Draganfly Inc. Q3 FY2023 Earnings Call

Greetings and welcome to all shareholders and stakeholders to today's Draganfly 2023 Q3 Earnings Call. My name is Rolly Bustos, and while I know most of you, I remind all others that I am the internal Investor Relations representative here at Draganfly. We appreciate you joining us today. We will start as usual, with our CEO and President, Cameron Chell, discussing the third quarter operational highlights. From there, our CFO, Paul Sun, will discuss the financials, and as always, we'll conclude with our Lead Director, Scott Larson, facilitating the Q&A portion. You are welcome to reach out to me individually after the call at [email protected]. Once again, I remind everyone that this presentation may include forward-looking information and statements. These statements are not guarantees of future performance or financial results, and undue reliance should not be placed on them. Any future events or financial results may differ from what might be discussed here. The full forward-looking disclaimer can be found on Page 2 of this presentation, and I'd be happy to send that to anybody upon request. So, Cam, please go ahead.

Thanks, Rolly. I appreciate the management team and executives for joining us today, as well as our customers, partners, and shareholders. I am excited to share that we've achieved a record quarter in 2023 with revenues of $2.138 million, including $1.6 million from product sales and nearly $0.5 million from service provisions. Our gross margin stands just below 42%, reflecting a gross profit of $894,000. By the end of the quarter, our cash balance was $2.4 million, and we completed a financing round of $4.5 million on October 30th. Notably, both of our plants are now operational. We completed the second plant and activated it in Q3, which has enabled us to progress with production and fulfill our order book while preparing for scaling our operations. It’s crucial to recognize the current geopolitical landscape and its influence on the drone industry, particularly regarding our growth potential. We previously discussed how the commercial drone industry is maturing, especially with regulations like beyond visual line of sight. The conflict in Ukraine highlighted the exceptional effectiveness of small UAVs in defense operations, prompting a significant shift in military strategies focused on air dominance. Traditionally, this meant large manned systems and integrated technologies, but now, small UAVs are set to dominate operations. This paradigm shift has triggered substantial budget increases from NATO and allied countries toward drone autonomy, particularly for establishing air superiority. New emerging markets, including those in Eastern Europe, the Middle East, and Africa, present vast opportunities in border security. The demand for small UAVs is anticipated to grow by approximately $20 billion by 2030, primarily driven by defense needs. Instead of relying on large infrastructures, defense sectors aim to deploy swarms of drones, leading to efforts like the Pentagon's Replicated Program, focusing on integrating thousands of drones over the next few years. Our product pipeline reflects an upward trend, aligning with this market demand. Our portfolio includes products that lie at the intersection of military and commercial sectors. For example, the Dragonfly 3 XL and our Heavy Lift Drones demonstrate strong market potential alongside military-focused innovations. Our heavy-lift drone can carry sizable loads and operate in various scenarios, including emergency responses like wildfires. Recently, we launched the 3XL hybrid version to meet specific customer needs, allowing for longer flight times with impressive payload capacities. Additionally, our Precision drop-down system is receiving orders, and our Starting X2 drone has generated significant pre-order traction. Our Commander 3 XL drone, designed for various military applications, stands out in the market with its robust performance. We are also establishing valuable relationships with entities like the US military and geological survey organizations, enhancing their capabilities with our technology. In summary, our products have proven to meet the rigorous standards required for government and military operations. We recently made significant strides by securing orders in the corrections sector and partnering with Canadian provincial governments for wildfire management. We are paving the way for widespread adoption of our Commander 3 XL drone in the energy research sector, anticipating substantial future orders as we further demonstrate its capabilities. Moreover, our recent venture into gas engine technology for the Commander 3XL hybrid has generated a promising pipeline. We also held our inaugural customer event, the Draganflyer Xperience, at our Joint A.I.R Center in Texas, which has become a key asset for showcasing our technology. Finally, I want to emphasize the importance of our new manufacturing plants. The industry is still developing, and reliable production capabilities are vital for meeting demand. We’ve made great progress in this area, and I commend the team for their efforts. Now, I will turn it over to Paul Sun, our CFO, to discuss our financials.

