Q3 2024 Red Cat Holdings Inc Earnings Call
Participants
Jeff Thompson; Chief Executive Officer; Red Cat Holdings Inc
Leah Lunger; Interim Chief Financial Officer; Red Cat Holdings Inc
Ashok Kumar; Analyst; ThinkEquity
Scott Michael
Presentation
Operator
Ladies and gentlemen, thank you for standing by. Good afternoon and welcome to the Red Cat Holdings fiscal 2024 third-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 June 18, 2024.
Joining us today from Red Cat holdings are Jeff Thompson, Chief Executive Officer; and Leah Lunger, Interim 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 other 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 contain time-sensitive information that is accurate as of today, March 18, 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
Thank you. Welcome, everyone, to our fiscal year 2024 third-quarter earnings conference call. I will first review our Q3 performance and recent achievements, after which Leah Lunger will review our financial results. Next, I will provide information about our outlook for the remainder of fiscal year 2024, and then we will take your questions.
I'm pleased to report that our third-quarter results were exceptional and we once again exceeded our guidance by 16%, achieving our best quarter ever and look forward to finishing the year with another record quarter of organic revenue growth. We believe the Teal 2 airframe is becoming a small UAS of choice for the DoD and other federal agencies, as well as over 10 NATO countries. Bringing the Teal 2 drone to market was a significant milestone and the first drone to focus on nighttime operations.
The Teal 2 was built to dominate the night. With this reliable new airframe and the traction we are getting with customers, software companies felt comfortable integrating onto the Teal 2 airframe. This has allowed us to capitalize on software partnerships that will significantly increase our gross margins. The Teal 2 business model has always been to offer an open source airframe and to be able to put the software that our customers want on the Teal 2 airframe, similar to an iPhone with the apps.
Let's talk about our current announced software partners. We are integrating Teledyne FLIR's Prism artificial intelligence platform onto our next-generation drone under development for the US Army's short-range reconnaissance, SRR program of record. Teledyne Prism AI. platform provides classification, object detection, and autonomous tracking technology in real time, during both nighttime and daytime operations.
We believe customers who purchase this software feature on our drones will increase our gross margins by approximately 25%. We are also integrating radio software features that allow the Teal 2 drone and the next-generation Teal drone to fly in EW environments, or electronic warfare environments. This feature will also increase margins by approximately 20%.
We recently announced our partnership with Primordial Labs, which will bring AI-driven voice control technology onto our platform. Primordial Labs' Anura interface will be incorporated into Red Cat's Teal 2 drones and future products where it will enable operators to leverage natural language to command and control autonomous actions for drones and swarms of drones.
Aero environment, we are fully integrated with Tomahawk Robotics, now part of Aero environment. This enables multi-ship and multi-domain capabilities. This software powers the TIL to four ships one product, allowing a single operator to fight for drones simultaneously to surveil targets with 360 degree situational awareness and or to protect an asset, which followed the asset capabilities and other formations. We have also fully integrated with reveal technology software that delivers intuitive rapid intelligence at the tactical edge blending of art computer vision artificial intelligence and edge computing technologies, giving the warfighter real-time two D maps in near real time 3D mapping and artificial intelligence insight. We have fully integrated with our partner, Athena AI. They have real-time situational awareness through a high-powered soldier readiness, and he's off WorldSpace tracking, detecting and identifying entities seamlessly practical insights of all detections designed to operate on soldier worn AI infrastructure at the tactical edge, advanced visualization of pattern of life and spatial temporal data. We believe that our gross margins with any purchase of one of these software solutions could be approximately 65% plus at the above customer chooses two or more software features mentioned above, we believe could approach 85% gross margins in a previous call. I discussed three revenue opportunities driving our growth, our organic, the replicator initiative and SRR. program of record.
Let's start with organic revenue growth. We launched the Tier two in Q1 2024. Q1 revenue was $1.75 million, a great first quarter for a brand-new drone. Q2 was $3.9 million, 123% sequential quarterly growth, two three was 5.85 million, 46% sequential quarterly growth. We believe that even without any large programs of record such as SRR., we can get to cash flow breakeven as we continue to gain market share in the small drone defense category, traditional feet on the street, organic revenue as the most difficult to execute our business development team has done a great job. And as they tell me, this will be the year of quote unquote, International.
Let's move on to the replicator initiative. The replicator initiative is a strategic effort by the United States Department of Defense aimed at countering China's military buildup. Here are the key points about the initiative. The objective, the replicator initiative seeks to deliver thousands of relatively low cost, affordable autonomous systems across multiple multiple domains within 18 to 24 months. These systems are designed to help the Pentagon address the growing military capabilities of China. The replicator initiative has many moving parts and to outsiders. It may look messy, the DoD and the DI. you are trying to move very quickly which is something new to a large bureaucratic process. We have paused their progress. Our swarm capability and being able to mount an 80 drone portable high on a ship is unique to Redcats and teal estate connected to the folks at the DoD and the DIU., and we believe RTL two and the new S., our drone, our perfect solution for the replicator COMMISSION goals.
