Coda Octopus Group, Inc. (NASDAQ:CODA) Q4 2022 Earnings Call Transcript

Coda Octopus Group, Inc. (NASDAQ:CODA) Q4 2022 Earnings Call Transcript January 30, 2023

Operator: Good morning and welcome to Coda Octopus Group’s Fiscal Year Ended 2022 Earnings Conference Call. My name is Rob, and I’ll be your operator today. For this call, Coda Octopus issued its financial results for the fiscal year ended October 31, 2022 including a press release, 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 it’s CFO, Nathan Parker. Following their remarks we will open the call for questions. Before we begin, Jeff Grampp from Gateway will make a brief introductory statement. Mr. Grampp, please proceed.

Jeff Grampp: Thank you, Rob. Good morning, everyone and welcome to Coda Octopus’s fiscal year end 2022 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 that 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 before 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 under the caption €œRisk Factors€ in our 10-K. You may get Coda Octopus’s Securities and Exchange Commission filings for free by visiting the SEC website@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’s website.

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

Annmarie Gayle: Thanks, Jeff. And good morning, everyone. Thank you for joining us for our fiscal year-end 2022 conference call. I’m excited to speak to you today about Coda Octopus. I’m very, very excited about the company. Now before we discuss our recent results and performance, I would like — I would first like to provide some background about our company to those listeners who may be newer to Coda Octopus Groups. Coda Octopus Group is an established business with a strong pedigree in underwater technology and defence engineering. We operate two discrete business operations, our underwater technology business and our filings, sometimes referred to as our products business, and our engineering business. We have a strong culture of intellectual property rights ownership in our technology business, and have a number of patents covering our technology.

And with the engineering business, we have sold supplier status for a number of proprietary parts sold into mission critical, Integrated Defense Systems. We view these business units as complementary and synergistic to each other, as we can jointly bid on projects where the combined skills provide a competitive advantage for such projects. We believe our business units also provide us with significant growth opportunities, combined with solid current revenue and profitability. I’ll be talking more about that today. Now, turning to our marine technology business. This business develops and supplies technology solutions to the underwater and diving markets for both commercial and defense customers. We have been operating as a supplier of solutions, comprising both hardware and software products for over 25 years, and all design, development and manufacturing of our technology and solutions are performed within Coda Octopus.

Now, we’re, we’re a market leader in real time 3D underwater imaging sonar technology as we have the world’s only real time 3D imaging sonar capability. This technology is the only one that can generate a real time 3D Image of moving objects underwater in zero visibility conditions. So the only technology in the world that can generate underwater, a real time 3D image of moving objects underwater in zero visibility conditions. And that’s important because much of subsea operations are plagued by zero visibility conditions and then we are the only solution in the market at that point. We market this technology on the Echoscope brand that is the Echoscope brands. Our other core technology relates to the transformational diving technology, the DAVD, which is Diver Augmented Vision Display system, which is the result of a direct requirement from the U.S. Office of Naval Research under its future naval capabilities to the DAVD came out of the requirements from the Office of Naval Research for its future naval capabilities program.

The DAVD is the only technology that provides the real time data platform to both the diver and dive supervisor where the data hub for the diver is on a pair of fully transparent glasses embedded in the divers helmet, face mask or other diving suits. So in other words, we are providing data to the diver on a pair of transparent glasses and that becomes this data hub for all types of different real time information. And this real time information is also shared by the dive supervisor on the surface. Now our sonar technology is used in a variety of underwater applications. These include construction, mining, bridge inspection, offshore renewables, oil and gas tracing , port and harbor security, survey and mapping, and more generally, for monitoring and inspecting moving objects on the water.

