Earnings Call Transcript - CODA Q3 2024

Operator, Operator

Good morning. Welcome to Coda Octopus Group's Third Quarter 2024 Earnings Conference Call. My name is Sherry, and I will be your operator today. Before the call, Coda Octopus issued its financial results for the third quarter 2024 ended July 31, 2024, including a press release, a copy of which will be furnished in a 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 Interim CFO, Gayle Jardine. Following their remarks, we will open the call for questions. Before we begin, Geoff Turner will make a brief introductory statement. Mr. Turner, please proceed.

Geoff Turner, Conference Call Host

Thank you, operator. Good morning, everyone, and welcome to Coda Octopus third quarter fiscal 2024 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 several factors, many of which are beyond our control, that 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. 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 may be 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 for the year ended October 31, 2023, and Forms 10-Q for the first, second, and third quarters of this fiscal year. You can access Coda Octopus' 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 the 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, CEO

Thanks, Geoff, and good morning, everyone. Thank you for joining us for our third quarter 2024 earnings call. Our revenue in the third quarter 2024 increased by 12% over the third quarter 2023 revenue, and we have delivered a solid set of results, including increases in our gross profit margin, operating income, net income, and earnings per share. During the second and third quarters of fiscal year 2024, there was a notable slowdown in the pace of placing orders concerning US Defense Programs. We believe that this is attributed to the funding gaps created by the upcoming elections, which is not unusual in a Presidential election year. This has resulted in lower order intake from US Defense Programs in the second and third quarters of fiscal year 2024, an area critical for our growth strategy. Notwithstanding these temporary challenges, I am very pleased with our overall results, including increasing revenue by 12%. In the third quarter 2024, the Marine Technology Business revenue increased by 6.5% over the third quarter 2023. I am particularly pleased with the increased utilization of our rental assets so far in fiscal year 2024, including during the third quarter, resulting in an increase in our gross profit margin to 82.9% in the third quarter 2024 compared to 82.1% in the third quarter 2023. As stated previously in the year, we expected that the revenue of our Engineering Business would be back-loaded. And indeed, in the third quarter, the Engineering Business saw an increase in revenue of 19.8% over the third quarter 2023 and an increase in gross profit margin from 50% in the third quarter 2023 to 62.6%. Moving to our third quarter 2024 overview. During the third quarter of 2024, we continued to make progress against our key growth drivers and we participated in some high-profile and high-impact events. To recap, our strategy is to work to embed our technologies into defense and other programs that have an opportunity profile for multiple year purchases of multiple systems. We have been performing business development focused on achieving this. The DAVD program is a good example where we're seeing funding allocated under the program for repeat annual purchases, including pull-through Echoscope sales. This model is critical for the success of our growth strategy. Bearing this in mind, in the third quarter, we continued to execute against the strategy outlined. A short summary of some of the highlights in the third quarter are: we completed a successful demonstration of the Echoscope PIPE sonar technology for a new major US Defense contractor for multiple undersea applications. Following this very successful demonstration, we're now going through this contractor's vetting process. We are very excited and pleased with the growing interest and realization of the power and added imaging capability that our real-time 3D Echoscope sonar uniquely provides over traditional sonar systems. Based on the ship hull scanning platform, which we developed and delivered to our Navy customer in fiscal year 2023, we have now completed several new ship hull scanning trials with different US Navy groups and for different applications. Again, we are particularly pleased with the momentum and level of interest we're seeing in this area of ship hull scanning application for which there is a real requirement to find a global solution. Although this application is challenging, largely due to the complex geometry and features on the ship hull, we have developed a solid understanding and capability, and are supporting several Navy groups with their ongoing evaluation of our custom design ship hull scanning solution, which has been developed under a multi-year US Navy program. We provided pre-mission support and training on the DAVD to two Navy commands in preparation for their field deployment on critical missions. The utilization of the DAVD in operations is vital for continued adoption within the fleet, and we're happy that these teams are now actively using the technology and realizing the benefits for their live operations. We also continued to see that these commands are submitting funding requests for further investment in the technology. This, again, is exciting, because we're seeing pull-through sales of the Echoscope from the DAVD program as we continue to build upon these relationships that we're establishing. We provided support to a major defense technical demonstration event, The Rim of the Pacific Exercise, RIMPAC, held biannually in Pearl Harbor, Hawaii, which is the world's largest international maritime warfare exercise. At this event, we supported the Navy's MDSU-1 Division to actively demonstrate a combined DAVD and Echoscope solution to multiple dive teams from many visiting countries who specifically attended to dive the DAVD system. Subsequent to the event, we have engagements with several allied navies for local trials of the DAVD and the Echoscope systems. We supported NIWIC in their demonstration of the Echoscope technology at the capability demonstration event for the Coastal Trident for undersea vehicle applications. The Echoscope was mounted on the VideoRay Defender platform. We were able to demonstrate the capability of the Echoscope to many potential users who we believe were able to witness the power of the technology and its applicability to their undersea defense application. Let me now turn the call over to our Interim CFO, Gayle Jardine, to take you through our financials before I provide our closing remarks.

