Coda Octopus Group, Inc.

Good morning. Welcome to Coda Octopus's group's second quarter 2024 earnings call. My name is Sherry and I will be your operator today. Before this call, Coda Octopus issued its financial results for the second quarter 2024 ended April 30th, 2024, including a press release, a copy of which will be furnished in a report filed with the SEC. It 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, its CEO, Anne Marie Gale, its interim CFO, Gail Jardine. Following their remarks, we will open up the call for questions. Before we begin, Jeff Turner will make a brief introductory statement. Mr. Turner, please proceed.

Thank you, operator. Good morning, everyone. Welcome to Coder Octopus second 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 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 statement. For more detailed risks, uncertainties, and assumptions relating to our forward-looking statement, 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 that 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 filing, 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 and second quarter of this fiscal year. You may get CoderOctopus 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 the Sodor Octopus website. Now, I will turn the call over to the company's chair and CEO, Anne-Marie Gayle. Anne-Marie?

Thanks, Jeff, and good morning, everyone. Thank you for joining us for our second quarter 2024 earnings call. Our revenue in the second quarter 2024 was in line with our second quarter 2023 revenue. Despite various challenges in the second quarter, we delivered a solid set of results, including increasing our operating income, net income, and earnings per share. During the second quarter, we observed a slowdown in the pace of placing orders relating to U.S. defense sector programs caused by the funding gaps created by the use of continuing resolutions to fund defense programs instead of a fully funded federal budget. This is not unusual where there is an upcoming presidential election. Notwithstanding these temporary constraints, I am very pleased that we were able to increase our revenue generation outside of the USC, which shows the diversity and resilience in our revenue stream. The marine technology business revenue in the second quarter 2024 was broadly in alignment with the second quarter 2023 revenue. I am particularly pleased with the increased utilization of our rental assets during the second quarter and therefore the improved gross profit margins of 80.2% in the second quarter 2024 compared to 75.3% in the second quarter 2023. We are also very pleased to see better traction in sales emanating from Asia, which was 15.9% higher in the quarter. Sales for this segment from the USA fell from 1.8 million to 0.6 million as a result of funding gaps created by the use of continuing resolutions to fund defense programs. This means that without a federal budget, there is limited funding for these programs and many of these are currently only partially funded. Our engineering business saw an increase in revenue and is making good progress in key areas. This business was also impacted by a reduction in order intake relating to their ongoing defense programs And sales from USA Defense programs for this segment fell from 1.1 million to 0.8 million. This is due to the funding gaps I touched on earlier. Moving to our second quarter 2024 overview. During the second quarter of 2024, we continued to make progress against our key growth drivers. As I mentioned, we saw increased traction for our ex-co-parental services. This resulted in an increase in gross profit margins. Although sales in the USA were significantly down due to the funding gaps relating to defense programs, our team was able to recover some sales in other geographies. I'm particularly pleased with this as it shows the diversification and resilience within our revenue streams. Of great importance, we also provided extensive support to the ongoing operations relating to the Francis Scott Key Bridge collapse. The circumstances surrounding the collapse were tragic and we are pleased that we could have assisted in some small way. This high profile engagement has reinforced the importance of our technology for these sorts of applications and has marketed the Ecoscope to other customers around the world, including in North America. The Ecoscope technology has been the primary sensor used for a broad scope of activities relating to recovery, salvage, and real-time inspection. This high-profile project again highlighted the importance of the capability of the Ecoscope technology, a single sensor for multiple real-time 3D imaging applications, including in disaster recovery programs. Over the years, the Ecoscope has been used