$UMAC CEO Allan Evans: Scaling America’s Drone Supply Chain (Impact Stock)

Pretty good. Pretty good. It's a Good Friday. We're going into this holiday weekend. So, by the time people see this, welcome back from vacation.

Yeah, sure. Upgrade Energy is the company you're talking about, Battery Pack House out in California, just moving into a bigger factory in Torrance from El Segundo. Really great folks with really strong sort of ethos, brand, cost, customer, product, quality alignment. So, we're really happy to actually join the team instead of maybe what we do more often is investment if we like it, but we don't see it really integrating or being really core. So, really really excited to do that. And then we've been distributing for them for a while. So, like a lot of the stuff has been selling through already. So, you know, we have a long history there.

One of the things we were talking about earlier is that a lot of my job is to sort of position for like the next moment, not right now. Our team's doing an awesome job of scaling our motor business and our headset business and all that flywheel starting to just, you know, spin up and up and up. And when you look at the FAA Part 108 rules, you're starting to say, okay, what's domestic going to look like? You know, and I think you were talking to Jeremy at Drone Nerds before and he's talking about window washing or you think about delivery or you think about whatever. And when you think about these applications, a window washing drone doesn't blow up. I know it shouldn't blow up, right? Let's just, it won't when certified and used in the appropriate manner. So when it goes up and down and washes the window, you change the batteries and it can go up and down and wash the window more and you recharge the batteries. And so for that, for delivery, for aerial photography, for inspection, batteries become the consumable because they only have like 500 cycles. So if you're professionally washing windows every day, you're going to go through new batteries every year and you're probably going to have five to 10 batteries per drone. So when you look at the next domestic market and you look at the breakdown of what a drone system is rather than a drone for any of these professional or corporate or enterprise applications, batteries start to make up a huge chunk of the life cycle cost and thus of the life cycle revenue from a components perspective of that product. And so right now where it'll still fit into a lot of the Department of War channel stuff. Yeah. Which is really where the demand is right now big time, you know. So we see that now we'll have that integration. We have time to really build this out and then integrate it into that next market segment where we see batteries just representing a really big part of the lifetime sort of TAM for any of these applications. So it not only is like, oh hey, it's a good idea right now, own the powertrain, regulate the powertrain so that it can get FAA approved, but position to capture a much larger chunk of the value in the market and the revenue in the market for components.

Yes. It's the only thing that makes it possible. Like it's really hard. Did I ever tell you how we hire people? Like what our interview process is.

Yeah. So right, the five people that you work closest with all interview. Anybody can say no for any reason. That's before we acquire a company, not invest in a company. And in this case, because Matt will come in as part of the leadership team, every member of our leadership team had the opportunity to say no to the acquisition. Everybody wants the team to come on board. And so when you do that and you start to collaborate and you build those relationships and you build out the team with everybody being like, yeah, let's go, there's a multiplicative energy that comes and a speed of integration and a desire to really be in a position and collaborate that is totally different than just the on-paper-it-making-sense, right? I think a lot of people are right about a lot of ideas on paper and they're right about like this business combination would be awesome but they forget that the businesses are all people and we're messy sloppy chemical sacks of feelings and bad decisions sometimes, right? And so unless you get that sort of secondary element, that human element to mesh, then these really good ideas often fall apart. So we're super excited about getting it together, getting it done, and going forward to do this and really start to work on setting up for that next demand wave. So, there seems to be some confusion out in the marketplace about where the batteries are going to be sold and where can you, you want to clarify that?

I don't know what the confusion is. We will make battery packs and sell them. We will source cells from anywhere we can with a preference for the US and we'll source in large enough volumes to encourage people that aren't in the US to maybe set up facilities in the US. Like it takes time, but with the energy and the attitude and the drive, I think people will, you know, it'll get there faster than people think.

We will make batteries in the US. We will sell them to our customers. They'll be made in the USA batteries without Chinese material.

I don't know who's confused. You're confusing me. Like, our supply chain team is awesome. Like, we know the rules. We follow the rules. We're not all like, yeah, let's sneak this one by. Like, we get audited. People come check out our factory. They go investigate our supply chains.

