Red Cat Q1 2024 Earnings Call Transcript

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September 19, 2023

There are 6 speakers on the call.

Operator

Ladies and gentlemen, thank you for standing by. Good afternoon and welcome to the Redcat Holdings Fiscal First Quarter 2024 Financial Results and Corporate Update Conference Call. At this time, all participants are in listen only mode. After today's presentation, there will be an opportunity to ask questions. Participants of this call are advised that the audio of this conference is being broadcast live over the Internet and is also being recorded for playback purposes.

Operator

A webcast replay of the call will be available approximately 1 hour after the end of the call through December 18, 2023. I would now like to turn the call over to Joey Delahoussay, Vice President of CORE IR, the company's Investor Relations firm. Please go ahead, sir.

Speaker 1

Thank you, Sarah. Good afternoon, everyone, and thank you for joining us for the Redcat Holdings fiscal Q1 2024 financial results and Business Update Conference Call. Joining us today from Redcat Holdings are Jeff Thompson, Chief Executive Officer and Joseph Hernan, Chief Financial Officer. During this call, management will be making forward looking statements, including statements that address Redcat's expectations for future performance or operational results. Forward looking statements involve risks and other factors that may cause actual results to differ materially from those statements.

Speaker 1

For more information about these risks, please refer to the risk factors described in Red Cat's most recently filed periodic reports on Form 10 ks and Form 10 Q and in Red Cat's press release that accompanies this call, particularly the cautionary statements in it. The content of this call contains time sensitive information that is accurate only as of today, September 19, 2023. Except as required by law, Redcat disclaims any obligation to publicly update or revise any information to reflect events or circumstances that occur after this call. It is now my pleasure to turn the call over to Jeff Thompson, Chief Executive Officer. Jeff?

Speaker 2

Thanks, Joey. Thank you. Welcome, everyone, to our fiscal year 2024 Q1 earnings conference call. I'll start by summarizing our recent performance and achievements, and then I will provide information related to our outlook for fiscal year 2024. After which, Joseph will review our financial results, and then we will take your questions.

Speaker 2

I am pleased to report that the TL2 drone is getting a warm welcome as the most unique and capable nighttime drone in the Group 1 class. We announced the TL2 at the Army Aviation Association of America Conference on April 26, a few days before our fiscal year end. The Teal Jones revenue for fiscal Q1 was $1,750,000 We cannot make a year over year comparison because the Teal 2 did not exist. But if you were a startup and launched a brand new product and did almost $2,000,000 in revenue in your Q1, it would be considered a home run, specifically if there was follow through, but more on that in our guidance update. And Joey and Joseph, can you make sure that your lines are muted?

Speaker 2

We're hearing some background noise. So we've got a we've met with a lot of investors recently and a lot of them are new to the story. So I'm going to kind of back up and discuss some of the regulatory tailwinds that helped create the United States drone market's current status. So December 2020, DJI, the largest phone manufacturer on the planet, was put on the U. S.

Speaker 2

Government's entity list. In December 2021, DJI was also put on the economic blacklist. Fast forward to July 2023, the American Securities and Crime Act, ASCA, passed the Senate unanimously, and we expect it to be law in the next few months. August 2023, Redcat's field 2 receives remote ID certification from the FAA. This was a huge achievement, documents over 300 pages, very difficult to get this certification from the FAA.

Speaker 2

Only a few of us have done it so far. It's so difficult that most companies could not pull it off and they actually delayed the status and the requirement for 6 months. So what do all these things what do all these regulatory tailwinds mean? Well, it means that the largest drone manufacturer in the world, whose number one market was the United States, can no longer by law be bought by anyone that receives federal dollars. It's not just the Department of Defense, it's local groups, it's fire departments, it's anyone that receives federal dollars.

Speaker 2

This has created a very large market and a very large vacuum for only us and one other manufacturer in the U. S. That can build the scale to fill. So this is very unique opportunity that doesn't always happen. Now I'll move on into our revenue and investment tailwinds.

Speaker 2

I'm going to discuss the current organic revenue growth, our immediate revenue. I'm going to then discuss the DoD newly announced and funded replicator initiative. We look at that as mid term revenue in the next 3 to 6 months. And then the short range reconnaissance SRR program of record, which is a 10 year program of record and most people on this call are waiting for this to happen, but it is a very significant program. So let's start with our organic revenue and our backlog.

Speaker 2

Today, we reported for Q1 $1,750,000 in revenue. Our guidance for Q2 is $3,000,000 71 percent sequential organic growth. Our guidance for Q3 is 5,000,000 dollars 67% sequential growth on top of 71% sequential growth. This guidance is based on signed purchase orders, and we expect more in the next 11 days. Q3 revenue of 5,000,000 dollars puts us at a $20,000,000 run rate after selling the TL2 for just under 5 months.

