Earnings Transcript for RCAT - Q2 Fiscal Year 2024

Operator: Ladies and gentlemen, thank you for standing by. Good afternoon, and welcome to the Red Cat Holdings Fiscal Second Quarter 2024 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 one hour after the end of the call through December 15, 2024. 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.

Joey Delahoussaye : Thank you, Sarah. Good afternoon, everyone, and thank you for joining us for the Red Cat Holdings Fiscal Second 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 related to cautionary statements in it. Content of this call contains time-sensitive information that is accurate only as of today, December 15, 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 : Welcome, everyone, to our fiscal year 2024 Second Quarter Earnings Conference Call. I'll start by summarizing our recent performance and achievements, and then we'll 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 the second quarter results exceeded expectations and our guidance of $3 million by 30%. Revenue was $3.9 million, 123% sequential growth from Q1. Our margins tripled to 30%. Joseph will supply more detail on this great achievement. On our last quarterly call, I talked about some of the regulatory tailwinds, hopefully leading to the passage of the American Securities Drone Act. I am happy to report that this past the house in the Senate this week and is on the President's desk to become law. What does this mean? Well, it means the largest drone manufacturer in the world, whose largest market is in 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 who receives any federal dollars. This will be immediate and significantly increase the total addressable market in the U.S. for Teal drones. I'll move on to revenue opportunities and investment tailwinds. I'm going to discuss the current organic revenue growth and the driver of our backlog. Let's start with organic revenue in our backlog. Today, we reported Q2 $3.9 million in revenue. Our guidance for Q3 is $5 million. We do not see a revenue from Q3 guidance for the 123% sequential growth in Q2. This guidance for Q3 is based on signed purchase orders. We also have $7.4 million and growing of funded backlog. As I said on our last call, Q3 revenues of $5 million puts us at a $20 million run rate after selling the Teal 2 for just under 5 months. This is an amazing growth story and would like to thank the entire TEAL team for making it happen. Now let's move on to long-term revenue opportunities. Short-range reconnaissance program, SRR program of record. Just to review or for the new investors that are on the call, the SRR program of record started over three years ago and was originally set to have three tranches

Joseph Hernon : Thank you, Jeff, and to everyone for joining the call today. As Jeff noted, we are reporting record revenues, record gross margin and record backlog for the second quarter of fiscal 2024 which ended on October 31. Each of these financial milestones are clear indicators that the Teal 2 is resonating in the marketplace and that Red Cat has not only reached an inflection point, but we have turned a metaphorical corner and are on a clear runway to continued growth in revenues, increasing product gross margin and a backlog that continues to grow despite record shipments. As Jeff noted, and I want to emphasize, revenues of almost $4 million for the second quarter, represent more than 400% growth year-over-year and 125% on a sequential basis. We have guided to continued growth in the current third quarter and are confident in our revenue outlook longer term. Our sequential improvement in gross margin on a percentage basis is very impressive. Two quarters ago, we had negative gross margin of 87%. And as we worked on developing a fully integrated manufacturing process for the Teal 2 and our then newly completed state-of-the-art manufacturing facility in Salt Lake City. Naturally, there were multiple test runs and processes, which required multiple efforts, resulting in negative gross margins. In our last quarter, our fiscal 2024, first quarter, we generated gross margins of 10%, which was a dramatic improvement. This quarter, we reported 30%, which is a tripling of our gross margin percentage on a sequential basis. In the eyes of a financial professional like myself, that is an impressive performance by our operating team. Looking forward, we believe that we can reach gross margins of 50% as production capacity scales and we spread our fixed manufacturing overhead over a greater number of units. There may be some variability going forward from quarter-to-quarter related to our contract work with the Army on our prototype. Gross margin on that contract can vary quarter-to-quarter based on the mix of work we perform relative to what's required for materials versus labor. This work is directly connected to our efforts to secure the [Army] SRR Phase 2 program contract. As Jeff noted, we were very excited to be awarded an additional $3 million of funding to support the prototype milestones that we have been announced as one of two finalists out of a starting field of 37 competitors speaks for itself, we are playing to win. Our backlog continues to grow even as we report record revenues. Backlog totaled $4.5 million at October 31, 2023, at the end of the second quarter. And as further increase into the fiscal third quarter to $7 million currently. This clearly demonstrates continuing and growing demand for the Teal 2. One of our key objectives during calendar 2024 will be to continue to grow revenues, increase our gross margin and control our operating costs. Our operating loss for the second quarter, net of stock-based comp, which everyone knows is a noncash charge, totaled $3.4 million in the fiscal second quarter compared to $4.1 million for the fiscal first quarter, representing a 17% improvement on a quarter-over-quarter basis. That is impressive in my opinion. We are intent on driving our quarterly operating loss lower during calendar 2024, and our recent capital raise now gives us the operating runway to execute on that objective. In summary, there are a number of key accomplishments that the company has been diligently working on over the past three years that are coming to fruition. Our state-of-the-art manufacturing facility in Salt Lake City, Utah, is complete and already demonstrating its ability to scale production. Our made in the USA platform gives us a huge competitive advantage in an industry that has historically relied on sourcing from China. We have completed a rigorous application and review process to secure key government approvals and certifications, including Blue, sUAS, authority to operate and approval to sell through the GSA. The long and arduous investment in building relationships and creating awareness of the capabilities of the Teal 2 by our sales team is yielding benefits as evidenced by a growing backlog. Finally, as Chief Financial Officer, naturally, I'm not going to predict when Red Cat will reach cash flow breakeven or report profitability, however, I can provide the following for perspective. Revenues for the Teal 2 are increasing, gross margins are growing, and our operating loss is relatively modest in absolute dollars. It will not require an unrealistically steep rate of growth for us to reach breakeven. I believe that steady growth and a focus on controlling costs can get us there. Meanwhile, we have two huge opportunities that could dramatically change the company's financial position in its market capitalization. The funded replicated program recently announced by the Department of Defense is focused on purchasing thousands of small form drones. Red Cat is an expert on small form drones. As Jeff noted, we are a finalist for the Tranche 2 program award. Tranche 1 was a $100 million program, Tranche 2 is expected to be much larger. Winning either of these programs would have a huge impact on the company including, I believe, its market capitalization and stock price. I will now turn the call over to the operator for questions.

