Coda Octopus Group, Inc. (NASDAQ:CODA) Q3 2023 Earnings Call Transcript

Coda Octopus Group, Inc. (NASDAQ:CODA) Q3 2023 Earnings Call Transcript September 13, 2023

Coda Octopus Group, Inc. misses on earnings expectations. Reported EPS is $0.09 EPS, expectations were $0.12.

Operator: Good morning, and welcome to Coda Octopus Group Third Quarter Fiscal Year 2023 Earnings Conference Call. My name is Sherry, and I will be your operator today. Before this call, Coda Octopus issued its financial results for the fiscal third quarter ended July 31, 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, it’s Acting CFO, Gayle Jardine. And following remarks, we will open the call for questions. Before we begin, Jackie Keshner will — from Gateway Group will make a brief introductory statement. Ms. Keshner, please proceed.

Jackie Keshner: Thank you. Good morning, everyone, and welcome to Coda Octopus’ third quarter fiscal year 2023 earnings conference call. Before management begins their formal remarks, we would like to remind everyone that some statements we’re 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 in our earnings release and public filings made with the Securities and Exchange Commission.

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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 Forms 10-Q for the first, second and third quarters this fiscal year. 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 a 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 third quarter 2023 earnings call. As a management, we have established over many years a good track record of running a profitable and sound business. In addition to remaining profitable in the third quarter, we have been profitable for 45 of the last 50 quarters and every year for the last 12 years. 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 underpins our growth strategy. We believe that the company has almost unrivaled potential with a unique product set at a time when the market will expand.

Against these impressive metrics, management’s core focus continues to be on organically growing the company. Despite disappointing results due to low order take in the third quarter, we remain optimistic about our business and the pipeline of opportunities we’re pursuing and the strong momentum we’re having in our core target market, the defense space. In addition, we have maintained a strong balance sheet and do not envisage the requirement for new capital to fund our growth plan. Our Marine Technology Business has two business models. These are outright sale of our technology and rental and associated services. The main reasons we have not met our third quarter financial goals are: firstly, although our Marine Technology Business continues to increase its quality of pipeline of opportunities, order conversions have slowed, principally outright sales from Asia and, in Europe, for rentals and associated services due to a fall in the number of offshore wind projects; secondly, our UK services business has also experienced significant delays in receiving orders because the priorities of its defense customers temporarily shifted to land-based defense applications to support the requirements in Ukraine.

This has affected naval requirement projects, the areas where we provide our solutions. Turning to the company’s outlook for Q4. Although we continue to be profitable at the end of this third quarter, we are behind on our full year 2023 business plan financial goals. As a reminder, we had been working to a revenue plan of $26 million overall for fiscal 2023. Due to the delays we have experienced year-to-date in converting opportunities into firm orders, we are reforecasting fiscal 2023 and now believe our results will be more in line with our financial year 2022 results. We continue to be laser-focused on our core strategy to grow the business and, as a management, we remain completely committed to this. As we focus on growing the business, we continue to believe we have significant opportunities around our Echoscope PIPE and DAVD solutions, including spin-off products such as the DAVD Digital Audio standalone product.

I’d now like to summarize our third quarter results. In the third quarter, our Marine Technology Business order intake was down significantly. This is due to two reasons: First, we have seen a slowdown in new European offshore wind projects being initiated. This has impacted on our rental and associated rental services revenues. It is widely reported, including on Bloomberg, that the cost of these fixed price offshore wind projects has soared 40% compounded by higher interest rates thus requiring renegotiation. Orsted, Vattenfall and Siemens, the big players in the wind market, have all reported significant revenue decreases in this sector. Our Echoscope cable monitoring and laying solution is used in this market. Second, we also saw reduced order take in key geographies, Japan, China and South Korea.

In these geographies, our technology is used primarily in underwater construction and offshore wind applications. Though we have continued to increase our pipeline of opportunities and believe that our inquiries and quotation levels are good, we have experienced significant delays in converting these into orders for the business. As a result of these factors, revenue fell in the Marine Technology Business and was $2.9 million in the third quarter compared to $4 million in the previous third quarter 2022. Despite the decrease in revenue in the third quarter, we do not believe that this is due to anything systemic or loss of our market position in the areas in which we excel. We believe it reflects the slowdown in offshore wind in the European market; the delays in European offshore service providers entering the U.S. offshore wind market, as reported by the likes of Orsted; and delays in converting opportunities emanating from Asia into firm orders.