It is the only technology that can generate a real time 3D Image of moving objects underwater in zero visibility conditions. This is significant as many underwater operations are stalled due to poor visibility conditions, resulting in significant cost overrun. Now turning to our engineering business, our other operating settlement, this is conducted through our two engineering subsidiaries, Colmek and Martech, where we act primarily as a subcontractor to prime defense contractors. These engineering subsidiaries supply embedded solution and subassemblies into mission critical defense programs, where we have long established relationships with U.S. and U.K. Prime defense contractors, such as Raytheon, Northrop Grumman, and BAE. We have a number of programs that we have been supplying proprietary parts for over 30 years, such as the U.S. Close-In-Weapons Support program for the Phalanx radar-guided cannon used on combat ships.

These long-term relationships provide us with long tail recurring revenues. Now, the engineering businesses seek to leverage these long standing relationship with Primes to expand the number of programs it supplies into these programs. This is crucial for the growth strategy of the engineering business. That is to grow the number of programs that it supplies, proprietary parts. And that’s really its business model to really supply subassemblies into larger defense programs, where there’s the opportunity for long tail recurring relationships and because we have these long standing relationships with Primes, we often get the opportunity to bid for work on these programs. Now, turning to our growth pillars, that we are really postulating our growth on, I’d like to talk about these a little bit now more.

Our key growth pillars are our Echoscope and sonar series, our Echoscope, sonar series technology, and our DAVD. In order to fully understand where the company’s growth opportunities lie, let me start with our sonar technology and the evolution we had made over the last several years. If you look back several years ago, we had limitations, gaining broad adoption of our technology due to size, weight, power requirements and price. Our technology was very expensive. On since February 2019, our technology was limited to use on work class vessels. These are very large vessels at sea, which is only a small section of our target market. And at the time, we only had one type of sonar to service the entire market. And because of those form factors, we talked about size, weight, power and also price, the market was very limited for us.

In February 2019, we launched our fourth generation sonar series, and expanded our range of sonar offering to cover six base models with various options, these options covering frequency, depth, range and resolution or persona. That is really what gives the type or model that we’re selling frequency, depth, range and resolution. With this 4G sonar series, we have removed the barriers to adoption and opened the market opportunities for technology as we have models that are suitable for all types of underwater vehicles, be they large or small. We built on this traction with our 4G sonar series by recently introducing our Echoscope PIPE, an acronym for Parallel Intelligence Processing Engine. This is the most technologically advanced imaging sonar available in the market.

The Echoscope PIPE introduced significant new capabilities to the subsea market by providing a single sensor that can generate multiple 3D images simultaneously in real time, using up to 10 different acoustic parameters such as frequency range, and many other filters. Now, our previous generation of imaging sonar, was capable of generating only one 3D image in real time. Our new generation of imaging sonars, which is the Echoscope PIPE can generate multiple 3D images, and the data is therefore available to different parts of the survey operation. This therefore allows customers to rely on one sensor and not having multiple sensors to do different tasks within this survey operation, thus reducing costs and making operations much more efficient for the subsea market.

So we’re really not only move the market on to real time 3D imaging sonar, but also generating multiple 3D images for the different parts of the survey operation from a single sensor. And that’s the promise of the Echoscope PIPE. And this is why we are excited about the markets. With our company being a first mover in innovating, and commercializing real time 3D sonar technology, as well as shifting market requirements, to real time 3D imaging in the subsea market, we have positioned Coda to be the market leader in real time 3D underwater imaging visualization. Real time 3D data underwater transforms the market because users can make real time decisions in — as opposed to the current competing technology, which uses one mission to collect the data and another mission to process the data.

And this is the key difference between our technology and what I describe as the legacy technology. The legacy technology, which is the multi beam technology goes out to sea, collects the data, come to wave process, the data. Now the environment at sea is all is fast moving. So that is stale data, our technology provides the only solution for real time decision making. I can go out on a bridge doing a bridge inspection, I can see all of the impairments in the bridge, I can see discover right there and then, I can prepare my customer deliverable immediately there. I don’t have to go away and post process the data. So we’re really excited about our technology. Now I’d like to give you an update on our PIPE, the Echoscope PIPE progress we have made in fiscal year 2022.