Speaker 2

This is amazing this is an amazing growth story, and we'd like to thank the entire Teal team for making it happen. So now let's move on to midterm revenue opportunities, which we believe 3 to 6 months. The Replicator Initiative. The Pentagon has unveiled a radical new strategy focused on fielding thousands of cheap, smart and autonomous war drones across multiple domains within 18 to 24 months to counter China's military. According to the Wall Street Journal, Deputy Secretary of Defense, Kathleen Hicks, said the Department of Defense plans to develop AI systems intended to be small, smart and cheap to counter threats from China and other countries.

Speaker 2

Overall, we're going to be delivering in the 1,000, Dick said during Tuesday's interview. Last week, she announced our replicator initiative, the latest effort to overcome the production valley of death, beginning with the accelerating the scaling of all domain attributable autonomous systems. So what does this mean? Tens of thousands of disposable drones need to be delivered to the war fighter in 18 months, which means orders most likely need to be delivered to these vendors in the next 3 to 6 months. We believe we are very well positioned or already in contact with this program.

Speaker 2

Now let's move on to long term revenue opportunities. SRR or short range reconnaissance program of record. Just to review or for new investors that are on the call, the SRR program of record started over 3 years ago and was originally set to have 3 tranches, tranche 1, 2 and 3. Tranche 1 would have a prototype contract and a production contract. The same was supposed to happen to tranche 2 and then tranche 3.

Speaker 2

We were awarded tranche 1 prototype contract and were not awarded the production contract. That production contract a couple of years ago was for $100,000,000 for 10.83 drones. Tranche 2 was supposed to be awarded months ago, but the U. S. Army notified us last December and said they're putting Tranche 3 into Tranche 2 to accelerate to get the final product into the war fighters' hands.

Speaker 2

This was due mostly because of the Ukraine war and everyone's understanding how important small drones are. And actually, that's what also started the replicator initiative. So tranche 23, which is now combined, which the next down selection, I believe, is at end of December or early January, if they announced the next down selection on time. We don't know what the actual contract amount is, but the $100,000,000 drones was for $100,000,000 was for 1,000 A3 drones. The remaining amount on this contract is for 12,000 drones.

Speaker 2

I'm not doing linear math. I'm not saying that this is going to be a $1,200,000,000 award, but I'm saying it's going to be significant. And now with the constant need for thousands of drones, we don't know if this will be sized up because of the need for small drones. I will now hand the call over to Joseph. Look forward to your questions.

Speaker 3

Thank you, Jeff, and to everyone for joining the call today. I will now provide a review of our operating results for the fiscal Q1, which ended on July 31, 2023. My comments are going to focus on a number of financial based milestones and events, which leave us strongly positioned for the balance of fiscal 'twenty four and beyond. As many of you know, we have a pending agreement to sell our consumer segment to unusual machines, which I will also refer to as The sales price includes an immediate cash payment of $3,000,000 plus $17,000,000 in shares of UN. We also expect to receive a favorable working capital adjustment of approximately $4,000,000 which will be payable in additional stock.

Speaker 3

The sale of the Consumer segment is contingent upon Universal Machines completing an initial public offering on a major stock exchange. Has recently advised us that they have significantly completed the registration process with the SEC and that they expect to complete an IPO during our fiscal Q2. Therefore, under the accounting rules, since the transaction is likely to close within the next 12 months, the accounting rules require us to report the Consumer segment as discontinued operations. The financial accounting and reporting for discontinued operations is much different than what we have historically reported. Basically, the operating results of our Consumer segment, which consists of Fat Shrek and Rotor Riot, have been condensed into one separate line in each of our financial statements.

Speaker 3

There is literally no combining of amounts related to our continuing operations, which is our Enterprise segment consisting of teal and Skypersonic with our discontinued operations, which is our Consumer segment consisting of Rotor Riot and Fat Shark. Since we expect to receive approximately $21,000,000 in shares of which will make us a significant shareholder, I will provide a brief review of the Q1 operating results for the Consumer segment. Driven by strong growth at Rotor Riot, Q1 revenues were almost at a record level. The operating loss for Consumer was very modest at less than $300,000 believes that there are multiple opportunities to continue growing the consumer segment under its stewardship. We believe that our shares in will have significant long term value and frankly represent a hidden value relative to Red Cat's current market capitalization.

Speaker 3

Turning now to the Enterprise segment. As Jeff noted, just before the start of fiscal 2024, we launched the TL2 in late April. The market response has been immediate and meaningful. We reported record sales for the Enterprise segment in the Q1 of fiscal 2024 and believe that higher sales will be reported each quarter throughout fiscal 2024. We are already beginning to receive repeat orders and presently have an order backlog of approximately $6,000,000 As we have noted in prior calls, we initially established relatively high inventory levels in response to supply chain challenges that emerged during COVID-nineteen.

