Red Cat Holdings, Inc. (NASDAQ:RCAT) Q1 2023 Earnings Conference Call September 12, 2022 8:30 AM ET
Company Participants
Joey Delahoussaye – Investor Relations
Jeff Thompson – Chief Executive Officer
Joseph Hernon – Chief Financial Officer
Conference Call Participants
Ashok Kumar – ThinkEquity
Kevin Dede – H.C. Wainwright
Operator
Ladies and gentlemen, thank you for standing by. Good morning and welcome to the Red Cat Holdings Fiscal 2023 First 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 1 hour after the end of the call through December 12, 2022. I would now like to turn the call over to Mr. Joey Delahoussaye, Vice President of Core IR the company’s Investor Relations firm. Please go ahead, sir.
Joey Delahoussaye
Thank you, Andrew. Good morning, everyone and thank you for joining us for the Red Cat Holdings’ fiscal 2023 first 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, September 12, 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?
Jeff Thompson
Thanks, Joey and thank you. Welcome to our first quarter fiscal year 2023 earnings conference call. This is an exciting conference call for Red Cat. This is the first quarter with organic revenue from Teal Drones production line in Fat Shark digital goggles. I will start with summaries of each subsidiary, including progress on the Army Tranche 2 program and high level status on Request for Proposals across the globe.
So, let me start with Rotor Riot. Rotor Riot continues to improve revenue and margins and is just starting to see in-person community events like quads and coffee return. In-person events are similar to music concerts that promote a record release. Rotor Riot had a record quarter and with a new digital advertising campaign. New digital goggle launches should provide tailwinds for the consumer segment for the next 12 to 18 months.
Let’s now talk about Fat Shark. In Q1, Fat Shark launched the new headset and saw the largest pre-order first day sales of any headset to-date. And Fat Shark has been around since 2007. The Dominator headset is getting great reviews and we hope to see follow-through for the next few quarters. Skypersonic, the Skycopter drone can be piloted virtually anywhere from virtually anywhere as the Skypersonic team recently demonstrated on Mt. Etna in July using Skypersonic’s long-range real-time remote piloting system, the drone on an active volcano in Italy was controlled by personnel in Houston, Texas in real-time. Whereas most drones cannot be piloted without connecting to the GPS network, Skycopter uses technology that is able to control and track the drone in locations such as Mars where GPS is not available. We believe the Skycopter will be a leader in infrastructure inspections next year. But we also believe that technology can be very useful on the battlefield and for first responders being able to fly indoors in caves and tunnels in GPS-denied locations is game changing not only for infrastructure inspections, but also for the dismounted warfighter.
And I will talk about Teal Drones. Let’s start with the production line. We are currently switching from PVT, production validation tests to ramp in mass production. Mass production enables Teal to continue to improve ongoing yields, qualify additional tools or vendors, make design changes based on customer feedback, any early field failures or cost down efforts. We have significant design improvements as we go into mass production, specifically the camera payload. We believe that having a made in USA factory up and running at mass production a strategic advantage for the RFPs we are working on and the Tranche 2 production contract. That brings us to SRR Tranche 2 short range reconnaissance program for the Army and the DIU. Teal Drones continues to meet the scheduled milestones for the Tranche 2 prototype design and expect to have a flying prototype by the end of the calendar year. The Tranche 2 production contract is still expected early in the first half of next year.
Now, let me talk about some of the potential sales pipeline for the Golden Eagle. We are fielding multiple requests for proposals RFPs with NATO allies for the Teal Golden Eagle and the Skypersonic Skycopter. We continue to work with these customers and prospective customers to translate their interest into firm purchase orders and contracts. We are seeing many opportunities and demand growing. We believe this will set Red Cat up for a strong fiscal 2023.
In summary, we have new products, new software capabilities, a new production facility and organic growth from Rotor Riot, Fat Shark and Teal Drones and expect the Skycopter, our least mature product to be very important revenue generator next year. We have much to do, but we are close to firing on all cylinders.
And with that, I will hand the call over to Joseph, our CFO.
Joseph Hernon
Thank you, Jeff and to everyone for joining the call today. I will now provide a review of our financial results for the first quarter of fiscal 2023, which ended on July 31, 2022. I am very pleased to confirm that fiscal ‘23 is off to a resounding start as revenues for the first quarter totaled $3.1 million, which represents 120% growth compared to the first quarter of fiscal 2022. Another comparative measure of the strength of the quarter is that revenues for the first quarter of fiscal ‘23 equaled almost half or 48% of our revenues for the full year of fiscal 2022. Q1 revenue growth was led by strong shipments of the Dominator, the new digital goggle released by Fat Shark. In addition, revenues for Teal continue to grow, even as we spend much of our focus on completing its manufacturing capacity expansion.
