Coda Octopus Group, Inc. (NASDAQ:CODA) Q2 2023 Earnings Call Transcript

Coda Octopus Group, Inc. (NASDAQ:CODA) Q2 2023 Earnings Call Transcript June 14, 2023

Coda Octopus Group, Inc. misses on earnings expectations. Reported EPS is $0.09 EPS, expectations were $0.1.

Operator: Good morning, and welcome to Coda Octopus Group’s Second Quarter Fiscal Year 2023 Earnings Conference Call. My name is Christine, and I’ll be your operator for today. Before this call, Coda Octopus issued its financial results for the fiscal second quarter ended April 30, 2023 including a press release, a copy of which will be furnished in the report filed with the SEC and will be available in the Investor Relations section of the company’s website. Joining us on today’s call from Coda Octopus are its Chair and CEO, Annmarie Gayle; and its CFO, Gayle Jardine. Following their remarks, we will open the call for questions. Before we begin, Jackie Keshner, from the Gateway Group will make a brief introductory statement. Ms. Keshner, please proceed.

Jackie Keshner: Thank you. Good morning, everyone, and welcome to Coda Octopus’ second quarter fiscal year 2023 earnings conference call. Before management begins their formal remarks, we would like to remind everyone that some statements we are making today may be considered forward-looking statements under securities law and involve a number of risks and uncertainties. As a result, we caution you that there are a number of factors many of which are beyond our control, which could cause actual results and events to differ materially from those described in the forward-looking statements. For more detailed risks, uncertainties and assumptions relating to our forward-looking statements, please see the disclosures and our earnings release and public filings made with the Securities and Exchange Commission.

We disclaim any obligation or undertaking to update forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made, except as required by law. We refer you to our filings with the Securities and Exchange Commission for detailed disclosures and descriptions of our business, as well as uncertainties and other variable circumstances including, but not limited to risks and uncertainties identified in our Form 10-K and Form 10-Q for the second quarter. You may get Coda Octopus’ Securities and Exchange Commission filings free by visiting the SEC website at www.sec.gov. I would also like to remind everyone that this call is being recorded and will be made available for replay via link in the Investor Relations section of Coda Octopus’ website.

Now I will turn the call over to the company’s Chair and CEO, Annmarie Gayle. Annmarie?

Annmarie Gayle: Thanks, Jackie, and good morning, everyone. Thank you for joining us for our second quarter 2023 earnings call. As a management, we have established over many years a good track record of running a profitable and sound business. We have also spent the last four years on the development of our new generation of underwater products and solutions, including our Echoscope PIPE and our Diver Augmented Vision Display system, DAVD, which underpin our growth strategy. Management’s core focus is now on organically growing the business. Our current business target is growing the Marine Technology business this year by 22.2% to reach $18 million and growing the Services business by 6.7% to reach $8 million. We have a strong balance sheet and do not envisage the requirements for new capital to fund our growth.

Although, at the end of this quarter, we are behind on our full year 2023 business plan financial goals, we continue to be laser focused on our growth strategy and executing against this. From Echoscope rental, and sales projects we’re working on have unpredictably (ph) slowed, mainly in Asia, and therefore, in the second quarter, we did not achieve our revenue target for Echoscope solution. I’d now like to summarize our second quarter highlights. Within our current business strategy, the two pillars of growth for our company are our Echoscope real-time 3D imaging sonar, the new generation of Echoscope PIPE and our recently launched Diver Augmented Vision Display system, DAVD system, which is in adoption by the U.S. Navy. I will therefore focus my remarks on these two pillars.

Turning firstly to the Echoscope. The underwater imaging sonar market is growing largely due to the new generation of underwater vehicles focused on bringing new capabilities to the subsea and underwater market. One of the key requirements for the defense market for these new vehicles is real-time 3D spatial perception and scene awareness technology. It is therefore our strategy to work on increasing the number of defense underwater vehicle programs, which the Echoscope technology is embedded in. If we are successful with our strategy, this would open up long tail and recurring revenues for the business under these programs, which is similar to the business model of our engineering business. In the second quarter, Echoscope sales were down and this is largely due to anticipated sales in Asia territory that did not come through in the second quarter as expected.

We, however, continue to focus on our overriding strategy to increase our market share of the imaging sonar markets. In this quarter, we provided support to two of the defense programs that utilize our Echoscope. These programs are now entering their customer trial phase. Turning to DAVD. The tethered DAVD system has now moved from the Navy’s R&D phase to their field adoption phase. And in the second quarter, we sold $1 million DAVD systems which will be distributed to new commands with the Navy, within our 2023 financial year fiscal projections, we have $2 million revenue targeted for DAVD. Thus, in the second quarter, we have achieved 50% of our targeted revenues for this product and with the opportunities we are currently pursuing, we believe we will meet our 2023 fiscal year target for the DAVD.

