Coda Octopus Group Inc

NASDAQ:CODA

Earnings Call Transcript 2024-Q1

[Operator]

Good morning. Welcome to Coda Octopus Group's First Quarter 2024 Earnings Conference Call. My name is Sherry, and I will be your operator today.

Before this call, Coda Octopus issued its financial results for the first quarter of 2024 ended January 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; its Interim CFO, Gayle Jardine. Following their remarks, we will open the call for questions.

Before we begin, Jackie Keshner from the Gateway Group will make a brief introductory statement. Jackie, please proceed.

[Jackie Keshner]

Thank you. Good morning, everyone, and welcome to Coda Octopus' first quarter fiscal 2024 earnings conference call. Before management begins their formal remarks, we would like to remind everyone that some statements 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 to differ materially from those described in the forward-looking statements.

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. 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 for the year ended October 31, 2023, and Form 10-Q for the first quarter of this fiscal year. You may get Coda Octopus' Securities and Exchange Commission filings 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 a 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, executive]

Thanks, Jackie, and good morning, everyone. Thank you for joining us for our first quarter 2024 earnings call.

Our first quarter 2024 results were in alignment with our internal business plan, but down on our first quarter 2023. Our internal business plan had budgeted for our Engineering business revenue for fiscal 2024 to be backloaded. This is largely because of reduced availability of funding for defense programs due to the use of continuing resolutions resulting from the upcoming U.S. elections. We also planned within our forecast for several booked engineering projects to be converted into revenue later in fiscal 2024 due to the lead times for receiving components.

Notwithstanding these challenges, we have made some encouraging operational progress with our Engineering business segment as I will discuss this later on in the call. Moreover, we are seeing increased order take by our U.K. Engineering business which had been significantly affected by delays in receiving orders in fiscal 2023.

While the Marine Technology business revenue was down at $3.5 million compared to $3.8 million in the first quarter of 2023, I am pleased with the recovery progress that this part of our business is making. In the first quarter, we saw increased utilization of our rental assets, which I am very encouraged by, and this trend is continuing.

Notable in the first quarter is that outright sales in Asia, a key strategic market for this segment, fell by 26%. A contributory factor to this is weak demand from China caused by macroeconomic factors and increased geopolitical tensions. Encouragingly, though, margins have continued to improve in the Marine Technology business.

Continued progress in the Marine Technology business is critical to our growth plans. As such, I will give a brief overview of what we are currently seeing in the marine industry. The industry's biggest trade show is Oceanology which occurs every 2 years and took place last week. We, therefore, anticipated in our first quarter that outright sales would be down as typically customers postpone significant investment decisions until after this event.

Fiscal 2023 results were impacted by the downturn in offshore renewable projects due to inflation, higher interest rates and supply chain problems. It has recently been reported that Equinor and Orsted have both now received provisional contracts in New York's fourth offshore solicitation. We're further encouraged by seeing increased inquiries for our rental solutions for offshore renewables. Although these are early days, this is good news for the marine industry and certainly for us.

We're also seeing increased opportunities for some significant underwater construction projects in the Middle East where some new islands are scheduled for development in calendar year 2024.

Moving to our first quarter 2024 overview. During the first quarter of 2024, we continued to make progress against our key growth drivers. As I mentioned, we saw increased traction for our Echoscope rental solutions. We also made good progress in advancing the DAVD untethered system customization and hardening program, and based on the ongoing evaluation, we have received overridingly positive feedback on the system and its potential. We are also encouraged by the engagement we are seeing with the customer and the pace of the program.

This is good news, and we are on track to receive the final tranche of funding of $1.25 million in our second quarter.

Following a fleet-wide survey by the Navy of the users who were previously allocated DAVD Tethered Systems, we received broader positive feedback from the various current users. It is also interesting to note that the feedback from users cited the Echoscope as game changing for their operations.

Furthermore, 3 new Navy user groups have requested from their respective commands DAVD and Echoscope as part of their operations, and existing commands have also put in request for additional systems. This is great news for the success of the DAVD technology and our company.

We also had our first sale of the DAVD tethered system outside of the U.S. Navy to a large Asian offshore service provider, which is involved in underwater construction and diving, who is also looking at the broader adoption of this technology for their operations. This is a high-profile project and the local environmental agency will be involved. This provider intends to create a core of super users and then look at a more systemic adoption of the technology, providing their initial project is successful.

