Coda Octopus Group Inc

NASDAQ:CODA

Earnings Call Transcript 2023-Q1

[Operator]

Good morning, and welcome to Coda Octopus Group's First Quarter Fiscal Year 2023 Earnings Conference Call. My name is Vico, and I'll be your operator today. Before this call, Coda Octopus issued its financial results for the fiscal first quarter ended January 31, 2023 including a press release, a copy of which will be furnished in the report filed with the SEC and will be available in the Investor Relations section of the Company's website.

Joining us on today's call from Coda Octopus are its Chair and CEO, Annmarie Gayle and its CFO, Nathan Parker. Following their remarks, we will open the call for questions. Before we begin, Jackie Keshner, from Gateway Group will make a brief introductory statement. Ms. Keshner, please proceed.

[Jackie Keshner, Gateway Group, Inc.]

Thank you, Vico. Good morning, everyone, and welcome to Coda Octopus' first quarter fiscal year 2023 earnings conference call. Before management begins their formal remarks, we would like to remind everyone that some statements we are 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 the forward-looking statements are made, except as required by law. We refer you to our filings with the Securities and Exchange Commission for detailed disclosures and descriptions of our business, as well as uncertainties and other variable circumstances including, but not limited to risks and uncertainties identified in our Form 10-K.

You may get 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 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, Chairman and Chief Executive Officer]

Thanks, Jackie, and good morning, everyone. Thank you for joining us for our first quarter 2023 earnings call. Last quarter, I walked through an overview of our business and key growth pillars for those that may have been new to our company. While I won't repeat myself today, I will reference some of the growth accelerators discussed and highlight some of the attributes of our company that we believe positions Coda to succeed.

I'd now like to summarize our first quarter 2023 performance. We had strong product sales and operational momentum for our Echoscope PIPE and DAVD system even as we navigated supply chain and foreign currency headwinds. We continued to pivot from R&D focus to sales and marketing and brand building and the first quarter 2023 saw us taking a number of actions in this direction, participating in several Industry Trade Shows for the promotion of our products and services, also holding key DAVD demonstrations for foreign navies and Tier I offshore service providers. We also had DAVD demonstrations with a U.S. Navy and Naval Surface Warfare Center, Panama City, which incorporated the DAVD in the new deep sea expeditionary with no compression diving suit. That's a diving suit called DSENDS.

We continue to believe that our most promising pillars of growth are our Echoscope and Echoscope PIPE products, as well as our Diver Augmented Vision Display system or the DAVD systems. I would like to provide some updates on our progress on each of these pillars in the first quarter of 2023.

Turning to the Echoscope by giving some short remarks about what is the Echoscope. With our company being a first mover in innovating and commercializing real-time 3D sonar technology, as well as shifting the 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. Echoscope technology is currently the only real-time 3D imaging sonar. It is the only sonar that can generate a real-time 3D image of moving objects underwater in zero visibility conditions. Almost all activities underwater involve imaging moving objects.

Typical examples of our Echoscope applications are offshore renewables were cables are being laid or repaired, breakwater construction or remediation work involving the breakwater, bridge inspection or placing or removing something from the seabed, or more broadly, real-time inspection and monitoring underwater in 3D. The Echoscope is the only choice for customers where there is poor or zero visibility conditions prevailing or imaging moving objects in 3D. This progress made by our technology business over the last four years, both in expanding the range of available Echoscope models and configuration and getting into some new underwater vehicle programs in the defense and commercial sector, we believe paves the way for us to increase our share of the imaging sonar market over the next two to three years, and that certainly is our goal.

Turning to the first quarter. Within the first quarter 2023, although our results were broadly in line with our first quarter 2022, we are pleased with the progress against our growth pillars. The technology business, which is our product business, generated in the first quarter 2023, $3.8 million in sales at the constant exchange rate versus $4.1 million in sales versus $3.8 million in the first quarter of 2022.

