Red Cat Holdings, Inc. (NASDAQ:RCAT) Q1 2025 Earnings Call Transcript

Red Cat Holdings, Inc. (NASDAQ:RCAT) Q1 2025 Earnings Call Transcript September 23, 2024

Red Cat Holdings, Inc. misses on earnings expectations. Reported EPS is $-0.17 EPS, expectations were $-0.08.

Operator: Ladies and gentlemen, thank you for standing by. Good afternoon and welcome to the Red Cat Holdings Fiscal 2025 First Quarter Financial Results and Corporate Update Conference Call. At this time, all participants are in a listen-only mode. [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 December 22, 2024. Joining us today from Red Cat Holdings are Jeff Thompson, Chief Executive Officer; and Leah Lunger, Chief Financial Officer. During this call, management will make 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 results on Form 10-K and in Red Cat’s press release that accompanies this call, particularly the cautionary statements in it. The contents of this call contains time-sensitive information that is accurate only as of today, September 23, 2024. 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.

Jeff Thompson: Thank you, and welcome, everyone, to our first quarter fiscal year 2025 earnings conference call. We’ll begin with some housekeeping items, followed by the exciting launch of our new product line, the Family of Systems. Leah will then provide a detailed review of our financial results. Afterwards, I will share our expectations and goals for the calendar year 2025. Finally, Leah and I will be available to answer any questions you may have. So let us start with housekeeping. I am pleased to announce that following requests from our lawyers, auditors, analysts, Board members and many shareholders, we will be switching to a calendar year starting January 2025. Our guidance will also align with calendar year for 2025.

Leah will provide more details on the mechanics of this transition. I’m pleased to report another record quarter for Q1 with approximately $2.8 million in revenue, a 59% year-over-year increase. However, the real highlight of Q1 is that we delivered the final prototypes to the Army for IOT&E. IOT&E stands for Initial Operational Test and Evaluation. This process is used primarily in the military and defense sectors to assess whether a system or product is operationally effective and suitable for its intended use before it goes into full rate production. We successfully delivered approximately 40 systems to the Army and built Teal 3 units for demos and partner integrations. Within weeks, the Teal 3 proved to be an immediate success. Our management, engineering and manufacturing teams quickly developed a plan to scale production for 2025.

Over the past four months, our engineering and manufacturing teams have been retooling and preparing for high volume production. We are also implementing quality management systems to meet scaling requirements and achieve AS9100 certification in 2025. A common question from investors is whether we can meet the demand of an SRR contract or other large-scale contracts. The answer now is a resounding yes. The pause in manufacturing of Teal 2 and building our Army prototypes impacted Teal 2 sales in two ways. First, we couldn’t produce and sell Teal 2 units, while retooling our factory. And second, once customers learned about the Teal 3, some chose to wait for its release. This is similar to how no one buys a new Apple iPhone in August. We believe these strategies have been successful, as evidenced by our record backlog of $13 million.

More details on backlog during our guidance update. In Q1, we launched the Red Cat Family of Systems, expanding from one product to three. This diversification enhances our product range and revenue streams which we believe reduces investment risk. The past five months have been incredibly busy as we scaled engineering, scaled manufacturing, expanded our product offerings. We are no longer a one product company. Let’s move on to products and Red Cat’s Family of Systems. Red Cat’s family of ISR and Precision Strike Drones will provide the industry with an alternative to conventional ISR strike systems on the market that are high-cost and non-retrievable. Red Cat’s sensor-to-shooter, S2S system for identifying targets with optional precision strike capabilities, is differentiated from other systems with its low-cost portable drones.

The objective of this new Family of Systems is to meet the increasingly urgent need of the Pentagon’s initiatives for swarms of low-cost attritable ISR and surgical strike drones deployable in air, land and sea environments. Red Cat’s new family of low-cost and portable unmanned ISR and precision lethal strike systems include three aircraft with complementary capabilities and a common ground control system, such as the Android Tactical Assault Kit, otherwise known as ATAK, for multi-vehicle command and control. These three systems are the Edge 130 Blue, currently the Teal 2; and last but not least, FANG, our new FPV drone. The Edge 130 Blue, a hybrid VTOL system, can be assembled and then hand-launched or ground-launched in just one minute by a single user to capture a high accuracy aerial imagery with long-range autonomy.