We continue to work with several offshore service providers globally on their plans for adopting the DAVD. Some of these are waiting for internal management decisions on funding. In February, we had a successful series of demonstrations of our Echoscope DAVD technology and the digital audio communication system to several bodies in Texas. These include the Fire Service, Department of Transport and other law enforcement agencies where our technology is being assessed for bridge inspection, port and harbor security, search and rescue, and diving support. The demonstration was well received by this potential community of users, and we are working with them on progressing their interest in our solution.

We are continuing to work with Naval Information Warfare Center, NIWC, as they advance the selection of their sensor package for the VideoRay Defender, and we have provided proposals for accessing the technology for extended operational trials. We believe these trials will start in April 2024. In addition, we continue to work with a foreign navy on integrating our Echoscope technology on the VideoRay Defender, which they have also adopted.

The safety and electrical assessment of our digital audio communication systems, Voice HUB-4, has now been completed by the Navy and they are expected to start trials in April.

Our Engineering business is making progress in key areas. We're pursuing 2 significant opportunities for our Thermite mission computers for 2 new applications, and we are now awaiting the completion of these negotiations. The relevant trials with our Thermite Octal were completed pre-COVID where these programs had stalled due to the pandemic. I am very pleased that these are now advancing and securing these programs, will be meaningful to our group. The success of Thermite will mean diversification of revenue for the Engineering business and improved margins.

We have also received a small batch order for 2 new defense programs of record. The significance of this, however, is that these are 2 new programs which are likely to go into the production phase in this fiscal year. This is a key component of success in the Engineering business operations, which depends on expanding the number of programs that it supplies proprietary subassemblies into.

Our U.K. Engineering business is also seeing an uptick in its order take and has received orders for 2 new programs relating to mine hunting autonomous vehicles and a new line of military land vehicles. We believe the results of the Engineering business will improve in fiscal 2024. A significant part of this segment's revenue is backloaded.

Let me now turn the call over to our interim CFO, Gayle Jardine, to take you through our financials, before I provide my closing remarks.

[Gayle Jardine, executive]

Thank you, Annmarie, and good morning, everyone. Let me take you through our first quarter 2024 financial results. Starting with revenue.

In the first quarter of 2024, we recorded total revenue of $4.5 million, compared to $5.6 million in the first quarter of 2023, a reduction of 20.3%. The Marine Technology business, our products business, generated revenue of $3.5 million, compared to $3.8 million, a 7.4% decrease from the first quarter of 2023. Our Marine Engineering business or services business generated revenue of $0.9 million, compared to $1.8 million, a 48.2% reduction from the first quarter of 2023.

As reported earlier by Annmarie, the decline in our consolidated revenue was largely as a result of the service businesses, reduced orders and supply chain issues, which have impacted our short-term ability to convert booked engineering projects to revenue in the current quarter.

Moving on to gross profit and margin. In the first quarter of 2024, we generated gross profit of $3.1 million, compared to $3.8 million in the first quarter of 2023. Gross margin was 69.2%, versus 67.1% in the first quarter of last year.

In our Marine Technology business, gross margin increased to 72.5% in the first quarter of 2024, compared to 72.2% in 2023, reflecting changes in the mix of sales and the lower commission costs recorded in the first quarter of 2024 due to the reduction in outright sales in Asia. Our Marine Engineering business gross margin increased to 56.4% in the first quarter of 2024, versus 56.0% in the first quarter of 2023, again, reflecting the mix of sales.

Now moving to our operating expenses. Total operating expenses for the first quarter of 2024 rose slightly to $2.5 million, compared to $2.4 million in the first quarter of 2023.

Our selling, general and administrative costs in the first quarter of 2024 totaled $2.0 million, an increase of 4.2% over approximately $2.0 million in the first quarter of 2023. As a percentage of revenue, our selling, general and administrative costs for the first quarter of 2024 was 4.58%, compared to 35.1% in the first quarter of 2023.

This increase was expected as we have previously stated that, due to the significant progress we've made in R&D in the last 4 years, we are now 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 expected SG&A to increase as we hired new staff in key areas and realized an increase in our payroll costs. In addition, we're still working on expanding our management team, and this will also increase our SG&A expenditure. We believe these investments will increase shareholder value as we continue our focus on increasing sales across our whole group.