Photo by Sven Piper on Unsplash

Well, the headline here is that we’ve been successful in getting our Echoscope PIPE sensors into new defense programs. This is really we have the opportunity before the company is at these prime defense contractors roll out the new generation of underwater vehicles. We have the opportunity to be the sensor of choice on those platforms. And this year, we sold into four different UX programs who are working on the new generation of underwater vehicles. We also sold into one new Japanese program, again working on the new generation of underwater vehicle for the Japanese defense market. In addition to that, in the commercial space, we sold four Echoscope PIPE sonars on a new underwater vehicle that is going to be used in that exciting application of offshore renewables, where we have the lead in many areas.

So we’ve made really good progress around Echoscope PIPE. So this progress made by our technology over the last four years, both in expanding the available models within our sonar series and getting onto some key new underwater vehicle programs in the defense sector, paves the way for us to increase our market share of imaging sonar market over the next two to three years. Our goals as a management are to cement our place in the existing programs that we’re currently working, and also, of course, to identify new programs, all the while expanding our share of the commercial market for our sonar. In this way, we aim to increase our marine business revenue, selling depending on the model type and configuration between say 60 and 80 sonars per year along with VAPB sales.

And therefore in the next two to three years, we’re targeting approximately 25 million in revenue for our technology business on a standalone basis compared to 14.7 in the fiscal 2022. So we’re really hoping that year-on-year we’re increasing the number of sonars we’re selling in the market and Echoscope PIPE will be that new platform as the demand is more and more for a single sensor with multiple 3D images. And at the same time, we’re hoping to add to our revenues by the rollout of DAVD and we’re now going to talk a little bit more about DAVD which is our second growth pillar. So this DAVD technology, this is transformational, as it radically changes diving operations by providing enhanced vision and operational awareness, even in zero visibility conditions.

And this technology is applicable to both defense and commercial markets globally. For the DAVD, we are the first movers in the market to transform diving operations by providing buyers DAVD solution, real time media content of all descriptions to the dive operations. Importantly, our technology is scalable and transferable to all types of diving operations. Our main focus currently is in the defense, including the military and commercial, but excluding leisure diving at this stage, thereby providing Coda with a significant market opportunity. So the DAVD which is transformational for the global diving market, is really we’re targeting the defense market in the commercial market. And at the moment, we’re leaving the leisure market. The DAVD technology moves the diver from the dark room operations and diving by touch to a real time information platform shared by the diver and the dive supervisor on the surface and also moves away from a largely voice directed dive operation.

So really, we are introducing a real time platform, real time data platform for the diver and the dive supervisor. This in turn significantly enhances efficiency, safety, timeliness, cost of operations and guarantees the success of the dive operations. We should remember that divers have limited time in the water. Anyone time it’s approximately 20 minutes, and you have to get the diver in the water to the dive side to do the activity and out of the water. So there are six key transport transformational aspects that DAVD provides for the market. First is location where we provide real time diver compass information, depth, and positioning information underwater. We provide navigation to the dive site. And we also identify along the way all hazards and waypoints to the dive site.

Second, we provide visibility, can we enhance the diver experience with real time video data, our 3D sonar data were required and augmented reality scene awareness for the diver underwater using our 3D model of the environment. Third, communication. Here we communicate between diver and dive supervisor with rapid text messages, images, detailed instructions where required and digital speech and audio. Fourth, we provide data; care, the diver and dive supervisor can share and access importantly, all project data and information on demand in real time. This includes engineering information of all forms, drawings, videos, text messages, manuals, 3D models of installation, shapes for whatever they’re looking for. So really a rich media content, which supports the diver and a dive supervisor in real time.