Looking forward, we remain confident that we will deliver strong revenue growth in fiscal ‘23. Operating expenses increased significantly in Q1 of fiscal ‘23, totaling $4.1 million compared to $1.8 million for the first quarter of fiscal ‘22. This increase was planned and expected and primarily relates to the acquisition of Teal Drones, which occurred after the end of the first quarter of fiscal ‘22. Since acquiring Teal in August of 2022, we have invested significantly in building out the Teal organization and preparing Teal for the multitude of revenue opportunities that are emerging. We have doubled the size of its facilities both to increase its manufacturing capacity and to house its workforce, which has increased significantly since we acquired Teal. While this strategy adversely impacts short-term operating results, it is necessary to position us to take advantage of much larger long-term growth opportunities.
As expected, other income and expenses in the first quarter of fiscal ‘23 was minimal compared to some of the large and fluctuating amounts that we reported in prior quarters. Most of these variable charges related to derivative features that were embedded in convertible notes and warrants that we issued in fiscal 2021. These derivative expenses and income on non-cash charges that are highly correlated to changes in our stock price. To-date, all of the notes have been converted into common stock and approximately 25% of the warrants have been exercised. As a result, future amounts related to these derivative features are expected to continue to be modest.
Our net loss for the first quarter of fiscal ‘23 totaled $3.8 million or $0.07 per share compared to $1.6 million or $0.05 per share for the first quarter of fiscal ‘22. Cash used in operations totaled $4.8 million in Q1 of ‘23 compared to $4.1 million in Q1 of ‘22. A key driver of our cash burn in addition to building the Teal organization has been building inventory levels, which totaled $6.4 million at the end of the first fiscal quarter of ‘23. These higher-than-normal inventory balances can be partly attributed to the supply chain issues, including the availability of computer chips, which are essential to many of our products. In addition, we have increased inventory levels to support the launch of the Dominator by Fat Shark and forecast sales growth for Teal. We ended the first quarter of fiscal ‘23 with almost $43 million in cash and marketable securities and less than $2 million in debt. We remain in a strong financial position to execute on our growth initiatives.
I will now turn the call over to the operator for questions.
Question-and-Answer Session
Operator
[Operator Instructions] The first question comes from Ashok Kumar with ThinkEquity. Please go ahead.
Ashok Kumar
Thank you, Jeff and Joseph congratulations. Two questions. One, you applied to the NATO allies RFPs, can you please give us some color on size and potential? Second question is any color on the Tranche 2 that would also be helpful? Thank you very much.
Jeff Thompson
Great. Thanks, Ashok. Thanks for being on today. Yes, so we have – our biz dev team has been demoing the Golden Eagle, as I have mentioned in previous calls all over the globe. And we have – I actually were – was at a few of the events at USASOC down in Fort Bragg area recently. And we are getting some great feedback and we have applied for a lot of RFPs to a lot of the Eastern European countries. We have a couple for about 600 systems, some for 300 systems, and 2 for over 2,000 systems. So, we don’t expect to win every single deal and some of them will probably be multi-vendor, but these are large, large possible proposals and contracts that we could win and being a made in U.S.A company and approved by the DoD we think gives us a strong position to do so. So we are in the middle of some of these, we hope to – couple of them we hope to hear within about a month and some of them go along in different stages where we have already been down selected for first stage and are already in the second stage. So, we don’t give guidance yet, but we have probably close to over 3,500 drones and we are in proposals right now. And on the Tranche 2 process, we are – we have gotten through some of the hardest parts, which is the product requirements document, which has to be approved and make sure that the DIU, which is running a very tough process, but we are getting through those stages and we are meeting the requirements of the drone that’s being proposed for Tranche 2. And again we are getting ourselves into mass production. If we win Tranche 2, we will be capable of basically hitting the ground running and produced this drone as quickly as possible.
Ashok Kumar
Great. Thank you very much and all the best.
Jeff Thompson
Great. Thank you.
Operator
[Operator Instructions] The next question comes from Kevin Dede with H.C. Wainwright. Please go ahead.
Kevin Dede
Good morning, Jeff, Joe. How are you guys doing?
Jeff Thompson
Hey, Kevin. It sounds like you are at the conference already. We assume.
