Coda Octopus Group, Inc. - Annual Report: 2017 (Form 10-K)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended October 31, 2017

[  ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number: 001-38154

CODA OCTOPUS GROUP, INC.

(Exact name of registrant as specified in its charter)

(Address, Including Zip Code of Principal Executive Offices)

(801) 456-8684

(Issuer’s telephone number)

Securities registered under Section 12(b) of the Exchange Act:

COMMON STOCK, $0.001 PAR VALUE PER SHARE

Securities registered under Section 12(g) of the Exchange Act:

NONE

TABLE OF CONTENTS

FORWARD-LOOKING STATEMENTS

This Form 10-K includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, which we refer to in this annual report as the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, which we refer to in this annual report as the Exchange Act. Forward-looking statements are not statements of historical fact but rather reflect our current expectations, estimates and predictions about future results and events. These statements may use words such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “predict,” “project” and similar expressions as they relate to us or our management. When we make forward-looking statements, we are basing them on our management’s beliefs and assumptions, using information currently available to us. These forward-looking statements are subject to risks, uncertainties and assumptions, including but not limited to, risks, uncertainties and assumptions discussed in this annual report. Factors that can cause or contribute to these differences include those described under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

If one or more of these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may vary materially from what we projected. Any forward-looking statement you read in this annual report reflects our current views with respect to future events and is subject to these and other risks, uncertainties and assumptions relating to our operations, results of operations, growth strategy and liquidity. All subsequent written and oral forward-looking statements attributable to us, or individuals acting on our behalf are expressly qualified in their entirety by this paragraph. You should specifically consider the factors identified in this annual report, which would cause actual results to differ before making an investment decision. We are under no duty to update any of the forward-looking statements after the date of this annual report or to conform these statements to actual results.

PART I

ITEM 1. BUSINESS

Overview

Coda Octopus Group, Inc. (“Coda,” “the Company,” or “we”) operates two distinct business segments. Its Products Segments designs and manufactures patented real time 3D sonar solutions and other leading products for subsea applications (“Products Segment” or “Marine Technology Business”). Its Services Segment supplies engineering services to prime defense contractors (“Services Segment” or “Engineering Business”) and focuses primarily on mission critical integrated defense systems that require a high level of reliability and quality controls.

The products sold by our Products Segment are used primarily in the underwater construction market, offshore oil and gas, offshore wind energy industry, complex dredging, port and harbor security, defense, mining both gems and deep sea minerals and marine sciences sectors. Our customers include service providers to major oil and gas companies, law enforcement agencies, government bodies (including maritime and navy organizations), ports, mining companies, defense companies, universities and research institutions.

Our Services Segment supplies engineering services primarily to prime defense contractors. We have been supporting a number of significant defense programs for over 30 years, such as the Raytheon Close in Weapons Program and Northrop Grumman’s Mine Hunting Systems Program and these programs are steadily growing. We also supply, upgrade and maintain proprietary parts to these programs on an ongoing basis. This business model ensures recurring and long tail revenues since we continuously supply parts to these programs.

The Products Segment sells its products through our three wholly owned subsidiaries, Coda Octopus Products, Inc. (USA), Coda Octopus Products Limited (United Kingdom), and Coda Octopus Products Pty Limited (Australia) and through our appointed agents globally. The Products Segment also rents its equipment to customers. The Services Segment operates through our wholly owned subsidiaries, Coda Octopus Colmek, Inc. (“Colmek”) based in Salt Lake City, Utah, and Coda Octopus Martech Limited (“Martech”) based in the United Kingdom.

Our corporate structure is as follows:

Corporate History

The Company began as Coda Technologies Limited. This company now operates under the name Coda Octopus Products Limited, a United Kingdom corporation formed in 1994 as a start-up company with its origins as a research group at Herriot-Watt University, Edinburgh, Scotland. Initially, its operations consisted primarily of developing software for subsea mapping and visualization using sidescan sonar (a technology widely used in commercial offshore geophysical survey and naval mine-hunting to detect objects on, and textures of, the surface of the seabed).

