Unusual Machines (UMAC) 14 Nov 242024 Q3 Earnings call transcript

Good afternoon, everyone, and thank you for joining Unusual Machines Third Quarter 2024 Earnings Call. With us today are Unusual Machines' CEO, Allan Evans; and CFO, Brian Hoff.

Following today's remarks, we will conduct a Q&A session.

As a reminder, this call is being recorded and a replay will be available on Unusual Machines' website at www.unusualmachines.com.

Now let me hand the call over to CEO, Allan Evans. Please go ahead, Allan.

Thanks, Christine. Good afternoon, everyone. Thank you for joining Unusual Machines' Third Quarter 2024 Earnings Call.

Before I begin, our lawyers have absolutely asked me to read the safe harbor statement. Please note that the company's remarks made during this call, including answers to questions and forward-looking statements are subject to various risks and uncertainties. These statements include our expected approval of more products for the DIU Blue Framework this quarter, our business-to-business drone component orders this quarter, the impact of our partnership with Red Cat Holdings on future sales, the effect of future U.S. tariffs on our consumer retail business, our expected revenue and gross margins from the retail market for 2024, our ability to manage our cash burn and improve margins, our 2025 revenue and bottom line improvements and our liquidity. Actual results may differ materially from the results predicted, and the reporting results should not be considered as an indication of future performance. A discussion of risks and uncertainties related to Unusual Machines' business is contained in its filings with the Securities and Exchange Commission, including the prospectus filed with the SEC on October 25, 2024. Further, it is difficult to predict if future tariffs will be imposed that affect our business and whether the wars in Ukraine and Israel will be affected by the U.S. elections.

Additionally, we are dependent upon third parties in getting the Blue UAS Framework approval for our drone parts in a timely manner and receiving subsequent orders for our main USA drone parts and drones. Unusual Machines disclaims any obligation to update any forward-looking statements as a result of future developments. All right. That is out of the way. This will be recorded and will be posted sometime in the next couple of days for those who aren't able to follow the whole thing.

We have some prepared remarks that we want to share to provide clarity on our third quarter results.

As usual, everyone, I apologize a little bit. I'm going to seem robotic because I'm reading. But again, trust me, this is absolutely the best way to be sure you get all the information that we want to share. After our comments, both Brian and I are going to be happy to answer questions in an open Q&A. Please throw those questions into there. We'll go through and we'll read them off and we'll answer them at the end. I will provide instructions on asking questions for those of you that aren't aware of how after our prepared remarks.

I think the most important thing and where I want to start is by absolutely recognizing the continued hard work our entire team has put in. Guys, I really appreciate it. This is only our third earnings report as a public company.

So we're still pretty early. This is actually only the first quarter where we have our own domestic manufactured products. This represents for us the very beginning of our work toward growing this components business and onshoring production.

While this time line probably feels slow to traders, it's happening very fast as operators or investors, and is actually going a little faster than we originally anticipated. That's exciting.

For me, though, the most important thing is to continue to focus on our 3 key priorities: cash flow, operations and growth. Cash flow is still a really big priority. We started this quarter with about $2.2 million and we finished the quarter with about $1.7 million. This matches and actually is slightly better than what we said we would do at the end of last quarter.

So we're happy to be on target there.

Additionally, just at the end of October, we closed a PIPE financing, where we got another $1.7 million in net proceeds.

So we're feeling pretty comfortable with our cash position and with our understanding and control of our cash burn rate. With that, going forward, we're planning on shifting a little more toward growth. This is probably going to result in a slightly higher burn rate because we can aggressively capitalize on our components business, and this can be a real competitive advantage with the potential change in tariffs and some of the other adjustments that we could expect from the new administration.

So we really see this as a window of opportunity where we can take some initiative and come out by materially improving both our top and bottom lines over the next 12 months or so.

The second priority for us is operations.