Thanks, Cam. Thanks, everyone, for joining. This is a quick snapshot for Q3. As Cam mentioned at the outset, Q3 revenue did represent our best Q3 to date. Revenue for the third quarter was up 14% to $2.1 million, up from $1.8 million in the third quarter of last year. Third quarter revenue comprised of $1.65 million from product sales, with the balance coming from drone services, and the increase in revenue is due primarily to higher product sales versus a year ago. Gross profit, as Cam mentioned, was $895,000, but would have been a bit higher at $903,000 excluding a small one-time cash write-down of inventory. Gross margin as a percentage of revenue was 42% and would have been a little bit higher at 42.2% this quarter, up from 44.1% in Q3 of last year. The increase in gross margin percentage was primarily due to sales that used inventory that had previously been written off, which made the margins appear higher. Total comprehensive loss for the quarter was $5.5 million, compared to a comprehensive loss of $5 million in the same quarter last year. This quarter includes a non-cash charge comprising a small write-down of $8,600 of inventory and an impairment of a note receivable of $105,000; without this, our comprehensive loss would have been $5.4 million. In Q3 of 2022, there was a loss that included a gain in fair value of derivative liability of $305,000, and otherwise we would have seen a loss of $5.3 million. So, the year-over-year change in loss was minimal and mostly driven by the benefit of an FX translation from last year, as SG&A expenses this year were down year-over-year. If you can go to the next slide on Slide 10, we see that for Q3 revenue was $2.1 million, increased by 12.6% compared to $1.9 million for Q2, due to both higher product sales and services. Gross margin percentage for Q3 was 41% due to a small inventory write-down and would have been 42.2% compared to 24.6% in Q2 of this year. So on an adjusted basis, gross margin would have been up 71.5% quarter-over-quarter. The increase is primarily due to sales that used previously written-off inventory. Total comprehensive loss again for Q3 was $5.5 million, compared to a comprehensive loss of $6.9 million in Q2 of this year. And again, recall there was a small non-cash write-down of inventory in Q3 and a write-down of a note receivable. Excluding those, the loss would have been $5.4 million, while in Q2 we had a write-down of $122,000. If we exclude that, it provides a fair comparison—the loss in Q2 would have been $6.8 million. Thus, our loss this quarter was much better quarter-over-quarter, primarily due to higher revenues and lower operating costs. Now, on the next slide, looking at our balance sheet, you can see our total assets decreased from $14.6 million at the end of 2022 to $9.1 million, largely due to the use of cash. Working capital surplus at the end of this quarter was $2.7 million versus $10 million at the end of 2022. We continue to have minimal debt, and the company's cash balance was at $2.5 million compared to $7.8 million as of December 31 of last year. As Chad mentioned at the outset, we did complete financing for $3.5 million. With that, I'll pass it back to you, Cam.

Thank you, Paul. Scott, I'll turn it over to you, if that's okay.

Yeah. Thanks. We have had — as is kind of typical for us — a bunch of questions that come in prior to this. So, we have several questions here and will try to get to as many as we can. Of course, Cam has already answered several with regard to the numbers and the results, so a few here differ. Cam, will start with you. What are the new areas that we're seeing the most opportunities and large opportunities in the pipeline? Where does that come from? What is it within corrections, facilities, energy, scanning—just a little color on some of the new opportunities that we haven’t seen in the past?

Yeah. So, I think the thing to note is that most of the opportunities are coming from government, in one form or another. We certainly have a nice flow of inbound commercial that are working through the system, and we've obviously closed a few of them. But if we look at the systems we have closed and our order book containing sizable needle movers now, the vast majority of them are government-based—I'd say 90%. So that wasn’t as predominant before, but that's what is coming through in terms of the close. And from that, we have lots of agency work, with the vast majority now being military work. Whether airborne, Army, Air Force, or Marine, they all have sizable orders. They really like utilizing the air center we have. It's not uncommon to see military adoption set the tone and build the use case for what comes in the commercial sector as well.

Okay. Can you provide a little bit of an update on the production facility in Saskatoon? You did talk about it, but could you provide more color? What is the capacity? Have there been supply chain issues that have come up in the past? A little more commentary on those issues?

I believe Paul Mellon and the team have done an outstanding job designing the product from the ground up a few years ago. We made sure that we wouldn't rely on supply chain constraints or management issues, and we incorporated swappable equipment processes. The new plant in Saskatoon has significantly reduced those risks due to our enhanced manufacturing capabilities. We expect to organically produce $45 million worth of output annually. Furthermore, we can expand into contract engineering. The initial plants must achieve those production numbers to obtain certifications and create prototypes before moving to contract engineering. We are now in a position to scale up, and I am confident we will operate at full capacity this coming year.

Any more updates on Ukraine? Is it still a focus? There hasn’t been much news on it in the last little bit. How do you see the next three to six months looking in terms of UAV and perhaps how Dragonfly fits into the mix?

Initially, we were quite focused on humanitarian efforts and were pleased to do that. However, as the conflict matured, the types of drones suitable for that environment have changed significantly. A drone we would have deployed earlier in that conflict wouldn't last 10 minutes now due to jamming, radio frequency interventions, and the need to keep a GPS-denied environment secure. The news factor from Ukraine has been overshadowed, unfortunately, by recent events in the Middle East, but the demand for drones is increasing. There's a notable rise in people's sophistication regarding what they need and want to buy. The testing environments are being standardized, which creates multi-decade opportunities in sectors like mining, which we are very active in. ISR work is growing, and utilizing the Commander 3XL for dual purposes, including ISR and potential combat scenarios, is a significant market that we're active in. We're a bit quieter than previously for good reasons, but Ukraine remains the largest immediate drone market globally, and we are actively engaged.