Let me tell you about lawyers and property negotiation. We're redlining a few contracts for some new space. I think, you know, we're close on signing another 15,000 square feet in Orlando for the battery production to match the 18,000 square feet in El Segundo. So that'll give us about, I think that's going to be about eight times more space than they had in their El Segundo factory and they were only running one shift. So it should give us something like 25 times the capacity of where they're at before if we have to three-shiftable sites. Might not be enough, which is crazy to say. We got some other places we're constantly looking at in different stages of negotiation and lease finalization. So, yeah, I'd have to double check, but I mean, I expect we'll be 100,000 square feet, 120,000 square feet, you know, in the next two or three months because we're also now being a little more proactive about being like, do we need that space? And then looking at our projected thing and being like, well, we'll need it here. So yeah, you know, as headcount keeps going up and other things happen.

There's always risk in anything, right? So let's start with that and let's say yes, there is risk of overgrowing. It's one of like I think the nastiest things that can happen to a hardware company. But if there's a million drones a year to displace, then there's probably about a billion dollars worth of parts that we make that represents that displacement market. So if we're only doing a hundred million in annual revenue, we're still only at 10% of that. So I don't think we're at the place where we got to look around and check and be like, did we get there from a market sizing perspective. Now, is somebody going to beat us to that market? If they do, we lost anyway. And so if we make the choice to be afraid of overshooting some small portion of the market, I think we haven't done the right risk-return decision as leadership for our investors where like this is winner take all. If we're wrong and we miss or we screw it, that's okay. If we're wrong and we pull back on the throttle and somebody blows past us, that's not okay. So, right now, no. Like, we need to keep growing as fast as we can without breaking down. And I think that's going to be true for the next 12 months. Like, and if we're really good at it, maybe in 12 months we'll be big enough where are we going to look around and be like, should we slow down this growth? And I'm guessing the answer will still be no, but it might be yes.

Well, I think there's a couple of things here that are assumptions that have a lot of impact on other companies and less on ours even though we're grouped into the category. The US budget there obviously need to move over to drones. So, the Department of War demand I think is here for two years no matter what. What it looks like four years out, I don't know. But I also don't care because FAA is going to open up the domestic market and there's a million drones a year in the US that are used for commercial, consumer, and enterprise things in our size category that will continue to drive that demand cycle. So we have the benefit of the Department of War energy really accelerating what we're doing so that we can get big enough and good enough to fit that consumer and commercial demand. So, I don't care if the Department of War is a demand driver two years out because I expect by like 29 or 2030 it to be maybe 20% of our blended channel rather than, you know, 90% of our blended channel just based on the multiple demand cycles that we see. And that's not to be dismissive, right? It's just we don't have that same hard exposure that I think some of the other defense tech companies do.

Yeah. No, this one stuck and it's going to be around for a while. A lot longer. I mean, talking to Jeremy, you know, I think I'm pretty, I have a pretty creative mind about use cases for drones. I mean, there's so much more to it than just the drone. I mean, the whole software and the solution for the windows and there's just so much, man. I mean, there's so much opportunity.

Absolutely. There's some other really dangerous jobs that people always look at that are, I think, going to be early use cases, too, that are constantly being explored in agriculture. You know those crop dusters? Flying that low in a plane is super dangerous. So there's a lot of folks that use drones to spray fields, right? That's another one of these like, yeah, a person shouldn't do that. Like accidents occur in that segment all the time. And instead of a plane crashing with a person in it, if a drone crashes in the field, it sucks, but like a life is saved, you know?

You know what? Yeah. I mean, you got the dogs that, but still, right. Yeah. The dogs help wrangle, but the drone helps find them because they could be way off, miles off in like some forest somewhere and you're like, where'd the cows go? You know, so they're like, oh, found them. All right, let's go. You know, so I really think public safety's really picked them up. You know, we, Campus Guardian at AESI Exponential was showing off in our booth and they're putting drones that can be remotely piloted in schools. To go deal with shooters. So if there's a shooter, they can indoors, take off a drone, and go deal with a shooter in the school without, like it's a very fast response as the police and everybody else show up. So there's a ton of things that you don't necessarily think about or you think it's a toy and you're like oh no, those, the aggregate of all those applications becomes extremely interesting and is going to be this huge domestic market that I think, you know, again the Department of War is the primary driver of all the growth right now, the driver of the reason why we're moving away from foreign drones, you know, they're like oh these matter so much that we got to bring them home.