We continue to pivot from an R&D focus to sales and marketing and brand building. The second quarter saw us having top quality engagements, some of these were closed door invitation only events with our target markets and we continued to raise awareness about our technology. We participated in several events for the promotion of our products and services, including two key events, which were by invitation. Special Operations Forces Week 2023, which was hosted in partnership with United States Special Operations Command and Military Diver Training Continuum in Panama City, which had in excess of 250 military divers participating, a significant target market for the untethered version of DAVD. We also showcase and presented the DAVD tethered solution at the Dutch Diving Regulatory body, SWOD, Special Weapons Ordnance Device exchange events in Papendrecht, Netherlands, which had a large turnout of diving companies, fire department, and that Depends, Labor Inspectorate in attendance.

We had successful demonstration of DAVD to the Dutch Navy in a vessel rescue penetration training facility in the Netherlands. We also had successful completion of DAVD trials with a major European offshore provider, who is actively discussing options for adoption. We also had successful engagement and demonstration of DAVD to new market opportunities for the Deep Saturation diving sector and multiple nation Special Forces untethered diving solutions. We successfully supported two different defense underwater vehicle programs of US Prime Defense Contractors with their Echoscope PIPE integration in preparation for their ongoing sea trials with their end user customers. In the quarter, we also saw strong inquiries for rental of the DAVD solution for projects that had hindered by low visibility water condition.

In the second quarter, therefore, we had solid momentum and progress around our key pillars of growth both the DAVD and Echoscope PIPE. Looking forward, we are also discussing potential adoption by a Japanese construction company, sales of the valuation system for the DAVD untethered solution and working with U.S. project sponsor for the full adoption of the DAVD untethered system in 2024. Turning to the DAVD adoption curve. DAVD is an important part of our growth strategy and we think it is important to update the market on the likely adoption curve for this recently launched technology. The customer adoption curve for nearly all such opportunities is the same. Stage one, initial demonstration and trials to establish interest. Then stage two, customer specific trials which are designed around their workflow typically on live operational missions.

And stage three, decision on adoption and investment plan. This process can take up to two years to culminate in a decision. To summarize where we are with some of these initiatives around the DAVD, therefore, turning firstly to DAVD tethered variant. DAVD tethered variant is an approved Navy use item, and it’s now in the field and adopted by the US Navy. The Navy has started purchasing field assistance as distinct from R&D systems. In this second quarter, we sold $1 million DAVD tethered systems. We’re now actively marketing this variant in both the commercial and defense sectors, including extending our model to lease and rental options. Turning to DAVD untethered variant. The DAVD untethered variant is now delivered and under evaluation with project sponsors and we expect some initial evaluation systems to be purchased for broader field assessment in the third quarter.

This variant was the center piece of the Special Operation Forces and Military Diver Training Continuum Event we attended in the quarter. Coda Octopus will continue to support the field evaluation by providing training and other technical support that may be required by the project sponsor. Interest has grown in the DAVD in new diving communities and we are working with teams in the saturation diving community for both the U.S. Navy and Commercial European Dive Contractors. Turning now to ongoing trials and adoption discussions. We have four second stage of foreign defense agency trials scheduled in our third and fourth quarters. One European offshore service provider in third stage and discussing investment plans, one European offshore service provider in second stage and we have already done DAVD customization work on the technology for this service provider.

We are actively discussing adoption options with one major Japanese offshore construction company, who is an established user of our Echoscope and who owns up to 15 Echoscopes within their operations. Due to their established use of our Echoscope technology, we believe the adoption process is likely to be much quicker, and we have provided commercial terms on the adoption to this customer. Turning to expansion of the business model for DAVD technology allowing market access. We also believe from recent business development efforts that we could fast track adoption through rental and lease of the DAVD technology. This will also broaden the accessibility of the technology in the marketplace. We continue to believe that the likely inflection point for the DAVD therefore is in finance year 2024, where we hope to have acquisition budget lines established with other customers outside of the U.S. Navy and where the U.S. Military commands has started purchasing DAVD untethered system, our biggest opportunity for the product following completion of their evaluation period.

