/A	Exercise of warrants	Common	$            5,727	$      49.00	116
2021-01-29	Broker	N/A	N/A	Exercise of warrants	Common	$                619	$      49.02	12
2021-01-28	Broker	N/A	N/A	Exercise of warrants	Common	$          27,245	$      49.00	556
2020-12-31	SageGuild	N/A	N/A	Exercise of warrants	Common	$        125,000	$      35.00	3,571
2020-12-14	Vendors	N/A	N/A	Non-cash debt settlement	Common	N/A	$      49.00	1,305
Fiscal 2020
2020-09-14	Advisors	N/A	N/A	Non-cash bonus	Common	N/A	$      49.00	14,285
2020-09-14	Investors	PI Financial	$      164,800	Brokered private placement	Common	$      3,087,138	$      49.01	62,993
2020-09-14	Broker	PI Financial		Brokered private placement	Warrant	N/A	$      49.00	3,363
2020-09-14	2020 Note holders	N/A	N/A	Non-cash conversion of convertible notes and commitment fee	Common	N/A	$      31.50	45,857
2020-09-14	2019 Note holders	N/A	N/A	Non-cash conversion of convertible notes	Common	N/A	$      39.20	5,944
2020-09-14	2019 Note holder	N/A	N/A	Non-cash conversion of convertible notes	Common	N/A	$      39.20	579
2020-09-14	SageGuild	N/A	N/A	Election made re non-cash asset acquisition in June 2020	Common	N/A	$      16.80	7,957
2020-07-14	Advisor	N/A	N/A	Non-cash bonus	Common	N/A	$      49.00	500
2020-07-13	Advisor	N/A	N/A	Non-cash bonus	Common	N/A	$      49.00	142
2020-06-12	SageGuild	N/A	N/A	Non-cash asset acquisition	Common	N/A	$      16.80	2,000
2020-06-13	SageGuild	N/A	N/A	Non-cash asset acquisition	Warrant	N/A	$      35.00	10,714
2020-06-12	Investors	N/A	N/A	Private placement	Common	$            8,000	$      35.00	228

II-5

2020-06-12	Consultant	N/A	N/A	Non-cash settlement for two months of services rendered	Common	N/A	$      35.00	871
2020-05-08	Advisors	N/A	N/A	Service rendered	Warrant	N/A	$      31.50	1,208
2020-03-25	Investors	N/A	N/A	Private placement	Common	$        422,875	$      35.00	12,082
2020-01-30	Investors	N/A	N/A	Private placement	Common	$      1,050,000	$      28.00	37,500
2020-01-30	Advisor	N/A	N/A	Service rendered	Warrant	N/A	$      28.00	214

Additionally, we have also granted compensatory securities under our LTIP as follows:

• Fiscal 2023 year to date: No securities have been granted under our LTIP in Fiscal 2023.

• Fiscal year ended September 30, 2022: 9,500 stock options with a weighted average exercise price of $69.59 each; 10,726 RSUs, 17,942 PSUs, and 514 SARs.

• Fiscal year ended September 30, 2021: 52,988 stock options with a weighted average exercise price of $104.30 each; 16,410 RSUs, 2,857 PSUs, and 2,142 SARs.

• Fiscal period ended September 30, 2020: 29,357 stock options with a weighted average exercise price of $45.50 each.

For further details, refer to Financial Statements section of this registration statement.

Item 8. Exhibits and Financial Statement Schedules.