But I think once that's done, you're going to see this emergence of new ideas. And I do think the end of the war in Russia, first, there's going to be a ton of great Ukrainian drone companies. So, let's just acknowledge that. But second, you're going to see all this energy that's going into conflict now be applied to these applications. So, I think that's when you're going to see a whole bunch of people are like, oh, we're not making drones that blow up anymore, but we know how to make drones. What is the whole interesting problem set and let's go solve a whole bunch of these problems now? So, I do think that when the war ends, the domestic market is going to proliferate like crazy as that same creative engineering talent, that energy, and that expertise get applied to a new set of problems. And so as long as we're making parts, that's going to, I think the end of the war is actually going to be a huge driver for us because of that shift to a more sustained domestic market rather than I think a diminishment for people carrying on that segment which could affect a lot of defense-specific drone companies.

I mean, you're seeing consolidation now. Like, you know, we're not really a major consolidator, but you look, Ericsson is grabbing a whole bunch of European and Israeli companies. Jeff at Red Cat just announced Quaz and a whole bunch of other stuff. And you're going to see, you know, AeroVironment occasionally makes purchases. Who knows what Anduril is going to roll in. So, you're going to continue to see this consolidation. I think from our end we're weird because we're here for the organic growth, you know, and there's not a lot of other big parts companies in our segment, so there's not a lot we can go be like, yeah, you fit. And then we're vulture snobs. You know, it just, and I mean that in like the, I still stay at the Residence Inn, right? Like, I fly, I just pick my seat on JetBlue, fly to Orlando and stay at the Residence Inn near the office. You know, it's a pretty bougie situation. And so we want people because we're a manufacturer, right? You can't develop this expensive cost basis or you'll never make it work. So, you know, when you look at how we approach it, like I think you're going to see a lot of that aggregate and then there'll be a few companies like ours that build up quickly but more organically to fill in what I'd say are the gaps where other companies that aren't really acquirable don't sit. So, you know, who are those out there? There aren't that many left. And then if you're a technology piece or a drone piece, I think you're going to get absorbed in.

No. Because what am I going to be like? Here's a physical thing. Here's a motor. Here's a battery. But also I have a SaaS model. For what? Like if we're looking at software companies, the next big ones are going to be whoever wins basically managing airspace for the FAA, right? There'll be some that do like defense integration, whatever. But I think there'll be maybe one like whatever the ADS-B equivalent is for the FAA, but we can't own that company. We could invest in it. We could see the benefit of it, but it doesn't necessarily fit inside of Unusual Machines, right? We could make the little hardware piece to detect and avoid so that something qualifies and like into the system, sure, but to own that whole system then doesn't make us, like might break a little bit of the marketplace. So, we're happy to be a shareholder in whoever wins. You know, we're happy to support the people we like because one of the things that's very true is with this whole onshoring movement or this reshoring or whatever you want to call it, there's just not a lot of familiarity with what versioning sort of consumer electronics industry looks like. You know, we haven't seen it in the US in 40 years.

