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 Third Quarter Financial Results and Corporate Update Conference Call. [Operator Instructions] Participants of this call are advised that the audio of this conference call is being broadcast live over the Internet and is also being recorded for playback purposes. A webcast replay of the call will be available approximately 1 hour after the end of the call through June 7, 2023. I would now like to turn the call over to Scott Gordon, President of CORE IR, the company's investor relations firm. Please go ahead.

Thank you, Kate. Good morning, everyone, and thank you for joining us on the Red Cat Holdings Fiscal 2023 Third 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, 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, March 7, 2023. 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, please go ahead.

Great. Thank you. Welcome to our fiscal year 2023 third quarter earnings conference call. I'm going to keep my prepared remarks brief as I was just told we have quite a few email questions. So let's get some housekeeping out of the way, and I'll start with the status of the sale of the Consumer division. Unusual Machines is expected to have its IPO later this month or early April, and that would cause the closing of this deal. And the proxy now has -- the voting proxy now has a quorum, and we'll share those results on the vote very soon. As a reminder, the sale of the Consumer division will be nondilutive event and will raise cash for Red Cat and allow us to focus on our core customers, the military and first responders. The Salt Lake City factory is complete and ready to go. We now have a state-of-the-art drone factory. We have chips to make thousands of drones, and we're only producing the new Teal 2 drone with the new camera payload. The Teal team has done an incredible job completing this in just 12 months. We now have the capacity to produce thousands of drones per month. Let's switch gears and talk about Tranche 2 or short-range reconnaissance SRR program of record. As I have previously mentioned, Tranche 3 has been pushed into Tranche 2. And we will receive more funds from the Army to include these new features into Tranche 2. We do not know the size of the award yet, but it should happen in the next couple of months. Next up is the Border Patrol. We made our first shipment to the Border Patrol for 54 systems in mid-January. This was only a few weeks after production started on the new Teal 2. We believe there is a significant opportunity for additional orders this calendar year and are very encouraged by the feedback from the Border Patrol. On to Skypersonic, where I am now. Skypersonic, our indoor drone division, has 2 significant opportunities coming up. One is a Navy SBIR, we call it, or a small business innovation research project for compact aerial inspection systems and for elevated and small spaces. This is a Navy SBIR, as I just mentioned. The program matches the Skycopter perfectly, and this is being actually submitted tomorrow, March 8. So we're hoping to get into another program through Skypersonic. The second is the Drone Infrastructure Inspection Grant Act. This is a bipartisan grant for $100 million that is expected to pass the Senate soon and has already passed the House. We also believe we are well positioned to be part of this grant. So I'm doing this call from Torino, Italy. This is where Skypersonic's office is, and we are co-located in the Leonardo campus. Leonardo is a large Italian defense contractor. In Torino, last week, we were invited to the DIANA NATO BOD meeting. And one of the goals of this organization is to introduce small companies to governments that need defense products. We had great introductions, and we were only 1 of 2 presenters. The previous 2 weeks, myself and the business development team have been to at least 5 different countries. We believe it's been a very successful trip, and the Teal 2 drone is getting a great response from operators and warfighters. We also received initial orders, and we believe we are well positioned to be awarded a sole-source contract, sole-source contract for hundreds of drones. Red Cat also became certified in the European country to be included in their defense catalog, breaking the log jam to be able to sell to these European countries. And finally, we have identified opportunities to get the new Teal 2 to the Ukrainian warfighters, and I will address that in a little bit more detail in the Q&A. In summary, before I hand the call over to Joseph, we have completed a new state-of-the-art factory in Salt Lake City with chip supplies to build thousands of drones. We have the best-in-class drone that is getting great response from the market, mostly military and recently, as in yesterday, first responders. We'll have more to come on this new development in the next couple of weeks. We have our outdoor drones and our indoor drones for our military customers, and we expect the next 6 months to be the most exciting 6 months in company history with material sales, partnerships and new products. So with that, I'm going to hand the call over to Joseph. I look forward to your questions.

Thank you, Jeff, and to everyone for joining the call today. I will now provide a review of our financial results through our fiscal quarter, which ended on January 31, 2023. Revenues exceeded $3 million for the second of 3 quarters in fiscal 2023 and have increased more than 50% on a year-to-date basis compared to the first 3 quarters of fiscal 2022. Gross margin remained challenged as we continue to refine and scale manufacturing at our expanded facility in Salt Lake City. We expect gross margins to improve going forward as product shipments increase and we improve the efficiency of our manufacturing and assembly processes. Operating expenses decreased almost 20% in the third quarter compared to the second quarter, the prior quarter, as the level of nonrecurring costs associated with the expansion of the Teal manufacturing facility and its head count have subsided. We expect operating costs to stabilize for the balance of the fiscal year and through the end of 2023. Net loss for the fiscal third quarter totaled $5.7 million or $0.10 per share, representing a 9% decrease from the prior quarter and more than a doubling compared to the third fiscal quarter of the prior year. That significant increase is directly related to the doubling in size and the build-out of the manufacturing facility at Teal as well as a more than tripling of its head count. We ended the third fiscal quarter with approximately $25 million in cash and investments. In addition, we have invested $7 million in raw materials, including chips, drones in production and finished product for Teal. We expect this investment in inventory to yield and support strong sales over the balance of the year. At this point, the Teal manufacturing facility expansion has been completed, our sales force has been built and trained, our sales pipeline is building and expanding, and we are looking forward to new and repeat orders over the balance of calendar 2023. I will now turn the call over to the operator for questions.