globally in many disaster recovery programs, including in South Korea, Japan, and Europe. We made further progress with Naval Information Warfare Center, NIWC, and supplied under a lease agreement two of our compact Ecoscope sonars for their ongoing evaluation of our technology for the Vidiary Defender Platform. We also continue to work with an Allied Foreign Navy, which has selected the Vidiary Platform on integrating our Ecoscope on their vehicles, and we have begun to provide training on the Ecoscope to their personnel. This is a good indication that the Ecoscope technology is included in their census selection program. We also made progress on the ship hull scanning program, which we have been pursuing with our Navy customers. And in the second quarter, we completed successful trials. This ship hull scanning platform which we delivered to the Navy in our third quarter of 2023, includes both the ECOSCOPE and DAVID capabilities. This is an important step forward under this program, which has been executed over a three-year period and for which we received $1 million in funding over this period. We're not aware of any effective solutions in the market for ship hull scanning. And if the company's developed solution is accepted by the Navy as meeting the requirements of this program, this could be significant for our business. Furthermore, there are many different Navy commands that are interested in the solution we have put forward. We also continue to make progress in the adoption of the davit system, and in the second quarter, we partnered with a U.S. service provider to complete a tunnel inspection project using the davit system and our Ecoscoop. We believe this was a resounding success as we were able to show the effectiveness of the DABIT and ECOSCOPE solution for these applications, particularly the return on investment for customers and the superior deliverables achievable with this solution. We're discussing adoption of the technology with this U.S. commercial service provider. We also made good progress in advancing the David Untethered System Customization and Hardening Program and received partial funding of $250,000. We anticipate the remaining $1 million will be released as the budgetary constraints mentioned earlier are removed. Despite this, the program of hardening the David on Tezit system is proceeding, and we are doing everything within our remit to move this program to a successful conclusion for the company and its shareholders. We continue to believe that this is the biggest opportunity for the David technology. Our newly launched AI-based Digital Audio Underwater Communication System has been undergoing Navy evaluation. We have now received overridingly positive feedback on the technology. From a survey conducted by the Navy of its divers involved in this evaluation, 100% of those involved believe that this product increased their diving capability and level of safety by providing clearer and crisper communications. They all said they would use the product on a mission if available and thought that it was superior to existing analog communication systems. We continue to make good progress with our goal of creating the conditions for returning the engineering business to its pre-COVID $10 million revenue profile. To achieve this, we will need to increase the number of new defense programs that we're supplying proprietary sub-assemblies into. We have now seen some new programs materializing, and I'm excited about this. In the second quarter, we received a partial award of $771,000 for production units for a new sub-assembly for an existing program of record, which is being upgraded due to obsolescence of some of the components. We had anticipated an initial award of $1.5 million under this program, but due to the funding gaps mentioned earlier, we received a partial award and expect the remainder when funding becomes available. We are excited about this program of upgrade as there are many existing systems in the field that will need to be upgraded with a new part which we have designed, and this will generate meaningful revenue on this program over time. We also received a new order for Thermite Mission Computers, which relates to a new Navy program. This is for an initial pre-production quantity of eight systems for a contract value of $280,000. We expect the larger production orders for this program in early 2025. Finally, we also continue to perform quality business development activities including working with our newly appointed business development focus group in the U.S., we can already see the promise of the success of this engagement. Let me now turn the call over to our interim CFO, Gail Jardine, to take you through our financials before I provide my closing remarks.