In June 2002, we acquired Octopus Marine Systems Ltd, a UK corporation, and changed our name to Coda Octopus Limited. At the time of its acquisition, Octopus Marine Systems was producing geophysical products broadly similar to those of Coda, but targeted at the less sophisticated, easy-to-use, “work-horse” market. The Octopus Marine Systems acquisition led to the introduction of the Motion product (F180® series) into the Products Segment.

In December 2002, Coda Octopus Ltd acquired OmniTech AS, a Norwegian company, which became a wholly owned subsidiary of the Company. This company now operates under the name Coda Octopus R&D AS. OmniTech owned the patents to a “method for producing a 3-D Image” which was acquired under the acquisition. At the time of acquisition, this company had been engaged for over ten years in developing a revolutionary imaging and visualization sonar technology capable of producing real time three-dimensional (“3D”) underwater images for use in subsea activities. Coda Octopus Products Limited (Edinburgh) then developed the visualization software to control and display the images from the real time 3D sonar. This patented technology is now marketed by us under the name “Echoscope®”. This technology is superior to the other imaging sonars in the market as it generates real time 3D images of the underwater environment irrespective of low or zero visibility conditions and, unlike conventional sonars, can image a volume (as opposed to a slice of data) including moving objects subsea. This technology is covered by patents in a number of jurisdictions, including the USA. Currently, a substantial part of our R&D efforts is focused on further innovation and development of this technology. Some of the discriminators of this technology can be found in the table set out in the section below titled “Real Time 3D Sonar”.

This acquisition allowed the Company to expand its business activities to include the high-end sonar imaging and hydrographic survey markets. At the inception of the Marine Technology Business our revenues were generated solely from our geophysical software product. We subsequently added our motion sensors product (F180^® series) in 2002 and our revenues were split over these two products. With the addition of our real time 3D products, our revenues from our Products Segment are now mainly generated from our real time 3D sonar products including accessories and associated services.

On July 13, 2004, the Company effected a reverse merger pursuant to the terms of a share exchange agreement between The Panda Project, Inc. (“Panda”), a Florida corporation, and a now defunct entity affiliated with Coda Octopus Ltd. (“Coda Parent”). Panda acquired the shares of Coda Octopus Limited, a UK corporation and wholly-owned subsidiary of Coda Parent, in consideration for the issuance of a total of 1,432,143 shares of common stock to Coda Parent and other shareholders of Coda Octopus Limited. The shares issued represented approximately 90.9% of the issued and outstanding shares of Panda. The share exchange was accounted for as a reverse acquisition of Panda by Coda. Subsequently, Panda was reincorporated in Delaware and changed its name to Coda Octopus Group, Inc.

In June 2006, we acquired a UK design and engineering company, Martech Systems (Weymouth) Ltd (“Martech”), which provides bespoke engineering solutions in the fields of electronic data acquisition, transmission and recording. Martech are suppliers to prime defense contractors, among others. Martech changed its name to Coda Octopus Martech Limited in December 2008. This company is part of our Services Segment.

In April 2007, we acquired Colmek (then Miller & Hilton Inc. d/b/a Colmek), a Utah corporation and custom engineering service provider of mission critical integrated systems to defense engineering prime contractors where a high level of reliability and quality is required. Colmek has been supporting a number of defense programs since the early 1990’s. Specifically, it supplies proprietary parts into these programs including providing upgrades to such parts to address either obsolescence issues or advancement in technology. This entity changed its name to Coda Octopus Colmek Inc. in December 2008. This company is part of our Services Segment.

In January 2017, we effectuated a one for fourteen reverse split of our issued and outstanding common stock. Throughout this document, all share numbers have been adjusted for the reverse stock split.

Coda Octopus Group, Inc., is organized under the laws of the State of Delaware as a holding company that conducts its business through subsidiaries, several of which are organized under the laws of foreign jurisdictions, including England, Scotland, Norway, Denmark and Australia. This may have an adverse impact on the ability of U.S. investors to enforce a judgment obtained in U.S. courts against these entities, or to effect service of process on the officers and directors managing the foreign subsidiaries.

Marine Technology Business (“Products Segment”)

Our Marine Technology Business sells and rents proprietary marine products in a number of worldwide market segments including:

In the commercial marine geophysical survey sector, our products include geophysical data acquisition systems, analysis software and motion detection equipment that are used primarily by survey companies, research institutions and salvage companies.