[Operator Instructions] The first question is from [ Scott Michael ], a private investor.

Can you clarify the number of chips that we have in reserve?

Yes. Well, the number hasn't changed since we put in the initial order of approximately 3,700 chipsets over -- almost 2 years ago now, which we'll -- they're not going to give you 100% yield. You're going to have some that don't make it and end up scrap. But we think that those could produce between 3,200 and 3,500 drones.

Okay. Do we have a source for chips? Should we get any large orders that exceeds this production capability?

Yes. Well, I mean, everyone watching the news understands the supply chain is better. It's not perfect yet by any way, shape or form. But people that put in large orders know that they're going to get certain shipments at certain times. You give us an order for 5,000 drones, you'll get extra -- you'll get 1,000 drones on day x, 1,000 more drones then. But the key item for us, we're not as concerned about getting supply in right now. It's more about having the factory to be able to, a, get it fully running at high capacities for the first shift and the second shift, if we get big orders and then we continue -- we add another line next to it. We have the room to do so. So that's all there now. We've invested all of that, and now the engineers aren't sitting on top of the factory work people and the inventory. They're actually in their own offices. We have a flying area now. So all the stuff that was kind of difficult to do because we're in the middle of construction, basically like living in a house while you're doing a reconstruction, is now over. And so we will have the capability to meet any large orders that we receive.

Okay. Two more questions. You referenced that Tranche 2 and 3 are being combined. And in your statement, you said that we should have news in the next couple of months. Was that pertaining to the size? Or is that regarding the Tranche 2 award? Because there was an article that was posted the other day suggesting that Army or that there will not be a soldier testing until the fall of this year, if I read it correctly. I may have read it incorrectly. To me, that would suggest Tranche 2 award would be into the beginning of next year or the end of this year. Is that accurate?

Yes. So I actually saw that same article. We get a heads up on that. And basically, what they talked about was that they started -- they did the first initial alpha test, which was, I think, January 9, where each company flew for the day. What I can report is that our drones flew close to flawlessly as you could get in an alpha product. Very proud of the Teal team, the engineering team, the team that flew that day. But we had a great demo day. And anyone in the drone industry knows that's not usually the case. But what I was referring to is there was originally 3 Tranches, and every Tranche has a prototype contract, which we won a prototype contract in Tranche 1 and typically a production contract. We did not win the production contract for Tranche 1 almost 3 years ago. And so Tranche 2 had a prototype contract, and there's 3 of us that won that. And then Tranche 3, which was going to start after they awarded Tranche 2, was pushed into there. So the money that you typically receive for Tranche 3, which would have been in about 6 to 9 months to a year, everyone's going to get for Tranche 2. So that award will probably happen in the next couple of months.

Excellent. And is there a possibility that, that award will be split up among the 3, which I believe is Vantage and Skypersonic? Is there that possibility it's going to be awarded to simply one entity?

We believe it's going to be one entity. And it's actually -- it's -- I don't want to correct you, but it's not Skypersonic. It's Skydio.

I'm sorry, my bad. Sorry about that.

Yes, that's okay. So Skydio, I don't know if you saw, but they recently got -- they did a financing for $230 million or 2-point-something billion valuation. Someone's got an alarm going off. And that really makes us look inexpensive right here, considering, I think, our position in the industry. But we believe we're well positioned for Tranche 2, and we solely focus on the military. That's just one of the customers that they deal with. I think they're mostly doing consumers and some first responder stuff now. But our sole purpose is to make sure the warfighter has the tools for reconnaissance and to help with missile guidance and things of that nature, something that I don't think the other companies are well positioned to do or even want to do.

Excellent. One final question. I appreciate your time. The 4 potential NATO contracts, have we been signed off on the DoD so that we're not going to have any trip-ups in terms of NATO interest or NATO country interest in our product? Or do we have to wait for the DoD to sign off on any sales?

No, we have all the proper paperwork for like the original drones that we sold to one of the NATO countries. We got through all the hoops. So someone orders them, we get through all of the ITAR regulations, and all those things are all squared away. So nothing will hold us up in that aspect.

[Operator Instructions] This concludes the question-and-answer session from call participants. I will now return the call to Scott Gordon of CORE IR to read pre-submitted questions for management. Scott?