Gayle Jardine, Interim CFO

Thank you, Annmarie, and good morning, everyone. Let me take you through our third quarter 2024 financial results. Starting with revenue. In the third quarter of 2024, we recorded total revenue of $5.5 million compared to $4.9 million in the third quarter of 2023, an increase of 12%. The Marine Technology Business, or Products Business, generated revenue of $3.1 million compared to $2.9 million, representing a 6.5% increase over the third quarter of 2023. Our Marine Engineering Business, or Services Business, generated revenue of $2.4 million compared to $2 million, representing a 19.8% increase over the third quarter of 2023. As discussed earlier, our total consolidated revenue increased in the third quarter by 12%. Both Marine Technology and Engineering Businesses saw an increase in revenue in the third quarter. However, sales to North America were down. We believe that this relates to the US Presidential election, where the convention is to make decisions on defense acquisitions after the election outcome is decided. Moving on to gross profit and margin. In the third quarter of 2024, we generated gross profit of $4 million compared to $3.4 million in the third quarter of 2023. Consolidated gross margin was 73.9% this quarter versus 68.8% in the third quarter of last year. In our Marine Technology Business, gross margin increased to 82.9% in the third quarter of 2024 compared to 82.1% in the same quarter of 2023. This reflected changes in the mix of sales, which included a high utilization of our rental asset and associated services. Our Marine Engineering Business gross margin increased to 62.6% in the third quarter of 2024 versus 50% in the third quarter of 2023, again reflecting the mix of engineering projects during the third quarter of 2024. I must point out that the gross margin of the Engineering Business in the current quarter is atypical and should not be viewed as an upward trend that will persist. Now moving on to our operating expenses. Total operating expenses for the third quarter of 2024 increased to $2.7 million compared to $2.5 million in the third quarter of 2023, which is largely due to increases in selling, general and administrative costs. Our SG&A costs in the third quarter of 2024 totaled $2.2 million, an increase of 11.7% from $1.9 million in the third quarter of 2023. As a percentage of revenue, our SG&A costs for the third quarter of 2024 were 39.5% compared to 39.6% in the third quarter of 2023. The increase in SG&A is mainly due to an increase in wages and salaries, office costs, and marketing. In accordance with our strategy, we continue to recalibrate our working capital bias from R&D towards business development and marketing activities. Accordingly, our third quarter marketing expenses increased by approximately 180%. This included the fees related to the appointment of a business development focus group we have hired in the US to assist us in this area. Operating income in the third quarter of 2024 was $1.4 million compared to $0.9 million in the third quarter of 2023, an increase of 61.2%. Operating margin was 25.4% compared to 17.6% in the third quarter of 2023, primarily due to the increase in revenue and gross profit margin. Income before taxes in the third quarter of 2024 was $1.6 million compared to $1.1 million in the third quarter of 2023. Net income after taxes in the third quarter of 2024 was $1.3 million or $0.11 per diluted share compared to $1 million or $0.09 per diluted share in the third quarter of 2023. Moving now to our balance sheet. As of July 31, 2024, we had $25.2 million in cash and cash equivalents on hand and no debt. This represents an increase of $0.8 million from October 31, 2023, where the comparable figure was $24.4 million. I would like in this call to address the use of cash. We intend to use a portion of our excess cash to fund an acquisition in this 2024 fiscal year. We have identified a target and are actively going through our due diligence. Subject to a satisfactory conclusion of this process, we intend to close this within this fiscal year, which ends on October 31, 2024. Thank you. I will now turn the call back over to Annmarie for closing remarks.

