Duos Technologies Group, Inc. (NASDAQ:DUOT) Q4 2022 Earnings Call Transcript

Duos Technologies Group, Inc. (NASDAQ:DUOT) Q4 2022 Earnings Call Transcript March 30, 2023

Operator: Good afternoon. Welcome to Duos Technologies Fourth Quarter and Full Year 2022 Earnings Conference Call. Joining us for today’s call are Duos’ CEO, Chuck Ferry, and CFO, Andrew Murphy. Following their remarks, we will open the line for your questions. Then, before we conclude today’s call, I’ll provide the necessary cautions regarding the forward-looking statements made by management during this call. Now, I’d like to turn the call over to Duos’ CEO, Chuck Ferry. Sir, please proceed.

Chuck Ferry: Welcome everyone and thank you for joining us. We always appreciate your attendance by many of our long-term and current shareholders, and we can also see that we’re joined today by a number of new shareholders. Welcome. Earlier today, we issued a press release announcing our financial results for the fourth quarter and full year as well as other operational highlights. A copy of the press release is available in the Investor Relations section of our website. I encourage all listeners to view that release as well as our 10-K filing with the SEC to better understand some of the details we’ll be discussing during our call. Before I begin with my opening remarks, I would like to address some recent events that are likely to have an impact on our primary rail market and bring much more focus from stakeholders, including customers, unions, regulators and the rail industry on what Duos can offer.

Due to the recent unfortunate derailment in East Palestine, Ohio, Duos has been contacted on many different levels to better understand what our technology does and the many years of investment in our railcar inspection portal and what that can offer. Very much of the first quarter into a greater since the derailment. Duos has been engaged in discussions regarding how our technology might be deployed on a greater scale in the United States to identify and reduce mechanical failures and derailments. More specifically, we have been requested to provide information on our railcar inspection portal capabilities to congressional leaders, regulators and unions, as well as current and potential customers as to the benefits of using technologies such as our railcar inspection portal, combined with artificial intelligence and human in the loop feedback processes that can augment currently mandated inspections.

Later in the call, I will provide additional details. Before I ask our CFO, Andrew Murphy to give us a summary of the 2022 results, let me discuss some highlights. The fourth quarter capped a strong finish to a banner year for our company. Despite significant external challenges throughout the entirety of 2022, we’re able to produce a record performance. Revenue was up 71% in Q4 and 82% for the full year, which is the highest revenue performance in company history. Additionally, we achieved a 100% renewal rate of recurring revenue contracts in 2022, leading to an approximate 30% increase in support in AI revenues compared to 2021. Operationally in Q4, we successfully deployed two new RIPs for Class 1 customers with at least two additional RIPs expected to come online in 2023, putting us on track to have a total of 15 RIPs installed by the end of the third quarter 2023.

Our AI catalog has 35 models that are available for deployment today and we expect to further grow that catalog to 50 use cases by the end of this year. We have also begun to develop AI applications to include passenger rail use cases. Heading into 2023, our current backlog sits north of $10 million, which eclipses our entire top line output in 2021, with more than $8 million expected to be recognized this calendar year, we have clear visibility to continue executing against the outsized demand we’re seeing. We’re also moving full speed ahead with our subscription offering, having identified the initial sites for Duo’s own portals. Our belief is that this new offering and pricing model will dramatically increase our potential customer base, while also expanding the margins and predictability of our revenues over the long term.

Our mission remains focused on the long-term growth and profitability of the company. Before turning the call over to Andrew, I’d like to thank our current customers, which represent 50% of the Class 1 operators in North America, not only for their business, but also for their leadership in identifying the value that can be brought to bear on safety and efficiency on the rail network by the deployment of improved wayside detection technologies, which includes our railcar inspection portal. We believe that our solution is particularly effective in augmenting the mechanical car inspectors who work hard every day under all weather conditions to identify, repair, and prevent mechanical failures and derailment conditions. And now I’ll turn the call over to Andrew to walk us through the financial results for the quarter and the year.

