Red Cat Holdings, Inc. (RCAT) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by. Good morning, and welcome to the Red Cat Holdings Fiscal 2023 First Quarter Financial Results and Corporate Update Conference Call. [Operator Instructions] I would now like to turn the call over to Joey Delahoussaye, Vice President of Core IR, the company's Investor Relations firm. Please go ahead, sir.

Thank you, Andrew. Good morning, everyone, and thank you for joining us for the Red Cat Holdings fiscal 2023 First Quarter Financial Results and Corporate Update Conference Call. Joining us today from Red Cat Holdings are Jeff Thompson, Chief Executive Officer; and Joseph Hernon, Chief Financial Officer. During this call, management will be making forward-looking statements, including statements that address Red Cat'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. 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-K 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 12, 2022. Except as required by law, Red Cat 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?

Thanks, Joey, and thank you. Welcome to our first quarter fiscal year 2023 Earnings Conference Call. This is an exciting conference call for Red Cat. This is the first quarter with organic revenue from Teal Drones production line and Fat Shark digital goggles. I will start with summaries of each subsidiary, including progress on the Army Tranche 2 program and high-level status on requests for proposals across the globe. So let me start with Rotor Riot. Rotor Riot continues to improve revenue and margins and is just starting to see in-person community events like quads and coffee return. In-person events are similar to music concerts that promote a record release. Rotor Riot had a record quarter and with a new digital advertising campaign, new digital goggle launches should provide tailwinds for the consumer segment for the next 12 to 18 months. Let's now talk about Fat Shark. In Q1, Fat Shark launched a new headset and saw the largest pre-order first day sales of any headset to date. And Fat Shark has been around since 2007. The dominator headset is getting great reviews, and we hope to see follow-through for the next few quarters. Skypersonic. The Skycopter drone can be piloted virtually anywhere, from virtually anywhere as the Skypersonic team recently demonstrated on Mount Etna in July, using Skypersonic's long-range real-time remote piloting system, the drone on an active volcano in Italy was controlled by personnel in Houston, Texas in real time. Whereas most phones cannot be piloted without connecting to the GPS network, Skycopter uses technology that is able to control and track the drone in location such as Mars, where GPS is not available. We believe the Skycopter will be a leader in infrastructure inspections next year. But we also believe the technology can be very useful on the battlefield and for first responders. Being able to fly indoors in caves and tunnels and GPS-denied locations is game changing, not only for infrastructure inspections, but also for the dismounted warfighter. And now I'll talk about Teal Drones. Let's start with the production line. We are currently switching from PBT: production validation tests to ramp and mass production. Mass production enables TEAL to continue to improve ongoing yields, qualify additional tools or vendors, make design changes based on customer feedback, any early field failures or cost-down efforts. We have significant design improvements as we go into mass production, specifically the camera payload. We believe that having a maiden USA factory up and running at mass production is a strategic advantage for the RFPs we are working on and the Tranche 2 production contract. That brings us to SRR Tranche 2, short-range reconnaissance program for the Army and the DIU. Teal Drones continues to meet the scheduled milestones for the Tranche 2 prototype design and expect to have a flying prototype by the end of the calendar year. The Tranche 2 production contract is still expected early in the first half of next year. Now let me talk about some of the potential sales pipeline for the Golden Eagle. We are fielding multiple requests for proposals, RFPs, with NATO allies for the TEAL Golden Eagle and the Skypersonic Skycopter. We continue to work with these customers and prospective customers to translate their interest into firm purchase orders and contracts. We are seeing many opportunities and demand growing. We believe this will set Red Cat up for a strong fiscal 2023. In summary, we have new products, new software capabilities, a new production facility and organic growth from Rotor Riot, Fat Shark and Teal Drones and expect the Skycopter our least mature product to be a very important revenue generator next year. We have much to do, but we are close to firing on all cylinders. And with that, I'll hand the call over to Joseph, our CFO.

