Coda Octopus Group, Inc. Q4 FY2022 Earnings Call

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 its 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.

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 in 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 “Risk Factors” in our 10-K. You may get Coda Octopus’s Securities and Exchange Commission filings for free by visiting the SEC website at www.sec.gov. I would also like to remind everyone that this call is being recorded and will be made available for replay via link in the investor relations section of Coda Octopus’s website. Now I will turn the call over to the Company’s Chair and CEO, 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 excited about the company. Now before we discuss our recent results and performance, I would first like to provide some background about our company to those listeners who may be newer to Coda Octopus Group. Coda Octopus Group is an established business with a strong pedigree in underwater technology and defense engineering. We operate two discrete business operations, our underwater technology business, in 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. With the engineering business, we have sole 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. We believe our business units 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. 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 generates a real-time 3D image of moving objects underwater in zero visibility conditions. That’s important because much of subsea operations are plagued by zero visibility conditions, and we are the only solution in the market at that point. We market this technology under the Echoscope brand. Our other core technology relates to transformational diving technology, the DAVD, which is Diver Augmented Vision Display system. This is the result of a direct requirement from the U.S. Office of Naval Research under its future naval capabilities program. The DAVD is the only technology that provides a 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 diver's helmet, face mask, or other diving suits. In other words, we provide data to the diver on a pair of transparent glasses, becoming this data hub for all types of information. This real-time information is also shared by the dive supervisor on the surface. Our sonar technology is used in a variety of underwater applications including construction, mining, bridge inspection, offshore renewables, oil and gas, dredging, port and harbor security, survey and mapping, and for monitoring and inspecting moving objects on the water. Our engineering business 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 solutions and subassemblies into mission-critical defense programs, establishing long-term relationships with U.S. and U.K. prime defense contractors, such as Raytheon, Northrop Grumman, and BAE. We anticipate these relationships expanding our number of programs supplied into these programs. Turning to our growth pillars, our key growth pillars are our Echoscope sonar series technology and DAVD. To fully understand where the company’s growth opportunities lie, let's discuss our sonar technology and the evolution we have made over the last several years. Until February 2019, our technology was limited to work class vessels which is a small section of our target market. In February 2019, we launched our fourth generation sonar series. 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 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. Our previous generation of imaging sonar was capable of generating only one 3D image in real time. Our new generation of imaging sonars, the Echoscope PIPE, can generate multiple 3D images and the data is therefore available for different parts of the survey operation. This allows customers to rely on one sensor, reducing costs and improving efficiency. We have positioned Coda to be the market leader in real-time 3D underwater imaging visualization, as users can make real-time decisions versus using legacy technology that collects data and processes it afterwards. I’d like to give you an update on our PIPE progress made in fiscal year 2022. We successfully got our Echoscope PIPE sensors into new defense programs. This year, we sold into four different UX programs working on new generation underwater vehicles. We sold into one new Japanese program, working on the new generation of underwater vehicles for the Japanese defense market. In the commercial space, we sold four Echoscope PIPE sonars for a new underwater vehicle application in offshore renewables. This progress, both in expanding available models within our sonar series and entering key new underwater vehicle programs in defense, paves the way for increased market share for imaging sonar over the next two to three years. Our management goals are to cement our place in existing programs and identify new programs while expanding our share of the commercial market for our sonar. We aim to increase marine business revenue, targeting approximately $25 million in revenue for our technology business on a standalone basis, compared to $14.7 million in fiscal 2022. Our DAVD technology is transformational for the global diving market, applicable globally in defense and commercial markets. This technology provides enhanced vision and operational awareness, even in zero visibility conditions. Our main focus is on defense applications and we are moving away from leisure diving for now. The DAVD technology transforms diving operations by providing real-time data to both the diver and the dive supervisor making operations more efficient, safe, and cost-effective. During fiscal 2022, we made significant progress in expanding the market for the DAVD, performing customization for a U.S. military command with expectations for multiple units in rapid succession if trials are successful. The DAVD systems have now moved from R&D to operational status, representing an important milestone for adoption. We aim to grow this revenue stream, adding approximately $2 million to $3 million in revenues annually. Let me now turn the call over to our CFO, Nathan Parker, to walk you through our financials before providing my closing remarks.

Thanks, Annmarie and good morning, everyone. Let me take you through our fiscal 2023 results for the 12 months ended October 31, 2022. For 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’s 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 many countries where we conduct business. This dynamic has started to reverse, which is encouraging for our business for the fiscal 2023 year. Without the adverse movements of currency resulting in lower translation of our revenues from 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. 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. We generated gross profit of $15.2 million representing growth of 2.9% over the $14.8 million in fiscal 2021 due to favorable year-over-year increase in revenue, which was partially offset by higher material costs. Our gross margin percentage for fiscal 2022 was 68.3% compared to 69.2% for fiscal 2021. 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 to 45.4% versus 38.6% in the prior year due to a greater percentage of revenue from engineering services contracts. Total operating expenses for fiscal 2022 totaled $10.2 million, a 6.8% decrease from fiscal 2021. Our research and development costs totaled $2.2 million, a 25% decrease from fiscal 2021 of $3 million due to reduced spending in our marine engineering business. Our selling, general administrative costs for fiscal 2022 totaled $7.9 million, essentially unchanged from fiscal 2021. Looking forward, we anticipate refocusing a significant portion of our resources from research and development to global business development, brand building and investor relations. We believe we’ve developed world class products and solutions, and now we aim to make meaningful progress in our markets through 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. EBITDA for fiscal 2022 totaled $5.9 million, a 5.1% decrease from $6.2 million in fiscal 2021. Net income before taxes for fiscal 2022 totaled $5.1 million or 23.1% of revenue, a 2.3% decrease from $5.3 million in fiscal 2021. 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. 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 cash from operating activities. That completes my financial summary and I’ll turn the call back to Annmarie for her closing remarks.