For the quarter, we generated approximately $1.5 million in sales. That's a 26% gross margin. This revenue is about a 9% increase over the second quarter, and we still remain ahead of our target of $5 million in sales for 2024. 9% quarter-over-quarter is okay, and you might be like, "Well --" But for us, this is actually a lot more impressive than the raw numbers because the third quarter is typically a slow quarter for retail sales.

And so seeing this improvement is actually really encouraging and we feel very good about it.

The third priority for us and I'd say the big opportunity and why everyone is here is growth. I'm going to delay the discussions around the growth and what we see coming until Brian has a chance to dive into our financials more. But before I hand it off to Brian, I want to discuss some of the unusual cap table and debt activity that happened in this quarter to just provide some high-level context as he goes through his analysis.

So in order to reduce our debt, interest payments and other cash spend, we negotiated conversion of $1 million in our outstanding debt to equity with some shareholders, and this was done at above market rates.

So as part of this, we also negotiated with them to reduce the interest rate from 8% to 4%, which reduces the interest payments we have to make. In doing this, we added a conversion feature at $1.99, which is about $0.50 above our share price when we put it in place to see the cash reduction.

So we think all this activity is really positive for the business, especially because we consider cash flow our primary priority. But it does create these like really funky GAAP derivatives that also have pretty high sensitivity to volatility and some other factors.

So Brian, thank you so much for working through the derivative calculations. I know that has been an exercise. With that high level, I'm going to hand the call off to our CFO, Brian Hoff.

Thank you, Allan, and thank you to everyone for joining us this afternoon.

As Allan noted, we ended the 3 months ended September 30 at about $1.5 million in revenue with 26% gross margin, which is the 9% growth quarter-over-quarter, which, again, we're very excited about. And this also puts us about $3.6 million with 28% gross margins year-to-date since the acquisitions of Fat Shark and Rotor Riot in February. After revenue, I want to focus on our loss from operations, which is about $1.4 million for the quarter. This includes kind of your normal GAAP stock comp expense, noncash kind of item that every kind of company has.

So after backing that out, that puts our net loss from operations around $1 million. We had about $400,000 in public company expenses during the quarter and some increase in professional fees related to some of the reaudit that we had to do back in August and some of the transactional stuff that we just went through related to the debt conversion. That puts us kind of in our normal loss from operations about $550,000 after we kind of look at those kind of few unique items.

So kind of in line with what we were expecting as we kind of continue to shift to growth. That's going to be kind of our plan to kind of bring that number down.

As Allan mentioned a few moments ago, you'll also see the very unique line items on our P&L in other expenses and kind of nonoperational loss, which is really all that derivative accounting, right? This kind of comes with the conversion of the debt. And all of this is noncash, just additional expense that GAAP really has us do, and that's about $700,000, which leads to the net loss of $2.1 million. Converting over to the balance sheet.

As we noted, we had $1.7 million in cash, which is a little ahead and kind of -- but in line with our expectations of what we were expecting when we were looking at it at the end of Q2. We looked at -- we just closed the PIPE at the end of October for that $1.7 million in additional net proceeds. Again, we're looking to head into the fourth quarter and into 2025 with a healthy cash position and excited about that. We're also continuing to manage our inventory balances very closely, and we ended the third quarter in line with our expectations, kind of came down a little bit. But as we head into Q4, we are gearing up our inventory for that kind of holiday push. We converted $1 million of our debt into equity.

So we started with $4 million, and now we have a $3 million balance. That's due at the end of November of 2025, so another year from now. And then you'll see a couple of other non-GAAP -- I'm sorry, noncash related liabilities, which is all that derivative stuff, which is another $600,000 worth of liabilities on our balance sheet.

