Red Cat Holdings, Inc. (NASDAQ:RCAT) Q1 2024 Earnings Call Transcript

Red Cat Holdings, Inc. (NASDAQ:RCAT) Q1 2024 Earnings Call Transcript September 19, 2023

Red Cat Holdings, Inc. misses on earnings expectations. Reported EPS is $-0.07 EPS, expectations were $0.11.

Operator: Ladies and gentlemen, thank you for standing by. Good afternoon and welcome to the Red Cat Holdings Fiscal First Quarter 2024 Financial Results and Corporate Update Conference Call. At this time, all participants are in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] 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. A webcast replay of the call will be available approximately one hour after the end of the call through December 18, 2023. I would now like to turn the call over to Joey Delahoussaye, Vice President of CoreIR, the company’s Investor Relations firm. Please go ahead, sir.

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Joseph Delahoussaye: Thank you, Sarah. Good afternoon, everyone, and thank you for joining us for the Red Cat Holdings Fiscal First Quarter 2024 Financial Results and Business 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 19, 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?

Jeffrey Thompson: Thanks, Joey. Thank you. Welcome, everyone to our fiscal year 2024 first quarter 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. I am pleased to report that the Teal 2 drone is getting a warm welcome as the most unique and capable nighttime drone in the Group 1 class. We announced the Teal 2 at the Army Aviation Association of America Conference on April 26, a few days before our fiscal year-end. The Teal Drones revenue for fiscal Q1 was $1.75 million. We cannot make a year-over-year comparison because the Teal 2 did not exist.

But if you were a start-up and launched a brand-new product and did almost $2 million in revenue in your first quarter, 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. We’re hearing some background noise. So 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 growing markets current status. So December 2020, DJI, the largest drone manufacturer on the planet, was put on the US government’s entity list. In December 2021, DJI was also put on the economic blacklist. Fast forward to July 2023, the American Securities Drone ACT, ASDA, passed the Senate unanimously and we expect it to be law in the next few months.

August 2023, Red Cat’s Teal 2 receives Remote ID certification from the FAA. This was a huge achievement, the documents over 300 pages, very difficult to get the certification from the FAA. 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 six months. So what are all these things — what are 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 receive 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. This has created a very large market and a very large vacuum for only us and one other manufacturer in the US that can build a scale to fill.

So this is a very unique opportunity that doesn’t always happen. Now I’ll move on into our revenue and investment tailwinds. I’m going to discuss the current organic revenue growth or immediate revenue. I’m going to then discuss the DoD newly announced and funded replicator initiative. We look at that as midterm revenue in the next three to six 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 in our backlog. Today, we reported for Q1 $1.75 million in revenue. Our guidance for Q2 is $3 million, 71% sequential organic growth. Our guidance for Q3 is $5 million, 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 million puts us at a $20 million run rate after selling the Teal 2 for just under five months. This is an amazing growth story and would like to thank the entire Teal team for making it happen. So now let’s move on to midterm revenue opportunities, which we believe are in the next three to six 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.

Overall, we’re going to be delivering in the thousands, Hicks said during Tuesday’s interview. Last week, we 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 three to six months. We believe we are very well positioned or already in contact with this program. 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, SRR program of record started over three years ago and was originally set to have three 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. We were awarded Tranche 1 prototype contract and we’re not awarded the production contract. That production contract a couple of years ago was for $100 million for 1,083 drones. Tranche 2 was supposed to be awarded months ago, but the US 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 fighter’s hands. 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 initiatives. So Tranche 2 and 3, which is now combined which the next down selection, I believe, is at end of December or early January, if they announce the next down selection on time.

We don’t know what the actual contract amount is, but the $100 million was for 1,083 drones, the remaining amount on this contract is for 12,000 drones. I’m not doing linear math. I’m not saying that this is going to be a $1.2 billion award, but I am 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. I look forward to your questions.

Joseph Hernon: Thank you, Jeff, and to everyone for joining the call today. I will now provide a review of our operating results for the fiscal first quarter, which ended on July 31st, 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 ’24 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 UM. The sales price includes an immediate cash payment of $3 million plus $17 million in shares of UM. We also expect to receive a favorable working capital adjustment of approximately $4 million, which will be payable in additional stock. The sale of the consumer segment is contingent upon universal machines completing an initial public offering on a major stock exchange.

UM 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 second quarter. 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 continued operations is much different than what we have historically reported. Basically, the operating results of our consumer segment, which consists of Fat Shark and Rotor Riot have been condensed into one separate line in each of our financial statements. 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 million in shares of UM, 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. UM believes that there are multiple opportunities to continue growing the consumer segment under its stewardship. We believe that our shares in UM will have significant long-term value and frankly represent a hidden value relative to Red Cat’s current market capitalization. Turning now to the enterprise segment. As Jeff noted, just before the start of fiscal 2024, we launched the Teal 2 in late April.