Weighing only 1,200 grams, the Edge 130 has flown two hours in forward flight mode, which is the longest flight time of approved Blue UAS drones. Teal 2, everybody already knows about this drone. We’ve been selling it for over 18 months. And then finally, FANG, an FPV drone that will add surgical strike capabilities. Warfighters can combine and deploy these FPV drones with lethal payloads and ISR drones based on the mission profile for seek and destroy capabilities. Since we just closed on FlightWave, I want to spend some time on the Edge 130 Blue. The Edge 130 Blue is a unique product in the drone space. It is a VTOL, Vertical Takeoff and Landing, fixed-wing airplane that is portable and fits in a warfighter’s rucksack. It has a long flight time on the Blue UAS Cleared List.

Demand for the Edge 130 has been much better than expected since we announced the LOI. I will talk about the significant contract wins when I discuss our guidance after Leah’s comments. I want to congratulate the FlightWave team on this engineering model. Now for the elephant in the room, Short Range Reconnaissance, SRR. The last few years, we have received our down selection for SRR prototype contracts in September. The final production contract award has been scheduled for down selection in September 2024 for almost two years. In late August, at the Pathfinder Conference in Huntsville, Alabama, the Army mentioned during a speech that SRR had a clear winner. We are hoping to have an update from the Army for this call, but that is not the case.

This is why we do not include SRR in our full year guidance for 2025 or any guidance. We worked very hard to give the Army a product that meets and exceeds their requirements. We hope to hear back in the next few weeks. I’ll now hand the call to Leah, after which we will talk about our guidance.

Leah Lunger: Thank you, Jeff. Hello, everyone and thank you for joining the call this afternoon. Today, I’ll be reviewing the highlights of our first quarter of fiscal 2025. Revenue for the first quarter of fiscal 2025 totaled $2.8 million compared to $1.7 million for the first quarter of the prior year. This represents year-over-year growth of 59%. Gross margin for the quarter was negative 17% of revenue. This was entirely due to the final delivery of prototypes for the SRR Tranche 2 program and was not related to product sales. We do not expect to have negative margins again in the future. In spite of this, we’re thrilled to have completed this engineering effort and excitedly await an announcement on whether we will be down selected for a production contract under the Short Range Reconnaissance program.

Cash used in operations for the first quarter of fiscal ’25 was $2.3 million. This represents a decrease of $4.6 million or 66% compared to the same quarter in the prior fiscal year and remained flat sequentially. We continue to prioritize efforts to control costs without limiting growth. We ended the quarter with $7.7 million in cash and just closed a debt deal securing an additional $8 million in financing. Looking to the future, we have been preparing manufacturing of our latest product, which we are calling the Teal 3 for right now. We expect to produce this drone for several years, which will allow us to steadily increase margins over time. As we have said in the past, we anticipate product margins to reach up to 50% under mass production.

Overall, we remain optimistic about the future of Red Cat and our ability to provide products that meet the needs of the warfighter. This is especially true with our new Family of Systems, which includes the FlightWave Edge 130 Blue, the Teal 2, eventually Teal 3, and FANG. Additionally, we believe this multisystem strategy will lower investment risk through product diversification. As Jeff mentioned, we are also going to be changing our fiscal year end from April 30 to December 31, beginning December 31, 2024. What this means from a reporting standpoint is that we will report quarter two results for the three months ended October 31, 2024, in accordance with the current fiscal year. Then we will file a transition report 10-K for the eight months ended December 31, 2024.

After that, all future filings will be based on a calendar year. I’m now going to turn it back over to Jeff to provide guidance for the upcoming calendar year 2025 before we take questions.

Jeff Thompson: Thanks, Leah. Red Cat expected to have news about SRR for this conference call. And as you know, we’re still waiting like everyone else on this call. As I said earlier, we usually get down selection news in September. But preparing for this call without SRR was very eye-opening. Without SRR or any other NATO programs of record, we’re still growing revenue 200% a year in a very healthy growing company. If we get news in the next couple of weeks, we will update our guidance for calendar 2025. As stated in the press release, we expect revenue for 2025 of $50 million to $55 million again without SRR or any other programs of record from NATO. We currently have a backlog of approximately $13 million, a company record. This could change day-to-day, as we finish sweeps this week. We can now open it up for questions.

Q&A Session

Operator: We will now begin the question-and-answer session. [Operator Instructions] And our first question today comes from Ashok Kumar with ThinkEquity. Please go ahead.

Ashok Kumar: Thank you, Jeff, and congratulations. Two-part questions. You have a backlog of $13 million. Can you give us any color on the product mix? And the second part is, will this backlog ship this calendar year? Thank you.