In the imaging sonar sector, we believe we possess an important and unique patented sonar technology based upon more than 20 years of research and development. This gives us a significant advantage over our competitors in the subsea imaging sonar market sectors. We believe that our real time 3D sonar products are revolutionizing the sonar market, especially in the following areas:

Our product range includes equipment based on our patented Echoscope^® technology and a range of complementary 3D accessories in combination with our proprietary software which also includes patented techniques for rendering and tracking.

Over the years we have significantly advanced our research and development with respect to both hardware and software components of our real time 3D sonar technology and have filed further patents and have increased our market share for imaging sonars. Our third generation of products include the Echoscope^® and other derivatives such as CodaOctopus^® Underwater Inspection System (UIS), our forward looking sonar, Dimension^® and our Echoscope^® C500 and more recently our Echoscope^® XD variant.

At present we are focusing on developing our fourth generation (“4G”) of real time 3D sonar solutions for various market applications and varying price points. Our 4G products will be aimed at expanding our market share by introducing more applications-focused products. In respect of our 4G of products, we are pursuing a 18-24 months’ roll out plan. In this connection, on January 16, 2018 we launched the first product within our 4G series of real time 3D sonars. This first product is approximately 50% lighter, 40% smaller and requires 30% less power than the 3G generation of products. This product is now marketed under the name of Echoscope^4G® Surface and is a shallow water system (for deployments and applications not exceeding 20 meters water depth). We believe this is a significant achievement as it potentially paves the way for more market applications for the technology and potentially increases our market share of imaging sonars.

We believe that the development strategy of our 4G products will help to standardize real time 3D solutions in the subsea market and grow the number of applications for this technology. However, these are complex products and we can give no assurance that we will be successful in realizing commercially viable products or that our goals of increasing our market share will be realized.

We believe that our patented technology is superior in its capability to the current sonars on the market including the multibeam which is the standard technology currently used, as it can generate real time 3D volumetric imaging data of underwater environments (including real time threat identification) and image moving objects in the water column even in the most challenging water conditions. This unique and superior capability provides unparalleled underwater scene awareness in high frame rates similar to cameras. The resultant scene data can be used for multiple tasks simultaneously including object detection and avoidance in true 3D, complex scene mapping and augmented reality 3D workspace imaging combining the real time 3D data with 3D models. This enables real time assessment and decision making. This technology is changing the work flow processes for a number of applications and delivering significant productivity gains and health and safety improvements to our customers, particularly in applications requiring imaging moving objects (either their placement or removal from the sea bed), conducting subsea operations in low or zero visibility conditions and therefore preventing downtime (with the associated costs for such downtime) in these projects and providing real time 3D measurements. Some of our customers are reporting productivity gains of as much as 5000% in block placements for breakwater and other types of projects.

The Echoscope^® has a wide range of applications including:

The technology enables real time 3D visualization of static scenes or moving objects from either a static location or a dynamically moving platform vessel (Autonomous Underwater Vehicle (“AUV”), Remotely Operated Vehicle (“ROV”)) or a surface vessel. Conventional sonars are capable of producing maps of static scenes only without the ability to image moving objects. A significant part of subsea activities consists of identifying moving objects including whether they may pose a threat.

The Echoscope^® technology is protected by patents, including a number of complementary patents such as a patent which covers our visualization methodology and our rendering of real time 3D images. For example, one of our recently awarded patents provides for a new method of using multiple sonar images to produce in real time 3D a highly detailed image with sharply defined edges while intelligently discarding “noise” in the image produced by passing fish or floating debris.

Sales and Marketing

We market the Echoscope^® both as a stand-alone sonar device and as a fully integrated system, which we market under the name “CodaOctopus^® UIS (Underwater Inspection System)”. This latter system is specifically aimed at the port security market and has been adopted by a significant number of ports in the United States. Since 2015 we built upon our success in selling in excess of 30 Underwater Inspection Systems to ports in the USA by selling a number of systems to an East Asian government agency for use in salvage operations and port and harbor inspection. Our 4G of products which will be smaller, lighter, with less power requirements will present a new opportunity to introduce a new UIS with a lower price point, thus presenting the opportunity to increase the number of ports investing in this equipment.