Any plans to reduce cost expenses going forward?

Absolutely. We've undergone an initial cost reduction exercise, which started last quarter and is reflected in the numbers. We've implemented this on many levels recently. A big part of this was possible without losing operational efficiency because we now have clear visibility into our order book. A year ago, we faced about 15 markets or verticals trying to determine which would be the biggest or fastest-moving; that was challenging while building out plant capacity. Now, after that year, we have a clearer idea of where we can focus those resources as we can measure opportunity costs effectively. This has allowed us to prudently go through cost reduction exercises without sacrificing our prospects for growth as we focus on specific markets.

A few more questions here for sure. Comment on the current business with Windfall. We discussed this on the last earnings call, mentioning that things are moving ahead. Any updates? What does it look like? Obviously not giving guidance, but some thoughts or comments on downstream activity specifically in the mining sector with Windfall Geotech?

We are absolutely committed to and understand that we are an important player in the data world. I would suggest that over time, Draganfly will become more of a data company. While we will always be known as a drone company, our strategic advantage lies in our ability to customize drones and sensors to collect data for our customers that others may not be able to, which is our differentiator. This applies across sectors, including commercial, energy, government, and military. Mining is one of the first areas where we can collect data and provide it back to customers effectively, where others can't. While I'm not able to comment specifically on Windfall, I can confirm that it is a robust market and a key focus for us in the commercial sector, particularly in mining data. Mining will set the standard for how data is collected and how AI will be employed in other markets. Windfall offers an incredible platform that we are building on. Last quarter, I discussed pipelines with Windfall; in this quarter, we will be discussing our order book. We're excited about what is happening there.

When Draganfly attends drone conferences and UAV shows, how do we see the competitive mix between Draganfly and some of the other drone companies? How does Draganfly fit into this mix? Are there trends from other companies that we might want to emulate in the future?

There is incredible creativity and innovation in this space. I have the utmost respect for the smartest individuals in this industry. Every time I attend a show or meet with fellow professionals, I am impressed by the ingenuity presented—some truly remarkable ideas. I think a differentiator for Draganfly, particularly since we've been around for a long time, is that the projects we pursue are customer-driven. There are many shiny objects in this space, but we choose not to pursue those that might look enticing but lack a significant production capacity or reliable demand signal. A few years back, our drone capability was minimal compared to today, but we were still engaged in contract engineering for military contractors and academia, generating revenue. We've moved in line with the market's demand for scaling and production. We focus on utility-type drones instead of the latest gimmicks or smaller models. That low-margin business can be tough without something incredibly strategic. We believe we are well-positioned for growth and while some companies may also excel, we're primarily focused on organic growth.

We've heard reports about several drone companies closing down. Are we seeing a trend toward consolidation in the industry? How does Draganfly fit into this, and are we looking for opportunities from companies that have wound down or closed?

Yes, during my recent visit to the CUAV show, it seemed like a common theme: half of these companies might not be around next year. So, yes, there’s definitely consolidation happening in the industry. The commercial market has taken longer to adopt, similar to past cycles. The key difference now is that the regulations are further along and we are witnessing commercial adoption but even more so, the military market is prevalent and overwhelming. The challenge for many companies, especially newer ones that haven't gone through rigorous testing, is that it doesn’t matter if you have an innovative product—you must be capable of sizeable production to sell to government or military customers. We are gearing toward consolidation while primarily focusing on organic growth. Our hands are currently full, and we need to execute on what is in front of us right now. We do expect to stand out in terms of production scale, and while there may be others in a similar position, I wouldn’t want to speculate too much. We're not against acquisitions, but due to current valuations and the demands of organic growth, we are not actively considering any at this time. However, should an opportunity arise, we would certainly take notice.

Okay. That was a long list of questions. I'll send it back to you to adjourn the meeting, wrap it up, and that will be it for this shareholder call.

Thank you, everybody, for taking the time. This time, we opted not to take live questions, as we received feedback that it seemed quite distracting. However, I love the live question aspect, so we look forward to some feedback on whether we revert back to that next time. But please feel free to reach out to us. Rolly is always available, and the rest of the executive team will do their best to respond quickly as well. First and foremost, I’d like to thank our employees for their hard work; it’s been a real grind as we navigate through some cost reduction efforts while scaling the business. Thank you for your trust, patience, and dedication. To our customers, our business is all about you, and we appreciate your time, trust, and patience. To our shareholders, we are committed to creating shareholder value for you. Thank you for your time today, and we look forward to an excellent quarter ahead.