Notable, however, is that within the mix of sales of this segment versus the products business, equipment sales were $2.15 million in the first quarter 2023 compared to $1.9 million in the quarter 2022, representing a 31% increase in equipment sales. This is good progress in respect of our strategy of increasing the Echoscope sonars we are selling quarter-by-quarter and year-on-year. We continue to pursue our goals to cement the Echoscope in as many of the new programs for underwater vehicles and at the same time continuing to expand our market share of the addressable commercial market.

Now turning to the DAVD. To recap first, how did the DAVD come about and what it is? The short recap: The DAVD emanates from a requirement of the Office of Naval Research referred to as ONR under its future Naval Requirements Program. Coda working with ONR and NAVSEA and Naval Surface Warfare Center, Panama City developed the DAVD. The DAVD embeds the pair of transparent glasses in the divers heads up display, and this is used underwater as the data hub for the diver.

The DAVD is a fully integrated suite of sensors which provide real-time data to the diver underwater and to the dive supervisor on the surface simultaneously. This means that both the diver and the dive supervisor can share the same subsea view and data, including life support data in real-time. This is the first time in diving operation. The diver and the dive supervisor sharing the same subsea view and a raft of data in real-time.

We have also transformed the analog communications, the digital communications underwater, thus making voice communication significantly clearer and more effective underwater. The DAVD is transformational for the diving market, both in the defense and commercial sectors because it provides a fully integrated suite of sensor data underwater, which is accessible in real-time by all parties involved in the dive operations.

Now turning to our progress on the DAVD in the first quarter 2023. First, our key customer, the U.S. Navy has now transferred the DAVD from their research and development phase to their field operations and command phase. This is an important milestone for the product as it means that the tethered system is now available for appropriate commands to purchase. This customer has now established a budget line for the acquisition of DAVD systems for new commands, and we expect to receive firm orders in our second quarter 2023.

In the quarter, also customization works group was completed for a DAVD untethered prototype system for a major U.S. Military Command evaluation. The evaluation will be – evaluation DAVD units to be purchased following the field trials. This is a significant leap forward for the DAVD product as it is now is an untethered system, allowing teams of divers to communicate among the team without any surface-based participation, and we believe this deployment presents the biggest opportunity for this product in the military sector. In addition, a major Tier 1 European offshore service provider adopted the DAVD system on a rental basis for critical European underwater construction projects.

If the field project is successful, we believe this will be the pre-cursor to full scale adoption of the DAVD by this world's leading service provider. We will be assisting this service provider on this project in April 23. We have also completed adaptation work for a second major Tier 1 European offshore service provider who is now changing their diving workflow to incorporate the DAVD as part of their standard operations. Further, we have completed successful trials of the DAVD in Dunoon, Scotland in February.

As a result of these trials, two key foreign navies are now working with us on a DAVD adoption plan, including discussions on purchasing evaluation systems in this financial year. We have a number of initiatives around the adoption of the DAVD and compassing both foreign navies mentioned earlier and European offshore providers. We are laser focused on getting these opportunities to the point where the DAVD is adopted within their diving operation, thus bringing scale and volume to this product.

I now want to talk about the adoption curve. DAVD is an important part of our strategy and we think it is important to update the market on the likely adoption curve for this recently launched technology. The customer adoption curve for nearly all such opportunities is the same. Stage one consists of trials that are on specific to that customer's workflow. This is designed to establish a certain level of interest in the product.

Stage two consists of evaluation designed to incorporate the DAVD in the customer's specific diving operation workflow, and we are intimately involved with the customer in this evaluation phase. This then culminates in a decision to move to stage three adoption. At that point, assuming a favorable review, the customer decides that this technology should be adopted in its workflow and sets up a purchase plan.

Based on the initiatives we are engaged in, we believe that the likely inflection point for the DAVD therefore is in financial year where we hope to have acquisition budget lines established with other customers outside of the U.S. Navy, and importantly where the U.S. military command has started purchasing system following completion of their evaluation of the untethered system we have recently customized and for which we are in trials in March and April this year.

