Red Cat Holdings, Inc. quarterly report, Q2 FY2022

Red Cat Holdings, Inc. — Form 10-Q Summary

Reporting period: Fiscal second quarter and six months ended October 31, 2021; filed December 20, 2021. The filing compares the three- and six-month periods with the corresponding 2020 periods. Red Cat provides drone products, services and related technology through its subsidiaries, including Fat Shark, Rotor Riot, Skypersonic and Teal Drones.

Financial performance and position

Metric	Three months ended October 31, 2021	Six months ended October 31, 2021
Revenue	$1.86 million, versus $0.43 million	$3.26 million, versus $0.98 million
Gross profit and margin	$153,000; 8%, versus $99,000; 23%	$255,000; 8%, versus $201,000; 21%
Operating expenses	$2.91 million, versus $589,000	$4.69 million, versus $1.07 million
Net loss	$2.74 million, versus $722,000	$4.30 million, versus $1.11 million
Basic and diluted loss per share	$0.05, versus $0.04	$0.10, versus $0.05

• Revenue growth largely reflected acquisitions: Fat Shark contributed $899,000, or 48%, of quarterly revenue and $1.89 million, or 58%, of six-month revenue. Teal contributed $402,000 in the quarter after its August acquisition.
• Management attributed lower gross margin percentages primarily to higher product and shipping costs associated with COVID-19 impacts.
• Six-month operating cash use was $8.57 million, versus $568,000 in the comparable period. The filing cites working-capital movements, including inventory and prepaid purchases, as significant cash uses.
• Cash was $11.56 million and short-term investments were $48.12 million at October 31. Current assets were $64.63 million, current liabilities $5.85 million, and reported working capital $58.78 million.
• Reported short- and long-term debt obligations totaled $2.77 million, excluding operating lease liabilities. Operating lease liabilities were $560,000. Cash and investments together totaled approximately $59.68 million.
• Six-month financing cash flow was $19.83 million; the company reported approximately $70 million in net proceeds from two stock offerings and approximately $50 million used to purchase investments. Investing cash flow was $25,000, primarily cash acquired in acquisitions.

Material changes and notable items

• Operating expenses and net loss rose substantially year over year, reflecting the enlarged business following the Fat Shark, Skypersonic and Teal acquisitions, higher public-company costs, and increased stock-based compensation. Six-month stock-based compensation was $1.28 million, versus $214,000.
• Red Cat closed public offerings in May and July 2021, issuing 4.0 million and 13.33 million shares, respectively. Net proceeds were approximately $14.6 million and $55.5 million. Common shares outstanding were 53.68 million at October 31 and 53.84 million as of December 15.
• Teal was acquired on August 31 for stock consideration. Its purchase-price allocation recorded $14.29 million of goodwill; the filing states the allocation remained subject to measurement-period adjustments. Teal may earn additional stock consideration of $4 million, $10 million or $16 million depending on Golden Eagle sales and services revenue targets over 24 months.
• In October, the Skypersonic purchase price was reduced by $602,000, with 149,829 escrow shares cancelled. In December, after the reporting date, Teal and Red Cat agreed to a $438,000 purchase-price reduction and cancellation of 150,639 escrow shares.
• Derivative fair-value changes produced a $273,000 six-month benefit, partially offset by $63,000 of interest expense. The derivative liability was $2.38 million at October 31; this non-cash valuation is sensitive to the company’s stock price.

Outlook, risks and contingencies

• Management plans to develop sales of drones and related components and cloud-based drone analytics, storage and services. The filing gives no specific revenue, profit or cash-flow guidance.
• Red Cat has incurred losses since inception and says it will continue to rely on equity and/or debt financing until product and service sales can sustain operations. Management cautions that existing financing may not be sufficient and additional financing may not be available on acceptable terms or at all.
• The Teal loan bears 10% interest, requires monthly payments of $49,275 and matures December 31, 2024. It is secured by substantially all Teal assets and guaranteed by Red Cat; default can make the loan immediately due. The company also reported that it was working with the SBA on forgiveness of Teal’s $301,000 PPP loan.
• Management identified a weakness in timely reporting of transactions for certain corporate bank accounts managed by individuals, increasing the risk of accounting errors or inadequate documentation. Management was evaluating remediation. The filing otherwise says disclosure controls were effective, but excepts this weakness.
• The filing reports no pending material legal proceedings and no off-balance-sheet arrangements. It states that Red Cat, as a smaller reporting company, was not required to provide risk-factor or market-risk disclosures in this report.

Important facts for investors to verify

• Whether acquisitions can deliver durable revenue growth and improve gross margins, which fell to 8% in both reported 2021 periods.
• Cash consumption, inventory and prepaid-purchase requirements, and whether cash plus investments will fund operations without further financing.
• Potential dilution from share-based compensation, warrants, preferred shares, acquisition escrow adjustments and Teal’s revenue-based earn-out.
• Teal’s secured debt terms and the status of the SBA PPP loan forgiveness process.
• Progress in remediating the bank-account reporting control weakness and completion of acquisition purchase-price allocations.