To conclude, therefore, we remain comfortable targeting approximately $25 million in revenue for our technology business on a standalone basis in financial year 2024. In financial year 2022, this business, that is the Marine Technology Business had revenue of approximately $15 million and this year, we’re targeting $18 million for this business on a standalone basis and at the same time maintaining our profitability. Turning now to new products and other progress. A number of key technologies were developed as part of the DAVD system, including the Digital Audio Communication Module and the subsea Edge Enhanced Video Module. The first of these has already been requested as a standalone product by the U.S. Navy and we have a purchase order to deliver the first small batch in our third quarter.

We are also in discussions with several vehicle manufacturers for the integration of our subsea Edge Enhanced Video Modules. These technologies allow us to expand our product portfolio through discrete packaging of already developed technology to further add and diversify our market reach and revenue. This product is also exciting for the company as the purchase process is significantly shorter due to the price point of these modules. We also believe that there is a real need to advance underwater communication systems by moving from analog communications to digital communications, which is what this new digital audio communications module is designed for. The addressable market for this we believe is significant, if our product meets the addressable market brief.

Now turning to our Marine Engineering Business. We continue to reiterate that this segment is important for our group as it has strong pedigree in defense engineering with stellar relationships with prime defense contractors spanning decades. These are important relationships for our group strategy. There is a strong crossover of engineering skills, which is vital for us to maintain competitive lead in real-time 3D imaging sonar and our diving technology. This business, that is the Marine Engineering Business supplies sub-assemblies into broader mission critical programs on the sub-contracts with prime defense contractors. This gives them the opportunity to have repeat orders to these sub-assemblies for the life of the program. Within this business segment, we are navigating headwinds from supply chain issues across various defense programs.

The supply chain difficulties apply not only to our own sourcing of components, but also crucially to our customers’ own supply chain issues in parts of the program unrelated to us. This is resulting in the broader program design requirements being slower to lock in due to the general unavailability of components. This has led to many instances of multiple iterations of the design proposal being submitted for the same work package, which in turn has resulted in slower order take, order intake in our first and second quarters. However, we have two new programs which are now moving from their prototype phase into production phase where we expect to receive purchase order for the manufacturing of these sub-assemblies. We have successfully completed the environmental assessment test for one of these programs recently and we expect to receive the manufacturing order for these in the financial year.

We have also started to deliver the first of a small batch of Thermite mission computers to a NATO country. This will cumulatively positively impact this business and is an important first step in restoring the services business to its $10 million revenue profile over the next two years. Let me now turn the call over to our acting CFO, Gayle Jardine to walk you through our financials before I provide my closing remarks. Gayle?

Gayle Jardine: Thank you, Annmarie, and good morning, everyone. Let me take you through our fiscal second quarter financial results. Let’s begin with revenue. In the second quarter of 2023, we recorded total revenue of $5.3 million compared to $5 million in the second quarter last year, an increase of 6.4%. The Marine Technology business generated revenue of $3.6 million, compared to $3.5 million last year second quarter, a 2.6% increase. We’re excited about the mix of sales and as previously mentioned by Annmarie, in the second quarter, we sold $1 million of DAVD units, which is 50% of our DAVD revenue target for this financial year. Looking now at gross profit margin. In the second quarter of 2023, we generated gross profit of $3.6 million, compared to $3 million in the second quarter of fiscal 2022.

Gross margin in the second quarter of 2023 was 68.3%, especially 60.8% in the same year ago period. In our Marine Technology business or product business, gross margin fell slightly to 75.3% in the second quarter of 2023 compared to 76.6% in the prior year second quarter, reflecting changes in the mix of sales. In the second quarter this year, we had more units of hardware in the mix of sales with less units of rentals and services. Our Marine Engineering business gross margin was 53.9% versus 23.9% in the prior year second quarter. In the prior period, there was a high concentration of revenues from a particular low margin project. Now moving to our operating expenses. Total operating expenses for the second quarter of 2023 increased 8.5% to $2.8 million, compared to $2.6 million in the second quarter of 2022, driven by a 10.3% increase in selling, general and administrative expenses, due to net increase and professional fees for services such as tax and audit.

Our selling, general and administrative costs in the second quarter of 2023 totaled $2.2 million, increasing from $2 million in the prior year second quarter. As a percentage of revenue, our selling, general and administrative cost for the second quarter 2023 increased to 42.3% of total revenue compared to 40.8% in the second quarter of fiscal 2022. Looking forward on our cost structure, given the significant progress we’ve made in R&D in the last four years, we remain focused on aligning a significant portion of our resources and strategy from research and development to global business development, brand building, and investor relations. We believe we have developed world class products and solutions that provide market leading positions for CODA.