This is safety as we provide navigation and dive time data synchronized in real time to ensure the diver monitoring including location, oxygen levels, path finding hazards and waypoints. And fifth, we’ve made significant advancements of the audio quality for diving operations underwater. So we’ve moved away from noisy analog to digital audio link that was served the entire diving community. The DAVD is an approved Navy Use item, including the accompanying Echoscope sonar, and it is currently in use by the U.S. by a number of U.S. Navy teams, such as MDSU, which is Mobile Diving and Salvage Unit. UCT, Underwater Construction Team, EXWC, which is Expeditionary Warfare Center and NSWC which is Naval Surface Warfare Center in Panama City. And SERMC, which is Southeast Regional Maintenance Center.

During the fiscal 2022, we made significant progress in expanding the market for the DAVD. First we have in 2022 performed the customization of the DAVD for a U.S. military command, which is the most significant opportunity for the DAVD in the U.S. currently. This is also this was done as a pay development, and we expect to deliver the first working prototype by early February. If trials are successful in spring, we expect to supply multiple units in rapid succession for further evaluation. And then, we expect a production order from this military command in fiscal 2023. Second, the second important milestone for the DAVD is that — the DAVD Gen 3 systems have now been supplied to the — the U.S. which have now sorry, which have now been supplied to the U.S. Navy have now moved from R&D to field operational status by the U.S. Navy.

So they’ve now moved the DAVD projects from R&D to feel operational status. This is an important milestone for the adoption of the technology in higher quantities. To date, we have supplied 20 of the latest Gen 3 systems which excludes the earlier generation. And for Gen 3, we have sold approximately $2 million worth of DAVD purchases, including some of our imaging sonars. Our first mover advantage and progress with these customers provide a high barrier to entry into this market by competitors. The DAVD is a complex product with hardware and software components. The software development takes many years. In addition, the use of the transparent glasses on the water, where we render the data to the diver which is the divers harbor is patented in the U.S. and Coda has the exclusive license with this.

Lastly, we at Coda Octopus are leveraging our years of underwater experience and incorporating our own proprietary technologies such as our real time 3D sonar, and software. Our real time 3D sonar is the only sonar that can produce real time images underwater, including 3D models of the underwater environment in all water conditions in convenient fear of visibility conditions. We’re targeting to grow this stream of revenues for the business, adding approximately $2 million to $3 million in revenues annually to the business over the next several years, representing about 50 incremental units of growth per year. So let me now turn the call over to our CFO Nathan Parker to walk you through our financials before providing my closing remarks. Nathan?

Nathan Parker: Thanks, Annmarie and good morning, everyone. Let me take you through our fiscal 2023 results for the 12 months ended October 31, 2022. For the fiscal year 2022, we recorded revenues of $22.2 million representing 4.2% growth compared to the $21.3 million of revenue we recorded in fiscal 2021. The increase in revenue was attributed to further penetration and markets for Echoscope and DAVD solutions and strong growth for our services business. It is important to note that we recorded this year-over-year growth despite currency headwinds of approximately $1.2 million as the U.S. dollar, which is our reporting currency strengthened significantly during fiscal 2022 compared to the currency of the many countries where we conduct business.

This dynamic has started to reverse itself more recently, which is encouraging to our business for the fiscal 2023 year. Without the adverse movements of currency resulting in lower translation of our revenues from our foreign subsidiaries, revenue would have increased by 9.9% instead of the 4.2% that we recorded. Our marine technology business recorded revenue of $14.7 million for fiscal 2022, representing a 7% decrease compared to $15.8 million in fiscal 2021. This decline is primarily due to the negative currency translation impact resulting from the strengthening of the U.S. dollar. Excluding this impact, revenue was approximately in line with the prior year at $15.6 million. Our marine engineering business recorded revenue of $7.5 million in fiscal 2022, representing growth of 36% compared to $5.5 million in fiscal 2021.