We also operate a rental model under which we rent our technology with associated services. The equipment is typically supplied with our expert engineers who either train our customers or become the operators of the equipment for our customers for the duration of the project. The rental option represents an increasingly important market and also provides access to the technology to a broader range of end users who typically do not purchase equipment such as large oil companies whose business model is to rent or lease equipment.

We have an internal sales and marketing team which is engaged in marketing and selling this technology; we also have a network of sales agents.

Products

Our products are marketed under the “CodaOctopus^®” brand and consist of three main product lines:

Data Acquisition Products includes integrated hardware acquisition devices that feature rich post-processing software for all levels of geophysical survey work, with which we commenced our operations in 1994.

Motion Sensing Products consists of a range of GPS-aided precision attitude and positioning systems and software for all types of marine survey and positioning work.

Real Time 3D Sonar includes our unique and patented real time 3D imaging sonars (Echoscope®) and cutting-edge software (including patented techniques for rendering and tracking algorithms) that we believe is shaping the future of subsea operations both within the commercial and defense sectors.

Real Time 3D Sonar

We believe that our real time 3D imaging sonar technology represents the Company’s most promising area for growth in the medium term. Some of the key differentiators of our technology compared to other imaging sonar technologies on the market are:

Our current third-generation product line consists of five products within the real time 3D sonar series:

These products are used either by mounting on a surface vessel, cranes, excavators, underwater vessels such as remotely operated vehicles (ROV) or autonomous underwater vehicles (AUV), mining crawlers and the like.

Echoscope^®

This is the first real time 3D sonar we brought to the market. We have variants rated at 300 meters, 600 meters and 3,000 meters which means these systems are fit to operate at this water depth at sea. We have also developed bespoke sonars which operates at 4,000 meters for a prime defense contractor’s autonomous underwater vehicle (“AUV”). The 3G Echoscope weighs 52 pounds and is around 15x11.8x6.3 inches in size. This is sold with software (see section below for various software options).

Due to the current price, size, weight and power requirements to operate the Echoscope, there are a number of applications or markets for which we do not supply this product. However, see section on Fourth Generation (“4G”) of Sonar Products, where these limitations are being addressed.

Dimension^®

This product was launched in 2013 and is aimed at the remotely operated underwater vehicle market (“ROV”) for navigation and obstacle avoidance underwater with a wider field of view and is suitable for applications which require safe navigation from one location to the next and real time forward looking 3D imaging of any underwater scene. Based on our patented Echoscope^® technology and our Vantage software, we believe that the Dimension^® product provides unparalleled real time visualization for subsea vehicle applications. Designed for a wide range of ROVs, the Dimension^® sonar is a unique, real time 3D sonar that transforms ROV underwater operations.

Echoscope^® C500 (“C500”)

The C500 was launched in 2014 and is based on our patented Echoscope^® technology. This sonar device delivers real time 3D sonar capability and is targeted at the ROV and autonomous underwater vehicle (“AUV”) applications.

Echoscope^® XD (“XD”)

Many applications require a wide area of view for imaging or visualization subsea. Our standard Echoscope^® offers viewing angles of up to 50° x 50°. The XD was launched in 2017, is based on our patented Echoscope^® technology and delivers real time 3D sonar capability. This latest product delivers a wider area of view (or, imaging area) – up to 90° x 44°. We believe that this will open the Echoscope^® to a number of new applications including bathymetry survey applications. The new capability can also be accessed by users of the current Echoscope® by purchase of an upgrade package.

Software Products

Our Software development capability is an important part of the success we have achieved to date with our real time 3D solutions and forms an important part of our strategy to maintain our lead in designing, manufacturing and selling real time 3D solutions.

Our software products are sold in combination with our real time 3D sonar solutions as a one-time purchase by our customers. During the first 12 months, the customer benefits from our support services. However, after the first year, should the customer need ongoing support services this is purchased as an annual subscription service which entitles the customer to 24x7x365 telephone, email and remote dial in support and minor software upgrades. In addition, where we issue major releases of our software (as opposed to minor releases (maintenance release)), this is a chargeable option for our customers.

The current software packages that we offer with our hardware (real time 3D sonar) are:

These are all Software Packages developed by the Company.

