RCAT - NASDAQ

Ladies and gentlemen, thank you for standing by. Good afternoon and welcome to the Red Cat Holdings Fiscal 2023 Second Quarter 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 March 15, 2023. I would now like to turn the call over to Joey Delahoussaye, Vice President of CoreIR, the Company's Investor Relations firm. Please go ahead, sir.

Thank you, MJ. Good afternoon, everyone, and thank you for joining us for the Red Cat Holdings fiscal 2023 second quarter financial results and corporate 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 the cautionary statements in it. The content of this call contains time-sensitive information that is accurate only as of today, December 15, 2022. 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?

Thank you, Joey. Welcome to our fiscal year 2023 second quarter earnings conference call. This has been a tough year for the economy and a brutal stock market. Many businesses and technology companies are battening down the hatches. But at Red Cat, we are focused on growth. The defense industry is growing, not shrinking in the U.S. and NATO. First, let's talk about the current military and defense drone industry. The defense space is going through a huge change. Ukraine war has demonstrated that drones are changing warfare and specifically small drones like the Teal Golden Eagle. Just some recent headlines, drone warfare in Ukraine and the changing battlefield, source CBC; Russia and Ukraine are fighting the first full scaled drone war, Washington Post; The drone war in Ukraine, Financial Times; The Tiny and Nightmarishly Efficient Future of Drone Warfare, The Atlantic; Ukraine Enters a Dark New Era of Drone Warfare, Wired Magazine. Two main developments are going to impact future war says Samuel Bendett, a military analyst at the Virginia-based research group CAN: The proliferation and availability of combat drones for longer a range, more sophisticated operations and the absolute necessity to have cheap tactical drones for close support operations. Just Google, Ukraine drone war, it comes back with 3 million plus results. Drones, and more specifically short range reconnaissance drones like the Teal Golden Eagle are changing warfare. Defense budgets across the globe need to replenish and many have doubled in NATO countries. Many of these new programs like the SRR program of record go well past 2030. Red Cat estimates that small unmanned aircraft fleet size of 64,000 for the U.S. Military and approximately 78,000 for U.S. allies. These projections and research were pre Ukraine war. Red Cat has invested heavily in our supply chain inventory. Most of these orders were 18 months ago. We have invested in a new factory in Salt Lake City that can produce tens of thousands of drones per year. We believe we are well-positioned now to meet the growing demand for made in USA drones. The Teal drone is a great drone. So like an iPhone, it's nothing without the apps. Our open platform has allowed for two great partnerships to give the war fighter a complete out-of-the-box system. We have announced partnerships recently with Reveal Technology and Tomahawk Robotics, and expect to add to this list of partners. Each Teal drone now ships with a fully licensed version of Kinesis software from Tomahawk Robotics. When you add the Reveal mapping capabilities, you can give the warfighter tactical advantages not seen before on the battlefield. I could spend an hour on the capabilities we are bringing to the table with these three companies. Let's talk about Skypersonic. The Skycopter is an inspection drone and we expect the Infrastructure Bill to produce large contracts in late 2023. We are on our second version of the Skycopter. It is a much more reliable drone now. We have also found a new market for the Skycopter, the military. The Skycopter is a great solution for GPS denied flying. This includes caves, abandoned buildings, tunnels and any other place you don't want to put a soldier at risk. We have received some great initial feedback from recent demonstrations for the U.S. Military down in Fort Bragg. Let's switch gears and talk about current contracts and then the SRR program. As you know, we have a $90 million contract with the Border Patrol. We are one of a handful of companies in the contract. They recently gave us a purchase order for approximately $1 million. They gave similar contracts to two other companies. We believe we are in a bake-off to replace the existing Chinese fleet. We expect to ship this order in January 2023. We believe we are well positioned with our capabilities to fly at night when most missions take place. Red Cat's mission is to dominate the night, and we hope to expand the Border Patrol contract throughout 2023 and beyond. SRR, otherwise known as Short Range Reconnaissance Tranche 2, SRR T2, program of record. Tranche 2 is going according to plan. We have weekly meetings with the Army and the first flyoff is in January, 2023. This is an alpha version of the new Tranche 2 bird. We are excited to demonstrate the capabilities of our new drone and payload. We are also pleased to report the Tranche 3 has been cancelled. They are adding Tranche 3 to Tranche 2 to accelerate the program. We believe this will increase the contract size of Tranche 2 as it absorbs Tranche 3 capabilities. To summarize, we are excited that our brand new factory is now producing the newest version of the Golden Eagle. We expect that the 2023 to be an explosive year for drones. And with that, I'm going to hand it over to Joseph. Thank you.