As sales orders began to materialize, and performance returns to more normalized levels. For fiscal 2022, we generated gross profit of $15.2 million representing growth in 2.9% over the $14.8 million in fiscal 2021 due to the favorable year-over-year increase in revenue, which was partially offset by higher material costs. Our gross margin percentage for fiscal 2022 of 68.3% compares to 69.2% for fiscal 2021, has a greater percentage over overall 2022 fiscal sales were generated from the marine engineering business, which should additionally has lower margins. Our marine technology business gross margin improved slightly to 80% in fiscal 2022 compared to 79.9% in the prior year. Our marine engineering business gross margin improved noticeably to 45.4% versus 38.6% in the prior year, as a greater percentage of revenue was generated from our engineering services contracts.

Now moving to our operating expenses, our total operating expenses for fiscal 2022 totaled $10.2 million, which is a 6.8% decrease from fiscal 2021 of $10.9 million due to lower research and development domain costs. Our research and development costs for fiscal 2022 totaled $2.2 million, which is a 25% decrease from fiscal 2021 of $3 million due to reduced spending in our marine engineering business related to the Thermite Octal development until we can really gauge both the market and customer requirements for this product offering, as well as a shift in our marine technology business expenditures, away from the capital intensive developmental phase of our real time 3D sonar technology. And that’s to series to feature enhancements including firmware and software improvements.

As a percentage of revenue, our research and development costs for fiscal 2022 decreased to 10% of total revenue, compared to 14% in fiscal 2021. Our selling, general administrative costs for fiscal 2022 totaled $7.9 million, which is essentially unchanged from fiscal 2021. As a percentage of revenue, our selling, general and administrative costs for fiscal 2022 decreased to 35.5% of total revenue compared to 37.1% in fiscal 2021. Looking forward at our cost structure, given the significant progress that we made in R&D in the last four years, we anticipate refocusing 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 now we can have we can make meaningful progress in our markets through these investments to create shareholder value.

Operating income for fiscal 2022 totaled $5 million, a 30.4% increase from $3.8 million in fiscal 2021. Operating margin for fiscal 2022 was 22.5% compared to 18.1% in fiscal 2021. The increase is primarily due to the higher revenue we generated coupled with our lower operating expenses for the year. EBITDA for fiscal 2022 totaled $5.9 million, which is a 5.1% decrease from $6.2 million in fiscal 2021. The slight decrease is due to our lower net income in fiscal 2022 compared to the prior year. Net income before taxes for fiscal 2022 totaled $5.1 million or 23.1% of revenue, a 2.3% decrease from $5.3 million or 24.6% of revenue in fiscal 2021. The slight decrease is due to a onetime $1.4 million benefit in fiscal 2021 from this payment, Payroll Protection Program, and employee retention credits, partially offset by higher revenue and lower operating expenses.

When adjusting for the Payroll Protection Program and our employee retention credits, we recorded in fiscal 2021 we grew our net income before taxes by 29.2% from $3.9 million to $5 million, which we think is a more accurate depiction of our strong results for fiscal 2022. Net income after taxes for fiscal 2022 totaled $4.3 million, or $0.40 per basic share, compared to $4.9 million or $0.46 per basic share in 2021. The decrease is largely driven by an increase in the company’s effective tax rate in fiscal 2022 as we have exhausted our past net operating loss carry forwards, as well as the one time Payroll Protection Program and employee retention credit that I have previously mentioned. Moving on to our balance sheet, as of October 31, 2022, we have approximately $22.9 million in cash on hand and no debt.

This compares to $17.7 million of cash on hand and approximately $64,000 in debt at October 31, 2021. We are able to grow our cash balances during fiscal 2022 while simultaneously continuing to invest in our business, as we generated $6.7 million in net operating net cash from operating activities. That completes my financial summary and I’ll turn the call over to Annmarie, for her closing remarks.