Our software packages are feature rich and includes patented techniques in a number of our modules. In general, our software package contain significant capabilities that are designed to address specific subsea challenges by application particularly in the context of a dynamic subsea setting (as opposed to a static mapping of the seabed as is typical for conventional sonar technology). Some of our unique features include:

The Echoscope^® and Construction Monitoring Software (CMS) have important applications for breakwater construction. Our CMS package has been recently updated to include patented algorithms for tracking and placement of single layer armor blocks used in breakwater construction.

We believe that our technology is becoming the preferred solution for subsea block placements in breakwater solutions because it allows crane operators to visualize in real time the moving blocks and tracking these into their placement position accurately. We believe that our solution has significantly simplified and made safer this area of the workflow process in breakwater construction. It has also increased significantly the lay-rate for blocks being placed with customers reporting up to 5000% increase in productivity.

We are not aware of competing technologies that offer real time 3D visualization and monitoring of subsea construction sites including previously laid blocks. In addition, the feature rich software package (CMS) which allows the complete workflow for breakwater construction to be planned within the software, greatly reduces project risks and timing while improving the quality of the projects. Furthermore, the patented tracking algorithms that have recently been enhanced and strengthened to provide opportunity for additional applications involving placing known objects or structures underwater.

We generate around 87% of our revenues in the Products Segments from our real time 3D sonar products (hardware and software). With the launch of the new products we would anticipate our revenues from this line to increase over time.

Fourth Generation (4G) Real Time 3D Sonar Products

During the last 18 months, we have invested a significant part of our research and development resources on developing our 4G real time 3D solutions for various market applications and varying price points. We expect to roll out this technology over the next 18-24 months.

Echoscope^4G® Surface

On January 16, 2018 we launched the first product within our 4G series of real time 3D sonars, the Echoscope^4G® Surface. This first product within our 4G range is 50% lighter, 40% smaller and requires 30% less power than our third generation of products. This allows us to compete more effectively against other conventional sonars within this price bracket and applications where size, weight and price are key factors. This product is suitable for shallow water applications only and is now available for customer trials, rental, licensing or outright purchase. Introduction of this product potentially paves the way for more market applications for the technology and potentially increases our market share of imaging sonars. Nevertheless, we can give no assurance that following launch we will be successful with this product.

Data Acquisition

We started our business in 1994 designing and developing the CodaOctopus® GeoSurvey software package. For over two decades, our GeoSurvey has been an industry leading software package on the market for data acquisition and interpretation and provides feature rich solutions and productivity enhancing tools for the most exacting survey requirements. Designed specifically for sidescan and sub-bottom data acquisition, CodaOctopus^® GeoSurvey has been purchased by numerous leading survey companies throughout the world. This product range includes:

CodaOctopus^® GeoSurvey Acquisition Products

These consist of a range of hardware and software solutions for field acquisition of sidescan sonar and sub-bottom profiler, which includes analogue and digital interfaces compatible with all geophysical survey systems. This is our original product range that includes the following products:

DA4G - 500, Sidescan sonar and sub-bottom profiler simultaneously

DA4G - 1000, Sidescan sonar and sub-bottom profiler separately

DA4G - 2000, Sidescan sonar or sub-bottom profiler

CodaOctopus^® GeoSurvey Productivity Suite

This consists of an integrated suite of software that automates the tasks of analyzing, annotating and mosaicing complex data sets, thus ensuring faster and more precise results.

CodaOctopus^® Instruments

These consist of simple, solid and robust solutions for sidescan sonar and sub-bottom profilers. Used throughout the world by leading survey companies, navies and academics, CodaOctopus instruments are ideal where minimal training and simple installation and set-up is paramount. Coupled with intuitive but powerful post processing software, the Octopus range meets the requirements of survey applications from the smallest inshore survey, rapid deployment naval reconnaissance to large scale site investigations. This product range comprise our DA4G series of acquisition systems which provide high quality, robust and reliable data acquisition from the latest digital and analogue sidescan sonar and sub-bottom profiler sensors.

DA4G™ is the 4th generation of our successful DA series and is built on twenty years of knowledge, experience and innovation in supplying unparalleled products and service to the worldwide geophysical survey sector. These purpose-built, turn-key, systems incorporate the very latest hardware specifications and are designed and delivered to meet the demanding nature of offshore survey work.