Operating income in the first quarter of 2024 was $0.6 million, compared to $1.3 million in the first quarter of 2023, a reduction of 58.7%. Operating margin was 12.4%, compared to 24.1% in the first quarter of 2023, driven by the change in revenues as explained previously.

Net income before taxes in the first quarter of 2024 was $0.8 million, compared to $1.4 million in the first quarter of 2023. Net income after taxes in the first quarter of 2024 was $0.6 million or $0.06 per diluted share, compared to $1.4 million or $0.12 per diluted share in the first quarter of 2023.

Moving now to our balance sheet. As of January 31, 2024, we had $25.0 million in cash and cash equivalents on hand and no debt. This represents an increase of $0.6 million from October 31, 2023, where the comparable figure was $24.4 million. Our working capital increased to $40 million from $37.6 million as at October 31, 2023.

I will now turn the call back over to Annmarie for closing remarks.

[Annmarie Gayle, executive]

Thank you, Gayle. I want to close by emphasizing that we continue to work to create stable, long-term shareholder value. In the 2024 fiscal year, there are a number of key management goals for our business to achieve with a focus on growth. We have a compelling calendar of prestigious business development activities in 2024 with a focus on defense applications and defense programs.

Some of our goals include achieving revenue in fiscal year 2024 which exceeds our 2023 revenue. Continuing to seek to increase the number of programs that our Echoscope technology is embedded in. Continuing to prioritize and engage in the DAVD untethered system customization and hardening program with the goal of securing the technology's adoption by the special forces community in late calendar year 2024 or early 2025. Continuing to work to ensure the successful rollout and adoption of the DAVD tethered system to the market, both in the defense and commercial market.

Supporting the rollout and adoption of the digital audio communication solution. Continuing to work towards returning the Engineering business to its pre-COVID $10 million revenue profile, and we're seeing traction with new programs which will assist in achieving this goal. Expanding the group's management team and capabilities; this is ongoing. Continuing to develop our pipeline of candidates under our M&A strategy with a goal of acquiring complementary value-accretive technologies into our portfolio.

We continue to believe in the growth prospects and strategy built around our disruptive technologies. It is our strategy to focus on penetrating the defense market with these technologies, including seeking the inclusion of our imaging sonars in the new generation of underwater vehicles, and securing the adoption of the DAVD untethered systems by the special forces.

By adopting this strategy it pivots the revenue model of the Marine Technology business to a multiyear and multi-sale model as we have started to see with our DAVD product line. Though it could take several years for these programs to mature, we continue to believe this is the best strategy for our business growth prospects. Therefore, we believe that our near-term growth will be incremental, but solid.

We are also committed to returning the Engineering Services business operations to its pre-COVID revenue profile, and we have started to see new programs entering their preproduction phases.

To conclude, we would like to thank our shareholders for their continued support. We are now happy to answer your questions. Operator?

[Operator]

[Operator Instructions] Our first question is from Brian Kinstlinger with Alliance Global Partners.

[Brian Kinstlinger, analyst]

I've got a handful of questions. You've talked about last earnings call as well as this earnings call about industry cancellation, shelving of major offshore renewable projects due to inflation, higher interest rates and supply chain problems. I think you mentioned a few positive signs. But maybe from a high level, do you think we're seeing meaningful progress in terms of negotiating the terms as it relates to electricity pricing resets for the rates?

[Annmarie Gayle, executive]

It's Annmarie. Look, I think while we are not directly involved in those discussions, we're not at the table there, what I can say from where I am sitting in our business, we're seeing increased demand for our Echoscope solution into offshore renewables.

If you recall, actually, Brian, -- I think it was 2019, I think we said $25 million. And that year, what was different in that year, we were on almost all European offshore renewable projects. What I'm saying to you now, what I am seeing in terms of the utilization rate for rental, it is very, very encouraging. We saw that in the quarter. We see that continuing in -- and really, at the moment, we have to potentially look at expanding our rental assets because -- and a lot of these projects are offshore renewables and construction.

So I definitely think that there are positive signs that some of these programs are going forward.

