Red Cat Holdings, Inc.

Ladies and gentlemen, thank you for standing by. Good afternoon and welcome to the Red Cat Holdings Fiscal Second Quarter 2022 Financial Results and Corporate Update Conference Call. At this time, all participants are in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then one on your touchtone phone. To withdraw your question, please press star, then two. 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 20th, 2022. I would now like to turn the call over to Scott Gordon, president of CoreIR, the company's investor relations firm. Please go ahead.

Thank you, Ilie. Good afternoon, everyone, and thank you for joining us for the Redcat Holdings Fiscal Second Quarter 2022 Financial Results and Corporate Update Conference Call. Joining us today from Redcat Holdings are Jeff Thompson, Chief Executive Officer of Redcat Holdings, and Joseph Hernon, Chief Financial Officer. During this call, management will be making forward-looking statements, including statements that address Redcat'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 REDCAT's most recently filed periodic reports in Form 10-K, Form 10-Q, and REDCAT'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 20th, 2021. except as required by law, REDCAT 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.

Great. Thank you, Scott. Good afternoon, and thank you all for joining our fiscal second quarter 2022 call and webcast. Also joining me today is Joseph Hernon, our Chief Financial Officer, We've completed many milestones in Q2. We were awarded a NASA contract. We closed the Teal Drones acquisition. We have brought on key hires for our business development and sales and opened a U.S. manufacturing facility in Salt Lake City. I will start and review our consumer companies, Rotoride and Bad Shark. Bad Shark is continuing to develop its digital system called SharkBytes. SharkBite is a high quality, low latency, high def FPV, which means first person view system. We are now seeing approximately 50% conversions from analog to digital. We expect that to add momentum to the 2022 calendar year revenue. We are also seeing crossover opportunities in commercial and military use cases. I'll now turn to Rotor Riot. Rotor Riot produces weekly drone media and has an online store where we can buy products seen on the weekly YouTube shows. Rotor Riot continues to grow and has over 235,000 subscribers. We are happy to report that we've been able to get most of our Rotor Riot supply chain issues fixed that were causing us to be out of stock on popular items. We expect the store to gain new users as Rotoride becomes a one-stop store for ready-to-fly FPV drones and has reliable inventory. Next, I'll talk about Skypersonic. Skypersonic has a drone platform that combines artificial intelligence software with the camera and sensors of the Skycopter Inspection UAV. They also have remote piloting capabilities, which breaks the one drone, one pilot drone problem. This capability was crucial in getting the five-year NASA contract we announced in September. NASA's crew will conduct simulated spacewalks and operations by remote piloting Skypersonic drones and rovers in a simulated Martian environment. Skypersonic's real-time transoceanic remote piloting platform will drive the piloting on both the drones and the rover. We believe Skypersonic software and hardware platform will benefit also from this recent infrastructure bill that was passed. There are millions of miles of sewer that will need inspections and hundreds of thousands of bridges that will need inspection. We expect Skypersonic to have an exciting 2022. Let's dive into our newest acquisition, Teal Drones. Steel Drones has built a complete drone platform. We believe it is one of the most capable drones in its category. I recently toured the new facility and was able to see the Golden Eagle fly simulated missions. Its performance was incredible. It's quiet, it's stable, and reliable. We recently announced the opening of a manufacturing facility of approximately 13,000 square feet. We have since decided to double the size of the manufacturing to 26,000 square feet. These new production lines will be able to produce thousands of drones a month. We have invested in machinery, robots, and inventory to meet existing and expected contract awards. Before we talk about contracts, I would like to talk about the recent events in the US. DJI was put on the Department of Commerce entity list last December. The U.S. government will place eight Chinese companies, including drone manufacturer DJI, on the investment block list. The House has a bipartisan bill banning existing government fleets of Chinese drones. The Senate has a similar bipartisan bill, and we expect both to pass. This gives Teal a great opportunity to fill the gap with maiden USA drones. By banning all federal dollars from Chinese drones, this opens public safety and first responders as a new category for the Golden Eagle. These new bills could also ground thousands of Chinese drones that will require immediate replacement from made-in-USA drones. So now let's talk about SRR. Most of the questions I get from investors is basically about the short-range reconnaissance tranche 2. The SRR contract is to put a drone in every rucksack. Teal Drones is almost two years into this process. We have nothing new to report, and we'll update our investors as soon as we hear back from the Army. I will now hand the call over to Joseph Hernon, our CFO.