The DA4G^TM range consists of a number of options and is backed (like all our products) with global service and support.

We generate around 5% of our revenues from the Products Segments from this range of products. With the launch of the new products we would anticipate our revenues from this line to increase over time.

Motion Sensing Products

Our F180^® (and the more recently introduced CodaOctopus F170^TM families) have been developed for the marine environment and is based on technology originally developed for the extreme world of motor racing. Modifications and enhancements have resulted in a simple-to-use, off-the-shelf product that brings accurate positioning and motion data into extreme offshore conditions for precision marine survey applications worldwide. Variants within the F180^® series include the F190™, exclusively configured for use ‘inland’, e.g. within ports and harbors, and the F185™, with enhanced precision positioning to 2 cm accuracy (<1”). Octopus iHeave, an intelligent software product for dealing with long period ocean swell compensation, is fully integrated within the F180^® series.

The F170™ family is designed with ease of use in mind. They are compact, simple to install and produce accurate position and motion data for the marine industry. Two product variants are available: the F170™ and the F175™. The F175™ allows integration of third-party GNSS systems thus enhancing the accuracy of the outputs and improving the robustness of the solution.

Our Motion Sensing Products are sold alone or in conjunction with our real time 3D sonars. We are currently expending a significant amount of our resources in developing the next generation of our motion sensors. Our newly developed suite of products will focus on expanding the market into which we sell these devices, including the AUV market which is an expanding market for our products in general.

We are aiming to launch our fourth-generation of Motion Sensing Products in March 2018. The new hardware motion sensing products will be based on more advanced technology and new software.

We generate around 8% of our revenues from the Products Segments from our Motion Sensing Products. With the launch of the new products we anticipate our revenues from this line to increase over time.

Coda Octopus Products Limited has the requisite accreditation for its business including LRQ accredited to ISO 9001:2008.

Marine Engineering Businesses (“Service Segment”)

Our Marine Engineering Businesses encompass:

These two operating entities supply mission critical integrated systems, test equipment, instrumentation and the like primarily to the defense sector where high levels of reliability and quality are essential pre-requisites for securing and maintaining these agreements with their customers. Typically, in the first instance we prototype products for these customers and after going through various acceptance tests, including first article inspection approvals, we are given the production contracts. Many of these production contracts have repeat orders profile which typically follows the life cycle of the defense program that is using the production part.

These arrangements often give us long term preferred/sole supplier status, technology refresh and obsolescence management for such customers and we generally use these long-standing relationships to win more contracts with these customers.

In addition, we are increasingly combining our engineering capabilities with our product offerings. This enables us to offer systems which are complete with installation and support and maximize the utilization of our collective expertise to advance our real time 3D technology.

Coda Octopus Martech Limited (“Martech”)

Martech operates in the specialized niche of bespoke design and manufacturing services mainly to the United Kingdom defense and subsea industries. Its services are provided on a custom sub-contract basis where high quality and high integrity devices are required in small quantities. Martech has the requisite accreditation for its business including LRQ accredited to ISO 9001:2008.

An example of Martech’s design and engineering services is the development of a ruggedized display unit in military vehicles capable of displaying variables such as wind speed, air temperature and humidity independent of the vehicle’s computer.

In late 2010 Martech was awarded a significant contract to design and build two pre-production decontamination units the successors of which have been designated as part of the ground equipment for a major international military aircraft program. The Company has since started production of these units which form part of the standard ground equipment for this military aircraft.

Martech is one of the first suppliers bringing to the market controllers for fire sprinkler systems which periodically test the associated pumps. Sprinkler systems are now required to be introduced in certain larger domestic buildings under UK legislation. Martech is a market leader in this market and in late 2017 was awarded a contract by a leading global pump manufacturer for approximately $650,000.

The Company enjoys pre-approvals to allow it to be short-listed for certain types of government contracts. Much of the more significant business secured by Martech is through the formal government or government contractor tendering process. Government contracts may be terminated at any time at the discretion of the government. If the government does terminate a contract, the Company is allowed to recover the costs incurred up to the date of termination. During the last few years, only one non-material government contract was terminated for convenience.