The market response has been immediate and meaningful. We reported record sales for the Enterprise segment in the first quarter 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 million. As we have noted in prior calls, we initially established relatively high inventory levels in response to supply chain challenges that emerged during COVID-19. These actions led by our COO, Allan 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, Dr. Evans.

With escalating demand for the Teal 2, we estimate that it will cost approximately $3 million to convert our existing $11 million of inventory into approximately 1,200 drones, which represents revenues of 18 million based on our base sales price of 50,000 per drone. This inventory conversion will generate net cash proceeds of approximately 15 million and represents one of a number of cash sources that we expect to realize in fiscal 2024. Our expected cash proceeds of 3 million from the sale of consumer is another source of capital. While we can’t immediately sell our 21 million shares of UM, 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. 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 Teal 2 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.

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. I will now turn the call over to the operator for questions.

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Q&A Session

Operator: [Operator Instructions] Our first question comes from Ashok Kumar with ThinkEquity. Please go ahead.

Ashok Kumar: Thank you. Two questions. The first question, two parts. In terms of your Q3 fiscal guidance of 5 million 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. The second question is on the competitive front on the SRR program. You’re competing with Skydio and Vantage and then you’re in a bake-off for the Border Patrol Program with the same competitors. So could you please give us an update on the opportunity and the Border Patrol Program. Thank you.

Jeffrey Thompson: 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 got an order for about a million drones from the Border Patrol. Skydio did also and Vantage Robotics also got a much smaller order. 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, this is the time of the 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 these conferences we were at last week.

And it’s a legitimate question. But let me just start with the C-level and the executives and the employees, we are not hired guns. The company, the employees, we own almost 40% of the shares outstanding. So we’ve written checks, we’re not hired guns. We don’t own 0.0% 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. As Joseph just mentioned, we’ll be turning millions of dollars of inventory into sales over the next couple of quarters. In our first three quarters, we’ve got about $10 million in shipped 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. As also as Joseph noticed, we expect to close UMAC in the next few weeks, which will generate approximately 3 million in non-dilutive capital. And he also mentioned the 1 million to 2 million in inventory or more. We also be getting approximately 2.4 million 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 million to $2 million. On top of that, last week and as recent as today, we’ve gotten term sheets, the 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 is approximately 7.4 million to 9.4 million in the next six months of non-diluted capital. And if you add a small debt offering, it goes from offering of 3 million to 5 million, which we could easily service in our models. That’s a total of 10.4 million to 14.4 million 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 million of revenue get us to cash flow positive. We’re not going to make that projection yet, but I can tell you that’s — it’s pretty darn close at that point. So I think I answered all three of your questions.

Ashok Kumar: Great. Thank you very much and all the best.

Jeffrey Thompson: Great. Thank you.

Operator: [Operator Instructions] Our next question comes from Jim McIlree with Dawson James. Please go ahead.

James McIlree: Yeah, thanks, and good evening. So in your commentary about — in the commentary about the inventory levels, it suggests that gross margin on this 15 million 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?

Jeffrey Thompson: Yes. I’ll touch on the high level and Joseph might want to address. This is something I review with. And the right person for this is Dr. Evans because he’s been building factories for the last 10 years. So I’m going to start from the fully utilized factory. If we were pumping out thousands of drones, we literally can get up into the 70% gross margins. At the beginning, you’re absolutely correct. Having the full burden of a factory, you open it 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 are 22% to we could get up to 70% once fully utilized saying to get large contracts with the replicator initiative or SRR can produce those type of margins.

Joseph Hernon: 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 ’24 because we’ve already bought and we’ve already paid for much of the material cost to produce these 1,200 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. Allan 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. 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. It’s kind of one of the reasons why we feel so good about our outlook for the rest of fiscal ’24 and beyond.

James McIlree: That’s great. If I can just ask another one here. So on the SRR 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 or is it more of a time and materials contract.

Jeffrey Thompson: No, no. Yes, I’m sure you’re bringing that up because the time and cost are over plus is a horrible business. Now 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. 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 is 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 value of death, which is the funding value of debt when you’re dealing with large government this replicated program, we expect to get paid up front, which alleviates also dilution for us like again as being a large amount of shareholders. So we — the pricing will be fixed pricing.

James McIlree: That’s great. And my last one is the 5 million in OpEx this quarter, is that a good number going forward?

Jeffrey Thompson: Yes, I would say so.

Joseph Hernon: Yes, I would say so as well. Unfortunately, I don’t see a lot of cost savings associated with the best in consumer. Obviously, there’s a really substantial fixed costs and being a public company. I do think the good news is that higher revenues should not result in dramatic increases in these expenses. You can see operations expense actually decreased in the fiscal first quarter. 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.

James McIlree: Great. Thank you very much. That’s it for me.

Operator: [Operator Instructions] 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.

Jeffrey Thompson: 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 BizDev team. You guys are awesome. And we’ll be seeing a lot of you out. We’re in a lot of conferences and I’ll even plug James’ and his company, but we’ll be at the Dawson James conference on the 12th and we’ll be at the LD Micro in early October. So please come see us.

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