To conclude, therefore, we remain comfortable targeting approximately $25 million in revenue for the technology that's the product business on a standalone basis in the financial year 2024. To put some context on this, in the financial year 2022, the products business had revenue of approximately $15 million and this year, we are targeting $18 million for this business on a standalone basis, and at the same time maintaining our profitability.

Now turning to our Marine Engineering Business. This segment is important for our group as it has strong pedigree in defense engineering with stellar relationships with prime defense contractors spanning decades. These are important relationships for our group strategy. There is a strong crossover of engineering scales, which is vital for us to maintain our competitive lead in real-time 3D imaging and our diving technology. This business that is the marine engineering business, supplies sub assemblies into broader mission critical programs under subcontracts with prime defense contractors. This gives them the opportunity to have repeat orders for these sub-assemblies for the life of the program.

Within this business segment that's the marine engineering business, we are navigating headwinds from supply chain issues across various defense programs. The supply chain difficulties apply not only to our own sourcing of components, but also crucially to our customers own supply chain issues resulting in the broader program design requirement – ability of components. This has led to many instances of multiple iterations of the design proposals being submitted for the same work package, which in turn has resulted in much slower order take in the first quarter for the Marine Engineering Business.

As we work to mitigate these issues, we also remain focused on growing the number of programs where we supply engineering sub-assembly to support the broader growth of this segment. It is critical to return the services segment to a $10 million plus revenue profile and therefore achieve our overall growth plan for the next two years.

Let me now turn over the call to our CFO, Nathan Parker, to walk you through our financials before I provide my closing remarks. Nathan?

[Nathan Parker, Chief Financial Officer]

Thanks, Annmarie, and good morning, everyone. Let me take you through our fiscal first quarter financial results. First, looking at our revenue. In the first quarter of 2023, we recorded total revenue of $5.6 million compared to $5.8 million in the first quarter of last year. The slight decline was due to a 12% sales decrease in our Marine Engineering Business as a result of supply chain issues with certain defense programs.

The Marine Technology Business generated revenue of $3.8 million compared to $3.8 million in the prior quarter. However, applying the constant rate, the Marine Technology Business revenue would have been $4.1 million. We are excited about the mix of our sales, as in the first quarter we saw an increase in our Echoscope sales.

Now turning to our gross profit. In the first quarter, we generated a gross profit of $3.8 million compared to $4.2 million in fiscal first quarter 2022. Gross margin in the first quarter of 2023 was 67.1% versus 71.3% in the same year-ago period. The reduction in gross profit was primarily due to higher product sales through CODA's network of sales agents, which carry higher commission costs.

Our Marine Technology Business gross margin decreased to 72% in fiscal first quarter 2023 compared to 85% in the prior year quarter. This was due to a disproportionate percentage of our product business being made through our sales agents’ network and thus incurring significantly higher commission payments. Our Marine Engineering Business gross margin was 56% versus 45% in the prior year as a greater percentage of revenue is generated from our engineering services contracts.

Now moving on to our operating expenses. Total operating expenses for the first quarter of 2023 decreased 14% to $2.4 million compared to $2.8 million in the first quarter of 2022, driven by a 34% reduction in R&D expenses due to the conclusion of several multi-year R&D programs. Our selling, general, administrative costs in the first quarter of 2023 totaled $2 million, reduced from $2.1 million in the prior year quarter. As a percentage of revenue, our selling, general and administrative costs for the first quarter of 2023 decreased to 35% of total revenue compared to 36% in the first quarter of 2022.

Looking forward on our cost structure, given the significant progress we have made in R&D in the last four years, we remain focused on aligning a significant portion of our resources and strategy from research and development to global business development, brand building and investor relations. We believe we have developed world-class products and solutions that will provide market leading positions for CODA and that can make meaningful progress in our markets to these investments to create shareholder value.