[Brian Kinstlinger, analyst]

Great. And then you highlighted Oceanology, where I'm sure you got to demonstrate your technology. In the past, when do you see the impact on new orders from this conference? Is it a couple of months, a couple of quarters? Maybe give us a sense for the sales cycle post this conference.

[Annmarie Gayle, executive]

Well, what we noted in the first quarter is that sales from Asia continued to be down. And although China plays a part, so does Japan and South Korea, where we saw reduced demand. And I think that that market will purchase in Q2, not necessarily China because we've lost visibility of demand from China. But I feel high level or high sense of confidence that Japan and South Korea will start, and Singapore, will start picking up following the show.

[Brian Kinstlinger, analyst]

Great. In terms of the DAVD tethered and untethered products, you gave a lot of information. What are the next goal posts? You mentioned the sales of your first commercial sale, sorry, for the tethered system, what's the contract value of that program? And when do you expect the actual revenue contribution to rapidly increase? How should we think about that timing?

[Annmarie Gayle, executive]

Well, Brian, thank you for that question because then -- and I think there needs to be more alignment with expectations of what we're doing. So DAVD is a program, and it's now a program of record. So DAVD started 2019. It took 5 years to mature before we had the system going through evaluation and now being on the approved Navy use list.

Now what I am excited about, Brian, is the fact that that passive revenue stream that I've spoken about, year in, year out, we're now seeing that because we're seeing existing commands putting in requests for more equipment, more DAVD tech solutions. And also, we are seeing new commands putting in requests for DAVD.

So I'm very, very excited about that. Whilst I can't give you a number of what that will mean, last year for the tethered system, we did $3 million. This year within our internal plan, we have $4.5 million. And I've always said that growth will be incremental for the DAVD.

What will be pivotal in terms of getting those numbers up will be to have, not just the U.S. Navy, but foreign navy also acquiring the solution. And we know that that is, I mean, for the untethered system, for example, we are funded jointly between the U.S. Navy and an allied navy, a significant allied navy. So implicitly, they're on that adoption train with us.

So I think what I am seeing is, and I'm excited about, as I said, the program for the DAVD tethered system going forward, it's passive revenues, we don't need to do any business development, it's on the approved Navy list and they're just buying equipment. And that's what I talked about for this business quite a lot. So overall, I think this year, we're trying to do $4.5 million.

And another thing I'd like to mention on the DAVD too that I see, and it's very encouraging for our company is the level of engagement we're enjoying with the key customers on the program, it's -- one of the barriers always is the sense that it goes much slower, but we've seen them doing several dives with the untethered system. All of the feedback overridingly positive for the business, and we don't feel there are huge hurdles for us to overcome in terms of the technology, its fitness for purpose, and the path that we're going down.

So overall, I continue to believe that the DAVDs will be significant for our group, and it's one of our disruptive technologies in the market.

[Brian Kinstlinger, analyst]

Great. That's helpful. Turning to the services or Engineering business. You were very clear that you hope to get it back to the pre-COVID levels, which were $9 million to $12 million. The federal government has essentially been in a continuing resolution almost every year since I've been following, which is 20 years. Notwithstanding the longer lead times, what else have been the limiting factors to that recovery?

[Annmarie Gayle, executive]

Well, the main thing is that every time -- first of all, every time there is the upcoming elections, that's clear, you'll never get your federal budget through, and that's the real background to the continuing resolution. So it just means that you -- for programs, that they're not optimally funded and they've got to meet choices, when they get a pot of money, some will go to X and some will go to Y, but not the amount that's contracted. So that's what we're seeing.

But the biggest factor for, for example, the Engineering business, has been the pace at which the new programs go forward. So what I reported, for example, on the U.S. engineering side, we have 2 new programs now which is going into its preproduction phase. We've now got the small batch orders. And why I'm excited about this and see the promise of returning the business to the $10 million is these parts that now we've received the small batch orders for are for established programs of record and the engineering part is a result of obsolescence. What that means is that the production quantities is likely to be large because they'll be retrofitting those for the assets in the field.

So I'm really super, super excited about those 2 programs that we have back there. And they're on -- we've now received, as I said, the preproduction order, the evaluation patch. And we expect the back end of this year that we will get the production orders. So that's on the U.S. side.