In addition, we still have the $19.6 million of goodwill and kind of other unallocated purchase price, which we're going through those GAAP accounting-related items to kind of figure out what that is going to look like at the end of the year. And we should have the allocations to any other intangibles completed by the end of the year. Overall, we're excited about the progress we've made since kind of the IPO, the acquisitions of the 2 company and especially heading into the fourth quarter. We've got a full quarter of our Blue UAS Brave F7 Flight Controller orders being fulfilled during this quarter, and also the larger holiday push, which we're thinking Q4 is going to be one of our best quarters.

So we feel confident in our current cash position to allow us to focus on those growth opportunities, which is a great place to kick it back over to Allan.

So thank you to all.

Thanks, Brian. There are a few items I want to clarify before we really dive into the exciting stuff. All the debt conversion and the PIPE have created some pretty substantial changes to our cap table.

So in order to simplify things, I just want to explain to you guys how we as management see it.

We have common stock and then we have preferred stock, and that preferred stock just converts to common stock. It has a percentage blocker for ownership percentage, but no other gimmicks really.

So if it all converted tomorrow, then our total common stock plus the preferred stock converted would be about 12.6 million shares.

So you could say that we have 12.6 million shares outstanding or adjusted.

We have another set of things, which are cash-only warrants and some stock that we reserve for the conversion of debt. Almost all of these warrants and that debt are -- have a strike price or a conversion price of $1.99. But that $1.99 represents value and mostly cash or cash we'd have to spend that the company would receive.

So if all the warrants are exercised and all the debt is converted, the company will get about $7 million in additional value, most of it being cash. This, as you would expect, represents about another 3.5 million shares, which is the $1.99 price.

So there's no gimmick there. This conversion, these warrants, they were intentional. We wanted to structure this to broadcast to everyone what our next financing is so that nobody is surprised and you're able to do the calculations while understanding what our intent is to finance operations for the long term.

So as part of finalizing all of this, we have a shareholder meeting on December 2. It's important that you vote because we don't have shareholder concentration. I can't just get anything to pass with 5 votes.

So as I just mentioned, we want to use the warrants as our next financing, and that is why management suggests yes on item #3, which is a share issuance above 19.9%. It's not a shareholder approval for anything other than those warrant shares, et cetera, to be able to be used and converted.

So it's already out there. It's nothing new.

So if you say yes, we can get the money sooner because we can force conversion, we can simplify our cap table and we can continue to really focus on operations.

So please read your proxy statement and vote right after this call if you haven't yet.

Speaking of voting, we just had a major election that we expect will have some impact on the future of our company.

We are accelerating inventory orders and domestic production of new parts in anticipation of the benefits that we're going to see from a potential change in tariffs on Chinese-made drone parts.

We expect this will improve our gross margins on everything we make domestically and push our competitive pricing for the Chinese products up to a higher level. This really galvanizes our growth plans. And the election also does introduce a little uncertainty around the European market in 2025. But before I dive into that, I really just also want to note that the comments I'm going to make about this are pretty speculative and they're sort of our current way that we're looking forward.

So again, because we expect tariffs, we're working very hard to accelerate our U.S.-made component business. The Brave 7 was well received.

We expect to have a couple of products approved this quarter for the Blue list, a few more products next quarter. And on top of that, the Brave 7 has been great because our team has done a wonderful job servicing the large customers that have placed orders.

So we expect this component business to actually start to significantly contribute to our revenue in a more meaningful way in quarter 4. Right now, most of the initial larger orders are coming from Europe due to the ongoing conflict in Ukraine. There's definitely uncertainty here long term. Like we don't know what the demand will be, what it looks like, how it looks like. But in the short term, in the right now, there is massive demand, and we are actually actively in the bidding process for what are large multimillion dollar contracts.

So there could be some very immediate large orders that help us scale domestic production even faster.

So in addition to the component sales for enterprise, we also have this really great opportunity to sell our U.S.-made components individually or as part of our ready-to-fly drones through our retail channel. If a tariff is put in place, our domestic components suddenly give us this extra 20% that we can use to either improve our gross margins or have more competitive pricing relative to our retail competitors.