Annmarie Gayle, CEO

Thank you, Gayle. I am very pleased with our third quarter results, which saw increases in revenue, gross profit, and earnings per share. We continue to work to create stable long-term shareholder value and execute against our strategy to increase the number of defense programs that our technologies are embedded in with the goal of securing recurring sales of multiple units under these programs. Our team is doing an outstanding job in maintaining superior margins and profits for our shareholders, while seeking to grow sustainably over time without compromising our track record of being a tightly-run profitable business. We believe that we are making good progress against some of the goals that we have set for ourselves in 2024, including: advancing the DAVD untethered system program for adoption by the special forces in early 2025; supporting the rollout of the DAVD technology; returning the Engineering Business to its pre-COVID $10 million revenue profile; and continuing to develop our pipeline of candidates under our M&A strategy. Through our M&A strategy, we aim to add complementary capabilities that will broaden the scope of our capabilities and opportunities with a focus on defense applications. Through our strategy, we aim to pivot the revenue model of the Marine Technology Business to a multi-year and multi-sale model as we started to see with the DAVD product line. To conclude, we would like to thank our shareholders for their continued support. We are now happy to answer any questions.

Operator, Operator

Thank you. Our first question is from Brian Kinstlinger with Alliance Global Partners. Please proceed.

Brian Kinstlinger, Analyst

Great. Thanks. Good morning. Excuse me. My first question is in the press release, the 10-Q, and you began your prepared comments with delays for orders that are typical at this stage of the election cycle. And I'm fairly certain we're headed for another CR that's going to begin in October. So, do you expect, as a result, both segments of your business will experience near-term pressure compared to the July quarter just reported? And if so, how long do you think that will last? Or do you have enough commercial business as well as opportunity with foreign governments that you think you can offset this pressure?

Annmarie Gayle, CEO

Good morning, Brian. Thank you very much for your well-considered questions. As we have said, when you look at our year-to-date results, you can see that sales from the Americas were down by approximately 35.9%. Last year this time, we were at $7.3 million compared to $4.6 million this year. This is really a reflection of the ongoing elections and, therefore, what it really means is that sustenance programs are being funded, but new programs are largely in abeyance until the outcome of the elections. What I am pleased to see, despite revenues from the Americas falling by 35%, is the resilience of our revenues, mostly from the commercial marine market. The focus of our growth strategy is certainly in the defense market, because that's really where you have real requirements and budgets, but it has always been the case for our business. We're well-established in the commercial marine market, and you could see from our revenue that we had a strong increase in our revenue outside of the US. Of course, I would like to see that we are dependent on funding from US Defense programs for our broader growth strategy.

Brian Kinstlinger, Analyst

Okay. And then, last quarter, you mentioned the first US commercial service provider was using the DAVD for a tunnel inspection project. Given what's happening on the government side of the US, that's going to be potentially important. So, I'm hoping you can discuss the near-term pipeline for commercial and, or is the DAVD adoption right now. Could you comment on the Pearl Harbor demonstration? Is that more a function of foreign government?

