Earnings Call Transcript - RCAT Q1 2025

Operator, 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. 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 contain 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, CEO

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 the 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 the 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, and 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 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, CFO

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, CEO

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.

Operator, Operator

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

Ashok Kumar, Analyst

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, CEO

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 the 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, Analyst

Great. Thank you very much and all the best.

Operator, Operator

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

Glenn Mattson, Analyst

Hi, thank you for addressing the questions and congratulations on the progress. Regarding the guidance of $55 million for calendar 2025, could you discuss the mix involved in that? Jeff, I know you’re quite enthusiastic about the activity with FlightWave. Can you share your expectations on how that will be distributed between the two main product lines and if FPV is included in that as well?

Jeff Thompson, CEO

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, Analyst

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, CEO

Yes, that's a great question. I'll provide some context before passing it to Leah. For the past year and a few months, we have been developing the Teal 2. It launched strongly and continues to sell well. However, we anticipated that once we delivered the SRR prototypes, we would move onto the next version. We are changing airframes every couple of years, which prevents us from achieving mass production for several years in a row, something that we expect to achieve with the Teal 3. Leah has also done some excellent modeling regarding how we can reach that 50% gross margin. Leah, would you like to elaborate on that?

Leah Lunger, CFO

Yes, I would be happy to. I really liked the example Jeff gave about the iPhone because I think we can all relate to waiting for the next one, and that's exactly what we've seen here. Thankfully, we don't expect that same situation anytime soon with the Teal 3 because we plan to produce it throughout next year and even longer afterward. We anticipate steadily increasing margins as we proceed without needing to change the production lines. With our Teal engineering and manufacturing teams able to focus consistently on the Teal 3, we believe we can quickly reach a 50% margin.

Glenn Mattson, Analyst

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, CEO

Yes, we closed a funding round about two hours ago and raised approximately $8 million. Leah put in a lot of effort to make this happen. We anticipate that this funding could help us reach the January or February timeframe, which is crucial for us as that's when we expect to receive our first set of funds from any large contract wins. Our aim is to reach those prepayments without incurring further dilution, which is why we opted for this small amount of debt. Leah, could you share some details about the terms of the debt?

Leah Lunger, CFO

Yes, definitely. There are a few main points to cover. 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 noted, we are looking to get through to the January, February timeframe. There are some warrants involved, with warrant coverage of approximately 30%, and they are cash only. The exercise price on those warrants is $6.50. If and when they are exercised, they would generate approximately an additional $4.9 million in proceeds. We have worked really hard on this, and we believe it will greatly benefit the company and help us move into next year.

Glenn Mattson, Analyst

Great. Thanks for the information. I have a couple of quick questions about SRR. Jeff, do you have any updates on when we might expect an announcement? Also, can you remind us of the scope? I believe the number I'm thinking of is around $79 million for the first government fiscal year as the total addressable market, so any additional details on that would be appreciated. Thanks.

Jeff Thompson, CEO

Yes, thank you. As mentioned, it has been publicly stated that there is a clear winner and the process is complete. However, once you submit your final prototypes, communication is limited, and we typically inform you of the down selection three or four days before the public announcement. We anticipate this could happen between early October and the annual Army show at AUSA. We are very confident, but without official notice, we cannot confirm anything at this moment. Additionally, the online information regarding the first year of deliveries between May and September of 2025 indicates approximately 79, which aligns with our findings.

Glenn Mattson, Analyst

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

Operator, Operator

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

Carlo Corzine, Analyst

Hi, everyone. I have a couple of questions. How is the SRR related to the anticipated NATO orders? I remember during our last discussion, you mentioned expecting some NATO orders as you have been collaborating with five or six different countries. Do these orders depend on each other? If the SRR doesn't go through, will NATO orders still come in or is it the other way around? Also, regarding the recent financials, are those figures combined? If not, when do you expect them to be merged with FlightWave?

Jeff Thompson, CEO

Yes. So SRR and any NATO contracts do not depend on each other at all. We've been conducting tests with various ministries of defense for nearly 16 months now, and we have a few that are very close to placing what we refer to as the initial order. This usually involves 100 or 200 systems to initiate training before a significant purchase is made. We are always anticipating that first order, similar to what we experienced with Border Patrol when they placed an order for 50 units prior to a larger order for the drone. Currently, we are close with a couple of NATO partners. We expected this to happen sooner, as we were originally informed that one of them was expected in June. However, we can't control these large bureaucratic processes. Nevertheless, looking at recent announcements from some European countries, there is considerable growth expected in their drone capabilities. We are optimistic about that and about SRR as well. The financials haven't been combined yet. Leah, would you like to add anything?

Leah Lunger, CFO

For FlightWave, we finalized the APA at the start of this month, and the financials reported today cover up to July 31. FlightWave will be included in our report as of October 31, which will be shared in mid-December. This report will encompass activities from September and October, providing data for two of the three months. Jeff can elaborate further, but regarding the fiscal year, we notice that with government contracts, their fiscal year ends in September. However, their budgets are not always finalized immediately, often requiring amendments, leading to our contracts typically being finalized around December or January. Accounting for this delay in line with the calendar year will enhance our visibility and consistency for the company.

Jeff Thompson, CEO

Carlo, to provide you with more details on that, as I noted in my prepared remarks, we've been receiving our down selection every September for the past four years. Following that, we receive a prototype contract for the upcoming year to build the prototypes with the hope of securing a production contract. Recently, they announced the MRR window, almost two weeks ago, which involved Anduril Ghost and PDW, both of which are two years behind their schedule compared to where we currently stand. We are moving toward a production contract. Typically, you receive a production or prototype contract around this time. Once you are down selected, the negotiation process usually takes two to three months. In fact, for the past three years, we have finalized contracts in December. By the time a deal is closed, we expect to start receiving our initial payments in January. However, the ongoing resolutions often create obstacles. Therefore, we are adopting their methodology to capture as much as we can in a more reliable manner, understanding that delays are common, but we generally manage to secure the full year and deliver these items.

Carlo Corzine, Analyst

Great. Thanks.

Operator, 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, CEO

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, Operator

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