Kevin Dede
Yes, I am. I apologize for the background noise. Looking forward to having you here. I think listen, Joe, I know you spent a lot of time reviewing the organic versus acquisitive contribution to sales, but could you just speak specifically to the fourth quarter to first quarter change please? You lost me a little bit on the Teal side.
Joseph Hernon
Yes, Teal revenue so far, Kevin, has been pretty modest. It’s growing gradually. It was almost all of the enterprise revenue in the first quarter. So it was about $1 million in the first quarter. Consumer accounted for about two-thirds of the revenue in the first quarter and that was split pretty even between Fat Shark and Rotor Riot. And consumer continues to get closer to operating breakeven. So we expect Teal revenue to continue to gradually increase, but it’s coming off of a fairly low base number. Right now, I don’t have a breakout of the Q4 revenues, but I can say that the growth – the sequential growth was largely driven by consumer although enterprise did help a little bit.
Kevin Dede
Okay. So, consumer two-thirds of the $3 million, roughly $3 million?
Joseph Hernon
Yes.
Kevin Dede
Okay. And then the balance roughly Teal?
Joseph Hernon
Almost all Teal, Skypersonic was negligible.
Kevin Dede
Okay, okay.
Joseph Hernon
And one of the things, Kevin, just one of the things we are doing beginning with the first quarter of this year is we are reporting on a segment basis, so that information will also be in our 10-Q.
Kevin Dede
Awesome. Okay. How about progress update on construction of the manufacturing facilities, just to look into material sourcing and your comfort and meeting timeline?
Jeff Thompson
Yes, that’s a great question, specifically, how manufacturing is so crucial to our – to Teal continuing to grow. And to just to add a comment to what Joseph just mentioned is we basically went from almost zero revenue to a $1 million in revenue for Teal in just one quarter and being the first couple of months of the factory getting up online. So, that’s a very early stage production line, which is now maturing. And as I mentioned in some of my comments in my press releases that we are now going from PVT to mass production and ramp, which we take all the things that we learned from the PVT stage and now we basically fix any issues and problems and vendors and tooling that we want to do to automate production line so that we can really scale it as we – if we get any of these RFPs we are going to have to start producing a lot of drones very quickly. So the – we are pretty good with – there are some components we are still having some tough times with in the supply chain. We think we have almost all of that resolved currently. Still cautious, but we did a lot of ordering and thanks to the Teal team and Dr. Evans for getting us to put orders in last year, we are in pretty good shape with our supply chain and chipsets to be able to continue to ramp Teal’s revenue from where it was two quarters ago basically zero to a $1 million to pretty dramatic revenue growth over the next few quarters. So, but yes, the production is getting there. It’s not the factory, as Joseph mentioned, is also we doubled it in size. Right away, as we started building, we realized we needed more. And so, that’s where we are right now with manufacturing.
Kevin Dede
Yes. So, you were – I remember speaking with you last time and you were still working through the construction of the facility now, where are you with regard to that? Is that the addition there? Has that been complete?
Jeff Thompson
No, the addition is, so I will give you exactly where is it. So we have a complete, same size location right next to the first location that we opened. We had the production line up and running. And then we decided to – we do expect to open up a wall and bring the other side in, which will, because we have a lot of inventory control capabilities inside the facility, specifically, when you are selling to the military, it has to be very secure. So we have to open up the other side and sometimes that slows down the existing production line, because of all the construction dust and things of that nature. We hope to have the construction done in the next month or two and put this behind us and that will also bring us into full mass production.
Kevin Dede
Can you peel the onion back a little bit on DoD contracts, are your drones expected to be weaponized and is that like an additional level of security and process?
Jeff Thompson
Yes. So, it’s the difficult thing that’s happening right now in the – with the Ukraine war going on, as people are realizing the small drones are so crucial for warfare. I mean you may saw the Fat Shark goggles, if you Google it, are being used for the 93rd Brigade in the Ukraine, to use racing drones, for small racing drones with kinetics on them. Fat Sharks, also looking at ways to make sure that the new Dominator goggle can be mounted on a warfighter’s helmet and have the proper antenna placement for things of that nature. And the next step where you see kinetics put on any drone that we make, that is a very lengthy process to get approved to do that. If we – there are RFPs out there for drones with kinetics on there. And if they want to use the Golden Eagle, we would partner with someone that’s already approved and gone through the 2-year process to do so. But on top of that, we have been working very closely. I was recently at the – last time we spoke as a few weeks away from going to use the sock to demo the 4-Ship product and the revealed partnership we recently announced where we actually demonstrated how to go, look at the target, surround the target. get real warfighter information to be able to give them a easy journey to that target without being seen through knowing where line of sight and when non-line of sight things of that nature. A lot of data can be derived from our 4-Ship products, and the reconnaissance that it can do. And then there is – the next step is how do you take small drones like class one drones to be a even more lethal product for the warfighter. So, we are not there yet. But, we are helping the other technologies that are out there that are taking out tanks, like the switchblade and things of that nature. So, we are trying to help the warfighter with as many tools as we can give them to help them and mitigate their safety.