Annmarie Gayle, CEO

Well, yes, so the RIMPAC event is really all about the untethered system, and we had a really good turnout there. We have some good quality ongoing follow-up, but that was a really pivotal event for our technology. As we've always said, this event was led by MDSU, which is the Mobile Diving and Salvage Unit, Division 1. We are seeing that the US is championing the technology because that's its event, and they had a superb turnout, with a lot of focus on the DAVD. Yes, it's slow, but we are very excited about where we've reached with the untethered variant. For the tethered variant, we are now seeing requisitions being put forward by different commands for acquisition of the technology. All of those acquisitions are on hold, but that doesn't mean they won't happen once the budget is available. Additionally, what we're also seeing, and I am very excited about this because it validates our strategy, is that we are seeing pull-through sales of the Echoscope. When we started this program, we weren't sure how the Navy would adopt the technology. Would it be just the DAVD system or would we see our Echoscope being pulled through? And indeed, we're seeing pull-through sales and excitement about our real-time 3D sonar technology, which is quite exciting. In terms of the commercial opportunities for the DAVD itself, those are ongoing, and we have it slower than we would like, but there are complexities for the adoption of the technology wholesale. We still have active discussions with three major commercial offshore providers, but all the discussions are about how to integrate the DAVD into their analog diving bell. For instance, we need to transfer the data over Ethernet when they don't have Ethernet capabilities, which presents challenges.

Brian Kinstlinger, Analyst

Okay. And then, last quarter, you talked about a Thermite program where there were pre-production orders to the Navy. Could you talk about how this program is advancing? And are you seeing any impact from the election on this program? Does that impact it?

Annmarie Gayle, CEO

No, not at all. As I said in my last call, we've got the first pre-production low quantity order that's ongoing. We expect the production order in 2025, and I don't expect that to be impacted. There's also the second opportunity for an aircraft program, which is also a big opportunity for us. We expected that order a little bit earlier, and while we still don't have it, the biggest barrier is the terms and conditions they've put forward to us. We're currently negotiating those terms and conditions to ensure they are viable for our business. The order is there, but we want to be sure that the terms we are signing are viable.

Brian Kinstlinger, Analyst

Great. Two more questions for me. First, you touched on the ship hull scanning feasibility study being done. How should we think about the market opportunity, as well as the pipeline in the near term and the sales cycle there?

Annmarie Gayle, CEO

Yes. It’s what I call an absolute white space because there are no solutions for ship hull scanning. There are hodgepodge solutions but not a direct solution. We were funded under this program to put forward a solution, and we delivered the platform, which embeds not only our Echoscope but also our heads-up display system. I believe we are close, the closest to what a solution could look like in the market. There are lots of different stakeholders interested. The addressable market is global because issues concerning what's on the ship hull are pressing. So, it is a real requirement, and we think we're close to being adopted. However, we do still have more trials to navigate through and more features to introduce. Overall, I'm excited about this program, and our focus group is helping us better understand and model the opportunities.

Brian Kinstlinger, Analyst

Great. My last question is around the discussion you talked about regarding M&A. It sounded like you have identified a target that has complementary products. Can you touch in any way on size? Is it a small tuck-in, or is it something larger? Anything you can provide would be helpful.

Annmarie Gayle, CEO

This target is really about expanding the group's capabilities. Please notice what I've said—not the product segment or the engineering, but the group's capabilities overall. So, to that extent, I'm very excited about it. The acquisition price we have in mind is about $6.5 million in cash. That's what I can disclose at this stage. If everything progresses as planned, in six weeks' time, I can share more about this.

Operator, Operator

Our next question is from Richard Deutsch with Sutter Securities. Please proceed.

Richard Deutsch, Analyst

Yes. Thank you. Annmarie, it's such a comfort to have someone with your vast history and knowledge running this show, and having followed this business for several years now, it's nice to see all the hard work starting to come into commercial reality. So, I really appreciate all the hard work you and the crew have done. Brian asked a bunch of the questions, but a couple of things I'd like to go into here. On the acquisition, do you see any shares being offered as part of this acquisition, either shares of CODA or would it be mostly all cash?

Annmarie Gayle, CEO

It's all cash. Just to clarify, this does not preclude key employees from participating in the group's stock incentive plan, but the cash we have on the table is what we’ve offered for the acquisition.

Richard Deutsch, Analyst

Sure. So, would this be mostly an engineering software R&D acquisition, or are you acquiring an existing hardware line?