And last but not least, let's talk about the short-range reconnaissance Program of Record otherwise known as SRR. But let me start with our newest addition to our Board of Directors, general Paul Funk. The second has joined and is an honor to have general funds on our Board. And we believe he knows what the war fighter requires. As we mentioned in our press release, small manned portable unmanned aircraft systems play an increasingly critical role in close reconnaissance to reduce risks and increased mortality to enhance operational success. Just to remind everyone that Red Hat is the only company of the two finalists for SRI. that will use the facility to enhance operational success. So the final winner take all selection is expected by September 2024. The contract is for approximately 12,000 drones. The award for the first tranche of production drones two years ago was $100 million for 1,083 drones, final delivery of prototypes in May 2020 for more on that, when we talk Q4 guidance, we believe we are well positioned with the first drones designed for nighttime operations, a drone that meets the Army's requirements, a drone system that meets the Army's cost requirements, a drone this open source. It can be continuously upgraded with third party features, a brand-new factory that can meet the Army's production requests and a drone that a Warfighter would use and with the capabilities to complete their mission goals, which leads to our factory production facility in Salt Lake City is in full mass production mode. We are now running 1.5 shifts to meet production goals as we continue to invest in facilities, people and processes. We are now demonstrating that we can build tens of thousands of drones yearly.
And to finish up, let's talk about Q4 guidance. Q4 guidance is approximately $7 million, putting us at almost a $30 million annual run rate. This guidance is also very impressive considering we must switch production to the Army prototypes in April to satisfy the SR. our final prototype delivery in May. If we meet our Q4 guidance, we will have gone from zero to revenue for a product that did not exist last fiscal year to 18.5 million in the Tier twos 1st year.
With that, I will hand the call over to Leah.
Leah Lunger
Thank you that we are thrilled to report record revenues again for the third quarter of fiscal 2024 totaling 5.8 million. This represents growth of more than 250% year over year and 49% on a sequential basis and exceeded our guidance by approximately 16%.
As Jeff mentioned, I wanted to congratulate our business development and manufacturing teams as we've reached a $20 million annualized run rate this quarter, which is a significant accomplishment. Once again, we have guided to continued growth in our fourth fiscal quarter and remain confident in our long-term revenue outlook.
Gross margin for the third quarter totaled 1.1 million or approximately 19% of total revenue on a percentage basis. This represents a year-over-year increase of more than 24% and a sequential decrease of 12%. We anticipate gross margin will steadily improve over time, despite fluctuations from quarter to quarter. This variability occurs for several reasons. First, material and effort required for the short-range reconnaissance contract with the Army vary by deliverables. Second, since we have prioritized building quality customer relationships, we have been generous with our warranty, which can cause variations in gross margin as well. Because of this emphasis on customer service, we're able to leverage feedback from real life product applications in order to iterate and ultimately provide the best possible product overtime. We anticipate warranty costs, but gradually lower relative to other components of cost of goods sold.
Third, this quarter marks the completion of the first full year of manufacturing the field to drone. During this time, our primary focus has been on growing revenue to capture market share. However, we are also implementing operational efficiencies expected to drive improvements in gross margin, which will be imperative as we work toward cash flow breakeven. We expect our full year gross margin to end between 25% and 30%. However, we believe that we can reach gross margins of 50% as production capacity scales exclusive of software add-ons discussed previously by GES.
During the third quarter, operating loss totaled 4.4 million and cash used in operations totaled $4.1 million, both of which represent a decrease for the third consecutive quarter, as evidenced by the steady improvement we are committed to controlling costs as we grow revenues and further research and development in anticipation of winning the SRR. program of record awards. Our combined cash and accounts receivable balances as of January 31st, 2024, totaled over $12.7 million. In December, we completed a capital raise, which has provided operating runway needed to achieve our strategic objectives during calendar 2024. Last month, we closed the sale of our consumer segment two unusual machines, which included a $1 million cash payment as well as a $2 million interest-bearing note receivable. The completion of this divestiture will enable us to focus even more intently on the success of our enterprise segment. Overall, we remain optimistic about the future of the company. We are very pleased to have finalized the latest amendment to our Army contract, securing the funding required to complete engineering and deliver prototypes despite funding delays within the DoD as one of only two finalists in the Army's short-range reconnaissance front to program, we believe we are well positioned to receive an award later this calendar year. The replicator program which is expected to include over 1 billion budget across several tranches is focused on fielding thousands of critical systems, including small UAS revenues continue to grow as we expand our customer base domestically as well as internationally, we have now sold our products to customers in over 10 different countries.