In the -- on the U.K. side of our Engineering business, this last year, revenues were significantly down because of the -- it's like the priorities had shifted for the main customers and they were really pursuing a lot of land-based applications. But what we are seeing now is an uptick of those orders that were meant to come through. Some of them are coming through. And we are -- that business is quoting also a lot at the moment. So I am excited about that part of the business.

And also, as I mentioned before, the Thermite , it's a good example, Brian, we had 2 really major opportunities for the Thermite pre-COVID, and those had stalled and stalled. And they've now just come back on the table. And those, again, will be good opportunities for business because now it's in the production phase that -- not the design phase for our business.

So the limiting factor has really been more a bit of COVID, the slowness, the recovery from COVID. But also the Engineering business, they go through different phase from they get a new program where they're doing the design phase, it's pretty small. But once that's written into the program and then you get the production orders, that's really what gives us the kick, and that's really where we are with these new programs.

Of course, for that business, it has to continue expanding the number of new programs it is supplying proprietary parts into. But I feel we're in a good spot now with recovery COVID and then also last year where we saw a lot of land-based applications, we're now seeing more and more naval requirements coming through and have won some orders there.

[Brian Kinstlinger, analyst]

So 2 more, wanted to follow up to that one. In terms of the 2 programs that are hopefully going to go into production in the U.S. as well as the new awards in the U.K., is there any way, at least in total to size, what these mean? Are these contributors of each $1 million, a couple of hundred thousand dollars? It's hard to understand the magnitude of the impact of these collective programs.

[Annmarie Gayle, executive]

Yes. So the way to really think about and the orders is that, first, there are a number of things because it's not just about the upfront production quantities you get today. It is the fact that this is our repeat orders that you get over the time. So at any one point, like those 2 new programs that we have in the U.S., I think that that will probably be around $4 million for that business. And then on the U.K. side, that's about $2 million.

No, those are not lifetime values, those are initial values that we expect.

[Brian Kinstlinger, analyst]

Wow. I can see why you think the recovery is ahead.

And then lastly, on the balance sheet, which is obviously healthy, what investments are the company -- is the company making to accelerate the adoption of your technology? Is it hiring more salespeople, marketing professionals? Just maybe highlight where you think you can invest to help accelerate adoption of your products.

[Annmarie Gayle, executive]

Great question, Brian. So I think I'm pleased to report, we've made really, really good progress since we last spoke. So we've now successfully, and I don't have permission to identify the group, but we've now successfully hired a focus group in the U.S., a very, very well-established focus group in the defense space.

And the whole idea of that U.S. focus group will be to provide a better understanding of the opportunities we are pursuing, helping us to map the opportunities and model the opportunities more clearly, which I'll expand on once we have that. In addition, the focus group will help us with identifying new programs and making sure we're not missing any programs. And generally, strategy.

So I'm very, very excited. We will have our kickoff with that focus group the 1st of April. And I'm pleased that they'll be very impactful for our business. They're well experienced in this area. In addition to that -- and that would be a significant investment for our business there, very significant in terms of the cost for our business.

In addition to that, one of the things we've been looking for is a leader for our DAVD tethered system technology in Europe. And I'm pleased to report that we are close to complete that agreement with this candidate, and that's -- this candidate will be based in the Netherlands where we have the top 20 dredges in the world there. So it's a significant location for us. And these things take time because you want to make sure that the person has the right access, the right experience.

So long and short, Brian, we are continuing to invest significantly in business development and expanding our management team. So our management team, not only are we short of a CFO, but the biggest thing for our business is senior personnel at marketing and futures officer for the vision and strategy of our business. So we will be investing heavily in expanding our management team, which I hope by this year we have the full complement of the team that can help us to pivot to where shareholders want us to pivot, but it does be time.

[Brian Kinstlinger, analyst]

Great. Actually, just one more. The focus group, is that a third-party you're hiring, or is that a team you're hiring to be part of Coda?

[Annmarie Gayle, executive]

It's a third-party team that provides this service, but we also get allocated a number of personnel to work with.

[Operator]

[Operator Instructions]

With no further questions at this time, I would like to turn the conference back over to Annmarie Gayle for closing remarks.

[Annmarie Gayle, executive]

Thank you very much, everyone, for your continued interest in Coda. Thank you for your continued support also and have a great day. Thank you, everyone.

[Operator]

Thank you. This will conclude today's conference. You may disconnect your lines at this time, and thank you for your participation.