Thank you, Anne-Marie, and good morning, everyone. Let me take you through our second quarter 2024 financial results, starting with revenue. In the second quarter of 2024, we recorded total revenue of $5.32 million, compared to $5.30 million in the second quarter of 2023, an increase of 0.4%. The marine technology business, or products business, generated revenue of $3.52 million compared to $3.58 million, a 1.6% decrease from the second quarter of 2023. Our marine engineering business or services business generated revenue of $1.8 million compared to $1.7 million, an increase of 4.7% from the second quarter of 2023. As discussed earlier, our total consolidated revenue increased in the second quarter by 0.4%. Our engineering segment revenue increased in the second quarter, and the product segment saw an increase in rentals, rental-related support services, and an increase in sales outside of the US region, including in our strategic market area of Asia, where outright sales increased by 15.9%. Sales from North America were down due to the reduction in the defence programme funding for the reasons Anne-Marie explained earlier. Moving on to gross profit and margin. In the second quarter of 2024, we generated gross profit of $3.7 million compared to $3.6 million in the second quarter of 2023. Consolidated gross margin was 70.2%. versus 68.3% in the second quarter of last year. In our marine technology business, gross margin increased to 80.2% in the second quarter of 2024, compared to 75.3% in 2023, reflecting changes in the mix of sales, primarily due to the increase in rental and the associated support service sales, which have a higher gross margin. Our marine engineering business gross margin decreased to 50.7% in the second quarter of 2024 versus 53.9% in the second quarter of 2023, again reflecting the mix of engineering projects during the second quarter of 2024. Now moving to our operating expenses. Total operating expenses for the second quarter of 2024 decreased to $2.4 million compared to $2.8 million in the second quarter of 2023, which is largely due to the reduction in our stock compensation charges in the period. Our selling, general, and administrative costs in the second quarter of 2024 totaled $1.8 million, a decrease of 17.7% from $2.2 million in the second quarter of 2023. As a percentage of revenue, our selling, general and administrative costs for the second quarter of 2024 were 34.7%, compared to 42.3% in the second quarter of 2023. The reduction is mainly due to a decrease in stock compensation charges. In accordance with our strategy, we continue to recalibrate our working capital towards business development and marketing activities. Accordingly, in our second quarter, marketing expenses increased by approximately 52%. This included the fees relating to the appointment of a business development focus group we have hired in the U.S. to assist in this area. Operating income in the second quarter of 2024 was $1.4 million compared to $0.9 million in the second quarter of 2023, an increase of 57.9%. Operating margin was 25.4% compared to 16.1% in the second quarter of 2023, primarily due to the increase in gross profit margin combined with the reduction in total operating expenses. Income before taxes in the second quarter of 2024 was $1.6 million compared to $1 million in the second quarter of 2023. Net income after taxes in the second quarter of 2024 was $1.4 million, or $0.13 per diluted share, compared to $1.0 million, or $0.09 per diluted share, in the second quarter of 2023. Moving now to our balance sheet. As of April 30, 2024, we had $23.7 million in cash and cash equivalents on hand and no debt. This represents a decrease of $0.7 million from October 31st, 2023, where the comparable figure was $24.4 million. This is mostly due to the purchase of long lead time items into inventory. So you will see that line item has increased accordingly. Our working capital increased to $41.0 million from $37.6 million at October 31st, 2023. Now I will turn the call back over to Anne-Marie for closing remarks.

Thank you. Thank you, Gayle. I want to close by emphasizing that we continue to work to create stable long-term shareholder value. I want to remind everyone that growth is a process and not an event. Think of it like a puzzle and we're putting the pieces together. In the meantime, we're running a profitable business. Our team is doing an outstanding job in maintaining superior margins and profits for our shareholders, while all the time seeking to grow sustainably without compromising our track record of a tightly run profitable business. 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 the defense applications. Some of our goals include continuing to seek to increase the number of programs that our Ecoscope technology is embedded in Further prioritize and engage in the David on Tethered System Customization and Hardening Program with the goal of securing the technologies adoption by the Special Forces community in early 2025. Supporting the rollout and adoption of the David Tethered System to the market, both in the defense and commercial space, supporting the rollout and adoption of the digital audio communication solutions. Rebuild 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 the 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. By adopting this strategy, it pivots the revenue model of the marine technology business to a multi-year and multiple sale model, as we have started to see with the David 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's growth prospects. Therefore, We believe that our near-term growth will be incremental but solid. To conclude, we would like to thank our shareholders for their continued support. We're now happy to answer your questions.

Operator? Thank you. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. And for participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Our first question is from Brian Kinslinger with Alliance Global Partners. Please proceed.