I will now turn the call over to the operator for questions.
Question and Answer Session
Operator
(Operator Instructions) Ashok Kumar, ThinkEquity.
Ashok Kumar
Thank you. First, congratulations on the operational results. And the appointment of We'll start general Paul from your board. Three questions. What is can you give us some color on the margins? And do you expect them to increase over the next 12 months.
Second question, as you mentioned, the replicator that's been a common theme on the on your last three calls on. Can you expand on why you're well positioned for this opportunity.
And the third, the last question is on the international opportunity. You had commented on that in your prepared remarks. Now, when can we expect to get some contract announcements.
Thank you.
Jeff Thompson
I think things should become.
Well, Leo, your first day you're getting the first half question, so I'm going to hand it over to Leon.
Leah Lunger
The margin question and we are thinking up. And so as I mentioned in the call, I do expect margin to improve over the next 12 months, although we expect there will be some variability by quarter, especially as we complete our engineering effort for the Army. And but there are a handful of early manufacturing Aspen aspects that we're working on. We expect to improve margins we've had some one-time scrap ions and we're working toward a 1% scrap rate, which would improve margins. We're also working on improving our yields, which would improve margins because of the related labor costs. And as we grow revenues, production volumes naturally increased and that should improve margins as well. Due to the overhead allocation in place, we believe that we'll receive better pricing on materials as we're able to increase our order volumes with increased production volumes. And we've also historically had a very robust warranty program so far that we expect to you lose Libya?
Jeff Thompson
Let me jump in on the warranties because you were on the one that are dealing with it mostly And I kind of upset me when we do this but just to be very frank folks where she mentioned, we have a very generous warranty program and the reason that we have a generous warranty program at the beginning, we're trying to gain market share on large programs that are converting from our competitors and lots of time.
These programs go on for five years.
So we've made the decision to make sure that these people get their drones fixed immediately if they can't be fixed in the field. And basically sometimes we get sent back to us and we find out that it was actually pilot and operator error, not our issue, but we still support the warranty as we're building market share and it's worked very well. We expect that the warranty of generosity is what I'll say, we'll continue to go down with all the other items that we have mentioned and where we've also been pretty aggressive with non-recurring engineering for the SR. program which is some of that does seep into GAAP margin. So we have a lot of levers that we'll be pushing over the next couple of quarters to increase our margins and hopefully get to that 50% mark. And and then we are the next thing as we start selling software on top of everything that can also increase the margins dramatically. And I think your second question was replicator, just some.
Yes.
So yes, so replicator of that is the problem with replicator is that no one's going to be making announcements. So it's probably going to frustrate the Street not only for Red Cap but other companies that are supplying drones. But we continue to demonstrate products at the DoD and the DIDI. you want and with the capabilities, they're big on swarm.
And we're the first company with a commercial swarm product called before ship.
We came out with that first and our and having that having that product. And recently with our swarm capability, we demonstrated eight hours of Perch and Stare using our overcoming the small drone battery limitations utilizing our swarm. So the way, I believe that we're well positioned as we have swarm capabilities.
We have small and portable drone swarms.
It's a perfect fit for the replicator initiative, and I really can't say more than that. And along, I think your third question on international, yes. But yes, so the our biz dev team has been working on more than 10 large RFPs for more than 18 months. And to be frank, a lot of them are larger than us are some of these RFPs are supposed to pop soon. It could be our largest contract yet. So the work we've done over the last year, almost two years on some of these RFPs are set to be announced winners later this spring. So we've tested well, the TL. two is doing fantastic. And so we do expect to make some announcements later this year for international.
Ashok Kumar
Thank you and best wishes to you.
Operator
Scott Michael.
Scott Michael
Can you hear me so that we can hear you?
Oh, thank you.
Can't what's the status on the chips?
Jeff Thompson
Chip production, our chip acquisition you mean as in supply chain?
Scott Michael
Yes.
Jeff Thompson
While we've been fine with supply chain for gosh, over nine months, we are yes. So I mean that supply chain is something that I'm always concerned about, but that is not how my my daily fact sheet anymore.
Scott Michael
Okay.
That's good to know. Thank you.
You said production is at 1.5 shifts right now.
Jeff Thompson
Currently we have a backlog, are we able to accommodate the hopeful anticipated awards with the current shifts we have or will we have to employ more shifts? How we look at in that round. We have plenty of the core chips, I think is what you're talking about that we bought almost two years ago and they were close to 5,000. We are we are not going to want to shift the shift in terms of our production. You have got and as you said, we have 1.5. So basically we've got a shift and a half we've got we started around nine and we end around nine. So we've just increased our shifts to handle the increased production needs by our customers. But we can expand to a full second shift. We're just not there yet. We're going to adjust our factory capabilities according to our demand.