Andrew?

Andrew Murphy: Thank you, Chuck. Before turning to the results, I would like to add my own commentary regarding the tremendous opportunity for Duos. As Chuck has just discussed, the recent events in Ohio have opened up channels of communication with many different stakeholders. From my perspective, as we chart the course for the company financially, we now have many different potential avenues for driving new sources of revenue, including sales of complex systems, which is our traditional business model, the announced subscription program for which we plan to make significant investments in the next several years and other opportunities which may include other lines of business. I would also like to comment that we have a focus on target — on driving growth with a target on achieving breakeven and profitability in the next 12 months to 14 months.

As previously discussed, we have been upgrading and expanding our overall technology capabilities with a particular focus on artificial intelligence as a key component of our overall product portfolio. While supply chain issues have shown some signs of improvement, time between contract award and full revenue recognition remains longer than was the norm in prior years. We continue to focus on our revenue mix to support accelerating growth in our recurring revenue service and software, while opportunistically growing revenues from project-based work related to the portal installations. We have also diversified our revenue sources, which Chuck will speak to later in the call. On that point, we previously introduced an additional business line focused on subscription offerings in which Duos will 100% own and operate our railcar inspection portals as strategic locations within the North American rail network.

We have begun procurement for equipment and components and have identified locations for the installation of our first Dual zone subscription RIPs. The RIPs will supply the same near real time machine vision-based data and artificial intelligence based protections to railcar and owners, but they will be offered on a subscription model. While installing subscription RIPs may have a depressive effect on revenue in the near term, we believe that the — over the long term, we’ll be able to drive greater lifetime value and higher margins. We also expect revenues to be more normalized in payment cycles rather than experiencing intermittent pops for new contracts, which will make our financial model more predictable. Chuck will share further updates on this initiative shortly.

Now, let’s go into the results for the quarter and for the year. Total revenue for the quarter increased 60% to $5.9 million compared to $3.7 million in the fourth quarter of 2021. We want to point out quickly a typographical error on this percentage that was noted in our press release that just came out. Total revenue for the year increased 82% to just over $15 million compared to $8.2 million for 2021. The increase in revenues was driven by new revenues being recorded after lengthy delays and receiving notices to proceed for anticipated new contracts earlier in the year that pushed delivery dates into the second half of 2022 and into 2023. The increase also resulted from the delivery of two RIP projects across 2022 in addition to (ph) the onset of a new high speed RIP project, which we will continue to recognize well into 2023.

Additionally, the growth in services and consulting revenue stems from our success in deploying artificial intelligence, as well as change orders to existing service agreements during the year. Cost of revenues for the quarter increased 91% to $3.8 million compared to $1.9 million for Q4 2021. For the year, cost of revenues increased 65% to $10.2 million, up from $6.2 million for 2021. The increase in cost stems from additional project work related to delivery of two RIPs as previously noted. The cost of revenues on technology systems grew at a slower pace than revenues, primarily because we neared completion of those two RIPs and thus recognized additional profits of these projects as it satisfied its project-related obligations. Cost of revenues on services and consulting increased as a result of one-time services completed on existing websites during which we incurred some additional material costs as well as project management engineering team labor to complete the project.

Additionally, we have made significant progress on manufacturing with special purpose high value RIP, which we anticipate completing during 2023. Gross margin for the quarter increased 24% to $2.1 million compared to $1.73 million for Q4 2021. For the year, gross margins increased 133% to $4.7 million compared to $2 million for 2021. The improvement in margin was a direct result in the increased business activity that we recognized in the latter half of 2022 that was related to the manufacturing and near completion — of installation of the two new RIPs, a number of one-time service events and significant progress made on the previously mentioned special purpose high value RIP. Operating expenses for the quarter increased 57% to $3.1 million compared to $1.97 million for the year.