(a) The following documents are filed as part of this registration statement:

Exhibit No.	Description
3.1	Articles of Amendment, as updated September 4, 2020 (incorporated by reference to Exhibit 3.2 to the Company's Form F-1 filed with the SEC on September 16, 2022)
4.5	Form of Underwriter Warrant For U.S. IPO (incorporated by reference to Exhibit 4.1 to the Company's Form F-1 filed with the SEC on November 7, 2022)
4.6	Form of Warrant Agency Agreement for U.S. IPO Warrants (incorporated by reference to Exhibit 4.2 to the Company's Form F-1 filed with the SEC on November 7, 2022)
4.7	Form of U.S. IPO Warrant (incorporated by reference to Exhibit 4.3 to the Company's Form F-1 filed with the SEC on November 7, 2022)
4.8	Form of U.S. IPO Pre-funded Warrant (incorporated by reference to Exhibit 4.4 to the Company's Form F-1 filed with the SEC on November 7, 2022)
4.9	Form of Warrant Indenture for Canadian Warrants (incorporated by reference to Exhibit 4.5 to the Company's Form F-1 filed with the SEC on November 7, 2022)

II-6

4.10	Form of Warrant Certificate for Canadian Warrants (incorporated by reference to Exhibit 4.6 to the Company's Form F-1 filed with the SEC on November 7, 2022)
4.11	Form of Canadian Compensation Option Certificate (incorporated by reference to Exhibit 4.7 to the Company's Form F-1 filed with the SEC on November 7, 2022)
4.12	Common Share Purchase Warrant Indenture between KWESST Micro Systems Inc. and TSX Trust Company, dated April 29, 2021 (incorporated by reference to Exhibit 10.7 to the Company's Form F-1 filed with the SEC on September 16, 2022)
4.13	First Supplemental Warrant Indenture between KWESST Micro Systems Inc. and TSX Trust Company, dated August 25, 2021 (incorporated by reference to Exhibit 10.8 to the Company's Form F-1 filed with the SEC on September 16, 2022)
4.14	Form of Private Placement Warrant (included in Exhibit 10.14)
4.15	Form of Private Placement Pre-funded Warrant (included in Exhibit 10.14)
4.16	Form of Private Placement Agent's Warrant (included in Exhibit 10.14)
5.1	Opinion of Fasken Martineau DuMoulin LLP
8.1	Tax Opinion of Dorsey & Whitney LLP
10.1	Definitive Technology Purchase Agreement between KWESST Micro Systems Inc. and DEFSEC Corporation, dated January 15, 2021 (incorporated by reference to Exhibit 10.2 to the Company's Form F-1 filed with the SEC on September 16, 2022)
10.2	GhostStep Technology Purchase Agreement, between KWESST Micro Systems Inc. and SageGuild, LLC, dated June 12, 2020 (incorporated by reference to Exhibit 10.3 to the Company's Form F-1 filed with the SEC on September 16, 2022)
10.3	CPC Escrow Agreement between Foremost Ventures Corp. and TSX Trust Company, dated May 2, 2018 (incorporated by reference to Exhibit 10.4 to the Company's Form F-1 filed with the SEC on September 16, 2022)
10.4	Surplus Security Escrow Agreement between KWESST Micro Systems Inc. and TSX Trust Company, dated September 17, 2020 (incorporated by reference to Exhibit 10.5 to the Company's Form F-1 filed with the SEC on September 16, 2022)
10.5	Value Security Escrow Agreement between KWESST Micro Systems Inc. and TSX Trust Company, dated September 17, 2020 (incorporated by reference to Exhibit 10.6 to the Company's Form F-1 filed with the SEC on September 16, 2022)
10.6	Long-Term Performance Incentive Plan, effective March 31, 2022 (incorporated by reference to Exhibit 10.9 to the Company's Form F-1 filed with the SEC on September 16, 2022)
10.7	Professional Services Agreement among KWESST Inc., DEFSEC Corporation and David Luxton, dated October 1, 2019 (incorporated by reference to Exhibit 10.11 to the Company's Form F-1 filed with the SEC on September 16, 2022)
10.8	Employment Contract between KWESST Inc. and Jeffrey MacLeod, dated September 1, 2019 (incorporated by reference to Exhibit 10.12 to the Company's Form F-1 filed with the SEC on September 16, 2022)