Kevin Dede
So, I did see that. I may have sent you the link when we saw it actually, when the 93rd used. Yes. So, I saw that, but I got the sense that that was sort of an aftermarket modification, right? Am I right with that assumption…?
Jeff Thompson
Yes. That was an aftermarket application where people are typically putting a specific grenade, that when it smashes into the facilities and the grenade goes out. But there are some upcoming RFPs for one way, kinetic class one drones. There is also some RFPs with armed drones that have – would have a six-shooter on them, reloadable. So, there is a completely different world of new class one drones coming out over the next year or 2 years.
Kevin Dede
So, you mentioned a partnership in helping you meet those milestones. Can you categorize where you might be in that negotiation process? Is there – I don’t know, is there a milestone that we could look forward to hearing about and seeing how Red Cat is positioned to participate in that market?
Jeff Thompson
So, there is – here is the – I will give you some short-term and long-term milestones, just to give everyone some goalposts on the call, not just specific to what you just asked. But I think some of the short-term, we continue to work with Border Patrol on that $90 million contract we got in January. We ex – so on the short-term side, we hope to hear –talk about that shortly. Some of the RFPs I mentioned with some of the NATO allies, we think we are in a good position. We are on a couple of those. So, those are some of the short-term goals that we have. There are some other moon shots that we are looking at that are early next year. But then the next large milestone would be the Tranche 2 production contract in early next year. And the last production contract was for $100 million for Tranche 1 and that was before the Ukraine war broke out. And small class one drones are much more important now than they were when Tranche 2, 2 years ago, production contract was awarded. So, those are kind of the goalposts on milestones. In the short-term, it’s mostly the RFPs. And the partners that we were talking about for the kinetics are based out of California, have been doing it for years. When we have something to announce with them, we will make sure that the Street is aware.
Kevin Dede
Okay. The Tranche 2 deal Joe though – Jeff has not been awarded, just to confirm and what’s…?
Jeff Thompson
Yes. So, let me – yes, this is a good housekeeping because people get a little confused with it. It’s a SRR, small range reconnaissance programs, a three tranche program, Tranche 1, Tranche 2, Tranche 3. Tranche 1 – each tranche has prototype contracts, and when you get a prototype contract, you are in the running to win a production contract. Tranche 1 was over 2 years ago, and Teal was one of the five companies that was selected to build a prototype, and they won a prototype contract. But Skydio was one of those five also, and they won the production contract 2 years ago. Tranche 2, there was 37 companies that applied and went demoed their bird in Georgia, and two were selected for the prototype contracts. Of those two, one will win the production contract. And then the same process will happen for Tranche 3. So, we are very well positioned for Tranche 2, not only because of our financial condition, but also the – will be a mature production line by the time Tranche 2 is awarded. And we will have – and we think that our supply chain will be in really good shape by the time those – that contract is awarded.
Kevin Dede
Okay. Then – apologies for hogging the call, Jeff. Just give us a little insight on the timeline for Tranche 3. And maybe your estimation the size of that contract.
Jeff Thompson
Yes. So, tranche – like I said Tranche 1 was $100 million. They don’t really announce the sizes of Tranche 2 and Tranche 3. We expect Tranche 2 to be $100 million to $200 million based on the data that we have, but we have no way to verify that. Tranche 3, we expect to continue to be as large as well. But Tranche 3 will not be announced the timelines and dates, is typically after the production for Tranche 2 is awarded.
Kevin Dede
Okay. Fair enough. Thank you. Appreciate all the color gentlemen. Congrats on the progress. Thanks for having me.
Jeff Thompson
Thank you. That makes sense.
Operator
[Operator Instructions] This concludes the question-and-answer session of the call. I would now return the call to CEO, Jeff Thompson for closing remarks.
End of Q&A
Jeff Thompson
Thanks everybody for joining the call. And I want to thank all the employees from all the different teams. You have done a great job over the last year, the finance team for getting earnings done early. And I look forward to seeing a whole bunch of you folks today and tomorrow at the H.C. Wainwright Conference. Thanks for joining.
Operator
The conference has concluded. Thank you for attending. You may now disconnect your line.
Be the first to comment