So if we manage this properly, I think we can use this advantage to improve both revenue and gross margin while capturing more market share in the retail business. It would be challenging to have this call without talking about the U.S. defense spending. The defense spending from the U.S. Department or the U.S. government in the FPV category was definitely below our expectations in this last government fiscal year. We see a long-term opportunity here still to do complete FPV drone products through our partnership with Red Cat Holdings.

We are still the selected supplier for the FANG drone, and we also really hope to be a component provider for their other products like the Teal Black Widow, which is being considered for the short-range reconnaissance program, and the FlightWave Edge 130.

So we still definitely see opportunity there. It just -- it didn't materialize for our specific category in the way we expected. The next 2 months is the holiday season, and this is typically the strongest quarter for us for retail sales.

So we plan on really focusing on marketing and having a strong holiday, but also starting to position for when the new administration takes office in January. We don't really expect to have great visibility into the B2B enterprise sales or any impacts from tariffs until the first quarter of next year because it's just so unknown. But we're really optimistic that these changes could very quickly accelerate our growth trends. Again, before I conclude my remarks, I want to say thank you again to our entire staff and also to everybody, all our shareholders. This would be impossible without you.

So thank you. Please remember to vote after this call. But otherwise, if you go and click the questions button and type questions, I'll read them out loud so they're recorded, and I'll go through and start to answer questions.

So we got a few in here.

The first one, why do you think the U.S. DoD was slower or didn't materialize like you expected? The U.S. DoD procurement, I think, just got jammed up in bureaucracy.

If you look the -- there was a continuing resolution, so they didn't get their budgets till late. And then it's a long process to get the money through.

And so I think they were just focused on other priorities and ran out of time, is what we saw with a lot of them. And I think we're going to see some delays again this coming year.

I think we're going to see continuing resolution until January because of the change in government administration. And I don't know how short-term disruptive some of the DOGE activities are going to be to procurement versus long term.

So I think the money for this category from the Department of Defense is going to be a little uncertain in short term. Who are your partners' customers that get you into the U.S. DoD assuming you do not sell directly? We are not a prime. We don't want to be a direct contractor with the U.S. government.

So we'll work with several others. The one that we're the most familiar with and have publicly put out there is Red Cat Holdings. But as a supplier to anyone, we're open to working with anyone that needs components in our category.

So here's the next question. It's good to see other demand offset the DoD. Do you think the DoD is more of a delay or something else? I think the U.S. DoD is a delay. And I think that we're still going to see -- we're on a delay from the U.S. DoD because we sell to the people that get the DoD contracts.

So if you look at short-range reconnaissance program that Red Cat is participating in was originally supposed to be announced in September, hasn't been announced yet. Those delays then cascade on a supplier like us because we don't get orders for components or bid the slot for components until they see their order.

So I think we'll start to see some of the delay come through and we'll start to see our relationships with some of those primes manifest. Can you walk us through how you're able to price above the market and how the warrants with a strike price of $1.99 are likely to play out? Yes.

So it's unusual. What we did is we had a very long conversation with a lot of our shareholders. They believe very strongly in what we're doing.

So they're willing to do $0.01 above market. And they look at this more -- we look at it more like venture where we want to disclose it.

So it's like, "Here's half the round.

Here's the next half of the round," if we can prove that it works. A lot of the warrants or at least some of the warrants have the company right to ask them to convert at $3 a share.

So I expect what we'll see after registration and it goes forward, people to look -- and we'll try to convert those warrants.

I think it's very share price dependent. But if we're -- where we're at today, I think they'll convert very quickly, and then we'll be fully capitalized with a very clean cap table and able to just continue to operate.

And so how they play out is really dependent on how shareholders -- if they believe in the company and if they say, "Hey, yes, you guys are doing it, keep going," then as long as we're in a place where we can push that conversion. All -- our shareholders are very interested in supporting us and I think would be very willing to convert. What are your contingency plans if U.S. tariffs are imposed? Do you need them? We don't need them. We're building U.S. parts.