Jeff Thompson: Great. Thanks, Ashok. Yes, this is a very exciting question. We’ve never had a product mix question because we only had one product. But about half of the backlog is FlightWave Edge 130 Blues, which as you know, we just closed about 16 days ago. We had a lot of interest since we signed the LOI because we are a great combination and incredible engineering team over there and we have great manufacturing capability and access to capital. We are hoping to ship a significant portion of that backlog by the end of calendar year. We are kind of in this really weird spot now where we are transitioning from our old fiscal year into a calendar year, but we are just basically running so hard to build drones, ship drones, get rid of some of this backlog and prepare for 2025, which as you know, with the new guidance is pretty compelling even without SRR.

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

Operator: Our next question comes from Glenn Mattson with Ladenburg Thalmann. Please go ahead.

Glenn Mattson: Hi, thanks for taking the questions and congrats on the progress. So when you speak to the guidance, the $55 million for calendar 2025, can you talk about the mix involved with that? I know FlightWave — Jeff, I know you are pretty excited about some of the activity you are seeing around that. Can you just give us a balance of kind of where you expect that to shake out between the two main product lines and if there is FPV involved in that as well?

Jeff Thompson: Yes. I think I’ll start with the FPV portion. FPV, it is a must-have product for the warfighter on the battlefield. So that is why we’ve included it in our Family of Systems. It really gives you a complete solution in strike capabilities. We don’t think that the FPV is going to be a large portion of our revenue for next year, maybe $5 million to $8 million because they are very low cost. I think the remaining revenue for 2025 from the forecasting that we’ve been working at will be pretty close to 50-50, the Teal 3 and the Edge 130 Blue. And we’ve been pretty conservative with our previous guidance and done pretty well before. So I think that is kind of a thumbnail of the mix of the $55 million.

Glenn Mattson: Great. Helpful. Leah talked about, I think, it was you said 50% gross margin, correct me if I’m wrong, but can you talk about if you are at that $55 million as you kind of in the back half of that run rate in the back half of next year? Can you talk about what the margin profile would look like at that point? Or if there’d be greater scale needed to get to those target margins?

Jeff Thompson: Yes. Yes, great question. I will just give some color before I hand it to Leah. For the last year and four or five months, we’ve been building the Teal 2. It came out of the box very hot and was selling very well, still selling very well. But we always knew that once we had the — what we were delivering for the SRR prototypes, is going to be the next rev bird. So we are switching airframes every couple of years, you never get to that mass production where you are making a drone for three, four years straight which would — will happen with the Teal 3. So — and Leah has done some great modeling on how we get to 50%. So Leah, if you want to add to that?

Leah Lunger: Yes, I would be happy to. I just — I would love the example Jeff gave about the iPhone because I think we can all relate to holding out for the next one and that’s exactly what we’ve seen here. But thankfully, we don’t anticipate that same situation anytime soon with the Teal 3 because we plan to produce it all of next year and for a longer time period after that. We expect to just steadily increase margins as we go and not having to change over the production lines and with the ability for our Teal engineering and manufacturing teams to really focus consistently on the Teal 3. We believe we can rapidly get to 50% margin.

Glenn Mattson: That is helpful. You did mention, Jeff, that you raised a little bit of debt, I believe it is post the quarter. Can you talk about the amount of capital you might need to get to profitability? Or is there any color you can give there?

Jeff Thompson: Yes. It is — we didn’t even make it into the press release because we closed about two hours ago. But we raised approximately $8 million. Leah really worked really hard to get that done. We do expect this could get us to January, February time frame which for us is very important because any large contract wins we — that’s approximately when we would receive our first set of funds to build out any large production contracts. So our goal is just to get to those prepayments without any more dilution. So that’s why we did this small piece of debt. But Leah, if you want to give some of the parameters on the debt?

Leah Lunger: Yes, definitely. There are a few main points I can go over. As Jeff mentioned, it will be proceeds of $8 million. There are no repayments for six months, which we are very excited about. As Jeff said, just kind of getting through to that January, February time frame. There are some warrants with it, but warrant coverage is approximately 30%, and they are cash only. The exercise price on those warrants is $6.50. So if and when they are exercised, those would generate approximately an additional $4.9 million in proceeds. So yes, as you said, we’ve worked really hard on this, and we believe it will do a lot of good for the company and help us get through the next — into next year.

Glenn Mattson: Great. Thanks for the color there. And just last, I will discuss a couple of quick ones on SRR. Jeff, do you have any sense — I know you could be any day now, is there any type of like specific times that you’re looking for, for when an announcement will be made, number one? And then can you just remind us one more time of the scope and I believe I have a number in my head of like $79 million in the first fiscal — government fiscal year, potentially as the kind of the TAM or SAM, I guess, maybe just a little more color on that would be great. Thanks.