Scott Michael
Okay. So you anticipate being able to knock out the backlog quickly, is that correct?
Jeff Thompson
Well, the good news is we have been doing that with these huge increases in revenue every quarter and we continue to sell more so we're kind of have the best of both worlds, but we will continue to increase our production to not get the backlog too high and to meet the timeframes that our customers want. So if our customers need 90 days, we're going to make sure they get it 90 days, they need it. And one 20 will make sure they get it one, 20 of the 60, we'll increase production and get it in 60.
So we have to adjust to our customers.
Operator
This concludes our question and answer session. I would like to turn the conference back over to Jeff Thompson, four pre-submitted questions and closing remarks.
Jeff Thompson
Great. Thank you. Allow me to correct some been more command. I'm sorry, they're not on the Chorus call here. Do you have them? Would you like me to read the first one?
Yes. The first question is when do you think we could get to profitability, what revenue or what margin or combination.
Okay, great. We'll try. You're going to keep being in the hot seat today. I'll hand that one to you and today.
Leah Lunger
And so based on our current quarterly operating expenses of about 5.5 million if we reach 50% gross margins. As we hope to then we we'd expect to reach profitability at approximately 11 million in quarterly revenue Okay.
Jeff Thompson
For the next question, as you've mentioned, several partnerships, do you expect to continue to look it acquisitions?
Yes, that's another good question. And we get asked that quite a bit as you see, we've done a lot of partnerships in the past. You've seen us do partnerships and then you do acquisitions. But right now we are fine with partnering with a lot of our software friends, we would definitely not do acquisitions down here would be so dilutive, but we are continuing to build relationships with all of our partners. And we think maybe next year. We start looking at acquisitions again. But right now, our revenue is growing so rapidly, and we're right on the cusp of getting some basically game-changing large contracts. So we're going to stay focused on making the deal too great. And then when we finalize the S or the next generation bird, which will be the new SR harbored.
So we're going to we're going to hold tight for a little bit.
Final question is now that you closed the sale of two unusual machines. Does this mean you will not be going back to the margins now?
That's a great question. That was just that the new one. So you're actually I'll let Leah review some of that and then I'll give some final comments on that after that?
Leah Lunger
Yes, for sure. So on the sale to unusual machines, as I mentioned previously, we received a CAD1 million cash payment after the closing of the sale as well as a $2 million note payable. To recap on the note is interest bearing at 8% and the interest is payable monthly in cash with the principal payment due in full on the maturity date on after 2.5 years. However, if you assume a complete offering of over $5 million, I know becomes payable in full foam, which will be just another good opportunity for funding for us. And we are working on finalizing the closing working capital unusually with these types of and types of deals that we have we expect to complete that within six to nine months of the closing date. And the closing working capital, which we currently expect to be around 3 million, will be either payable in cash or added to the note on that is that determination is up to Red Hat on.
Jeff, do you want to comment on the stock that we own in Numax?
Jeff Thompson
Yes, we also own 4.25 million shares and we are probably going to do some sort of a dividend. We haven't made that decision yet as a Board to existing right cash shareholders, but any other remaining shares that we keep we would never sell and hurt you max stock. But if they had a block buyer or things of that nature, there's ways for us to raise continue to raise non-dilutive money. So as you can see with the revenue ramp, we've certainly proven that we beat guidance three times in a row. Now with our revenue ramp and our costs continuing to come down, we believe that we're not going back to the market at all and to be very frank I getting if we get an MSR award or replicate or award all of those or give you a chunk of money upfront. So our thought process in our modeling is we are out of the market. So we're pretty excited about that.
Operator
And this concludes our question-and-answer session. I would like to turn it back over to Jeff Thompson for any closing remarks.
Jeff Thompson
Great. Thanks, Dave, and thanks to everybody. We have mentioned, we believe that we are in a great position to supply drones to the United States military, and we are proud and honored to have them as a customer. We are also ready and willing to help our allies and expect to start getting traction in NATO soon.
Field drones are incredible tools that give asymmetric capabilities to the warfighter. Our full stack technology, including what's being developed for SR., enables Datalink resilience in EW environments, GPS denied navigation using visual based navigation battlefield decision making with artificial intelligence, natural language operation with a I object detection and recognition with a high and will ultimately be able to deliver kinetic effects with human assist to fully close. The kill chain.
Small drones have changed warfare for ever. Ukraine has demonstrated what small drones can do to expect expensive military assets. The Wall Street Journal's recent headline reads drone swarms are about to change the balance of military power, basically describing what kill drones has developed. A second half of calendar 2024 is going to be pivotal for Red Hat, and we are set up for success. Thanks again and good night.
Operator
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