And that we can make meaningful progress in our markets through these investments to create shareholder value. Now to focus on operating income, which in the second quarter of 2023 was $855,000 compared to $481,000 in the second quarter of 2022. Operating margin was 16.1% compared to 9.7% in the second quarter last year. Net income before taxes in the second quarter of 2023 was $1 million compared to $493,000 in the second quarter of 2022. Net income after taxes in our second quarter 2023 was $1 million or $0.09 per diluted share, compared to $611,000 or $0.05 per diluted share in the same quarter last year. Finally, looking at our balance sheet. As of April 30, 2023, we had $23.5 million in cash and cash equivalents on hand and no debt. This represents a $1.1 million cash decrease in the quarter due to the timing of our federal tax and state tax payments for the prior year, as well as prepayments for tax in this year, which totaled $1.27 million.

This tax payment is also reflected in a $1 million reduction in our current liabilities. For the year-to-date, we have had a cash build of $0.5 million. That completes my financial summary. Now, I will turn the call back over to Annmarie for closing remarks. Annmarie?

Annmarie Gayle: Thank you, Gayle. As stated previously, although, in the second quarter, we are behind in our business plan, we are focused on executing our existing plan and growth strategy. We have significant momentum around our gross pillars and again our focus is converting these into tangible near term opportunities for the business. Management will continue its efforts to explore the rental and lease model for the DAVD with the objective of galvanizing market adoption. We also have a near term growth catalyst from the Digital Audio Communications Module. If we’re successful with this module, it will provide the company with diversification of revenue which counterbalances the longer sales cycle of both the Echoscope and the DAVD and potentially as a good stream of additional revenues for the company.

We have a demonstrated track record of consistent profitability, and we have a solid on leverage balance sheet with cash on hand and no debt, which gives us confidence in our outlook for CODA. Furthermore, with our solid balance sheet, we do not envisage needing growth capital for the growth targets we have set out for the next two years. We’re now happy to take your questions. Operator?

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Q&A Session

Operator: Thank you. [Operator Instructions] Our first question comes from the line of Brian Kinstlinger with Alliance Global Partners. Please proceed with your question.

Brian Kinstlinger: Great. Thanks so much, and thank you for all the very detailed information on your markets in your end, and the exciting things going on. I wanted to start with your financial targets for fiscal ’23, especially the $18 million for marine projects. This would mark a substantial increase in demand for the second half of the year, especially with only a modest contribution, if I heard you right, which is about $1 million more for the DAVD. So first, have you seen an improvement in the Asian market? And then, whether you have or have not. what does give you the confidence in the second half of the year? You’re going to see much stronger results compared to the first half.

Annmarie Gayle: Brian, hi. It’s Annmarie. Thank you very much for the question. Yes. We’re really off plan, as I said and really, by this time, we really should have done around $9 million and that largely what we’ve seen really good level of inquiries, good level of proposal writings and good quality of opportunities that we are pursuing. However, what we’ve really seen is the slower pace of conversion from the Asian market, but nothing leads us to believe that the opportunities have gone away. We still think that they’re valid opportunities for 2023. So whilst I believe that we are definitely off plan and we’ve got a lot of more to do to achieve that $18 million, I really think from what I am seeing for our business is that we still could be very close to the projections, the internal projections.

Look, we haven’t reforecasted because then, we have no reason to do so. As we said, what we’re seeing is slower pace of conversion, but nothing indicating that the opportunities that we are pursuing have gone away. They’ve just slowed. And that’s, not unusual, I mean, our sales cycle and quarterly fees are not necessarily linear, although within our projections, they are just for modeling purposes, linear. But, really, our focus is full year revenues and believe on a full year basis, we have no reason at this stage to reforecast that.

Brian Kinstlinger: Okay. And then as it relates to your two underwater vehicles in trials with the Echoscope PIPE. Is CODA’s technology the only one selected for those trial phases? And how long do you expect a trial phase might last?

Annmarie Gayle: Well, we don’t know what’s on the defense vehicles that are being, what other senses are there. We only know that our sensor is part of that solution. And I think that the two programs that we worked on this quarter, I think that they are at their advanced stage and from information we have, if this program or trials are successful, they’re likely to do a small batch in the beginning of Q1 next year, but it’s subject of course to their trials being successful and they continue to execute at the pace that we’re currently executing.

Brian Kinstlinger: Great. In the last quarter, you talked about having four of these underwater vehicles in the U.S. and one outside the U.S. Maybe share any details you commented on two. Are the other three, have they gone away? Are they still in the pipeline? There’s just no update on them. Just trying to understand how that pipeline may or may not have changed.