Martech is a key supplier of various parts to our marine products business and has been assisting in the further development of a number of those products.

Coda Octopus Colmek, Inc. (“Colmek”)

Colmek is a service provider of defense engineering solutions, particularly in the fields of data acquisition, storage, transmission and display. It has grown and diversified since beginning its operations in 1977 and now provides services and products to a wide range of defense, research and exploration organizations in the United States. Colmek has the requisite accreditation for its business including LRQ accredited to ISO 9001:2008.

Colmek designs, manufactures and supports systems that are reliable and effective in multiple military and commercial applications where ruggedness and reliability under extreme operational conditions are paramount and where lives depend on accurate and precise information.

Colmek has long standing relationships with a number of prime defense contractors and has been supporting a number of defense programs for over 30 years including the Close in Weapons Support Program (CIWS) for which it supplies proprietary parts and services and technical refresh programs for these parts. As a result, Colmek has repeat revenues from these long-standing programs. Colmek continues to expand the number of established programs into which it supplies proprietary parts.

In June 2014 Colmek completed the acquisition of the Thermite^® which is a rugged visual mission computer line and the Sentiris^® AV1 XMC video card for $1,100,000 in cash. Colmek also acquired hardware, Thermite stock, and other intellectual property rights (such as software code and trademarks pertaining to these products).

The Thermite^® Product fits within established programs with Department of Defense (“DoD”) prime contractors and benefits from being a single source product under this program. Customers for this item include the US Army, Benchmark, and Endeavor Robotics Defense and Security Division. Since acquiring these two products in 2014, we have received orders in excess of $2,500,000.

Thermite^® Rugged Visual Computers

We are now designing and developing the next generation of the Thermite® and expect to re-engage the existing customer base for this product.

Sentiris^® AV1 XMC

Since acquiring the Sentiris®, we have successfully completed the first article inspection (“FAI”) approval phase and are now in the production phase. We have received orders for approximately $700,000 since completion of the FAI process.

This is expected to be a significant new product as this program is funded and there will be ongoing demand for this product over the life of the program.

Stinger™ family of Rugged Small-Form-Factor PCs

The Stinger 1000 is a unique rugged computer that provides a cost-effective solution for harsh mobile computing environments. Utilizing PC-104 architecture and employing creative ruggedization, Colmek has engineered a stable platform which is easily tailored to any application.

The Stinger 1000 rugged mobile computer is highly customizable, presenting an inspiring assortment of selectable attributes. The stinger mobile computer is engineered to meet military requirements. Colmek has successfully deployed Stinger products on Unmanned Aerial Systems (UAS), and shipboard for satellite-based tracking systems.

RhinoTuff™ family of Rugged Touch Screen Computers

The robust RhinoTuff™ rugged touch screen computer is built exclusively for reliable operation in the world’s harshest environments. It is modular and user-definable affording maximum flexibility. This all-weather, all terrain, all-in-one PC thrives in a field where the average “tough” computer is simply not tough enough, including, mining and construction sites, oil fields, marine environments, and military battlefields.

Rugged Chassis/Enclosures

The chassis and enclosures offered by Coda Octopus Colmek are fully customizable to military/industrial needs. Colmek is a key supplier on high profile programs including Raytheon’s Phalanx Close-In Weapons System (CIWS) and Northrop Grumman’s airborne mine hunting sonar AN/AQS-24. We also offer a variety of enclosures technologies.

Other products offered by Colmek include subsea telemetry & data acquisition systems, rugged workstations, analog-to-digital converters and rugged LCD displays.

Competition

In our Products Segment, we are exposed to the following competitive challenges:

Data Acquisition Products

The sonar equipment industry is fragmented with several companies occupying niche areas, and we face competition from different companies with respect to our different products. In the field of geophysical products, Triton Imaging Inc., a US-based company, now part of the ECA Group (Toulon, France), Chesapeake, a US-based company, and Oceanic Imaging Consultants, Hawaii, USA, dominate the market with an estimated of 25% each of world sales, while we believe that we control approximately 5% of world-wide sales.