II-7

10.9†	Master Professional Services Agreement between KWESST Inc. and General Dynamics Land Systems - Canada Corporation doing business as General Dynamics Mission Systems - Canada, dated December 1, 2021 (incorporated by reference to Exhibit 10.15 to the Company's Form F-1 filed with the SEC on September 16, 2022)
10.10	Subcontractor Agreement between KWESST Micro Systems Inc. and CounterCrisis Tech, dated July 6, 2022 (incorporated by reference to Exhibit 10.17 to the Company's Form F-1 filed with the SEC on September 16, 2022)
10.11†	Canadian Government Contract amongst Modis Canada Inc., Thales Canada Inc., KWESST Inc. and the Canadian Department of National Defence, dated May 1, 2023
10.12	Amended and Restated Employment Contract between KWESST Inc. and Sean Homuth, dated July 31, 2023
10.13	Form of Placement Agency Agreement between KWESST Micro Systems Inc. and ThinkEquity LLC, dated July 18, 2023
10.14†	Form of Securities Purchase Agreement dated July 18, 2023 between KWESST Micro Systems Inc. and the Purchasers
10.15	Form of Registration Rights Agreement dated July 18, 2023 (included in exhibit 10.14)
21.1	List of Subsidiaries of KWESST Micro Systems Inc. (incorporated by reference to Exhibit 21.1 to the Company's Form F-1 filed with the SEC on September 16, 2022)
23.1	Consent of Kreston GTA LLP
23.2	Consent of KPMG LLP
23.3	Consent of Fasken Martineau DuMoulin LLP (included in Exhibit 5.1)
24.1	Power of Attorney (included on signature page of this registration statement)
107	Filing Fee Table

† Portions of this exhibit have been omitted in accordance with the rules of the SEC. KWESST Micro Systems Inc. agrees to furnish a copy of all omitted exhibits and schedules to the SEC upon its request.

Item 9. Undertakings.

The undersigned registrant hereby undertakes to provide to the Underwriter at the closing specified in the underwriting agreement, certificates in such denominations and registered in such names as required by the Underwriter to permit prompt delivery to each purchaser.

Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers and controlling persons of the registrant pursuant to the provisions described in Item 6, or otherwise, the registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act and is therefore unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person of the registrant in the successful defense of any action, suit or proceeding)is asserted by such director, officer or controlling person in connection with the securities being registered, the registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Securities Act and will be governed by the final adjudication of such issue.

II-8

The undersigned registrant hereby undertakes:

(1)To file, during any period in which offers or sales are being made, a post-effective amendment to this registration statement:

i.To include any prospectus required by Section 10(a)(3) of the Securities Act;

ii.To reflect in the prospectus any facts or events arising after the effective date of the registration statement(or the most recent post-effective amendment thereof) which, individually or in the aggregate, represent a fundamental change in the information set forth in the registration statement. Notwithstanding the foregoing, any increase or decrease in volume of securities offered (if the total dollar value of securities offered would not exceed that which was registered) and any deviation from the low or high end of the estimated maximum offering range may be reflected in the form of prospectus filed with the SEC pursuant to Rule 424(b) if, in the aggregate, the changes in volume and price represent no more than a 20% change in the maximum aggregate offering price set forth in the "Calculation of Registration Fee" table in the effective Registration Statement;

iii.To include any material information with respect to the plan of distribution not previously disclosed in the registration statement or any material change to such information in the registration statement.

(2)That, for the purpose of determining any liability under the Securities Act, each such post-effective amendment shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof;

(3)To remove from registration by means of a post-effective amendment any of the securities being registered which remain unsold at the termination of the offering;

(4)To file a post-effective amendment to the registration statement to include any financial statements required by "Item 8.A.of Form 20-F (17 CFR 249.220f)" at the start of any delayed offering or throughout a continuous offering.