Annmarie Gayle, CEO

I am not prepared to discuss the target or what they do at this stage. If everything goes to plan, I can provide more insights in six weeks' time.

Richard Deutsch, Analyst

I understand. On your call today, unless I missed it, did you have any update on your digital audio product, which I believe has tremendous potential?

Annmarie Gayle, CEO

You didn't, actually. And I do believe it has significant opportunities. I expect, Richard, to see purchase orders in September from the Navy for the digital audio product. There will be another round of funding in September. It may not be at the level we anticipate, but I believe they will start purchasing, albeit in lower quantities. I expect additional purchase orders in September since it has passed all the safety assessments, and we are now just waiting for the purchase orders.

Richard Deutsch, Analyst

Okay. That's great. Is there any above-water application for the digital audio, or is it all just underwater?

Annmarie Gayle, CEO

Well, there is potential for above-water applications, though it's not massive. For instance, medical chambers could use the digital audio system because they face similar communication challenges when someone enters a medical bay. So, there is certainly that medical application for the digital audio communication system that we have.

Richard Deutsch, Analyst

Okay. And just two quick ones here. On the ship scanning, how close are we to a winner of the technology being approved, or will this just require another round of further development?

Annmarie Gayle, CEO

Well, I don't believe we need a massive development phase, but the thing is, in terms of budgets, as I said, we're working closely with our focus group to comprehend the budget and get clarity on where that is coming from and the people behind the program. I don't have more complete information yet, but as soon as we have safety sign-off under the program, we'll begin targeting the global market. Right now, we are just working with the US Navy, but we'll start broader global marketing for the solution once we receive their safety assessment.

Richard Deutsch, Analyst

Okay. And my final question is, do we currently have any sales or exposure to China, considering that situation?

Annmarie Gayle, CEO

Yes, we do have exposure. China is the biggest global market for offshore renewables, and that's primarily what they are using our technology for. That said, it's becoming increasingly challenging to sell to China. Additionally, I'd like to address that there’s a broader issue—many components used by numerous companies are showing up on the Bureau of Investigation security blacklist. What this means is that you can't buy those components anymore, leading to re-engineering and additional costs. So, the situation with China is fraught, impacting sales cycles and component procurement.

Richard Deutsch, Analyst

I see. Well, just to go a little further into that, during this recent quarter, can you tell us how much revenue we were generating from China?

Annmarie Gayle, CEO

I can't provide a specific number, but I would estimate it's around $600,000.

Richard Deutsch, Analyst

Fair enough. Thank you again so much. We appreciate your work and thanks for your answers.

Annmarie Gayle, CEO

Thank you, Richard, for your questions.

Operator, Operator

Our next question is from Andrew Scott with 395 Group. Please proceed. Andrew, your line is live.

Andrew Scott, Analyst

Hello?

Operator, Operator

Go ahead, please.

Andrew Scott, Analyst

Okay. Thank you. Annmarie, great quarter. Your enthusiasm is very strong on this call, so it's making us a lot more hopeful. Your financial results were great. The return on equity and your management effective ratio are very good. I just had one question. I heard about the acquisition and the potential defense contractors. It sounds like a lot of great things are on the horizon. How about overall market adoption? I know things have slowed down in North America a little bit with the Presidential election, but more on a macro perspective. Are you seeing greater adoption with your multitude of Coda Octopus products? Have you started to see a turn or more market penetration? Can you give a little bit of an outlook on what you're seeing?