Thanks, Jeff, and to everyone for joining the call today. I will now provide a review of our financial results for our second fiscal quarter, which ended on October 31st, 2021. Revenues during the quarter totaled almost 1.9 million, representing a new quarterly record for the company. This represented an increase of more than 300% compared to the second quarter of last year, in an increase of 33% compared to our first quarter of this fiscal year. We expect to report continued sequential revenue growth going forward. Gross margin as a percent of revenues was 8% during the second fiscal quarter compared to 7% in the first fiscal quarter and 19% during the same the second quarter of last year. The lower gross margins that we have been experiencing in the first half of fiscal 22 reflect higher product and shipping costs as we have been impacted like many businesses by COVID-19. We expect gross margins to improve going forward, especially as we begin to scale up manufacturing at our newly opened and expanded facility for teal drones in Salt Lake City. Operating expenses totaled $2.9 million in the second fiscal quarter compared to $1.8 million in the first fiscal quarter and $500,000 in the second quarter of last fiscal year. This increase compared to the second quarter of last year reflects the acquisitions of Fat Shark, Skypersonic, and Teal, all of which were acquired subsequent to our reporting results for the second fiscal quarter of last year. The sequential increase compared to our first fiscal quarter related to the acquisition of Teal Drones, which closed early in the second quarter, and represents our largest acquisition to date. Net loss for the second quarter totaled approximately $2.7 million, compared to $1.6 million in the first fiscal quarter and $700,000 in the second fiscal quarter. We ended the second fiscal quarter with almost $60 million in cash and investments. For the first six months of our current fiscal year, ending on October 31st, our year-to-date net loss adjusted for non-cash expenses such as stock-based compensation was $3 million, meaning that our current cash balance provided approximately 20 times coverage of that net loss for the first six months of this fiscal year. I think that really demonstrates that we're in a really good financial position to execute on our growth initiatives over the balance of the fiscal year. I will now turn the call over to the operator for questions.

We will now begin the question and answer session. If you wish to ask a question on today's call, you will need to press star, then the number one on your telephone keypad. If your question has been answered and you wish to withdraw your request, you may do so by pressing star, then two. If you are using a speakerphone, please pick up your handset before entering your request and speaking on the call. One moment, please, for the first question. And our first question today comes from Kevin Deedy with HCW.

Hi, Jeff. Joe, thanks for taking my call. Congrats on the numbers. I'm thinking most of the 1.9 was generated by Teal. Is that the right way to think about it? Not yet.

Go ahead, Joseph.

Yeah, I would just echo that short statement Jeff made. I think at this point, Kevin, in looking back on the second fiscal quarter, certainly you know, Teal made, you know, an immediate impact, you know, on our revenues, but it wasn't even a full quarter yet for the company. And, you know, I'll let Jeff kind of comment maybe on the outlook going forward. Yeah.

Yeah, Kevin, it was, you know, they did contribute, but I think they're going to significantly start to contribute as we head into the next calendar year. As we mentioned in our press release, we expect them to start generating about a million dollars a month starting around January. We expect that to actually move up as we get into further down the year. And, you know, we're getting lots of traction. We're continuing to work with the large contracts on the government, hoping to land some of those soon. But we're also actually already out there – our biz dev team has been flying around the globe, going to other NATO countries and, you know, pitching the golden Eagle and doing demonstrations to other military countries. And we'll get some good traction there. So we're going to have, you know, starting early next year, we're going to have some pretty aggressive revenue growth coming from the, the TL acquisition.

Can we, can we look at it from another perspective, Jeff, what would you estimate the, that DJI's revenue run rate was in their sales to U.S. customers where they've now been excluded?