Operating expenses increased 22% to $11.6 million compared to $9.5 million for 2021. In Q4, there was an increase in sales and marketing related to the increased investment and overall capability of the commercial team. Research and development costs declined during the quarter, which was a result of — some of the technical resources from the IT and engineering teams being temporarily consumed as part of the significant increase in project and service revenues that led the company performing additional projects and one-time service work year-over-year. Additionally, general and administrative cost increased primarily due to a focus on employee retention and increased headcount as for the growth plan. For the year, we had additional costs related to staff retention via non-cash charges of an employee stock option plan as well as the discretionary performance program, which was a new initiative for the entire organization designed to drive higher performance and attract and retain better quality resources in a tight labor market.

As a result, employee retention in the fourth quarter was 100%. We still face pressure on existing staff compensation as a result of inflation during 2022 but remain focused on managing and stabilizing administrative costs without interruption to customer service. Net operating loss for the quarter totaled $950,000 compared to operating losses of $240,000 for Q4 of 2021. The increase in net loss was driven by increases in cost of revenues as well as operating expenses. Net operating loss for the year totaled $6.87 million compared to a net operating loss of $7.4 million for 2021. We continue to face inflationary and supply chain pressures through 2022 and have worked to balance these impacts through management of customer contracts and other cost control efforts.

The decrease in loss from operations was a result of mostly improved revenue stemming from the deployment of new portals, received materials and manufacturing related to a high value set of portals to be completed during 2023. The net loss for the quarter totaled approximately $950,000 compared to a net loss of $200,000 for Q4 2021. For the year, the net loss totaled $6.86 million compared to a net loss of $6.01 million for 2021. The increase in the net loss is primarily attributed to a one-time effect of the PPP loan forgiveness program gained in the first half of 2021. Despite the increased net loss year-over-year, we showed an improvement in operating loss level in 2022. Now let’s discuss the balance sheet. We ended the quarter with approximately $1.1 million in cash and cash equivalents compared to $894,000 at the end of 2021.

We had an additional $3.4 million in receivables bolstering our near-term liquidity position to approximately $4.53 million. We also have $1.4 million of inventory consisting primarily of long lead items for two pending RIP installations as disclosed on our 8-K. We have raised $4 million for our largest shareholder to support the buildout of our subscription RIP business. In summary, our cash position remains strong and while we expect a near-term increase in spend and inventory levels to support commercial efforts will continue to monitor supply chains to reduce financial impact where possible. I’d now like to provide an update on our financial projections before turning the call back to Chuck. Based on committed contracts and near term pending orders that are already performing or scheduled to be executed through the remainder of 2023, we are reiterating our revenue expectations for fiscal year ending December 31, 2023.

We expect total revenue to range between $20 million and $21 million, representing an increase of 33% to 40% over 2022. At the end of 2022, the company’s contracts and backlog represented approximately $10.7 million in revenue, of which approximately $8.4 million is expected to be recognized in calendar year 2023. The balance of the contract backlog is comprised of multi-year services and software agreements as well as project revenue spanning into fiscal year 2024. We expect our improvement in operating results to be reflected over the course of the full year 2023. As a result of the of typical business seasonality as well as timing and other factors, we expect revenue in the first quarter of 2023 to decline compared to the fourth quarter of 2022 before subsequently increasing throughout the remainder of the year.

We are still working to manage through the ever changing lists of supply chain and shipping challenges, including product shortages and unreliable lead times, which may impact the timing of revenue recognition but not the revenue backlog in totality. That concludes my financial commentary. I’ll now pass the call back over to Chuck.

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Chuck Ferry: Thanks, Andrew. Appreciate it. And before I get into my regular comments. I just want to clarify, I made a comment in the opening remarks where I said revenue was up 71%. In fact, I stand corrected because my CFO used the correct number. Revenue was up 60% in Q4 and 82% for the full year. So I just want to make that clarification as we go forward. Thanks, Andrew. Following on my opening comments and before addressing the specific performance metrics of the company, I’d like to spend some time addressing what the company is currently engaged in since the recent derailment that attracted so much national attention. Due to several highly publicized strange derailments the last several weeks, as I’ve said, has been pretty tumultuous period for the broader rail industry.