We believe that in the fourth quarter of 2023, we will see some of these opportunities materializing into orders. Within our current business strategy, the two pillars of growth for our company are our Echoscope PIPE real-time 3D imaging sonar and our recently launched Diver Augmented Vision display system, DAVD, which is in adoption by the U.S. Navy. I will therefore focus the rest of my remarks on these two pillars. Firstly, turning to the Echoscope and progress in this area in the third quarter. The underwater imaging sonar market is growing largely due to the new generation of underwater vehicle focused on bringing new capabilities to the subsea and underwater market. Recently, it was announced that the U.S. Navy has now standardized the Videoray Defender as its preferred solution in the small underwater vehicles category.

In general, the new generation of underwater vehicles present new capabilities, which in turn is fueling the demand for more capable sensors such as ours. One of the key emerging requirements for the defense market for this class of vehicle is real-time 3D spatial perception and scene awareness technology. And in keeping with the U.S. Navy selection of the Videoray Defender, we were selected for an executed trials on this platform with Naval Information Warfare Center, NIWC, in our third quarter. It continues to be our strategy to work on further increasing the number of new defense underwater vehicle programs in which the Echoscope technology is embedded and trials like these are a key precursor to such success. In the third quarter, as part of a second phase defense navy program, we completed and delivered for customer evaluation a full survey grade diver handheld solution, which embeds our Echoscope PIPE imaging sonar and the DAVD for the Navy and which will be used for high-resolution real-time 3D mapping and inspection in ship hull applications.

Also, in the third quarter, a coordinated trial was planned and executed at the San Diego Naval Information Warfare Center, NIWC, facility to support the need for real-time 3D inspection and critical mapping from a small man portable remotely-operated vehicle, ROV. The trials flawlessly and successfully showcased the Echoscope’s capability to perform real-time 3D inspection, target identification, and high-resolution mapping, as well as uniquely allowing the ROV pilot to fly the ROV in zero-visibility conditions using the live real-time 3D display from the Echoscope PIPE. In addition to the NIWC vehicles team, other U.S. and UK Navy attendees were able to witness the demonstration. Evaluation of the trial result is ongoing with different related departments.

We also received, in the third quarter, very favorable mission results from three of our defense customers who have selected, integrated and recently demonstrated our Echoscope technology on their subsea vehicles. These programs vary from small vehicles to larger vehicles, all greatly benefiting from the real-time 3D volumetric data unique to our patented Echoscope technology. Notable also, as these defense customers have success with the technology on one of their programs, they take the same solution into other programs. For example, one defense customer has expanded the use of our technology on four different vehicle programs. We continue to believe that there is significant momentum around our Echoscope-based solutions. Secondly, now turning to our progress on the DAVD in the third quarter.

As a reminder, the tethered DAVD system has now moved from the Navy’s R&D phase to their field adoption phase. As part of the continued fleet field rollout, in the third quarter, we performed two crucial training events. SWRMC in San Diego received their initial DAVD training as new user group to the DAVD family. SWRMC is responsible for all ship maintenance and diver salvage in the busy San Diego area, and they have already been able to utilize the DAVD system on a live mission. Additionally, UCT in Port Hueneme received additional DAVD units. In the third quarter, we trained the Navy’s newly appointed Field DAVD Super User, who has been brought onboard to work with the Navy DAVD Program Manager specifically to ensure the operational success of the newly fielded DAVD system.

On an ongoing basis, we will support joint field missions as part of the Field DAVD Super User’s onboarding process. During the quarter, we also supported U.S. Navy dive inspection and salvage operations in Maui in response to the recent devastating wildfires where the DAVD Echoscope Inspector System was used for real-time 3D mapping and monitoring the underwater environment. In the third quarter, we continued to make progress on the two variants of the DAVD system, tethered and untethered. By way of progress on adoption, a major European offshore provider has completed its findings on the DAVD tethered system trials, which they performed in our second quarter. Quoting directly from their report, they concluded that, “The advantage of the DAVD alone, compass, depth, taking snapshots and presenting graphical information for diver and supervisor, or combined with a 3D live sonar video stream is clear and increases safety and efficiency.