Thank you, Jeff, and to everyone for joining the call today. I will now provide a review of our financial results for the first quarter of fiscal 2023, which ended on July 31, 2022. I am very pleased to confirm that fiscal '23 is off to a resounding start as revenues for the first quarter totaled $3.1 million, which represents a 120% growth compared to the first quarter of fiscal 2022. Another comparative measure of the strength of the quarter is that revenues for the first quarter of fiscal '23 equal to almost half or 48% of our revenues for the full year of fiscal 2022. Q1 revenue growth was led by strong shipments of the Dominator, the new digital goggle released by Fat Shark. In addition, revenues for Teal continue to grow even as we spend much of our focus on completing its manufacturing capacity expansion. Looking forward, we remain confident that we will deliver strong revenue growth in fiscal '23. Operating expenses increased significantly in Q1 of fiscal '23, totaling $4.1 million compared to $1.8 million for the first quarter of fiscal '22. This increase was planned and expected and primarily relates to the acquisition of Teal Drones, which occurred after the end of the first quarter of fiscal '22. Since acquiring Teal in August of 2022, we have invested significantly in building out the Teal organization and preparing Teal for the multitude of revenue opportunities that are emerging. We have doubled the size of its facilities, both to increase its manufacturing capacity and to house its workforce, which has increased significantly since we acquired Teal. While this strategy adversely impacts short-term operating results, it is necessary to position us to take advantage of much larger long-term growth opportunities. As expected, other income and expenses in the first quarter of fiscal '23 was minimal compared to some of the large and fluctuating amounts that we reported in prior quarters. Most of these variable charges related to derivative features that were embedded in convertible notes and warrants that we issued in fiscal 2021. These derivative expenses and income are noncash charges that are highly correlated to changes in our stock price. To date, all of the notes have been converted into common stock and approximately 25% of the warrants have been exercised. As a result, future amounts related to these derivative features are expected to continue to be modest. Our net loss for the first quarter of fiscal '23 totaled $3.8 million or $0.07 per share compared to $1.6 million or $0.05 per share for the first quarter of fiscal '22. Cash used in operations totaled $4.8 million in Q1 of '23 compared to $4.1 million in Q1 of '22. A key driver of our cash burn in addition to building the Teal organization has been building inventory levels, which totaled $6.4 million at the end of the first fiscal quarter of '23. These higher-than-normal inventory balances can be partly attributed to the supply chain issues, including the availability of computer chips, which are essential to many of our products. In addition, we have increased inventory levels to support the launch of the Dominator by Fat Shark and forecast sales growth for Teal. We ended the first quarter of fiscal '23 with almost $43 million in cash and marketable securities and less than $2 million in debt. We remain in a strong financial position to execute on our growth initiatives. I will now turn the call over to the operator for questions.

[Operator Instructions] The first question comes from Ashok Kumar with ThinkEquity.

Thank you Jeff and Joseph, congratulations. Two questions. One, you applied to the NATO allies RFPs. Can you please give us some color on sizes and potential? The second question is any color on the Tranche 2? That would also be helpful.

Great. Thanks, Ashok. Thanks for being on today. Yes. So we've -- our biz dev team has been demoing the Golden Eagle, as I've mentioned in previous calls, all over the globe. And we've -- I actually were -- was at a few of the events at USASOC down in Fort Bragg area recently. And we're getting some great feedback, and we've applied for a lot of RFPs to a lot of Eastern European countries. We have a couple for about 600 systems, some for 300 systems and 2 for over 2,000 systems. So we don't expect to win every single deal and some of them will probably be multi-vendor. But these are large, large possible proposals and contracts that we could win and being a maiden USA company and approved by the DoD, we think, gives us a strong position to do so. So we're in the middle of some of these. We hope to -- a couple of them, we hope to hear within about a month. And some of them will go along in different stages, where we've already been down selected for a first stage and are already in the second stage. So we don't give guidance yet, but we have probably close to over 3,500 drones in proposals right now. And on the Tranche 2 process, we are -- we've gotten through some of the hardest parts, which is the product requirements document, which has to be approved and make sure that the DIU, which is running a very tough process, but we are getting through those stages, and we're meeting the requirements of the drone that's being proposed for Tranche 2. And again, with getting ourselves into mass production, if we win Tranche 2, we'll be capable of basically hitting the ground running and produce this drone as quickly as possible.

[Operator Instructions] The next question comes from Kevin Dede with H.C. Wainwright.

Joe, I know you spent a lot of time reviewing the organic versus acquisitive contribution to sales. But could you just speak specifically to the fourth quarter to first quarter change, please? You lost me a little bit on the TEAL side.