These events have led to increased calls for widespread safety and compliance requirements for railcar owners and operators. In response, we initiated a strategic communications plan several weeks ago to respond to the incoming request for information. To date, we have successfully engaged approximately a dozen congressional leaders from both parties in the House and Senate, including senators from our home state of Florida and have been invited to provide our input on pending legislative actions, including the proposed Railway Safety Act of 2023. This bill, which was introduced by a number of senators, including Florida Senator Rubio. We were privileged to be invited to attend an all-day committee session recently, where the bill was discussed and had been asked to provide input related to our area of expertise.

We’ve been equally engaged with our current Class 1 partners, the Federal Railroad Administration, the Association of American Railroads, Labor Union leadership and numerous other stakeholders to answer questions and support their respective action plans. As mentioned in my opening remarks, our main customers representing three out of the now six Class 1 railroads, plus the national passenger rail carrier have all taken leadership roles in the adoption of wayside detection technology for the continuous improvement of rail safety, efficiency and operational productivity. We will continue to work with key stakeholders to support their efforts and remain as involved in these — remain involved in these developments as possible moving forward. Before talking about some operational updates, I want to provide some commentary concerning the turnaround plan that I put in place, when I joined the company in September of 2020.

At that time and in concert with our senior management and Board of Directors, we put a three year plan in place to resolve numerous long standing issues that deal was facing, including sub-par operational execution, customer satisfaction with our support services, and non-standard practices regarding our software development AI programs. I’m pleased to report that as of the end of 2022, the company has turned the corner on all of these major issues and is now executing at a high level and capable of tackling much larger and more complex projects such as the installation of two complex RIPs capable of automated mechanical inspection of high speed passenger trains at up to 125 miles per hour on the Northeast rail Corridor between New York and Washington DC.

I’m pleased to report that we have largely completed our manufacturing for these systems, and recently visited the site and walked the track with senior leaders from the customers team to prepare for the on-site installation in the next few months. Given the completion of our turnaround plan, I’d like to discuss some of our major operational updates. As a reminder, our operating strategy is focused on the following: number one, managing our technical and operational delivery at the high standards, which is now being achieved; adding much more recurring revenue through our subscription model, support services and maintenance, and artificial intelligence offerings; three, continuing our primary commercial focus in the rail sector; and four, adding a second commercial line of business, primarily focused in the trucking and intermodal industry and potentially in the aviation industry.

And lastly, focus on retaining top talent in a very competitive market space. One of the core components of our updated company values has been a commitment to achieving operational and technical excellence. We believe this approach leads to higher customer satisfaction and improved new deal closure rates. As part of our turnaround plan and with the help of my senior management and technical staff, we have continued meeting our service level agreements maintaining a high availability rate on all systems for all customers. Our engineering teams are currently developing a new cutting edge visual system focused on railcar wheels and brakes that will be deployed with our national passenger carrier and will be capable of being utilized for freight cars as well.

Moving to our second focus area, which is to continue adding more recurring revenue through our new subscription model support, services and maintenance, and artificial intelligence offerings. As I mentioned earlier, we’ve maintained a 100% renewal rate on all recurring revenue contracts in 2022. Additionally, we continue to grow support in AI revenues as Andrew discussed in his commentary. Our primary focus continues to be on building an industry leading artificial intelligence capability. I am encouraged with the way our AI team is performing, and the pace at which we’ve been able to introduce updates to our leading inspection capabilities. Since the end of the third quarter, we’ve released 13 new AI detection models for use within our RIP solution, most of which are related to wheel and brake conditions.