Now looking at our overall income and earnings. Our operating income in the first quarter of 2023 was $1.3 million compared to $1.4 million in the year-ago quarter. Our operating margin was 24.1% compared to 23.6% in the first quarter of last year. Net income before taxes in the first quarter of 2023 remained flat and $1.4 million compared to the year-ago quarter. Net income after taxes in the first quarter was $1.4 million or $0.12 per diluted share compared to $1.2 million or $0.11 per diluted share in the same year-ago quarter.

Now moving on to our balance sheet. As of January 31, 2023, we had $24.5 million in cash on hand and no debt. This represents a $1.6 million cash billed in the quarter.

That completes my financial summary. Now I'll turn the call over to Annmarie for closing remarks.

[Annmarie Gayle, Chairman and Chief Executive Officer]

Thank you, Nathan. As we look to the remainder of the fiscal 2023, we will continue to support the momentum of our products business through further solidifying our current programs and identifying new opportunities. As we grow our product deployment, we will remain focused on increasing the number of programs we are supplying in our engineered business.

We remain pleased with the traction we have generated for our Echoscope PIPE and DAVD solution and we are optimistic about their future prospects as the main pillars of our growth for our company. We have demonstrated track record of generating high margins and solid profitability, and we have had very healthy balance sheet with cash on hand and new debt, which gives us confidence in our outlook for CODA.

We are now happy to take your questions. Operator?

[Operator]

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Now our first question will come from the line of Brian Kinstlinger with Alliance Global Partners. Please proceed.

[Brian Kinstlinger, Alliance Global Partners]

Hi. Thanks for taking my questions guys. I wanted to start first with the component shortages that are driving delays for your services and engineering business. What's your visibility into receiving shipments of these components and can you approximate how much revenue you've been not able to generate as a result of these shortages, either in a one quarter or 12-month kind of perspective?

[Annmarie Gayle, Chairman and Chief Executive Officer]

Well, thank you very much, Brian. So let's start with orders on hand. So if I give you an example, we have a contract on for UK services business, and we've had that contract since November and that contract is a manufacturing contract for a major European industrialist, manufacturer, and that order is $2.3 million for the business. Since November last year, we are waiting on a single component to convert this to revenues for the business and we've had several full start on the components required. So it's very difficult because then we get what we call a lot of decommit. You have a firm commitment from the component supplier to supply the item on a particular date, and right at that point, we get decommit. So it's very difficult to say with any confidence given what's happening in the market.

If you think of the FPGA market, it's really supply scans, so we don't have a lot of work, although we might have commitments. The risk is that we get decommitted at the last minute by the component supplier and there's not a lot of reason to explain from this component supplier why they've decommitted this. It's simply the data's moved. So we see this a lot. Nevertheless, I mean we are really, really working to mitigate some of these. The problem is when a design is locked in, you are fixed with that component and then you have to go through a qualification process to get a substitute component within the project.

[Brian Kinstlinger, Alliance Global Partners]

All right. And just to be sure – one more question then we'll move to more important pieces of your business. Are customers generally understanding? Have there been cancellations of orders? Just talk about what the customer is communicating as a result.

[Annmarie Gayle, Chairman and Chief Executive Officer]

No, no. Because then for example, this contract that I talk about, this customer also weighted in and tried to get the component because there are a sizable manufacturer and they still – it's the same outcome. So we're working really closely with the customer and everybody, they're in the same position. This is not just a CODA problem, this is a global problem with the supply chain shortages that we see. So customers are understanding and cancellation is not an option. These are programs that we work on year-in, year-out. These are our proprietary parts, so there's no risk of that. And also just to say within the chain, it is a domino effect because it's not just CODA that's suffering that problem.

[Brian Kinstlinger, Alliance Global Partners]

Got it. Thank you. And then with your comments regarding the targets for fiscal 2024, we can back into at least a rough expectation for the DAVD next year. Are you able to quantify the total addressable market for tethered and untethered DAVD and does a pending untethered DAVD have a different targeted audience or might some navies wait for this untethered product before ramping their purchases?