So in the US, we're always talking about technology and not about manufacturing excellence, which is its own entrenchment and its own piece of everything. And so in a lot of cases, you know, we're working with folks in DC to just be like, hey, what's the end of life process? You know, and they're like, what do you mean end of life? In the consumer thing or with the FCC thing, like we have to notify this far out that we're discontinuing this product SKU and doing the next one and set up the supply chain and stuff and they're like, oh. Just because there's not, you know, it hasn't been so entrenched in what we're doing that it's not the mass familiarity. In a lot of cases we're the first ones to really hit scale at least in the drone segment where some of these emerging rules are being made with the FCC and stuff. So, we're going in and being like, hey guys, love what you're doing. Love the policy. Love the mission. Love the vision. Love reshoring. Can we write some rules around this or everything's going to break? And, you know, and we're in there and we're like, all right, we're not bitching. We're not saying what the rules should be. We're not saying go back and change it, but we need rules here. And they're like, what do you mean? And we're like, well, this is how it works in consumer electronics. This is what it means when we're doing 100,000 of a thing. This is the downstream impact for our customer. And they're like, oh, and it's been so long since 100,000 plus of a thing and that material flow and that sort of have been normalized. So, you know, when you look, there's a lot of that as part of what we're doing. That's been, that part's been really cool, like to work on helping with the good ideas that make sense in a world that is bigger than just what Unusual Machines does.

Yes and no. In the conflict in Europe right now, they have all the parts and so they're able to reconfigure based on the parts to make new things. That's sort of where we see what we're doing as being important. If you have access to a whole bunch of really great parts, you can go configure new finished products, right? So, I think one of the things people like in China, it's like they have all the Lego bricks, so they can go build a new Lego creation. Why in the US what we're really working on is being

Like, 'Okay, we have blue bricks and the 2x4s, you know,' and they're like, 'Well, I need this kind of brick.' And we're like, 'How many people need that kind of brick?' All right. Okay. We'll add that brick to our offering. And so I think that's where the pace of final product innovation is really driven and gives them an advantage, and is being used both in Ukraine and Russia and globally to continue that. But you know, I think we're getting more and more of these bricks, and so then you're seeing people in the US be faster about building Legos, and but it all sort of winds up in that stack. And there's just not—it's both simpler than that but also way more complicated, right?

Because in China DJI only releases a new model every so often of their flagship model. Like a standard consumer electronics product cycle is three years. So you can generally with one full product team do a new iteration about once every three years. And that's what you see from them. And then they have some other product teams that do other stuff.

But when you're literally in a conflict where like lives, livelihood, and everything depend on finding an advantage, you know, you're willing to take really high risks. You're willing to try 10 different things in case one works. Why commercially you can't try 10 different things because you'd go out of business. So there's a different risk to innovation framework that exists in a conflict that accelerates innovations because you can be wrong a lot more to find that thing that makes you right. And so I think in living in that cycle and with the very unfortunate pressures of war because war sucks.

Oh, hold on. That's a little unfair.

It's a little unfair.

Problem. So, it is absolutely a statement based on survival bias.

Yes. Okay. So, you have to have two pieces to generate outsized expected value. First, you have to have a very high risk appetite. But then you also have to be able to very quickly understand the quality of each one of the attempts. And anything that doesn't have a high quality trajectory very quickly needs to be abandoned.

And so, anybody with those two aptitudes is likely to have winners and a whole bunch of losers and end up in that category. But I would say those are the parameters that are necessary for people to win. Right? So if we go back to Jeremy, if you want to take that, he was willing to take the risk to buy an entire container of drones.

Had that not worked, he probably would have left the drone business and taken another risk somewhere else. But because it worked and he sold the entire container before it landed, he saw the quality of that risk and then he focused on that high quality risk and generated outsized returns.

And so I very much try to communicate in all of this where I think we sit when I say anything like when you say hey is there a risk of overgrowing? Yes. What is the expected value of that? How do we pay attention to it? When do we make a choice is much more important to have a strong appetite for risk, not be afraid, make decisions with uncertainty, but even more important is to discern the quality of that. And then what you get in a lot of cases is CEOs or whomever is making the decision, they fall in love with an idea and can't just knife it.

Yeah, you're absolutely right. Right. I mean, I think about a lot of small businesses that, you know, if they would have just cut something that wasn't working, they would have saved themselves a lot of headache, right? And a lot of wasted effort.

That is an accurate statement, right? So somebody would be like, 'But this thing is working.' So what?

Yeah. Super hard. Super hard. There's no question about that. But that's really what you're looking for is, you know, can those decisions be made, but also can the discernment be made to be sure these things are given enough time to show their true nature.

That's always the challenge of being the CEO.

My job is to position and set us up for six to 18 months from now.