As of today, we have 35 models deployed and operational with plans to reach up to 50 different models by the end of 2023. I believe that we are the only company in this industry that self performs all aspects of hardware, IT, software and AI, which enables a more reliable and integrated solution with actionable and reliable data outputs. Two miles in particular that I’d like to highlight today relate to passenger railcar detection. The specific focus of the new models is on the carrier plate and F-Pin securement, both of which are difficult to observe or critical for passenger safety and rail and avoidance. High speed images monitor and detect missing draft gear carrier plate bolts and cotter keys for the carrier plate and F-Pin, respectively, helping to preplan maintenance more economically.

These models are the first release of passenger railcar AI detections and are adaptable to other transit car types. Our ability to use data analytics to see how effective we are is improving. In 20 22, our RIPs performed over 7 million comprehensive railcar scans, of which more than 573,000 were unique railcars. This metric encompasses all railcars scanned locations across the U.S., Canada and Mexico, representing approximately 35% of the total freight car population in North America. We expect this number to continue growing as the number of RIPs and customers on our network expands. Contracts we secured last year and earlier this year, both for new installations as well as upgrades to existing portals, include provisions for increased algorithm delivery, a trend we expect to continue going forward.

From a high level, as we layer on to subscription clients, additional services, and increased maintenance work across a larger customer base, we expect to achieve consistent profitable growth. As we see our recurring revenue streams as a platform for operations that should account for an increasing percentage of revenue over time. Moving to our primary commercial focus in the rail sector, as I noted earlier, the team has had senior level engagement in nearly all Class 1s in recent weeks, which we expect to drive significant commercial activity in the coming months. I’ll now provide an update on current deployments. Beginning with the $10.1 million Master Services Agreement with a major national passenger carrier, completion is expected in 2023.

In March, we secured contract modifications worth an additional $1.1 million and expect to add a further $2 million in upgrades to our high-end RIP that is designed to capture images at up to 125 miles per hour. The completion of the first two portals is currently slated for Q3 of this year. When online, these RIPs will be the most sophisticated portals in North America providing significant safety enhancements on the heavily traffics Northeast Corridor. Moving to another recent deployment. In January of last year, we announced a contract for a Class 1 rail operator to deploy additional RIP on the U.S. side of the customers southwestern border operations in Texas and installation and development efforts have been successfully completed. Without a Class 1 customer, we successfully installed another new portal in the Southeast United States.

We are also discussing with this customer the potential to develop more long-term comprehensive railcar inspection pool coverage of the network. One pantograph installation with a major Canadian transit agency has also been officially completed with a project expected to come online shortly. We have added work to provide maintenance services and artificial intelligence modeling. In February, we also announced that we had 30 AI models and operations for another Class 1 customer located in Mexico. This deployment is a major achievement as we build out further AI capabilities. While we are devoting significant resources to execute against our current backlog and have successfully kept up with timelines as mentioned, closing new customers and exploring new lines of business is also a primary consideration.

Moving to our new subscription model, we have been actively engaged in discussions with numerous prospects who have expressed strong interest in a subscription. We’ve already contracted our first subscriber and are in negotiations for additional subscribers. Additionally, we’re on track to begin installation of our first subscription RIPs in the Southeastern United States during the second half of 2023. Moving to our final area of focus, recruiting and retaining talent. During the quarter, we announced the appointment of Thomas Hughes, as our new Vice President of Sales. Thomas brings over 30 years of experience in sales management roles for high growth software and hardware companies. In this new role, Thomas is responsible for supporting our commercial and go-to-market strategies for the new subscription offerings.

As you might have sufficed (ph), he’s been quite busy since joining Duos and we’re glad to have him. On a more general level, we continue to operate in a tight labor market with inflation, interest rate rises and other macroeconomic events playing a role in increased competition for top talent. With these factors considered, I’m especially proud of the incredibly talented team we’ve assembled and have been successful in retaining this past year. In summary, I’m pleased to report that 2022 is the first year where the financial results reflect the efforts that our team has put in since late 2020. Our operational turnaround is complete. We are engaged at the highest levels with our strategic rail customers. We are being consulted by industry experts, government leaders and regulators.