Annmarie Gayle, CEO

As you saw, year-to-date, you could see that I am particularly excited about the increased utilization of our rental assets and associated services, which I believe went up year-to-date from $1 million to $1.8 million. I think what's striking for me is that most of the rentals have been around in an application called cable laying. We are effectively synonymous with breakwater solutions, and when it comes to laying cables, it is Coda Octopus that is recognized as the go-to. This year we've achieved substantial success with a patent awarded a few years ago around the cable laying application. That patent automates the Echoscope technology, allowing us to predict cable touchdown points. This is significant because if the cable you're laying gets tangled, it's a deal breaker and leads to expensive delays and complications. Within the engineering specification, you also need precise information on where the cable will touchdown. Through our solution, we have conquered that. In Europe, we are now perceived as the standard solution for cable laying. So, I’m particularly excited about that growth. Broadly, as I said, rentals are increasing, which I find particularly encouraging due to their profitability. While we see slower progress in securing purchase orders for the DAVD, I'm still very enthusiastic about the DAVD with several opportunities in the pipeline.

Andrew Scott, Analyst

Yes. Thank you. Great job. Great quarter. We think your products are the best. All right. Thank you. I'll turn it over to the next question.

Annmarie Gayle, CEO

Thank you.

Operator, Operator

And our final question is from Steve Emerson with Emerson Investment Group. Please proceed.

Steve Emerson, Analyst

Thank you. Annmarie, great, great quarter, and in particular, great call. I greatly appreciate the insight into opportunities that weren't in my model. I'd like to flesh out a little bit this attachment market; it sounds like that has to be a live diver, not a robot.

Annmarie Gayle, CEO

When you think of a robot, yes, the biggest challenge underwater is turbidity. It's the water conditions, current, and visibility that present barriers to effective operation. Even if you have a robot, we do have applications where we're embedding the Echoscope into a robot, but you still require the Echoscope because that provides real-time visualization in zero visibility conditions. So, that's the first thing; it's not replaced by a robot, but a robot could act as a deployment platform just like a diver’s handheld device. Moreover, there are limitations when dealing with ship hull scanning. Not only is there geometry to consider, but you are often in a GPS-denied area. So, you won't have accurate positional data, which our solution addresses. Our system embeds the Echoscope along with underwater navigation systems, allowing us to derive some semblance of position and heading.

Steve Emerson, Analyst

I’m just thinking about ports in conflict zones that can have a significant amount of ship traffic, or they may operate in convoy. I’m wondering how many of these systems need to be employed in a particular port or how long it takes to scan a hull? As an add-on question, how much funding have you received or have R&D funding for this application?

Annmarie Gayle, CEO

I'll start with the funding. This was a multi-year program, and we were funded about $1.7 million over the life of the program, which includes also delivering the solution. Regarding the operational need, if I move away from the combat situation, let's address the core application. You need to monitor all ships entering your port for potential hazards, whether drugs or hostile actions. Therefore, this is not limited to combat zones—it's essential for any port operation. The application is viable for monitoring any vessel entering your waters.

Steve Emerson, Analyst

So, it sounds like a $1 billion total addressable market, or when you have penciled out the available market, what kind of range or number of units do you come up with?

Annmarie Gayle, CEO

I am not prepared to discuss that yet. First, we need to confirm we have a solution in hand. We're focused on validating the technology. I would reiterate that the market is global. I'm excited about our recent successes in the quarter regarding the ship hull scanning application; however, I don't want to provide specific numbers about addressable markets before confirming our technology's readiness.

Steve Emerson, Analyst

Are we approaching the end of the three-year R&D contract? Are we nearing the final evaluation of our project, and can you provide any timing estimates for this project?

Annmarie Gayle, CEO

We have completed the project. We've delivered the platform last year, and now we support the Navy with their ongoing evaluations. I can’t provide a specific timeline for when orders will emerge, but it is an ongoing support role.

Steve Emerson, Analyst

Got it. In regard to the possible acquisition negotiation, can you give us an idea of what area this acquisition would enhance?

Annmarie Gayle, CEO

As I've mentioned, it's about expanding group capabilities, not just segment expansion. It's a highly complementary fit with our existing business.

Steve Emerson, Analyst

Okay. Thank you for your help and for the great progress.

Annmarie Gayle, CEO

Thank you, Steve, for your insightful questions.

Operator, Operator

Thank you very much for attending the earnings call today. Have a great day.

Geoff Turner, Conference Call Host

Thank you. This will conclude Coda Octopus' conference call. You may disconnect at this time.