Red Cat Holdings, Inc. Q4 FY2024 Earnings Call

Ladies and gentlemen, thank you for standing by. Good afternoon, and welcome to the Red Cat Holdings Fiscal 2024 Annual Financial Results and Corporate Update Conference Call. At this time, all participants are in a listen-only mode. 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 November 8, 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 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 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, August 8, 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.

Thank you. Welcome everyone to our fourth quarter and full fiscal year 2024 earnings conference call. I will start by summarizing our performance and recent achievements. Leah will then take you through our financial results in greater detail, and then Leah and I will take your questions. I am pleased to report record results for the quarter and a record-breaking fiscal year for Red Cat. First, for the full fiscal year, revenue increased 286% to a record $17.8 million compared to $4.6 million last fiscal year. Fourth quarter revenue rose to $6.4 million, over a 100% increase from the same period last year, and now a new top-line quarter record. This is our fourth consecutive quarter of top-line sequential growth averaging above 10%. The last four quarters were driven by feet-on-the-street organic sales revenue. None of this revenue was from a program of record production contract or the Replicator Initiative. These record-breaking achievements were completed with a single product, the Teal 2. During this past fiscal year, global demand continued to surge for small, portable autonomous systems, and Red Cat responded accordingly. We invested across the organization to strengthen our product portfolio and expand our manufacturing capacity to meet the evolving needs of our customers. Our product portfolio has expanded from one drone to three drones, completing our recently announced Family of Systems. Let's discuss the Red Cat Family of Systems. Our Family of Systems strategy is a result of looking to our urgent user needs regarding the deployment of low-cost, portable, field-repairable and recoverable ISR and precision strike systems. This is a paradigm shift in the drone industry where more expensive, non-recoverable systems have dominated the market for the last decade. The Family of Systems addresses a variety of mission sets for medium-range ISR, short-range reconnaissance and first-person view, FPV, precision strike capabilities, commanded and controlled from a singular tactical ground control system and optimized for GPS-denied and other contested environments. I will now discuss our recent acquisitions and partnerships. I will start with FlightWave. Our proposed acquisition of FlightWave Aerospace brings medium- to long-range ISR and high-resolution mapping capabilities to the Red Cat portfolio through their flagship products, the Edge 130 Blue. With a range of 20 kilometers and extended flight endurance, the Edge 130 outperforms other drones in its class while maintaining a small, portable form factor, which is critical to frontline warfighters. In the near future, the Edge 130 will complement the solutions of Red Cat's other subsidiary, Teal Drones, by performing joint meshed network autonomous ISR missions in multiple domains such as land, sea and air. We also have an exclusive partnership with Sentien Robotics. The partnership between Red Cat and Sentien Robotics will enable Red Cat to provide warfighters with the ability for continuous, uninterrupted reconnaissance on enemy targets with drone swarms. Teal Drones' battlefield-tested drones, coupled with Sentien's fleet-handling capabilities, give warfighters tools and technology they have never had access to. New technology is dramatically changing the nature of warfare, and we believe those who can integrate defensive and offensive assets across multiple domains and rapidly deploy those capabilities against adversarial targets will gain tactical superiority. This agreement with Sentien is a major step towards the autonomous deployment and control of drone swarms and the capability to launch from small boats or ships. This brings us to the Replicator Initiative, which seems to be focused on the Indo-Pacific region. For investors new to the Red Cat story, the Replicator Initiative is a program launched by the U.S. Department of Defense aimed at rapidly delivering advanced autonomous systems to the military. Announced in August 2023, the initiative focuses on creating and deploying thousands of all-domain attritable autonomous systems, or otherwise known as ADA2, within 18 to 24 months. The Senate Appropriations Committee recently approved a defense spending bill for fiscal 2025 that would provide full funding for the Pentagon's high-profile autonomous systems initiatives known as Replicator. And lawmakers raised the possibility that even more money could be allotted for the effort. This DOD funding for drones is going to be the primary vehicle the U.S. government uses to kick-start domestic production. This budget, plus the continuing resolution last year and other allocations, will result in about $1.5 billion in funds for Replicator alone going to drone manufacturers from now until September of 2025. That will be approximately $100 million per month. We believe we are well positioned for future Replicator tranches with our Family of Systems combined with our swarming capabilities. Last but not least, let's discuss programs of record. Again, for the people new to the story, a program of record in the Department of Defense refers to an acquisition program that has been officially recognized and funded with the future year's defense program. This means the program has successfully passed through the necessary approval processes and is included in the DOD's budget planning. SRR, the Short Range Reconnaissance program, is a U.S. Army initiative designed to equip soldiers with small, rapidly deployable, unmanned aircraft systems for reconnaissance and surveillance activities. The primary goal is to enhance situational awareness and provide a tactical advantage at the platoon level. This program of record selection process has gone on for over five years. It started with 37 companies and is now down to Red Cat and one other company. The final test for the Army was in May. We had to deliver approximately 50 final prototype systems. The final down selection is scheduled for the end of next month, September 2024. We believe this production contract will be in the hundreds of millions. Usually, when we talk about programs of record, they are U.S.-based contracts. Red Cat is also in late stages for NATO programs of record. We believe that they are also significantly larger than the U.S. SRR program of record. These programs are expected in the next two months to have their down selection. In summary, 2024 was a great year for the Teal 2 with record revenues. We are steadily reducing cash burn while gaining market share. We expect 2025 revenue to be another record year in top-line growth and scale. We expect the FlightWave deal to close soon, adding significant revenue to the 2025 calendar year. We believe we're well positioned for a Short Range Reconnaissance program of record win worth hundreds of millions of dollars, and we hope to finalize NATO-based programs of record before the end of calendar 2024. And with that, I will hand the call to Leah.