And we have opened channels of communications with many stakeholders to make Duos a leading contributor to the rail industry’s technology deployments. Duos Tech is now ready to scale up to meet the anticipated demands of the 2023 Rail Safety Act may bring. As you may be aware, we just raised an additional $4 million from the largest shareholder, which was executed at the above market valuation a first for the company. The primary use of these funds is for building company owned pools, which will support multiple subscriptions. The talent of our collective team combined with the operational technical improvements have been made and support from long term shareholders has produced a great year and we entered 2023 in a good position to continue to scale and become profitable.

And with that, we’re ready to open the call for your questions. Operator, please provide the appropriate instructions.

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Q&A Session

Operator: Thank you. We will now be conducting a question-and-answer session. Thank you. Our first question is from Michael Latimore with Northland Capital. Please proceed with your question.

Michael Latimore: Great. Yeah. Thanks a lot. Congrats on the strong growth this year and good to see the reiteration of guidance there. I guess you mentioned that you’ve contracted with your first subscription customer. I guess can you sort of mention what type of company that is? What industry verticals that in? And then, do they have some expectations of a certain number portals by year end?

Chuck Ferry: Yes. I’m going to shy away from naming the customer outright. I will tell you it’s one of our four major centers that I’ve been talking about. And we’re pretty excited that it’ll — it’s kind of gotten the ball rolling here on the subscriptions.

Michael Latimore: Great. It sounds like, the plan is to build these your own or are there some buyback options too?

Chuck Ferry: Yeah. Our primary plan right now is to — on a go forward basis, we have a plan in place right now and we’re going to execute it here, second half of this year where we plan to build anywhere from three to five of our own railcar inspection portals. It will be on key right way locations that we’re already in discussions with some rail, track owners with. Those locations will be on the critical focal (ph) points, as well as high traffic areas — that have high traffic of hazmat on them and with that, we’ve got a number of interested subscribing customers that are our employees to kind of take advantage of that. So that’s primarily what we’re looking at. In terms of buyback, we have entered into some discussions with a couple of our customers about potentially buying back some of our existing portals, but continuing to operate those portals kind of in a lease format if you will or subscription format for those customers for probably the next 10 to 15 years.

So that’s in discussion right now and don’t want to get too much further into details in respect for those negotiations that are ongoing.

Michael Latimore: Got it. And maybe can you — with some of these sorts of visible derailments recently there’s been some discussions about just sort of throwing more of these hot box detectors at the problem. I guess, can you talk about the value of your technology relative to that option?

Chuck Ferry: Yeah. Part of our discussions with the congressional leaders and regulators and union members, I think collectively those industry experts would say that hot box detectors are really just one type of wayside detectors. There are heat detectors. The hot boxes are one of them. There are acoustic detectors. There are — what they call geometry detectors. And then we are in the space what we would call machine vision AI or camera detectors, visual detectors. So I think the discussions that I’ve been allowed to participate in, I think there is an effort to include all categories of wayside detectors would likely be considered in this incoming Rail Safety Act, but we’ll have to see how that works its way through Congress.

Michael Latimore: And you mentioned hiring of a senior salesperson here. I guess as you look at the pipeline over the next or just the pipeline going forward. What sort of the mix of potential subscription customers versus just getting more customers buying your kind of complex systems?

Chuck Ferry: Yeah. Tom comes with a great, great experience, not just technology, but also in and amongst primarily the Class 1 railroads. So, we’re glad to have him. I would say the mix of our pipeline as it stands now since we’ve introduced the subscription concept probably now about eight months ago. I would assess that probably at least a third if not half of our pipeline of opportunities is in that recurring or subscription format. We still do have a number of opportunities in our pipeline that are still interested in actually purchasing the equipment. Some of those customers continue to be Class 1 customers. Although, we have had interest by Class 1 customers to also allow us right of way access and operate in a subscription format.