Thank you, Jeff, and to everyone for joining the call today. I will now provide some financial highlights of our results for the second fiscal quarter, which ended on October 31st. Year-to-date, our revenues for the first six months of fiscal '23 increased 41% compared to the same period last year. This reflects contributions from all of our wholly-owned subsidiaries. Most notably, year-to-date revenues for Teal increased significantly on a year-over-year basis as it begins to generate revenues from its military contracts and relationships. During the quarter, much of our focus continued to be on building out the Teal organization and preparing it for the multitude of revenue opportunities that are emerging, some of which Jeff just described. We doubled the size of its manufacturing facilities, both to increase its manufacturing capacity and to house its workforce, which has more than tripled since we acquired Teal. While this strategy has resulted in higher operating costs, we strongly believe that controlling the manufacturing process internally best positions us to take advantage of sales opportunities rather than relying on third-party manufacturers. Operating expenses totalled $7 million in the second fiscal quarter compared to $3 million in the same quarter last year. This increase largely reflects our people and facilities expansion at Teal, which at this point is significantly completed. After careful deliberation, the company has decided to sell the Consumer segment and exclusively focuses efforts and resources on the Enterprise segment, which means Teal and Skypersonic. As Jeff noted, the war in Ukraine has changed the rules in the battlefield with drones playing an ever-increasing role. We believe that our initial government contracts are a positive indication regarding the future scope and size of additional contracts. We will realize a profit on the sale of the Consumer segment and the proceeds of $18 million will provide non-dilutive capital to support our growth initiatives. We ended the third quarter with almost $33 million in cash and marketable securities and remain in a strong financial position. I will now turn the call over to the operator for questions.

[Operator Instructions] At this time, I would like to turn the call to Joey Delahoussaye of CoreIR to read pre-submitted questions for management. Joey?

Thank you, MJ. Jeff, over the last few weeks, we received a few questions from investors recently. And -- but this would be a good chance for you to address those for all investors. Why don't we just dive right in on these questions? Can you provide any update on the divestiture of the Consumer segment and when that will possibly close?

Yes. I think it's on track. They have recently filed their S-1, which is part of the IPO process for them, which gets the clock ticking so that we can get to a close because that's -- their IPO is one of the conditions to close the deal. And I know they've submitted their S-1 to the SEC. So that is a good first step. And so as soon as they get reviewed and get the okay, they'll get up to the market to IPO. And we will be able to get -- as Joseph mentioned, that will raise $18 million for us of non-dilutive capital.

Okay. Great. And in past press releases and conferences, you've mentioned having exposure to the Ukraine conflict and possible international sales being part of your pipeline. Do you have any update on how some of the international efforts may be going?

Well, there's no contract wins yet, but we are still -- and that's expected because of the timelines of the RFPs, but we do have quite a few RFPs and our team will be in Europe and Africa. They actually just got back from Africa in -- starting in late January, and they'll be there for a couple of months because there's a lot of activity there, specifically with our new bird that we'll be bringing. So we hope to get some of these RFPs or at least a couple of them I know that we should be finding out if we're down selected in January, which is good. So yes, there's a lot of activity, not only in Europe and NATO and Africa right now, we are working on two different things in Africa. But also in Asia, we're starting to get quite a bit of activity on some pretty large contracts.

Okay. Great. And then last one. In your prepared remarks, you gave an update -- a bit of an update on the Army's Short Range Reconnaissance program. Is there anything else that investors should possibly know about where that stands?

Yes, we just found out about this, and they basically took Tranche 3 and all the capabilities that were going to be required for Tranche 3 and they absorbed them into Tranche 2. We believe this is also because of the activity in the Ukraine. Everyone needs drones now. They don't want to wait another three years for the Tranche 3 program to get the drones that they need for the warfighter. So that that's a pretty significant change for us. And we're pretty excited that how far along we are in this process and that would actually not have to finish in May through September, and they start the whole process and we demo for Tranche 3 late next year. It's all going to be -- those three years are going to get combined right in the Tranche 2.

Wow, that's pretty interesting. Does that mean then that the Tranche 2 program is possibly a bigger in award value now that it's combining, I guess, essentially elements from Tranche 3?

Yes, absolutely, it would be much larger than Tranche 2 would have been by itself. And when we looked at the beginning of the program for the SRR program, it looked like it was going to be about a little under $0.5 billion program of record that was years ago. Tranche 1 ended up being $100 million. So now that Tranche 2 and Tranche 3 are combined, if we fill out the rest of that program of record, it could be a very substantial contract for hundreds of millions of dollars. Yes, it's pretty exciting. And also we typically would get additional capital from the Army for Tranche 3 prototypes. So we were hoping that we also get additional capital from the Army early next year for the additional features and prototyping. So this is really good news for us. Actually, it's great news for Red Cat and Red Cat shareholders. We're pretty far down the process. We now have a factory that's capable of handling Tranche 2/2 and 3 now. We -- there's a lot of contracts out there across the globe, and it’s a brand-new Golden Eagle that’s just starting to come off the production line. It’s flying great. We've got the best payload in the industry, basically that for -- that means best camera for most people to understand that. And with that new camera and the thermal capabilities, we can dominate the nighttime and nighttime is when all the missions take place. So the Golden Eagle and the new Teal capabilities with the new payload are made specifically for the military, for the Department of Defense and very much focused on the Army, Marines and Navy. So we're building drones for the military. We're not a consumer company that happens to make some drones for the military. We're only focused on the military and don't make consumer drones. So we expect it to be quite an exciting 2023.

Great. Well, Jeff, thanks for those answers. Those were the last of the previously submitted questions. And I'd like to turn the call back over to you for any other closing remarks.

Well, I don't have any additional remarks. I just want to thank everybody for jumping on the call, and we'll talk to you when we do our next quarter. Thanks, everybody.