Speaker 3

These actions led by our COO, Alan Evans, enabled us to secure chips and other electronic components at a time when they were very hard to procure and at reasonable prices. That savvy move leaves us very well positioned today. Thank you, Doctor. Evans. With escalating demand for the TL2, we estimate that it will cost approximately $3,000,000 to convert our existing $11,000,000 of inventory into approximately 1200 drones, which represents revenues of 18,000,000 dollars based on our base sales price of $50,000 per drone.

Speaker 3

This inventory conversion will generate net cash proceeds of approximately $15,000,000 and represents 1 of a number of cash sources that we expect to realize in fiscal 2024. Our expected cash proceeds of $3,000,000 from the sale of Consumer is another source of capital. While we can't immediately sell our 21,000,000 shares of the 180 day lockup period is relatively short and could begin to generate cash proceeds late in fiscal 2024. We expect that orders from government agencies will continue to be the source of most of our enterprise revenues. Due to the high certainty of the funding sources for government based orders, there are greater than normal opportunities for us to secure financing secured by these orders.

Speaker 3

Finally, one of our greatest assets is our manufacturing facility in Salt Lake City. Since acquiring Teal in 2021, building this facility has been a huge focus of management, our dedicated employees and our precious capital. The facility is now fully operational and continues to scale manufacturing output. At this time, we are not able to fully leverage its manufacturing capabilities, which is resulting in lower than targeted gross margins. However, as Jeff just noted, we expect orders for the TL2 to continue to grow throughout fiscal 2024 and we will manufacture these additional drones at a lower unit cost, which will increase gross margins and operating cash flows.

Speaker 3

Our drones are made in the USA, which continues to become more critically important to government agencies, including the military branches. We believe that this provides us with a huge competitive advantage in an industry that is positioned for significant long term growth.

Operator

Our first question comes from Ashok Kumar with ThinkEquity. Please go ahead.

Speaker 4

Thank you. Two questions. The first question, two parts. In terms of your Q3 fiscal guidance of $5,000,000 and your current cost structure and improving margins, will that get you close to cash flow positive? And the second part of that question is, given your current cash position and the near term burn, is there a need to raise capital?

Speaker 4

The second question is on the competitive front On the SRR program, you're competing with Skydio and Vantage, and then you're on a bake off for the border patrol program with the same competitors. So could you please give us an update on the opportunity on the Border Patrol program?

Speaker 2

Sure. So let me start with your last question and go backwards here. So yes, we all of us got orders earlier this year. We had an order for about 1,000,000 drones from the Border Patrol. Skydio did also and Vantage Robotics also got a much smaller order.

Speaker 2

So yes, we are in a bake off to gain their business. We have nothing new to report, but it is interesting and that's exactly who we're going up against for the large SRR, short range reconnaissance program of record. So as soon as we hear, and this is the time of year, could be any day if we hopefully we do hear something, you'll be the first to know. Secondly, I'll go into your question about, do we need to raise capital? And we've gotten that question a lot while we were at all

Speaker 3

these conferences we were at

Speaker 2

last week, and it's a legitimate question. Hired guns. The company, the hired guns. The company, the employees, we own almost 40% of the shares outstanding. So we've written checks.

Speaker 2

We're not hired guns. We don't own 0.00% and just want to do a bunch of raises and dilute everybody. Because if we dilute the shareholders, we're half the shareholders almost. So we do not want to do that. So let me go through some of the details on this.

Speaker 2

As Joseph just mentioned, we'll be turning 1,000,000 of dollars of inventory into sales over the next couple of quarters. In our first three quarters, we've got about $10,000,000 in shift revenue we'll be posting, which is more than all of last year, and we're not even done with sales yet. So those numbers could actually be higher. Also as Joseph noticed, we expect to close YOUMAK in the next few weeks, which will generate approximately $3,000,000 in non dilutive capital. And he also mentioned the $1,000,000 to $2,000,000 in inventory or more.

Speaker 2

We will also be getting approximately $2,400,000 from our SRR prototype contracts starting in November and that goes through March. And we have also recently received research project that could generate approximately $1,000,000 to $2,000,000 On top of that, we've last week and as recent as today, we've gotten term sheets for small debt offerings, not convertible debt. And we stated, as Joseph mentioned, exploring credit lines based on our government contracts, which are much less expensive debt. So to summarize this non dilutive way to raise capital over the next few months, it's approximately $7,400,000 to $9,400,000 in the next 6 months of non diluted capital. And if you add a small debt offering, it goes from offering of $3,000,000 to $5,000,000 which we could easily service in our models.