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

Ashok Kumar : Just -- you talked a lot about the Replicator initiative from the DoD on your last call. And you didn't mention it today. So could you just update on that? The second question is, do you expect further margin expansion in fiscal third quarter and retaining your top line guidance for the January quarter of $5 million? So I just want to clarify that. And the last question is now that you are one of the two finalists for the SRR and what should we hear next and is there a chance that they select both companies?

Jeffrey Thompson : Yes. So the Replicator initiative has made a lot of news, it's a very exciting initiative. We want to be respectful of the DoD and the [DIU's] mission and we've been getting closely more involved and their mission is to not talk about what specific things are going to be happening and what they're acquiring out there. So we're going to stick with their mission and not talk about what's going on out there and respect that as we don't want to give away what type of assets they are buying to defend against China as that the Replicator initiative is more based on China than anywhere else. The margin expansion for this Q, for Q3, we're pretty excited about getting to 30% this quick. Our biggest goal is to get to 50% and we've made quite a climb in just one quarter. We expect as we add more units to each quarter that the margins will get better. We sometimes have, can't really call them onetime items, but they are onetime items, they're actually once-in-a-lifetime items. When you're bidding on a large project like SRR, you have a lot of stuff that will be nonrecurring that you have to do that can actually end up into the margins. And most of the work for SRR Tranche 2 is done at the end of March, once we deliver the last group of systems to the Army, which is at the end of March. So a lot of costs will go away after March, and we expect margins to continue to grow throughout the rest of the year. And then the SRR program, we -- currently, it is a winner take all. But if you do see the push -- we've seen the push from things like Replicator, they need as many drones from as many people as they can get. There's only two manufacturers that manufacture drones like the drones that are being used in the Ukraine. So we are as Americans, we hope we can make enough drones. We would love to win it as a sole source contract. If they do choose two because they need so many drones -- I just got back from Ukraine, I got to be with the pilots, I guess, do a ride along. They're basically using a lot of drones just like ours, and we hope to get them more of the Teal 2. So I think I answered all three of your questions.

Operator: Our next question comes from Jim McIlree with Dawson James.

James McIlree : Can you talk about pricing this quarter versus last quarter and versus what's in the backlog?