Yes... TEAL revenues so far, Kevin, has been pretty modest. It's growing gradually. It was almost all of the enterprise revenue in the first quarter. So it was about $1 million in the first quarter. Consumer accounted for about 2/3 of the revenue in the first quarter -- and that was split pretty even between Fat Shark and Rotor Riot and consumer continues to get closer to operating breakeven. So we expect TEAL revenue to continue to gradually increase, but it's coming off of a fairly low base number right now. I don't have a breakout of the Q4 revenues. But I can say that the growth -- the sequential growth was largely driven by consumer, although enterprise did help a little bit.

Okay. So consumer, 2/3 of the $3 million, roughly $3 million?

Yes.

Okay. And then the balance, roughly of TEAL?

Almost all TEAL. Skypersonic was negligible.

Okay. Okay.

And one of the things, Kevin, just so you know, one of the things we're doing, beginning with the first quarter this year is we are reporting on a segment basis. So that information will also be in our 10-Q.

Awesome. Okay. How about a progress update on construction of the manufacturing facilities, just to look into material sourcing and your comfort in meeting time lines?

Yes, that's a great question, specifically how manufacturing is so crucial to our, to TEAL continuing to grow. And just to add a comment to what Joseph just mentioned, is we basically went from almost 0 revenue to $1 million in revenue per TEAL in just 1 quarter and being the first couple of months of the factory getting up online. So that's a very early stage production line, which is now maturing. And as I mentioned in some of my comments in the press releases that we're now going from PBT to mass production and ramp, which we take all the things that we learned from the PBT stage and now we basically fix any issues and problems and vendors and tooling that we want to do to automate the production line so that we can really scale it as we -- if we get any of these RFPs, we're going to have to start producing a lot of drones very quickly. So the -- we're pretty good with -- there are some components we're still having some tough times with in the supply chain, we think we have almost all of that resolved currently, still cautious. But we did a lot of ordering and thanks to the TEAL team and Dr. Evans for getting us to put orders in last year we're in pretty good shape with our supply chain and chipsets to be able to continue to ramp TEAL's revenue from where it was 2 quarters ago, basically 0 to $1 million to a pretty dramatic revenue growth over the next few quarters. So -- but yes, the production is getting there. It's not -- the factory, as Joseph mentioned, is also we doubled it in size, right away as we started building, we realized we needed more. And so that's where we are right now with manufacturing.

Yes. So you're -- I remember speaking with you last time, and you were still working through the construction of the facility. Now where are you with regard to that? Is that the addition there? Has that been completed?

No. The addition -- so I'll give you exactly where it is. So we have a complete same-size location right next to the first location that we opened. We had the production line up and running. And then we decided to -- we basically have to open up a wall and bring the other side in, which will -- because we have a lot of inventory control capabilities inside the facility, specifically when you're selling to the military, it has to be very secure. So we have to open up the other side and sometimes that slows down the existing production line because of all the construction dust and things of that nature. We hope to have the construction done in the next month or 2 and put this behind us, and that will also bring us into full mass production.

Can you peel the onion back a little bit on the DoD contracts? Or -- are your drones expected to be weaponized -- and is that like an additional level of security and process?

Yes. So it's -- the difficult thing that's happening right now in the -- with the Ukraine work going on is people are realizing that small drones are so crucial for warfare. I mean, you even saw the Fat Shark goggles if you Google it, are being used for the 93rd brigade in the Ukraine to use racing drones for small racing drones with kinetics on them. Fat Shark is also looking at ways to make sure that the new Dominator goggle can be mounted on a warfighter's helmet and have the proper antenna placement for things of that nature. And the next step where you see kinetics put on any drone that we make. That is a very lengthy process to get approved to do that. If we -- there are RFPs out there for drones with kinetics on there. And if they wanted to use the Golden Eagle, we would partner with someone that's already approved and gone through the 2-year process to do so. But on top of that, we've been working very closely. I was recently at -- the last time we spoke, I was a few weeks away from going to USASOC to demo the 4 Ship product and the Reveal partnership we recently announced where we actually demonstrated how to go look at a target, surround the target, get real warfighter information to be able to give them an easy journey to that target without being seen through knowing where line of sight and where non-line of sight, things of that nature. A lot of data can be derived from our 4 Ship products and the reconnaissance that it can do. And then there's -- the next step is how do you take small drones like Class 1 drones to be an even more lethal product for the warfighters. So we're not there yet, but we're helping the other technologies that are out there that are taking out tanks, like the Switchblade and things of that nature. So we're trying to help the warfighters with as many tools as we can give them to help them and mitigate their safety.