Great, thanks for taking my questions. I've got a laundry list. Anne-Marie, two quarters ago you discussed the challenges in both offshore renewables and underwater construction markets that was leading to delays. Some of it was pricing challenges due to inflation. Can you update us as to the state of these markets and how the environment is the same or different today?

Thank you, Brian, very much for that question. As we saw in the second quarter, we saw really increase in the utilization of our rental assets. And that's largely being driven by offshore renewables, renewables programs and projects, actually, and also underwater construction activities. So what we're seeing is increased demand for our rental solutions for underwater construction, some of which includes offshore renewables.

Great. And then the work you did with the Francis Scott Key Bridge and the headlines of that disaster, how, if at all, have you been able to use that to drive awareness or increased adoption of your technology?

Well, that drove awareness, Brian. Also, I mean, it also was a good way reinforcement of the capability of our technology and the uniqueness of our technology and what it can deliver so that was really a good marketing awareness campaign for the business globally and we've seen tractions coming from that exposure that we've had so you know all these things will take time to percolate into a firm orders, but we certainly have had some new contacts from that event. And including also what I'd like to emphasize also, Brian, is that including some of the programs, the defense programs that we've been working on in the U.S., this has just reinforced really they're finding and what they're doing and helping to galvanize outcomes on some of these programs. So all in all, really, really good piece of marketing for our business.

Great. And then in terms of the DAB, some great news on the tunnel program that you discussed. I'm curious if you see an inflection point in orders for either tethered or untethered systems the next 12 to 18 months based on this progress you're making.

Oh yeah, so certainly let's take the Tethered system which, as you know, is in the market. It's on the approved Navy use items. And there what we are seeing is new commands putting in requests or requisitions for acquiring the technology. We know several commands are trying to get budget to do this. But the barrier in this quarter and possibly the next quarter is really where we see defense programs budgets are really limited at the moment. But certainly we could see strong interest in the David technology. And more importantly, Brian, when we started, when we did the initial rollout of the David to the Navy, one of the key things we weren't sure of was how they would buy the technology. Would it be just the David or would they buy the Ecoscope also? And I'm pleased to say that they definitely find the Ecoscope along with the David game changing. So that will be sold or purchased by them as a pair. So that is very exciting for our business because That is an established program now. And to a large extent, the David system is a passive field now within the U.S. Navy because it's an approved Navy use item. What this business has to do is to continue providing training, working with the different commands, working with the Navy to heighten awareness in its community for the David capability. And thereafter, I think, you know, it will sell itself. So I'm excited about that for the David Tevid system. For the untethered system, really there, that work is ongoing. As you know, we have eight systems fielded with both the US Navy and the foreign Navy, and they're working together to evaluate the system. And even though we have actually been affected by limited funding at the moment, The program continues to work at space. We continue with the hardening and turning over revisions to the products of the Navy. So although there is a gap in funding, it is not at all affecting the progress that we're making onto these programs. So coming back, therefore, to the inflection point, I really think that we're seeing good and solid traction in the market for the DAV technology all around. And I think it will take time for people to adopt the technology, but we are getting closer and seeing that. The tunnel program that we did in the US, really, really important. We also, in the last quarter, as you know, sold our first davit system in South Korea. I think that they were very, very pleased. Also, another very high profile that they've used the technology on, and they themselves are on the road to adoption. We have several major offshore service providers in Europe who are still going through their own internal process for the damage. So I feel very much that we're getting closer. The recognition of what the technology is capable of that's growing and really it's about now getting people over the line to start putting in their budgets for the technology so i think that we'll probably see much more increased um demand for the system um coming from the us once the budgetary constraints are removed And also I am excited about the, um, the, um, joint program that we have both with the U S Navy and with the foreign Navy, because then I think that that is going very, very well. And we certainly want to get the system in the hands of the special forces using it. They have big budgets and really, um, we're excited about that.