Jeff Thompson: Yes. Thanks. Yes, we are — like I said, it’s been said publicly that there is a clear winner and it is done. So — but when you submit your final prototypes, you don’t really get to communicate. So you don’t have any information until I call you and give you the news of down selection, usually three or four days before the rest of the world finds out. We think it could happen anywhere from early October or maybe they wait to the big Army show they have every year at AUSA. We are very confident. But when we — until we get official notice, we have no idea. And yes, some of the things that you can find online for the first year of deliveries between May and September of 2025 is approximately 79. That’s the same number we found out there.

Glenn Mattson: Great, okay. Thanks I’ll pass it on. Thanks very much.

Operator: And our next question comes from Carlo Corzine with Dawson James Securities. Please go ahead.

Carlo Corzine: Hi, guys. Just a couple of things. The SRR, how is that tied — actually, I think the last conversation, you thought you’d see some NATO orders. I know you’ve been working with five or six different countries, thought you’d see NATO wars possibly before SRR. And are they tied together? I mean, if you don’t get the SRR, will you get NATO, vice versa? And my second question is in the financials that just came out, are those combined? If not when will they be combined with FlightWave [for quarter] (ph)?

Jeff Thompson: Yes. Okay. Great. Yes. So SRR and any NATO contracts are not — they don’t rely on each other whatsoever. We’ve been doing tests with certain ministries of defense for some almost 16 months now. We are — we have a couple that are getting real close. We think we’re pretty darn close to getting what we call the initial order. It is typically 100 or 200 systems to get the training started before they do a very significant buy. And that’s — you’re always waiting for that first order. It’s kind of like what happened with us in Border Patrol, they give us an order for 50 before they give us a large order, and we can — the drone for the Border Patrol. So we are getting close with a couple in NATO right now. We were hoping it would come in quicker.

We were originally told one of them was supposed to happen in June. We just have no control over these large bureaucratic systems. But if you look at some of the country’s announcements in Europe, there is a lot of growth in what everyone is expecting to build their drone arsenal. So we are feeling pretty good about that, and we are feeling pretty good about SRR. The financial not combined yet. Yes. Leah, do you want to –.

Carlo Corzine: When do you expect those to be combined? And why didn’t you go with the government year on October 1 instead of calendar year?

Leah Lunger: So for FlightWave, we closed the APA at the beginning of this month, and the financials reported today are through July 31. And so FlightWave will be included in what we report as of October 31, that will be reported in mid-December. And at that — in that filing, it will include the September and October activity. So it will be two of the three months. And then Jeff can speak more to this, but for the fiscal year what we see a lot with the government contracts, there — the government fiscal year is through September, as you’ve stated. But what we find is that their budget isn’t always finalized and then there are sometimes amendments and our contracts tend to be finalized around that December, January time frame. And so building in a little bit of that delay with a calendar year just will give us better visibility and better consistency for our company.

Jeff Thompson: Carlo, just to give you a little bit more color on that. Like I mentioned in my prepared notes is every single year for four years, we’ve been getting our down selection in September. They then give you a prototype contract for the next year of building the prototypes to hopefully win a production contract. I don’t know if you’re aware, but they announced the MRR window, which is the company level which was almost two weeks ago now, which was Anduril Ghost and PDW. They’re two years behind in that program from where we are now. We’re going to a production contract. But so you get a production contract or prototype contract right around now. Once you get down selected, you typically negotiate for two to three months.

We’ve signed probably the last three years in December. By the time we have a closed deal, we are heading and we got to start getting our first checks in January. So — and if you look at all the continuing resolutions, they always get in the way. So we are using their methodology to capture as much of it in something that’s going to be more reliable for us knowing that it is usually delayed, but we’ll typically get the full year and get to ship these items.

Carlo Corzine: Great. Thanks.

Operator: This concludes our question-and-answer session. I would like to turn the conference back over to Jeff Thompson for any closing remarks.

Jeff Thompson: Well, thanks everybody for jumping on. We obviously have an exciting year coming in 2025. Maybe it could be even more exciting in a few weeks. We will keep everybody informed as soon as we know. But regardless, we are in great shape. We are excited. We are building great stuff. People love it. Our new product in FlightWave is fantastic. Our new FANG product is fantastic. The Teal 3 has got an incredible response. So we look forward to talking to you in the future. Thanks, everybody.

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