Red Cat Holdings, Inc.

Ladies and gentlemen, thank you for standing by. Good afternoon and welcome to the REDCAT Holdings fiscal 2023 second quarter 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 telephone keypad. To withdraw your question, please press star, then do. 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 Delahousie, Vice President of Core IR, the company's investor relations firm. Please go ahead, sir.

Thank you, MJ. Good afternoon, everyone, and thank you for joining us for the Redcat Holdings Fiscal 2023 Second Quarter Financial Results and Corporate Update Conference Call. Joining us today from Redcat 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 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 on Form 10-K and Form 10-Q and then 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 15, 2022, 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.

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 REDCAT, 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. The 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 in the changing battlefield, source CBC. Russia and Ukraine are fighting the first full-scale 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, said Samuel Bendet, a military analyst at the Virginia-based research group CNA. The proliferation and availability of combat drones for longer 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. REDCAT estimates that small unmanned aircraft fleet size of 64,000 for the U.S. military is and approximately 78,000 for U.S. allies. These projections and research were pre-Ukraine war. REDCAT 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, but like an iPhone, it's nothing without the apps. Our open platform has allowed for two great partnerships to give the Warfighter 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 inspect the infrastructure built 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 in 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. REDCAT'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, SRRT2, 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 that Tranche 3 has been canceled. 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 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 through 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 totaled $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 Thiel, which at this point is significantly completed. After careful deliberation, the company has decided to sell the consumer segment and exclusively focus its efforts and resources on the enterprise segment, which means Thiel and Skypersonic. As Jeff noted, the war in Ukraine has changed the rules on 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.

Thank you. Ladies and gentlemen, if you wish to ask a question on today's call, you will need to press star then the number one on your telephone. If your question has been answered and you wish to withdraw your request, you may do so by pressing star then 2. 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. As a reminder, to ask a question, you may press star, then 1. At this time, I would like to turn the call to Joey Delahousie of Core IR to read pre-submitted questions for management. Joey? Joey, is it possible your line is muted?

Yes. Sorry. Thank you, MJ. Jeff, over the last few weeks, we've received a few questions from investors recently, and I thought 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?

Yeah, I think, you know, 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 their IPO is one of the conditions to close the deal. And I know that they've submitted their S-1 to the SEC, so that is a good first step. And You know, 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, you know, as Joseph mentioned, that'll raise $18 million for us of non-dilutive capital.

Okay, great. And then 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 might be going?

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 starting in late January, and they'll be there for a couple of months because there's a lot of activities uh, there, uh, 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, uh, which is good. So, uh, yeah, there's, there's a lot of activity, uh, not only in, uh, uh, Europe and NATO and, uh, Africa right now, we have working on two different things in Africa, but also in Asia, we're starting to get, uh, quite a bit of activity on some pretty large contracts.

Great. And then the last one, you know, 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, you know, should possibly know about where that stands?

Well, yeah, we just found out about this. And, you know, 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's... that's a pretty significant change for us. And, you know, we're pretty excited that how far along we are in this process and actually not have to finish in May through September. And they start the whole process and the demo for tranche three late, late next year. It's all going to be, those three years are going to get combined right into tranche two.

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?

Yeah, absolutely. It would be much larger than Tranche 2 would have been by itself. And, you know, 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 a half a billion dollar program of record. That was years ago. You know, tranche one ended up being $100 million. So now that tranche two and tranche three are combined, you know, if we fill out the rest of that program of record, it could be a very substantial contract for hundreds of millions of dollars. Yeah, it's pretty exciting. And also we typically would get additional capital from the Army for tranche three prototypes. So we're hoping that we also get additional capital from the army, uh, early next year, uh, for the additional features and prototyping. So this is really good news for us. Actually, it's great news for, for Redcat and Redcat shareholders. Um, we're pretty far down the process. We now have a factory that's capable of handling tranche two slash two and three. Now, um, we, there's lots of contracts out there across the globe, uh, and, uh, The brand-new Golden Eagle is just starting to come off the production line. It's flying great. We've got the best payload in the industry. Basically, that means, you know, best camera for most people. 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, John, thanks for those answers. Those were the last of the previously submitted questions. 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.

The conference is now concluded. Thank you for your participation. You may now disconnect.