Speaker 2

That's a total of $10,400,000 to $14,400,000 of non dilutive capital, which is more than enough to get us to cash flow positive. And I think your question for Q3, will $5,000,000 of revenue get us to cash flow positive? We're not going to make that projection yet, but I can tell you that's pretty darn close at that point. So I I think I answered all three of your questions.

Speaker 4

Great. Thank you very much and all the best.

Speaker 2

Great. Thank you.

Operator

Our next question comes from Jim McIlree with Dawson James. Please go ahead.

Speaker 5

Yes, thanks and good evening. So in your commentary about yes, hi. In the commentary about the inventory levels, it suggests a gross margin on this $15,000,000 of revenue of about 22%. I'm assuming that that's because you've got a high burden of the factory. When you get to either a reasonable capacity utilization or fully utilized, what kind of gross margins would it be reasonable to expect?

Speaker 2

Yes. I'll touch on the high level and Joseph might want to because this is something I review with And the right person for this is Doctor. Evans because he's been building factories for the last 10 years. So I'm going to start from a fully utilized factory. If we were pumping out thousands of drones, we literally can get up into the 70% gross margins.

Speaker 2

At the beginning, you're absolutely correct. Having the full burden of a factory, you open at day 1, which we have recently, and if you're producing 25 or 50 or 120 drones, your margins look horrible because you got to put this full burden of the factory on top of that. But with our material margins, we're typically right now already in the 40% to 50% range. But we're here doing GAAP. So those your numbers of 22% to we could then get up to 70% once it fully utilized, saying we get large contracts with the replicator initiative or SRR can produce those type of margins.

Speaker 3

Yes. I don't have a lot to add on top of that. I think that one of the points that I was trying to make is that we're in a unique position from a cash flow perspective in fiscal 'twenty four because we've already bought and we've already paid for much of the material costs to produce these 1200 drones. That won't be a typical situation, but because of COVID and the scarcity of electronic components and there was a lot of price gouging going on. Alan had the foresight to go out and frankly spend quite a bit of the money we raised in 2021 to put us in a position where we wouldn't be unable to fill orders because we couldn't get the components we needed.

Speaker 3

So we're in a unique position right now. And as part of your initial question, yes, we're just dealing with a capacity utilization challenge, which is very common for emerging companies that built the type of facility that we built, which is another that's built, that's behind us, that's firing on all cylinders and that's a huge step for an emerging growth company like us to have behind us. And it's kind of one of the reasons why we feel so good about our outlook for the rest of fiscal 'twenty four and beyond.

Speaker 5

That's great. Thank you. If I can just ask another one here. So on the SRO and the replicator programs or contracts, are these fixed priced contracts? So you will have the ability to improve margins as you improve your manufacturing?

Speaker 5

Or is it more of a time and materials contract?

Speaker 2

No, no. Not yes, I'm sure you're bringing that up because the time and material cost over plus is a horrible business. These are fixed. They'll be fixed to our GSA pricing. We're not even allowed to adjust that typically unless there's a large volume.

Speaker 2

But yes, our margins will improve dramatically. All of the orders that we've announced before have been GSA pricing. So this will the SRR program will be based on fixed pricing. The replicator program, which something that also we didn't really go into, but when they were announcing the making sure that these small companies that are building these small drones don't go into the valley of death, which is the funding valley of death when you're dealing with large government. This replicator program, we expect to get paid upfront, which alleviates also dilution for us, like again, as being a large amount of the shareholders.

Speaker 2

So we the pricing will be fixed pricing.

Speaker 5

That's great. Thank you. And my last one is, the $5,000,000 in OpEx this quarter, is that a good number going forward?

Speaker 2

Yes. I would say so.

Speaker 3

Yes. I would say so as well. Unfortunately, I don't see a lot of cost savings associated with divesting consumer. Obviously, there's a really substantial fixed cost in being a public company. I do think the good news is that higher revenues should not result in dramatic increases fiscal Q1.

Speaker 3

So I think we're going to be able to leverage both gross margin and our OpEx, meaning that as revenues increase, I don't see dramatic step in step increases in OpEx.

Speaker 5

Great. Thank you very much. That's it for me.

Operator

Showing no further questions. This concludes our question and answer session of the call. I will now return the call to Jeff Thompson for closing remarks.

Speaker 2

Sorry, folks, I was on mute. Well, thanks everybody for joining us. I want to thank the team at Teal. I want to thank our biz dev team. You guys are awesome.

Speaker 2

And we'll be seeing a lot of you out. We're in a lot of conferences, and I'll even plug James' company. We'll be at the Dawson James Conference on 12th and we'll be at the LD Micro in early October. So please come see us.

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