Thanks again, Kate. Jeff, we've received a few questions from investors recently and thought this would be a good forum for you to address them. So I'll just kind of ask these in sequence. Do you have an update on the Border Patrol contract following the initial shipment of 54 drones to them? Do you expect more sales to the Border Patrol?

Yes. Well, we did receive the first order, which we shipped in January. We're getting some great feedback from them, and we've learned a lot about the program. And let me just start with this, is that after getting to know some of these folks, these border agents are super users. They fly, I think, one in the Air Force. They fly tens of thousands of hours every month. These guys are heroes. They're out there sometimes by themselves flying these drones. So we're very happy to give them products that can help them. Specifically thermal cameras, they can make sure that no one sneaks up on them. But to address the market of Border Patrol, from what we've gathered from our meetings is they typically have about 400 drones that are in service, and they need to have 200 or so other drones to make sure those 400 always stay in service. So I think the total addressable market for the Border Patrol could possibly be close to 600 drones. We're not saying that we're getting 600 drone order in the next couple of months. But we believe that, that is up for -- that's an option to replace these older drones they've been flying.

Excellent. Switching over to Ukraine and other NATO countries, do you have anything to share from your recent trip to Europe? I mean, obviously, you've shared some. Any success with Ukraine or other NATO countries? I think you touched on that a little bit, but maybe you can amplify.

Yes. It's -- well, let me back up a little bit. So most of the sales that are happening with other defense companies are -- already have programs of record that have been in place for years. One of them would be like AeroVironment with the Switchblade. And they've done some FMS sales and the Puma and things of that nature that have been long-term programs of record with birds that, frankly, don't have payload as good as our payload. But we don't have a program in record in place. If we did, we probably would have already sold hundreds of millions of dollars’ worth of drones for the Ukraine invasion. So since we don't have that yet through the program of record of Tranche 2, they have to be -- people have to be creative to get drones into the Ukrainian Army. So some of those steps we found out, we've had to get to the right people that want to use the drones. I don't know if you read -- the Wall Street Journal had a great article on what the operators on the front line want. They want a very high-end thermal drone that can have great detection. The ones they're using right now are horrible, which would allow them to fly missions at night, which 90% of all missions are done or plus -- 90% plus are done at night. So we can give them the tools that they actually want that could enable them to fly all night. And just an FYI, our EO camera, our daytime camera, is also magnificent. We went from a 12 megapixel, I think a 64-megapixel. Our software updates has just made great improvements. So the daytime operation is incredible also. But anyway, we -- first, you have to get the people that want the drones to tell the people that they need the drones in the capital, and then they have to get the information over to DC. And then once we have that information in DC, then we can take it to the people that can actually write checks from this existing aid that's been going over recently. Even the new $400 million, the $2 billion, we can be part of this, and we think we're really close. And they're going to need thousands of drones. So we now know how it works. We've been over here in Europe working on it, and we hope to have some results very soon.

Switching gears. So this question addresses financing needs. Will Red Cat need to do a financing to meet contract?

No. So just some things to remind people. A, we're actually probably going to receive -- we don't know the size of the Army Tranche 3. But that's just share 100% margin revenue right there to do something that we're already going to do anyway. And then the sale of the Consumer division is going to produce cash and will also give Red Cat shareholders a significant ownership of the IPO. And they have a great team over there at Unusual Machines. As you see, Rotor Riot is actually growing very rapidly. Fat Shark is the leading goggle company out there. So we think they're going to have a very successful IPO, and I think they will. And I'll be happy to be part of it. And that's only going to help Red Cat. So we're pretty excited to have them IPO, but that will help us so we can focus on the military and first responders. And I think the 2 divisions are going to get their focus that they need and they require so that they can thrive. So between all those things, that's new additional capital. Even without that capital, with all the investments that we've made in chipsets and building a factory, we are now just ready to focus on sales, sales, sales. And those sales, I think, will start producing quite a bit of revenue, and that's going to bring the burn way down, even though we have years of runway now. As we get first a couple of significant orders, that runway is going to go out for 5 to 10 years. So there is no need of a financing right now.

Great. The last question was addressed in the live Q&A. So that concludes our questions submitted, so thank you. Operator, I'll turn the call back over to Jeff for closing remarks.

Well, great. Thanks. Thanks, everybody, for joining. We've been doing a lot of hard work. I want to thank all the employees. Everyone has been doing a great job, this dev team. I now know what they go through. We sat in fields for hours and then with live artillery going off, flying drones and freezing our butts off. So I just want to thank everybody for all the hard work. And I'm kind of just going to restate my summary in my remarks because we now have a completed new state-of-the-art factory in Salt Lake City. We have tons of chips to build thousands of drones. Our drone is the best-in-class now, getting a great response. We'll have some new news with first responders coming over the next few weeks. And Skypersonic is starting to get its legs in the military. So lots of opportunities, lots of exciting things coming your way. And I'm just very excited to be here with you, and thanks for joining the call. That's all I have.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.