Thank you, Jeff and everyone, for joining the call this evening. As Jeff highlighted, fiscal '24 was an exceptional year, marked by record revenues of $17.8 million compared to $4.6 million in fiscal '23. This represents growth of 286%. All four quarters of fiscal '24 brought record revenue sequentially. Quarter four revenues totaled $6.3 million compared to $1.1 million in the same quarter of the prior year, representing a 485% increase. Gross profit for fiscal '24 totaled $3.7 million or approximately 21% of total revenues compared to negative 18% in fiscal '23. We continue to expect steady improvements in gross margin over time as we focus efforts on manufacturing efficiencies and reductions in cost of goods sold. We now have dedicated teams for manufacturing, engineering and warranty and returns to accomplish these goals effectively. Our focus on controlling costs while scaling revenues led to a decrease in operating expenses for fiscal '24. Adjusted operating expenses, which exclude noncash items of impairment loss and stock-based compensation expense, totaled $17.5 million in fiscal '24 compared to $18.1 million in fiscal '23. This represents a decrease of approximately $600,000 or 3%. As a percentage of revenue, adjusted operating expenses decreased from 391% of revenue in fiscal '23 to 98% of revenue in fiscal '24, which demonstrates our success in controlling costs while nearly quadrupling revenues. Our combined cash and accounts receivable balances as of April 30, 2024, totaled over $10 million. Additionally, in July, we secured $4.4 million of non-dilutive financing through the divestiture of our investment in Unusual Machines. Closing this transaction eliminated our equity method investment while providing additional funding for accomplishing our strategic objectives. We are pleased to report that our cash used in operations has decreased significantly on both a quarterly and annual basis. Cash used in operations for quarter four of fiscal '24 was $2.3 million. This represents a decrease of $1.8 million or 43% sequentially and a decrease of $5.2 million or 69% compared to the same quarter in the prior fiscal year. On an annual basis, cash used in operations decreased by $6.6 million or 27% compared to fiscal '23. Overall, fiscal '24 has been a year of growth and accomplishments. We have successfully scaled revenues both domestically and internationally while controlling costs, and we look forward to continued revenue growth and improved profit margins in the upcoming year. Shortly after year-end, we completed our engineering efforts for the Army, having delivered final prototypes in April and May of 2024. We remain one of only two finalists in the SRR tranche 2 program, and we believe we are well positioned to receive an award next month. During the call today, I referenced adjusted operating expenses, which is a non-GAAP financial measure. Adjusted operating expenses exclude noncash items of impairment loss and stock-based compensation expense. The most directly comparable GAAP financial measure is operating expenses. Listeners can find operating expenses as well as the quantitative reconciliation of the differences between adjusted operating expenses and operating expenses on Red Cat's website.

We will now begin the question-and-answer session.

Before we start with the questions, I just want to do a little bit of housekeeping. I know we have a very large list of questions already, so please avoid repeating questions. For guidance, we will resume guidance next quarter. We expect to hear on SRR down selection in the next few weeks. We hope to close FlightWave in the next week or two and believe they could add $10 million to $20 million in revenue in calendar 2025. So we will be able to give and resume guidance once these data sets are resolved. So I want to get that out there before we took questions. Thank you.

Thank you. A three-part question. The first question is that you had mentioned you had $10 million in cash and receivables. Does that include the $4.4 million you just closed with UMAC? The second question is you mentioned that some of the NATO programs of record, the POR are larger than the U.S. Army POR. Can you give us the magnitude? And the last one is, have you received any demand for the FlightWave Edge 130 system? Thank you.

Great, thanks, Ashok. Actually, Leah, why don't you grab the first one and I'll grab the second and third?

Yes, I'd be happy to answer that. So the $10.4 million in cash and accounts receivables was our balance as of April 30, and we closed the sale of our investment in Unusual Machines last month. So the $4.4 million mentioned is in addition to cash and AR as of year-end. Okay, go ahead, Jeff.