The 3D sonar fits well within our scope of work and our survey division is aware of this. We think that the combination of DAVD and 3D sonar has potential within our organization.” This provider is one of the Big Four global dredging companies that together control 80% of the global dredging capacity and have confirmed their intention to adopt the DAVD and we are working on a model for initial adoption. We also have made progress with the DAVD untethered variants. DAVD untethered prototype systems were delivered to our project sponsor earlier this year as part of their evaluation program. We have made further progress in this quarter and have been awarded initial further funding of approximately $750,000 out of a total contract value of $1.8 million.

The scope of delivery for this funding is supplying eight evaluation system and performing further customization work. This is significant because for the first time another foreign Navy has co-opted into the U.S. Navy DAVD program. We’re still optimistic that this variant will move forward to field operation in financial year 2024, subject to successful completion of the evaluation stages, and we continue to focus on completing the funded customization work package. Turning now to trials and adoption discussion. We have good quality discussions ongoing with a second major European offshore provider where we have completed customization work necessary for their specific helmet and rebreather system, and we planned some field work with this customer later this year with a DAVD system.

We also provided in the second quarter commercial terms to a major Japanese offshore construction company who is an established user of our Echoscope. We have since made further progress and have been invited to conduct a pre-adoption DAVD training with this customer later this month. Also in this month, we will also be demonstrating the DAVD to several interested Japanese customers in both the defense and the commercial sectors at the same time. We’re also excited about the second phase trials with the Spanish Navy later this month in Alicante, Spain, which forms part of our continued DAVD World Engagement program. They are interested in both the tethered and untethered variants. We continue to believe that the likely inflection point for the DAVD is in financial year 2024 where we hope to have acquisition budget lines established with a broader customer base, including foreign navies and commercial offshore service providers.

To restate, despite challenges with order take during the quarter, we have good traction and momentum behind our solutions and believe we have achieved key milestone targets around these. As we work towards closing fiscal 2023, we remain confident about our longer-term goals to grow the business, and we believe we are well positioned for this. Now, turning to our Marine Engineering Business. This business supplies sub-assemblies into broader mission-critical programs under contract with prime defense contractors. This gives them the opportunity to have repeat orders for these sub-assemblies through the life of the program. We continue to reiterate this segment is important for our group as we have a strong pedigree in defense engineering with stellar relationships with prime defense contractors spanning decades.

These are important relationships for our growth strategy. There’s also a strong crossover of engineering skills, which is vital for us to maintain our competitive lead in real-time 3D imaging sonar and our diving technology. Year-to-date, the UK part of our services business has experienced significant delay in receiving orders. This is largely due to their defense customers’ priorities having switched temporarily onto land-based applications related to Ukraine, which has temporarily put naval-based requirements on hold. This delay has affected order take and has also contributed to our business being off plan. Approximately $2.5 million worth of orders anticipated in the first quarter of our 2023 financial year have not yet been released for the reasons outlined earlier.

We will continue to work towards restoring the services business to its $10 million revenue profile over the next two years. Finally, before we discuss our third quarter financial performance in greater detail, I wanted to briefly mention our most recent leadership appointment. Last week, we announced the appointment of John Price as our new permanent Chief Financial Officer effective on November 27 of this year. John is joining Coda with more than 28 years of experience working in financial roles, having served as the CFO of NASDAQ-listed Assure Holdings Corporation since 2021. John brings a seasoned background in corporate finance and accounting, along with key public company and technology industry experience. We look forward to welcoming John to the company later this year, and we would like to thank Gayle Jardine for her work as Acting CFO in the interim.

Let us now turn the call over to Gayle 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 third quarter financial results. Starting with revenue. In the third quarter of 2023, we recorded total revenue of $4.9 million compared to $6.3 million in the third quarter last year, a reduction of 22%. The Marine Technology Business generated revenue of $2.9 million compared to $4 million, a 28.5% decrease from the prior-year quarter. As reported earlier by Annmarie, this decline in our consolidated revenue was a result of weak demand from strategic markets and geographies, such as Asia for outright sale and Europe for rentals, particularly in the offshore renewable sector. Our UK services arm was also affected by delays in receiving key orders due to its customers’ focus being on land-based defense applications to support the Ukraine efforts and not the naval-based applications that apply to our business.

