Coda Octopus Group, Inc. — Q2 2017 Form 10-Q
Business context and period. The unaudited report covers the three and six months ended April 30, 2017. Coda designs and sells underwater sonar and related products, and provides marine engineering services, primarily to defense contractors. Its two segments are Marine Technology (products) and Marine Engineering (services).
Financial performance and position
| Metric | Three months ended April 30 | Six months ended April 30 |
|---|---|---|
| Revenue | 2017: $5.28 million; 2016: $5.75 million | 2017: $10.64 million; 2016: $10.52 million |
| Gross profit / margin | 2017: $3.26 million / 61.8%; 2016: $3.51 million / 61.1% | 2017: $6.64 million / 62.4%; 2016: $5.74 million / 54.6% |
| Operating income | 2017: $1.38 million; 2016: $1.72 million | 2017: $3.10 million; 2016: $2.17 million |
| Net income | 2017: $1.27 million; 2016: $1.58 million | 2017: $2.85 million; 2016: $1.87 million |
| Net income per share | 2017 basic/diluted: $0.14 / $0.14; 2016: $0.23 / $0.18 | 2017 basic/diluted: $0.31 / $0.31; 2016: $0.28 / $0.21 |
- Quarterly revenue declined 8.1% year over year, while first-half revenue increased 1.1%. First-half net income rose 52.1%; first-half comprehensive income was $3.61 million versus $1.10 million, including a $767,887 currency translation gain compared with a $772,201 loss in 2016.
- First-half cash from operations was $2.50 million, compared with $2.85 million in 2016. Investing activities used $2.01 million, including $2.35 million of property and equipment purchases partly offset by $327,000 of asset-sale proceeds. Financing activities used $1.13 million, including redemption of preferred stock. Cash increased $133,647 to $5.74 million; the cash-flow statement includes a positive $767,887 foreign-exchange effect.
- At April 30, cash was $5.74 million, working capital was $11.27 million, and stockholders’ equity was $13.68 million. Current assets were $15.91 million and current liabilities $4.59 million.
- Loans and notes payable totaled $9.00 million: $2.16 million current and $6.84 million long-term. Cash less reported debt was approximately $3.26 million.
Material changes and management commentary
- Quarterly Marine Technology revenue increased 38% year over year and represented 63% of revenue, versus 42% a year earlier. Marine Engineering represented 37%, down from 58%; management attributed the weakness to delayed defense-customer purchase orders amid uncertainty about U.S. government budgets. First-half segment revenue was $5.75 million for products and $4.89 million for services.
- Management attributed stronger first-half gross margin to sales mix, particularly higher-margin rentals of real-time 3D sonar systems. It cited new wind-energy and marine-construction markets, while noting continued pressure from reduced oil-and-gas spending and weaker sterling.
- On April 28, 2017, the company borrowed $8 million from HSBC at a fixed 4.56% annual rate, secured by company and U.S. subsidiary assets and guaranteed by foreign subsidiaries. It used the proceeds to repay the outstanding secured debenture principal. The filing says accrued debenture interest was satisfied partly with 1,000 Series C preferred shares stated at $1,000 each and partly in cash. The HSBC loan requires monthly principal-and-interest payments of $149,350 and annual principal payments of $700,000; management expects repayment in about 45 months, although stated maturity is April 2022. A separate $1 million CEO working-capital loan remained outstanding at 4.5%, due May 31, 2018.
- R&D spending increased 20.2% in the first half to $499,000. Management expects further investment in sonar and motion-sensing products, targeting more competitively priced products in late 2017 and 2018, but cautioned that development may not yield viable products.
Outlook, risks, and unusual items
- No quantified revenue, earnings, or cash-flow guidance is provided. Management said delayed defense orders put the company behind its fiscal-year business plan.
- Risks discussed include oil-and-gas market weakness, defense procurement uncertainty, Brexit and possible trade disruption, foreign-exchange volatility, competitive engineering labor costs, and reliance on product and service sales for working capital. The company said it does not hedge currency exposure. Management estimated currency movements reduced first-half profit by $150,071 and net assets by $1.24 million; a $104,603 transactional exchange loss was also recorded for the half year.
- The filing reports a significant customer contributed 27% of first-half revenue. Management also states that the company has limited external sources of capital.
- Disclosure controls and procedures were deemed ineffective at period-end due to a material weakness involving inadequate segregation of duties associated with limited staffing. Management reported remedial steps but said remediation was ongoing.
- The company reported no current lawsuits and no material off-balance-sheet arrangements. It identified no material legal proceeding in the filing.
Important facts for investors to verify
- Confirm the HSBC loan’s complete payment schedule, collateral and guarantee terms, prepayment provisions, and the treatment and conversion rights of the Series C preferred shares issued in the refinancing.
- Track defense purchase-order timing and whether Marine Engineering revenue recovers, as well as oil-and-gas demand, rental contribution, and segment margins.
- Assess the recoverability and billing timing of $4.19 million in unbilled receivables, and the effect of foreign exchange on reported results and net assets.
- Monitor R&D spending, product-launch progress, and the company’s remediation of its disclosed internal-control material weakness.
- The cover page marks “No” for having filed all required reports during the preceding 12 months; verify the company’s reporting-compliance status and context.