I think the faster tariffs are imposed, the more it advantages us in the retail market and everywhere else.

So if they're not imposed, I think we're okay, too.

So I don't think we need contingency plans there.

Just the idea that they're going to come has actually caused us to accelerate and move toward that growth in a way where we want to do more of it faster. The next question. Was converting the debt really worth it? Yes. Any time we can reduce cost basis, we can eliminate debt, which we could have to pay at a future point -- any time we can clean this up, especially, I think, with the terms under which we cleaned it up, we would do it again.

I think we might change how we would structure it to save Brian some time, but that's about it.

Next question. Is there a risk we cannot deliver the demand in production? There's always some risk when you're doing hardware that you have a hiccup or you have a recall or whatever. But we're -- we believe that we could get orders for some of our components at $100,000 a month, and we've already structured our supply chain to be able to scale in and deliver to that, if necessary.

So we don't see any extraordinary risks from scaling. It would be a challenge, but we have a plan to do it and we've been able to do some of these things before.

So I feel very confident in that, particularly for certain components. And we've had discussions with suppliers, et cetera, in case we see that level of demand.

So we feel pretty good actually about our ability to address it. And I mean, it would be awesome.

So we're hoping to really face that challenge. And I think we're in a good position to do it at this point. That's all the questions so far. If anybody else has questions, lob them in there. We got another one. Will it be necessary to achieve net profitability in order to pay off debt maturing in 2025? No. We don't need to achieve net profitability.

We are managing cash flow. But if you look, we structured the conversion on that debt at $1.99.

So that as long as we're executing, that's part of that $7 million in value.

As that debt would go away, we'd get about another $4 million in cash from the warrants with the cash we have now. We wouldn't have to stop and get distracted by some of those things. And if you really look, particularly with the change in the administration and this shift to the splinternet, we really see the next 18 to 24 months as the window of opportunity for us to succeed or not. Really what we think is if it's not us winning some of these segments, somebody else in the next 2 years will be the winner.

And so we've tried to structure all of this to tell everybody on this call or everybody that pays attention that, "Hey, we're set up to go. We're going to go. We're pushing really hard. And you can pay attention and you'll find out if we've won sort of #1 or #2 position as a provider in the marketplace." And you'll know in 2 years because there's going to be a demand for all of this and somebody will have to fulfill it.

Next question. What are the video quality and engineering metrics that define the competition frontier? That really depends on the components, on the category.

I think it's missing a very key aspect, which is, what is the price? So I think there's in all these categories good, better, best.

I think it depends on the use case, if it's a conflict in Europe versus if it's domestic. But I do think if you want to dive into it further, send us a note at ir@redcatholdings and we'd be happy to go through how we look at our product development and where we see it competitively.

Next one, what is the split between enterprise and consumer? And within enterprise, what does the concentration look like? Right now, the split is pretty much all consumer still. We just had 1 month of sales that were enterprise. The concentration is a little bit unknown because it's so small. We had one large customer that we're starting to work with in that quarter, but we hadn't really started shipping a whole bunch.

So I think we'll be able to answer that question better at the end of this quarter, at the end of quarter 1, and we'll really know what it looks like. Also, I'd like to apologize. It's investors@unusualmachines.com. I gave you the Red Cat e-mail. I'm hardwired to know that one still from my time there.

So I'm sorry. Are there other questions? Again, I really appreciate everybody. We try to be as candid as possible and share with you how we're seeing things.

So I really appreciate your time. I'll give it about another minute. But if there are no other questions, then we'll be able to end the call. All right. It doesn't seem like there are any other questions. Again, everybody, thank you so much for your time. I really appreciate it. I hope you guys have a great holiday season. And please reach out to investors@unusualmachines if you have additional questions. And I hope you guys have a great evening. Thanks. Bye.