Moving on to gross profit and margin. In the third quarter of 2023, we generated gross profit of $3.4 million compared to $4.6 million in the third quarter of fiscal 2022. Gross margin in the third quarter of 2023 was 68.8% versus 72.8% in the 2022 third quarter. In our Marine Technology Business, or Products Business, gross margin fell to 82.1% in the third quarter of 2023 compared to 86.7% in 2022 third quarter period, reflecting changes in the mix of sales and higher commission costs in the period. Our Marine Engineering Business gross margin increased to 50% this quarter versus 48.2% in the 2022 third quarter. Now moving to our operating expenses. Total operating expenses for the third quarter of 2023 fell slightly to $2.50 million compared to $2.54 million in the third quarter of 2022, driven by a slight reduction in both selling, general and administrative expenses and research and development expenses.

SG&A remains below our targeted internal budget, largely because of reductions in staff headcount and targeted new hire positions remaining unfilled. Our selling, general and administrative costs in third quarter 2023 totalled $1.9 million and remained in line with the previous ’22 third quarter. As a percentage of revenue, our selling, general and administrative costs for third quarter 2023 was 39.6% of total revenue compared to 31.3% in the third 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 remained 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 expect SG&A to increase on a full year basis as we hire new staff and expand our management team. We believe we’ve 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. Operating income in the third quarter of 2023 was $0.9 million compared to $2 million in the third quarter of 2022. Operating margin was 17.6% compared to 32.3% in the third quarter of 2022, driven by the change in revenues as explained previously. Net income before taxes in the third quarter of 2023 was $1.1 million compared to $2 million in the third quarter of 2022. Net income after taxes in our third quarter 2023 was $1 million, or $0.09 per diluted share, compared to $1.8 million, or $0.16 per diluted share in the same quarter last year.

Moving now to our balance sheet. As of July 31, 2023, we had $24.9 million in cash and cash equivalents on hand and no debt. This represents an increase of $1.4 million in cash in the third quarter and an increase of $2 million in the nine-month period year-to-date of 2023. That completes my financial summary. Now, I will turn the call back over to Annmarie for closing remarks.

Annmarie Gayle: Thank you, Gayle. As stated previously, although in the third quarter we are behind in our business plan, we continue to be profitable and are focused on executing our existing plan and growth strategy. We have significant momentum around our growth 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 system with the objective of galvanizing market adoption. We also have a near-term growth catalyst from the digital audio communication module, which has progressed in this quarter. If we’re successful with this module, it will provide the company with diversification of revenue, which counterbalances the longest sales cycles of both the Echoscope and the DAVD and potentially adds a good stream of additional revenues for the company.

We have a demonstrated track record of consistent profitability and we have a solid unleveraged 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 additional capital for the growth targets we have set out for the next two years. To conclude, our management remains committed to executing the company’s growth strategy and delivering value for our shareholders. We’re now happy to take your questions. Operator?

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Q&A Session

Operator: Thank you. [Operator Instructions] Our first question is from Brian Kinstlinger with Alliance Global Partners. Please proceed.

Brian Kinstlinger: Hi, Annmarie. Thanks for taking my questions. First, looking at the 10-Q, you’ve been clear the revenue from Asia has been pressured for two consecutive quarters, and you highlighted the slower conversion of proposals to orders. Do you expect these trends to continue given the challenging economy in Asia or are there signs that this slower conversion is temporary?

Annmarie Gayle: Well, we’ve got a really strong customer base in those geographies. Well, everything that we see, these are delays, and the opportunities for the business have not gone away. So, we remain confident and we still see at the beginning of our Q4 revalidation requests coming in. So, I certainly believe that, in Q4, we’ll get some of those orders and certainly, in Q1, we would expect some of these orders to also come through. So, overall, I think these are more delayed than they’ve gone away, Brian.

Brian Kinstlinger: Great. And then, on the DAVD, the tethered side, sounds like you’ve got a lot of training. Is that ramped in command centers? And then, you highlighted at the end the interest in Japan and Europe. And then, you mentioned an inflection point in fiscal ’24. First, is that beginning of the year? Do you think that’s more towards the end of the year? And help us understand what that means in terms of a revenue range? Is it going to be much more significant, do you think? I’m just trying to understand what that inflection point really means.

Annmarie Gayle: Well, look, I mean, this year we set out to do something like $2 million of DAVD revenues. And I think that we have met that actually, and we’ve exceeded that a little bit. What I see, as you’ve rightly said, the tethered version is now fielded. This is now an item that’s open for purchase by any command in the U.S. So that’s very good news for the business. In addition to that, what we’re seeing is that, as I mentioned, is that we’ve got one European — major European offshore service provider having conducted rigorous trials, have confirmed that this could be game-changing for their organization and their intention to adopt the DAVD. We also have pre-adoption discussions in Japan. And later this month, we will be running training with a major Japanese customer that we think will adopt the DAVD in this calendar year.