Great. Now I think the natural follow up to that, I heard you mentioned it may be one more quarter on the budget side. But if I'm not mistaken, the CR ended at the end of June. Have you begun to see a recovery yet slow, not a recovery at all yet on the budget side? Just maybe take us through on the Marine and or engineering services, what's happened since the CR ended?

No, I think it's really the appropriations now. And I think that what we're seeing on programs is that appropriations have not been made to their programs. So, many programs are still only getting partial budget. I think the next point where we will see funding released is in July. That's my understanding. In any event, for the programs we're working on, July is critical because there's going to be new tranche of funding to various programs. So I think, Brian, this is not really unusual in an election year um there's all this political environment that's fraught and um so i i this is not a big surprise for business however as i said i expect in july there will be some funding being released what i don't certainly have visibility of is the extent of this funding round for programs like the david program programs like for engineering business that We're waiting for a number of key orders. So I don't have disability. But what we have consistently seen is partial funding as opposed to full funding.

Got it. Last question for me, then I'll get back in the queue. You mentioned the pre-production order for the thermite program, which is great to see. I know you've been hoping that thermite demand would start to pick up. You mentioned the production could begin in the first quarter of 2025, I think. Can you estimate the size of the opportunity for you on that production program?

Well, the one where we've got a small initial evaluation system order, my understanding is that potentially there'll be 200 units under the program for our purchase order. So we wait to see, but that's the number we're working towards.

And can I look at the eight units delivered in $250,000 as an ARPU, or is that not accurate?

No, that's accurate.

Okay, great. Great. Thanks so much, Anne-Marie.

No, thank you, Brian.

As a reminder, it is star 1 on your telephone keypad if you would like to ask a question. Our next question is from Fernando Canto with Private Investor. Please proceed.

Hi, Annemarie. Congratulations on a very good quarter. I just have a question. I see on the first quarter that the own bill receivables were $763,000, and they went up this quarter to $1.580 million. Is there any explanation for that, please?

Did you say receivables receivables? On-bill receivables. On-bill receivables. Gay, can you take that question for us, please?

Sure. Can you hear me? Fernando?

Yes, we can hear you.

Yeah, basically, it went up from 1.6 to 1.6, 1.6 million from 0.9 million, and that reflects the increase in our accumulated project expenses incurred on uncompleted contracts. So it's work that we have invested a lot of time and materials in some projects that haven't yet built, so that's why they are on the balance sheet as contracts in progress or unbilled receivables.

Right, that's possibly for your third quarter then.

Yes, I think that just what we said, we saw an increase in our engineering projects in the second quarter. And in the first quarter, it was really, really off plan. We're seeing that business coming back on plan. And as I mentioned, in my first quarter earnings call, we expect a lot of the engineering businesses' revenues to be backloaded, and we're seeing that coming through. Right.

All right. Well, thank you very much, and congratulations again, Anne-Marie.

Thank you very much. Thank you, Fernando. Thank you, Fernando.

Thank you. Our next question is from Andrew Scott with SLF. Please proceed.

Hi, Anne-Marie. Great quarter. I know you're probably a little bit frustrated with growth, but I just wanted to remind everybody that you're doing a great job in managing your business. I had a chance to calculate your ROA, your ROE, your return on shareholder equity, and I'd like to challenge everybody else to run the same numbers. with other marine-related companies, and you guys are at the top of your peer group. So great job in running a business. I heard some of the questions before, so a lot of the comments that I had have been answered. But you have a great balance sheet. You've got ingredient sufficiency to grow the company through acquisitions. Are there any verticals, any markets that you're specifically looking at? But again, just great job in running the business. Very exciting.