Annmarie Gayle: Thank you very much Nathan. Thank you. So as we look, look into our fiscal 2023 our key management goals are to continue to develop the market for our main technologies, particularly in the defense space, where there are various new programs for the new generation of vehicles — such as underwater surface vehicles and autonomous vehicles, where they’re looking for the new generation of defences, which we believe our Echoscope technology will be front runner for many of these new underwater vehicles that are emerging. And secondly, to introduce the DAVD technology to foreign navy and the commercial offshore sector. We have been pleased with the attraction of Echoscope PIPE for DAVD fruition that have been receiving and are hopeful about our future prospects representing these main pillars of our growth.

We’re excited about the outlook for Coda, as we have world class products and solutions that are transformational to the underwater imaging and diving market. And we mean transformational because our technology, the Echoscope PIPE and our DAVD are certainly the next generation of technology for these markets, which is set to displace the legacy technologies that are way behind our technology and where the market is now moved on to a real time information platform. This therefore provides us with significant growth opportunities in our market. We have a demonstrated track record of generating high margins and solid profitability. And we have a very healthy balance sheet with cash and new debt. We’re now happy to take your questions, operator?

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Q&A Session

Operator: Thank you. We’ll now be conducting a question-and-answer session. Our first question comes from line of Brian Kinstlinger with Alliance Global Partners. Please state your questions.

Brian Kinstlinger: Hi guys and congratulations on hosting your first conference call here. First as it relates to the revenue for the products business, excluding foreign exchange, it definitely had an impact that you highlighted. What were the other major challenges to growth in fiscal 2022 as sales in that business was relatively flat year-over-year?

Annmarie Gayle: Yes, I think that’s a great question, Brian. And hi, thanks for the question. I think what we saw in the last fiscal year, and which actually, we reported on, I think, in Q2, I think that our pipeline in terms of opportunities that we’ve been tracking and the level of close that we’ve been doing and preparing, they’ve been definitely much higher in the 2022 period. But what we’ve seen is the conversion rates, many of the — our pipeline centered around 2023. So we work closely, much more, but things were shifting into 2023. And I think this is partially where we’re going to see a rebalancing or rebounding in oil and gas and preparatory work for that, when you start say you’re going to prospect a new oil and gas installation, then I think that takes time to plan.

So what we’re seeing is a lot of pipeline activities and then, moving out into 2023. So what we expect, for example, in the 2023 period is to see rentals taking off much more than they had in the last two years, for example, Brian. So I think it’s largely to do with timing more than anything else. And also, we still had the overhand from COVID. We should still remember that can boost the sectors in which we operate. People are still working from home. What that means is that they’re not really profiteering as many projects as we were doing pre pandemic. So things are just being normalized, I think.

Brian Kinstlinger: Great. My second question as it relates to the Echoscope being used, and several defense contractors for underwater vehicle programs. You said selling to those were an opportunity for you, for your technology to be embedded as vehicles are rolled out. My question is, are these contractors still evaluating competing technologies Echoscope? Or have you received design wins for any or all? And what’s the next data point for these contractors?

Annmarie Gayle: Well, I don’t know if they’re evaluating other technology. But I think if you are evaluating, then you’re not purchasing our technology. The fact that we’ve been able to sell into these prime defense contractor is good evidence that we are part of the solution that they’re working on. So, they wouldn’t invest so much money just for evaluating. So I think we have a high degree of confidence from the moment we sell the first two systems into the program, that we’re part of the design. And, more importantly, we have been allocated part numbers for those parts. So we think within their overall solution, when we get a contract, it would be for that particular program with this part number. So, so I don’t know if they’re evaluating other technology, but the fact that our technology, and this is what’s happened in the past, where we were — had this sort of difficulty in expanding the market for technology, because there was no new vehicles coming to the market.

But you can say now that there’s a whole new set of opportunities for the business because of the new generation of underwater vehicles that are coming to the market and replacing the old generation that would have been equipped with the legacy technology.

Brian Kinstlinger: Thank you. I have a couple more, but first on the DAVD. Can you speak to the advantages of being of operational status for the DAVD, as opposed to being an R&D program?