Yeah, so they are, I haven't been able to find any recent numbers because they, you know, they've basically been thrown out of any government and enterprise capability right now. So they are, I wouldn't have those numbers and no one would share them with us, but we, You know, we believe there's, you know, hundreds of millions of dollars of potential revenue from DGI not being allowed to be part of government funding anymore, whether it's, you know, we know some fleets that are in public safety that are over a thousand drones that are actually DGI drones currently, which we know if some of these bills get passed where you can no longer fly your existing fleet that are Chinese made. You can't renew anything and you can't buy anything new. But to ground the existing fleet could be, you know, thousands of drones per department. You know, obviously the military isn't doing anything with Chinese drones, but, you know, those contracts are also very large. So we think that there's, you know, this vacuum from the DGI ban and now all the Chinese drone bans, are really going to drive things hopefully as close to the Golden Eagle than anyone else.

Who would you size up as able and ready to manufacture competitors?

That's a great question. I know that on the consumer side, you know, of the five that are allowed that are, you know, in the SRR program, Skydio is probably the biggest threat because, But I think that with our more military-style bird, the Golden Eagle, the new manufacturing facility that we just set up, is really going to give us the capabilities to meet those large contracts. But for competitors, I would say there's only Skydio that we would have to worry about.

So granted Salt Lake City, but my understanding was you were trying to build out facilities in – PR, am I thinking about that incorrectly? And then why Salt Lake City?

Yeah, so the TEAL team is all there. The manufacturing is going to be in Salt Lake City. We've just moved into a new facility that I was at two weeks ago. They're moving from basically pre-production to actually a real assembly platform where they can actually get better yields and better reliability. And, again, from the activity that we have on the sales side now, we've actually opted to double the size of that factory just two weeks ago.

When do you suspect you'll be sort of at full factory utilization?

Well, I mean, the factory can put out thousands of drones a month. So for us to get there, that's going to take a while, but we're – We're excited to get to 200, 300 drones a month over the next 12 months, but we're not going to be stopping there. The SRR contracts are getting awarded late next year, and we have other big opportunities. So we're going to be building this facility as quickly as we can. We've been buying up a ton of inventory. We're getting everything we need to get up to, you know, thousands of drones per month, which, you know, and they cost about $14,400 if you look at the GSA website. So it's going to be some pretty significant ramp in capability and revenue.

Well, congratulations, Jeff. Joe, thanks for taking my questions. Thanks, Kevin.

Our next question comes from Scott Michael, a private investor.

Thank you. I don't know if I can be heard. Can you hear me? Okay. Okay. Thank you. Um, do you have, uh, congratulations on the building by the way, is there a timeframe for the completion of the upgrade in the teal production building?

Uh, well, we, we, we, we just started building it in September and it's already producing groans. You know, we closed in September. And right away we got into the new facility and started building the production and manufacturing capabilities. The new site that's going to be right next to the existing site is, you know, we just signed. So that's going to take some while. But we can get up to thousands of drones in the existing location. But we are already planning to, you know, really bring capacity way up.

Okay. Okay. Thank you. Secondly, the timeframe for the Fatshark development on the digital system, is there a timeframe for that as well as the Skypersonic infrastructure attempts?

Yes, I'll start with the last question first. So, as you all know, the infrastructure bill just got passed this fall. No one's expecting significant awards to happen until at least mid-next year. So for actual infrastructure, official infrastructure contracts for Cypressonic, we don't think we'd see anything until mid-next year. They are also doing a ton of work also around the globe, not just teal drones, but we've been working with Aramco. I know we just finished a large training, a 10-day training period for the Aramco drone purchases that they've made. We're continuing to work with GM on inspecting their sites and helping them with inventory in parking lots, using our artificial intelligence. We continue to get other wins. We're starting to see not just the teal drones made in the USA is important, but a lot of large companies do not want to award inspection contracts to uh, Chinese made inspection drones. So our made in USA, uh, Skycopter also gives us some great opportunities for here and now inspection revenue, which, um, you'll continue to see, hopefully we continue to see more wins like we did with NASA, uh, in the remote piloting capability gives us a huge advantage and we're also made in USA. So I think you'll, You'll see some steady growth out of Skype or Sonic, and then we don't know what's going to happen once we start seeing infrastructure dollars hit.

Okay, thank you. And the Fat Shark development of the digital system, is there a timeframe for that?