Thank you very much, Nathan. As we 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 next generation of underwater vehicles. We believe our Echoscope technology will be the frontrunner for many of these emerging vehicles. Additionally, we aim to introduce the DAVD technology to foreign navy and the commercial offshore sector. We’ve received promising interest for both Echoscope PIPE and DAVD technologies, and are hopeful about our future prospects. We are excited about the outlook for Coda, as we have world-class products and solutions that are transformational to the underwater imaging and diving market. Our technology, both the Echoscope PIPE and DAVD, represents the next generation of solutions aimed at displacing legacy technologies. This provides us with significant growth opportunities in our market. We have a proven track record of generating high margins and solid profitability. We are now happy to take your questions, operator?

Thank you. We will now open the floor to questions. Our first question is from Brian Kinstlinger with Alliance Global Partners. Please go ahead with your question.

Hi guys and congratulations on hosting your first conference call here. First, relating 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 were relatively flat year-over-year?

That’s a great question, Brian. Thank you. What we saw in the last fiscal year, and as we reported on in Q2, was that our pipeline in terms of opportunities we’ve been tracking was much higher in the 2022 period. However, the conversion rates shifted into 2023. It largely pertains to timing and the preparations required for new oil and gas installations. We anticipate rentals to take off much more than they had in the last two years. The lingering effects of COVID have contributed to this transition. Many sectors are still normalizing their operations.

Great. My second question relates to the Echoscope being used on several defense contractors for underwater vehicle programs. Are these contractors still evaluating competing technologies to Echoscope? Or have you received design wins?

I don’t know if they’re evaluating other technology. If you are evaluating, then you’re not purchasing our technology. We've been able to sell into prime defense contractors, which indicates we are part of the solution they’re developing. Our past challenges in expanding the market for technology are being resolved with the new generation of underwater vehicles arriving.

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?

When you’re in R&D, you’re still evaluating the technology. When it’s operational, it means it’s in the field for use. Now it’s up to those commands to purchase the items.

Thank you. And similar to the products business, do you view Colmek, or the entire engineering services business? You’re still a bit below fiscal 2020 of $8 million, and the peak of $12 million in fiscal 2019. What have been the prohibitive factors in that business?

The engineering business is trending positively this past year, but needs to get to where it was in 2019. The focus is on securing new programs annually. While we’re making progress, the visibility on activities with primes has been limited. We hope to quote more this year.

Last question, you gave us some good insight into the two to three-year outlook of where the business could be. As the first quarter is nearly concluded, any update on trends?

We’re still evaluating the quarter, but I've noticed good traction in quotations. We’re definitely writing more proposals than we were this time last year.

Hi, good morning. Congratulations on the progress with the Echoscope PIPE. What do you attribute the success you had in that area? Is it more in terms of cost savings, efficiency, or technology benefits?

It’s all of the above. The key thing is that, while upfront costs are high, users realize significant returns on investment. The Echoscope PIPE allows much more efficient operations and performance compared to previous technologies.

There’s been a tremendous amount of investment in offshore renewables. Are you starting to see demand from that area now?

Yes, we’re receiving rental opportunities. We are the only technology that can visualize moving cables during installations in this domain. We’re expecting substantial demand for our technology, especially as many of our customers are moving into this market.

Yes. Hi. Good morning. In talking about Echoscope. Can you clarify the term subsea?

It's not below the ocean floor. It refers to anything underwater. Subsea can sometimes be used informally in our industry.

In terms of where your operations are, give me insight on who’s where and what’s done where?

The largest part of our operation is in Scotland, where we have our Center of Excellence for R&D and manufacturing. We’re transferring more DAVD development to Orlando for U.S. production and innovation. We also have engineering operations in Dorset and limited operations in Denmark for EU relations.

As for our cash, around $22 million is divided between our U.S. and foreign subsidiaries. Approximately $14 million is U.S.-based and the bulk of the foreign cash is in Scotland.

In fiscal 2023, what do you estimate the income tax rate will be?

We anticipate a similar tax rate to what we’re seeing this year at around 16.2%.

Has the supply chain situation eased off with semiconductors?

We haven’t seen easing at the moment; it’s a global issue. We have managed this through historical inventory levels, but those are running out.

You mentioned it was difficult to find employees. Are you still trying to hire?

We are hiring specialized software and engineering staff through recruitment companies given the specific skills required.

Regarding revenue trends, could you assure investors the revenue won't drop below $5.5 million per quarter?

I cannot provide that assurance at this time. We will be releasing our management targets, so please look out for that. Thank you, Walter and everyone for joining the call today, and for your interest in Coda Octopus. Have a great rest of your day.

This will conclude today’s conference. Thank you for your participation. You may now disconnect your lines at this time.