So I did see that -- I may have sent you the link when I saw it actually when the 93rd used...

Yes you did send that to me.

So I saw that, but I got the sense that, that was sort of an aftermarket modification, right? Am I right with that assumption?

Yes... That was an aftermarket application where people are typically putting a specific grenade that when it smashes into the facility, the grenade goes out. But there are some upcoming RFPs for one-way kinetic Class 1 drones. There's also some RFPs with armed drones that would have a 6-shooter on them, reloadable. So there's a completely different world of new Class 1 drones coming out over the next year or 2.

So you mentioned a partnership and helping you meet those milestones. Can you categorize where you might be in that negotiation process? Is there... I don't know, is there a milestone that we could look forward to hearing about and seeing how Red Cat is positioned to participate in that market?

So there's -- well, here's the -- I'll give you some short-term and long-term milestones just to give everyone some goalposts on the call, not just specific to what you just asked. But I think some of the short term, we continue to work with Border Patrol on that $90 million contract we got in January. We -- so on the short-term side, we hope to talk about that shortly. Some of the RFPs, I mentioned with some of the NATO allies, we think we're in a good position on a couple of those. So those are some of the short-term goals that we have. There are some other moonshots that we're looking at that are early next year, but then the next large milestone would be the Tranche 2 production contract in early next year. And the last production contract was for $100 million for Tranche 1, and that was before the Ukraine war broke-out and small Class 1 drones are much more important now than they were when Tranche 2, 2 years ago, production contract was awarded. So those are kind of the goalposts on milestones. In the short term, it's mostly RFPs and the partners that we were talking about for the kinetics are based out of California. They've been doing it for years. When we have something to announce with them, we'll make sure that -- the [indiscernible] is aware.

Okay. The Tranche 2 deal, Joe, though, Jeff, is -- has not been awarded just to confirm? And what's -- so let me...

Yes, this is some good housekeeping because people get a little confused with it. It's SRR, a small range reconnaissance program, a 3-tranche program, Tranche 1 Tranche 2, Tranche 3. Tranche 1 in each tranche has prototype contracts and when you get a prototype contract, you're in the running to win a production contract. Tranche 1 was over 2 years ago, and TEAL was one of the 5 companies that was selected to build a prototype, and they want a prototype contract but Skydio was one of those 5 also, and they won the production contract 2 years ago. Tranche 2, there was 37 companies that applied and went and demoed their bird in Georgia and 2 were selected for the prototype contracts. Of those 2, one will win the production contract. And then the same process will happen for Tranche 3. So we're very well positioned for Tranche 2, not only because of our financial condition, but also the -- will be a mature production line by the time Tranche 2 is awarded, and we'll have a -- and we think that our supply chain will be in really good shape by the time those -- that contract is awarded.

Okay. Then apologies for hogging the call, Jeff. Just give us a little insight on the timeline for Tranche 3 and maybe your estimation of the size of that contract?

Yes. So Tranche, like I said, Tranche 1 was $100 million. They don't really announce the sizes of Tranche 2 and Tranche 3. We expect Tranche 2 to be $100 million to $200 million based on the data that we have but have no way to verify that. Tranche 3, we expect to continue to be as large as well. But a Tranche 3 will not be announced, the timelines and dates is typically after the production for Tranche 2 is awarded.

Okay. Fair enough. I appreciate all the color, gentlemen. Congrats on the progress. Thanks for having me.

Great. Thank you. Thanks Kevin.

[Operator Instructions] This concludes the question-and-answer session of the call. I would now return the call to CEO, Jeff Thompson for closing remarks.

Thanks, everybody, for joining the call. And I want to thank all the employees from all of the different teams. You have done a great job over the last year, the finance team for getting our earnings done early. And I look forward to seeing a whole bunch of you folks today and tomorrow at the H.C. Wainwright conference. Thanks for joining.

The conference has concluded. Thank you for attending. You may now disconnect your line.