Great. Thanks. Yes. So the programs of record in NATO are significant, and you can understand why with them being so close to the Ukraine war. So I'll just give an example of one of them and compare it to SRR. SRR is about a little under 6,000 systems. It's still a very significant contract, but at least one of the programs of record in NATO is for 25,000 systems, it's 4x. So they are pretty massive compared to the SRR program of record. And then I think you mentioned demand for the Flight Edge 130. We've got a great response since we announced the LOI. A lot of our customers want the cost knowing that we can actually build and meet the demand. It's a great system. And Mike has done a great job designing that system, and the employees there have made a very unique platform that can fly longer than any other vehicle in its size and range. We think it's a great replacement for the now discontinued AeroVironment Ravens. So we've seen great demand signals for the Edge 130. Thanks.

Thank you and all the best.

The next question comes from Glenn Mattson with Ladenburg Thalmann. Please go ahead.

Thank you for taking my question and congratulations on the successful quarter. I wanted to ask about the production capacity, particularly since there was a time in Q4 when production was lowered to focus on the Teal 3. Is that back on track now? Additionally, regarding FlightWave and the recent acquisition, do you plan to move that manufacturing into your existing facility? I would appreciate any updates on how that will unfold. Thank you.

Yes, thank you, Glenn. We're back in production and currently on a significant hiring spree to scale up production of the future Teal drone, which we submitted for the Army prototype. We're preparing for large-scale production, currently referred to as the Teal 3. It took us nearly six weeks to resume production, and it was a straightforward decision to prioritize building the perfect prototypes for the Army, which could lead to a contract worth hundreds of millions. We opted to ensure the prototypes were flawless, and the team did an outstanding job—the new drone has been flying perfectly. Regarding FlightWave, once we finalize the deal, we plan to pursue simultaneous production paths. They currently have significant demand, and we aim to meet that by continuing production in California while also establishing a new production line in Salt Lake City. As you can see, we've been hiring extensively to support both initiatives.

You mentioned a potential figure of $25 billion for FlightWave in 2025. Is this based on anticipated awards you expect to secure? You spoke extensively about the Family of Systems and the Replicator program, explaining how you might be positioned to win awards tied to that potential revenue source. Could you provide some background on this figure, given you shared it? Thank you.

Yes. The FlightWave system has transformed us from a single-product company to one offering three drones that work together through a single controller. The FlightWave capability places us in a different category of drone. While it remains a Class 1 drone, it can compete with Class 2 drones at Class 1 prices, and this has been well received due to its unique flight time, which exceeds that of its predecessors, and its portability. It can be easily launched without needing two people or requiring a large open space. We believe there is significant demand for this unique product, and FlightWave is positioned to meet a substantial need. It boasts impressive capabilities, including speed and range, making it one of the fastest drones in the Blue UAS group. Given these factors, we project that sales for this product will safely reach between $10 million and $20 million in the next calendar year, 2025.

Great. Thanks. Jeff, regarding the NATO matter, I didn't fully understand what you mentioned. I believe you said there would be a selection in the next two months, and then I thought I heard you say it would be awarded by the end of the year. Did I capture both points correctly? If not, could you please clarify?

Yes, once you are down selected, you then proceed with production contracts. So your time frames are accurate.

Thank you. It was a great quarter, Jeff. I wanted to revisit the manufacturing capacity. I believe the full capacity in Salt Lake was once 300. Can you tell me what FlightWave's capacity is and our current status on that? We used to discuss the backlog, which we can't announce due to many contracts, but I would appreciate seeing it monthly as we continue to secure contracts you can't disclose. Lastly, which option provides the lethal payload? Is that a new development? I was under the impression that achieving that level of accreditation took about two years, or did you acquire it through one of your acquisitions? That's all.

Thank you, Carlo. I’ll take a different approach here. We do not produce munitions for our FANG FPV drone, but we are developing kinetic capabilities for the Teal 3. Both of these drones will have strike capabilities. Looking ahead to next year, we plan for the Edge 130 to also support a kinetic payload, which could be very advantageous as it would outlast the Switchblade 300, which has a flight time of only 12 minutes. When we collaborate with partners, we can deliver a variety of payloads through our drop mechanisms, whether they are kinetic or not. They could transport supplies or ammunition without requiring our approval. The companies creating the actual kinetic munitions would need to secure those approvals, which can take up to two years.

Okay. And on the capacity at Salt Lake?

Yes. The Salt Lake facility can handle thousands of drones, though achieving that volume each month is challenging. However, we can reach 1,000 drones a month for the Teal 2/Teal 3 if we receive the desired demand. As you can see, we are actively preparing for that level of scale. Regarding the capacity at FlightWave, we don’t have definitive information yet. We expect to finalize things in the next week or two and plan to significantly increase their capacity. We are seeing strong demand for the Edge 130, which is an excellent product with a great team behind it. However, I don’t have the specifics on FlightWave at this time.

Okay, thank you.

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

Great. Well, thanks for joining us tonight. I want to thank our investors and our employees. I want to thank the finance team for getting two years of audits done in three months. That was a heavy lift. The entire field team for delivering an incredible prototype for the U.S. Army. And I saw a very interesting quote from the CEO of Rheinmetall today. It doesn't convert so well from Germany, but he said, the super cycle, a long-term surge in defense spending is in full swing. Now I'll leave you with that. Thanks, and good night.

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