So, I think we have a swirl of — or swell of good activities around the DAVD and we do expect that, that will be a significant part of our revenues in 2024. On the untethered version, I would expect that to be more the backend of 2024, because, as I pointed out earlier, I think that program has moved forward. I’m very, very excited about that because for the first time, Brian, we have a foreign Navy jointly funding the program and having their own requirements in the U.S. work package. And we’ve always said that one of the paths to adoption will be the U.S. Navy itself working with foreign navies on adoption, and we’re seeing that coming through. So, I am really, really excited about the progress. I mean, in this quarter, we were funded to the tune of $750,000 of $1.8 million contract, and part of that is for eight evaluation systems, and the other part is for some customization work for the Navy.

So, I’m really excited about the DAVD, the prospects for the business for the DAVD. And I think we’re making really, really good progress because a number of things happened in this quarter. As I said, we’ve got a European — a major European offshore service provider being happy about the trials. We also are doing pre-trial training in Japan. Also at the same time, demonstrating the capability to a wide breadth of Japanese customers. So, I feel really, really excited about where we are with the DAVD. And I do believe that the biggest opportunity we have with the DAVD, as I’ve always said, is going to be the untethered version. And therefore, what we are seeing now with that variant is that it’s moving into its second evaluation phase, which is that they’ve bought evaluation systems and we’re doing some customization work for them.

Brian Kinstlinger: And quickly a follow up on that. How long do you think evaluating those eight units takes? Is that a couple of months? Is that a couple of quarters? How do you think about that?

Annmarie Gayle: This is why I said that I really think that we will really start seeing the impact of revenue impact, because we’ve started acquiring systems. I feel that’s going to be more in the backend of 2024.

Brian Kinstlinger: Got it. Okay. And then in terms of your revenue goals, you highlighted, obviously, this year you’re behind plan. Your first year, I’m curious, do you think you’re one year behind plan given all these catalysts? Are you a little bit more than that given the market conditions? And then, secondly, your full year outlook suggests the fourth quarter is much stronger than the third quarter. Is that because of these orders starting to convert? Or is it more what you highlighted the digital audio module is going to offset the weakness that you’re seeing right now?

Annmarie Gayle: No, it’s really, Brian, some of the delays. We expect orders from Asia to start coming in in the fourth quarter. As I said, we’re seeing some activities on revalidation of our proposals. So that’s all looking robust for the fourth quarter. Look, I do believe that in the fourth quarter our results overall in 2023 will be more in line with our 2022 results. And whilst we might not have grown in the way that we set out to grow, our growth strategy is still intact. I think that despite challenging market conditions, the business still demonstrates that it can be not only profitable, but I think that earnings will still be quite strong for the business. And I think that looking at the pipeline of opportunities that we see for the business, I have — still feel excited about the opportunities, particularly for really where we are going to make a difference in terms of our growth strategy.

Brian, let me be clear. It’s the number of — on the Echoscope side, it’s the number of underwater vehicles that the technology is embedded into, and that’s the defense side. So, to some extent, the budget there is a different budget from the commercial market where that’s susceptible to the broader macroeconomic conditions. So, really, our goal is to grow the opportunities in the defense market where we can see repeat revenues. And we are certainly seeing a swell around our technology in the defense space. Absolutely, there is quite a lot of traction and momentum. We’ve got good quality business development activities around the Echoscope. And a lot of these activities, Brian, just to say, are closed-door events or invitations that we have received to come and demonstrate the technology on these new platforms.

So, the technology is becoming well known in the defense space, and we are having success there. So, I think that’s what’s going to make a difference to our revenue in 2024. And therefore, this is really why I am still quite confident about our growth strategy and our plans to grow the business. And that’s really our focus. Of course, I don’t — can’t predict precisely what the market conditions will be. But what I’m telling you right now is that I’m excited about the business, the quality of activities that we’re engaged in. They’re very, very promising. The results we’re having, very, very promising. So, I’m excited about next year.

Brian Kinstlinger: Thanks. Just one point of clarification, and then that’s all I’ve got. I just want to make sure I understand. We’re halfway through the October quarter. Are you saying the conversions have started to already happen? Or you expect they’re going to happen in the next six to seven weeks?