(5)That, for the purpose of determining liability under the Securities Act to any purchaser: if the registrant is subject to Rule 430C (§230.430C of this chapter), each prospectus filed pursuant to Rule 424(b) as part of a registration statement relating to an offering, other than registration statements relying on Rule 430B or other than prospectuses filed in reliance on Rule 430A (§230.430A of this chapter), shall be deemed to be part of and included in the registration statement as of the date it is first used after effectiveness. Provided, however, that no statement made in a registration statement or prospectus that is part of the registration statement or made in a document incorporated or deemed incorporated by reference into the registration statement or prospectus that is part of the registration statement will, as to a purchaser with a time of contract of sale prior to such first use, supersede or modify any statement that was made in the registration statement or prospectus that was part of the registration statement or made in any such document immediately prior to such date of first use

(6)For the purposes of determining liability under the Securities Act of 1933 to any purchaser in the initial distributions of the securities, the undersigned registrant undertakes that in a primary offering of securities of the undersigned registrant pursuant to this registration statement, regardless of the underwriting method used to sell the securities to the purchaser, if the securities are offered or sold to such purchaser by means of any of the following communications, the undersigned registrant will be a seller to the purchaser and will be considered to offer or sell such securities to such purchaser:

i.Any preliminary prospectus or prospectus of the undersigned registrant relating to the offering required to be filed pursuant to Rule 424;

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ii.Any free writing prospectus relating to the offering prepared by or on behalf of the undersigned registrant or used or referred to by the undersigned registrant;

iii.The portion of any other free writing prospectus relating to the offering containing material information about the undersigned registrant or its securities provided by or on behalf of the undersigned registrant; and

iv.Any other communication that is an offer in the offering made by the undersigned registrant to the purchaser.

(7)Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the registrant pursuant to the foregoing provisions, or otherwise, the registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person of the registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue.

The undersigned registrant hereby undertakes that:

(1)For purposes of determining any liability under the Securities Act of 1933, the information omitted from the form of prospectus filed as part of this registration statement in reliance upon Rule 430A and contained in a form of prospectus filed by the registrant pursuant to Rule 424(b) (1) or (4) or 497(h) under the Securities Act shall be deemed to be part of this registration statement as of the time it was declared effective.

(2)For the purpose of determining any liability under the Securities Act of 1933, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof.

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SIGNATURES

Pursuant to the requirements of the Securities Act of 1933, the registrant certifies that it has reasonable grounds to believe that it meets all of the requirements for filing on Form F-1 and has duly caused this registration statement to be signed on its behalf by the undersigned, thereunto duly authorized in the City of Ottawa, Province of Ontario, Canada, on this 1^st day of August, 2023.

KWESST MICRO SYSTEMS INC.
By:	/s/  Jeffrey MacLeod
	Jeffrey MacLeod
	Chief Executive Officer and Director

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POWER OF ATTORNEY

KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints David Luxton and Jeffrey MacLeod as his true and lawful attorneys-in-fact, with full power of substitution and re-substitution, for him and in his name, place and stead, in any and all capacities to sign any and all amendments (including post-effective amendments) to this registration statement and to sign a registration statement pursuant to Section 462(b) of the Securities Act of 1933, and to file the same with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.

Pursuant to the requirements of the Securities Act of 1933, this registration statement has been signed by the following persons in the capacities and on the dates indicated:

SIGNATURE	TITLE	DATE
/s/ Jeffrey MacLeod		August 1, 2023
Jeffrey MacLeod	Chief Executive Officer (Principal Executive Officer), Director
/s/ Sean Homuth		August 1, 2023
Sean Homuth	Chief Financial Officer (Principal Financial and Accounting Officer)
/s/ David Luxton		August 1, 2023
David Luxton	Executive Chairman and Director
/s/ John McCoach		August 1, 2023
John McCoach	Director
/s/ Paul Fortin		August 1, 2023
Paul Fortin	Director
/s/ Paul Mangano		August 1, 2023
Paul Mangano	Director

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SIGNATURE OF AUTHORIZED REPRESENTATIVE IN THE UNITED STATES

Pursuant to the requirements of the Securities Act of 1933, the undersigned, the duly authorized representative in the United States of KWESST Micro Systems Inc., has signed this registration statement on August 1, 2023.

Authorized United States Representative

	/s/ Paul Mangano
Name:	Paul Mangano
Title:	Director

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