Thank you very much, Andrew. We're also very, very, thank you for that. I'm really excited about the business and it is correct. I mean, it is, I think also what was for me very, very positive in the quarter is that, you know, we saw challenges. It was a very, very challenging environment for defense programs. But the team was able to pivot and really make up revenues from other jurisdictions and geographies. And Asia is up by 15.6%. I'm really excited about that because that is a key market for us. Also, you know, we've launched our digital audio communication system. And whilst that's not a big ticket item, the market is considerable for that technology. And we now know that Navy is moving forward with that product. I'm also excited because then this further diversification of our revenues, and it also is a good opportunity entry point because it's the same customer base for the David. So when we're talking to our customers about digital audio and they buy into that technology, cheap and cheerful at the bottom end, I mean, that is really the entry point to get them to think about the David. So I'm really excited about where we are with the business. And of course, deeply frustrated about the slowdown in government funding. But we're still, all the programs that we have, the defense programs, they're moving forward. And I am really, really excited about the prospects for the business in the long term.

Yeah, that's a big deal. That diversified revenue model, you know, you're shifting away from your traditional and you're diversifying different countries in your revenue group. I think that's a really overlooked fact, and I think that's really going to help your business growing, going forward. Yeah. I think the next 12 months are going to be very exciting for Coda. Again, great job in running the business. I know the margins went up, your profits went up. And while you're struggling, you know, to get the growth going again, I heard you say before it's, you know, it's a process, not an event. I think you're right, but you and your team are doing a great job. I'm driving bigger numbers to the bottom line. So as a shareholder, we really appreciate that. Thank you. Thank you.

Thank you very much, Andrew. Thank you. Great job, guys.

Our next question is from William Bremer with Vanquish Capital Partners. Please proceed.

Good morning. How are you, Anne-Marie?

I'm very well. Very well. How are you doing?

Fantastic quarter, given many variables that you really can't control with the budgets. Going back to Brian's commentary on the thermite, if my math is correct, the 200, that would equate to about a $7 million order. Is that correct? Over time. Over time. Wow. That's fantastic to hear. Fantastic. Also, I wanted you to give us just a little history. You have been utilizing AI for quite some time. Can you give us a little more history? granularity in terms of how many of your products you've embedded AI technology to, and you've been such an early adopter in this technology going back, if I may be mistaken, probably at four or five years. Is that correct?

Well, I think the first AI product was in, where are we now, 2024. I think around 2019 actually was the first AI product actually where we well that was on our um geophysical software range and really what we've done there and we've really changed the market actually um and that product that we have is called seed up and what it really does i mean when you go for an oil and gas installation and collecting site scan data really at the pre-stage the pre-development stage really what you're looking at the sea bottom you're saying what's on the seabed how many boulders are there geophysicists can take quite a long time just tagging the boulders um in the boulder field and what we've done we've absolutely used ai to um automate that and our boulder detect detection product will do a geophysicist will probably spend four days on something that we have down to two hours So that's the leading product in the market, actually. And we've then also pivoted now to our digital audio solution where we're using AI technology, mainly in a sort of helium environment for speech correction of the diver's speech. So when you're in sort of a helium environment, your voice gets all squeaky. So we really, using AI technology, been able to clean that up completely.

Fantastic. Fantastic to hear. One thing I'd like you to consider, and I know how busy your team is with all the different end markets that you are addressing, and I really appreciate the commentary that you just made. Would you and your team be open to having an investor day, a portfolio management day, an analyst day, Maybe down in Florida where you have a subsidiary to showcase to the capital markets your underlying technology. I think that would help get the word out even better that for some of us that have been invested in this company for over five years to finally see it to come to fruition. maybe a nice offering, just something for you.

Great idea, Brian. Great, great idea. And we'll certainly look at that. But great idea.

Thank you. But this is William. I appreciate it. Thank you, Anne-Marie.

Thank you. Thank you.

At this time, this concludes our question and answer session. I would now like to turn the call back over to Anne-Marie Gall for closing remarks.

Thank you very much for your interest in CODA Octopus. Have a great day, and thank you for joining our call today.

Thank you. This will conclude today's conference. Thank you for joining us for CODA Octopus's conference call. You may now disconnect.