[Annmarie Gayle, Chairman and Chief Executive Officer]

No, they're two different markets actually. You have the surface and the deep diving. The deep diving is really the untethered version. So we've been focused then on the U.S. market for the time being because then the product started as a U.S. project. And if I think about – it's a difficult question, but if you think about how many seals there are, there are 2,500 sea seals. There are in the U.S. Navy experimental diving unit, there's one 120, and then for others like combatant divers, amphibious support, there's 1,225. So in total, in terms of diving personnel, you have about 3,845.

Now, when I look at this, Brian and say, okay, for us what we have modeled as – because then when we think of how a technology is adopted, it's always going to be a phase adoption of the product. So because there's management risk, all of these for the customer, so we've kind of modeled something like 15% of that market over five years, and it might be conservative, but for just the way the adoption curve is, and as I said, when you phase in new technology, it will take time. And so 15% of that addressable market in the U.S. would be about $47 million. And we think that – and that's just 15% we have targeted.

[Brian Kinstlinger, Alliance Global Partners]

The $47 million, 15% of the 40s – 15% of 40s – $47 million is 15% is what you're saying?

[Annmarie Gayle, Chairman and Chief Executive Officer]

Yes, 15% is $47 million.

[Brian Kinstlinger, Alliance Global Partners]

And that's just U.S.?

[Annmarie Gayle, Chairman and Chief Executive Officer]

And that's just the U.S. based on those numbers that I gave you, 2,845 diving personnel. And I also want to clarify that $43 million excludes complimentary Echoscope sales. This is pure DAVD, so I've not included within $47 million.

[Brian Kinstlinger, Alliance Global Partners]

Right.

[Annmarie Gayle, Chairman and Chief Executive Officer]

The pairing of the Echoscope with the DAVD and the way we think that will go down for commands is it won't be a one for one, but certainly there will be a number of Echoscopes that we will introduce with the DAVD because as I had mentioned before, what the sonar data there in that environment, why it's important. Divers are diving in zero visibility conditions and that's really the Echoscope that's going to provide insurance from that.

[Brian Kinstlinger, Alliance Global Partners]

That was really helpful. Last question I have and then get back in the queue. Is there any predictability as to the mix of agent sales versus direct sales, which currently have a little bit of a different margin profile? And then in addition, can you talk – are DAVD sales direct or indirect, and what is their impact on gross margin as they become a bigger piece of your business?

[Annmarie Gayle, Chairman and Chief Executive Officer]

Yes. So just to say, Brian, and one of the things we have emphasized as we pivot from R&D into real hardcore sales and marketing. That necessarily means that we are agnostic where sales come from and we are expanding our agents network globally, including in Asia. So what we really want is more sales. Although what that means then there will be commissions paid on those sales. But then at the same time, if we expand our direct workforce, there's also that cost, it will not hit margins, but it certainly will be our operating costs. So we think – I mean, I can't give you a projection of what percentage will come, but we're certainly pushing the boot out to capture all corners of the market globally for our technology.

The DAVD is different, right at this moment we do not see the DAVD being via agents just because of the process of adopting the DAVD. But having said that, for example, helmet suppliers might be good distributors of the technology, and that discussions we have ongoing and in that context, we would pay a commission, but we are not at that point yet.

[Brian Kinstlinger, Alliance Global Partners]

Great. Thank you so much, Annmarie.

[Operator]

Thank you. At this time, this concludes our question-and-answer session. I'd now like to turn the call back over to Annmarie Gayle.

[Annmarie Gayle, Chairman and Chief Executive Officer]

Thank you very much everyone for joining today and we look forward to speaking to you again. Thank you very much for your time today.

[Operator]

Thank you for joining us today for Coda Octopus’ conference call. You may now disconnect.

[Annmarie Gayle, Chairman and Chief Executive Officer]

Thank you.

[Nathan Parker, Chief Financial Officer]

Thank you.