Jeffrey Thompson : Yes. I mean our pricing is standard. Most of our stuff has to be bought through the GSA. The border patrol buys for the GSA, they all basically come through that. And so a drone and controller combo is approximately $15,000 for that combo. If you're just buying a drone with one controller, it's around a little over $10,000 just for the drone. So those prices don't change pretty much at all unless there's significant volume, which we're not there yet.

James McIlree : Yes. The volume was what I was really trying to get at is if you're hitting the volume breakpoints anytime soon. But it sounds like no.

Jeffrey Thompson : What do you mean by breakpoints?

James McIlree : Well, at some level of volume, the customer would get the lower price.

Jeffrey Thompson : Yes. No, they haven't hit those thresholds yet. It's -- there's a small discount once they order 100 systems and then the next break is pretty far up.

James McIlree : Okay. And then secondly, do you need or do you have foreign military sale of approval?

Jeffrey Thompson : We haven't applied for any foreign military sales currently. The FMS and FMFs, even though the NDA is hopefully getting signed later today by President Biden, the NDAA does not fund FMS and FMF. We -- the trip that I did just get back from to the Ukraine was to do a few things. One, you have to get your drone tested against electronic warfare and GPS jamming, then you have to basically go through the ODC and the Embassy in Ukraine, which we did. So once we get our testing parameters back from their testing sites, we then submit the letter of request that we get from the Ukrainian government to the U.S. Embassy and the ODC and they'll ship it to DSCA in Huntsville for the FMS -- to get that far, you typically get an FMS award, the U.S. Army will buy the drones and send them to the Ukraine. So that's the entire reason that I actually went to the Ukraine was for an FMS hopefully buy from the Army's for the Ukrainians.

Operator: [Operator Instructions] This concludes the question-and-answer session from call participants. I will now turn the call over to Joey Delahoussaye of Core IR to read pre-submitted questions for management. Joey?

Joey Delahoussaye : Yes. Thank you, Sarah. Jeff, we received a few pre-submitted questions from investors recently and thought this would be a good forum for you to address those questions. So with that, the first question is last quarter, you said that you did not believe you needed to do an equity raise, and we're looking at non-dilutive financing. Can you explain maybe what changed given the recent equity raise?

Jeffrey Thompson : Yes. No, absolutely. So the bottom line is all of the non-dilutive possibilities, we had no control over. As we likely mentioned Replicator tonight which is who knows when that's coming. We -- Getting an FMS award is they prepay the debt term sheets we were getting were horrific and would have destroyed the company. So basically, we didn't want to play Russian roulette while we're having so many good things happening, great revenue growth, margin expansion, all things that can get us to breakeven. So we raised the money that we needed to. And you'll notice that we no longer have a going concern in our queue. So we're -- we hope that this is -- Joseph wouldn't say this is enough to get it there, but I think that with everything that we have and the revenue growth that we have, I think we're going to be good.

Joey Delahoussaye : Okay. Perhaps that addresses the next question, do you think you now have the capital you need to get to breakeven?

Jeffrey Thompson : Yes, this gives us the opportunity to get those non-dilutive opportunities that we can't control in time, but we -- there is no way that the SRR program is not getting awarded between May and September. And we have plenty of money to get to September so that's a non-dilutive event. If the FMS contracts I was just talking about, that I went to the Ukraine for, they'll pay an upfront contract also. We are going to hopefully see our grant come in from the manufacturing grant that we just received it was non-dilutive, but that's taking more time than we thought, we hopefully get that in the next month or two. So this money gets us where we need to be, and I think it's enough to get us to breakeven.

Joey Delahoussaye : So that was the last of the previously submitted questions, and thanks for your answers on each. Hopefully, this gave investors some additional insight into what's going on within the company. Now I'd like to turn the call back over to you for any closing remarks, Jeff?

Jeffrey Thompson : Great. I want to thank everybody. It's unusual for us to have to do this on a Friday, but this is when our actually last day of the quarter. And to file the quarter was. We won't be doing this on Fridays anymore, we would typically done it on Wednesday or something earlier, but we last week threw us off a little bit. We've done a lot in the last two weeks. But anyway, I'm pretty excited. I want to thank the TEAL team, they're doing a great job, Biz Dev team, they're doing a great job selling our drones. It's going to be a very exciting 2024. Thanks, everybody.

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