Yeah, well, they have versions of it now. It's continuing to be improved and continue to get better features and continue to get updates. The system is amazing. It's very low latency, much faster. much lower latency than the Chinese competitor's goggle set for FPV. So we're out there selling it now, and we're starting to finally see, as I mentioned in my remarks, we're starting to see people switch from the analog platforms to the digital platforms. So that's a great stage because the analog systems work. um the fat shark goggles are very well made so they last a long time so people don't really have to replace them all the time but now that we're seeing about 50 of the the people coming on board are using are switching to digital and hopefully we can see that conversion rate go up then the hd system will continue to get traction uh throughout the year okay two other questions if you don't mind um has the chip issue been resolved but

for a teal and then secondly, or lastly, I know you can't comment on the tranche to status, but can you at least reference if the government has not eliminated, uh, peel from the consideration at this point?

Oh, absolutely not. Teal is not eliminated from the process. Um, we continue to work with them, which is, uh, you know, we're pretty excited about, but again, we don't have anything, uh, to report there. And I'm sorry, what was the other question?

The chip for production for TEAL. Last conference, I believe, there was an issue securing chips. I think you only had 600. Has that chip issue been resolved for manufacturing purposes?

Not completely, but we are starting to see relief in some chips coming in quicker than we had planned for. One of the bigger issues we were having last call was the batteries which Which you know when I got my tour I don't mean to go on a tangent here But people don't realize how many features the battery that we've designed that teal has designed They've done. I mean, there's like a hundred features in that smart battery. It is an amazing piece of technology But we have that resolved and we are starting to see some relief going into you know the you know all of the supply chain constraints and But not every single chipset is perfectly available. So our team was actually very forward in, you know, mostly Allen Evans, our COO, really pushed us to make sure we ordered early to get in the front of the line. And that's worked out really well. So we don't think that we'll be constrained as we're building up our monthly build capability. We think that we'll be fine and we'll get through this chip shortage.

Okay, thank you very much.

Thank you. Thanks for the questions.

Our next question comes from Dan Fan, a private investor.

Hello, this is Dan. If you can hear me okay, congratulations on the growth in revenue and productivity from Teal Trones. Most of my questions have been answered, but I have one left. So given these supply chains have been relieved and There were a lot of proactive activities I've heard there as far as, you know, getting us ready to produce more teal trones that the main revenue stream right now. My only question left is, so what are we doing with the 60 million plus or the significant amount of cash equivalent to continue with the growth in terms of investment for the short term or long term into next year?

Yeah, that's a great question. Yeah. So, um, you know, first of all, let me back up a little bit. So if we get one of the large, uh, government contracts, uh, it could be for tens of millions of dollars, if not 50 or a hundred million dollars over five years of drones orders, which means we got to, we would need to put a good chunk of capital to work. That's the reason that we raised the money in July is to have the capital to be able to, uh, a build out a factory that can handle the, the, the actual requests for a large contract. We could actually build what we are quoting and then to be able to have the actual capital to, to buy all the parts to, to fill such a large order. We're also just at the beginning of building our enterprise sales team. And, and, um, you know, we're, we're not fully, uh, employed. We don't have all the employees that we're looking to get. We were hiring. We had about 10, uh, hires that we're looking just for Teal, and then the sales team probably has five or six people the next year that we'll be filling in with high-quality biz dev and sales folks. So we'll be investing in our sales and marketing and manufacturing, customer service, all the things that we're going to need to be able to supply these large government contracts with good service and possible other acquisitions.

Okay, then that was my next question. If there was any acquisition in the plant, it would make us more competitive in this field.

Yeah, most of the – anything that we're looking at right now, as I mentioned on the last call, is mostly software-driven that would help the TEAL platform. Got it.

Thank you very much.

Great. Thanks for your questions.

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

Great. Thanks. Uh, I just want to thank all the employees at Redcat. Um, we're, we've got an incredible team. Uh, I was able to go out and see the folks at Teal. My next question is to get up and see the folks at Skypersonic. They're doing a great job. Uh, I'm at Rotoride all the time. Uh, but, uh, so we're, we're, you know, we're pretty darn excited about this next year calendar year. We have a weird year end for our fiscal year, but, uh, We're very excited. I want to thank all the employees. I want to thank our customers, and I want everyone to have a great Christmas. Merry Christmas.

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