Motion Sensing Products

In the field of motion sensing equipment, where our product addresses a small part of the overall market, we believe that we have four principal competitors: TSS (International) Ltd in Watford, England which is focused on the mid-performance segments with about 25% of the world market; Ixsea, a French company which covers all segments, with about 20% of the market; Kongsberg Seatex, a Norwegian company (part of Kongsberg Gruppen) which has products across all segments, with about 15% of the market; and Applanix, a Canadian company, now part of Trimble which has one major product focused on the high end of the market, with about 20% of the market. We believe that our market share in the field of motion sensing equipment is only about 5%. This market is fiercely competitive and with the advancement of technology, there are new entrants to the market such as SBG Systems (a French based manufacturer of motion sensors). Due to the price pressure in this market, we are selling our products more in conjunction with our real time 3D sonars than on a standalone basis.

Real Time 3D Sonar

In the field of Real Time 3D imaging, we are unaware of other companies offering a similar product. The entry into this market is dependent upon specialized marine electronics, acoustic and software development skills. The learning curve, which has resulted in the advancement of our real time 3D sonar device, is the culmination of two decades of research and development into this field. We are aware of a number of high profile and substantial competitors’ real time 3D projects that have failed. Over the last several years there have been lower grade sonars entering the market for 3D imaging. Companies such as Tritech International Ltd., United Kingdom, BlueView Technologies Inc., USA (now a part of Teledyne Technologies Incorporated), and Norbit Group AS Norway are examples, but none of these sonar offerings are directly comparable or competitors in respect of our real time 3D solutions. Specifically, we believe that they do not have the same capabilities as our patented Echoscope^® technology in terms of generating real time 3D images of submerged objects and environments in low or zero visibility conditions. However, Teledyne has in the last four years acquired a significant number of subsea companies (examples are Reson and BlueView) along with expertise. Teledyne has much greater resources and liquidity than the Company. We therefore can give no assurance that companies such as these will not enter this market.

We seek to compete on the basis of producing high quality products employing cutting edge technology that is easy to use by operators without specialized skills in sonar technology. We intend to continue our research and development activities to continually improve our products, seek new applications for our existing products and to develop new innovative products.

In our Services Segment, we are exposed to the following competitive challenges:

Marine Engineering Businesses

Through our marine engineering operations, Coda Octopus Colmek, Inc. and Coda Octopus Martech Limited, we are involved in custom engineering for the defense industry in the United States and in the United Kingdom. Martech competes with larger contractors in the defense industry. Typical among these are Ultra Electronics, BAE Systems, and Thales, all of whom are also partners on various projects. In addition, the strongest competitors are often the clients themselves. Because of their size, they often have the option to proceed with a project in-house instead of outsourcing to a sub-contractor like Martech or Colmek.

Intellectual Property

Our product portfolio and technologies are protected by intellectual property rights including trademarks, copyrights and patents. We have a number of fundamental patents including a patent covering the stitching together of acoustic imagery. This covers the real time acoustic image generation element of what we do, and we believe it provides us with a competitive advantage.

Patents

Our patented inventions along with our strategy to enhance these inventions are at the heart of the Company’s strategy for growth and development.

Our patent portfolio consists of the following:

Trademarks

We own the following registered trademarks: Coda^®, Octopus^®, CodaOctopus^®, Octopus & Design^®, F180^®, F180 4G Series®, Echoscope^®, Echoscope 4G^®, Survey Engine^®, Dimension^®, DAseries^®, CodaOctopus^®Vantage; CodaOctopus^® UIS; CodaOctopus^® USE, Sentiris^® and Thermite^®.

We also use the following trademarks: F170™, F175™, F190™, UIS™ TEAM™ and TEAM+™. In addition, we have registered a number of internet domain names.

Research and Development

During the fiscal years ended 2016 and 2017 we spent approximately $1 million and $1.4 million, respectively, on mainly developing our real time 3D sonar technology (our Products Segment) and Thermite^® refresh (our Services Segment).

Our products are complex and therefore we can give no assurance that we will be successful in the above-stated objective. Furthermore, even following launch we may not succeed. Moreover, we may incur significant research expenditures without realizing viable products.

Government Regulation

Because of the nature of some of our products, they may be subject to United States and other jurisdictions’ export control regimes and may be exported outside these jurisdictions only with the required level of export license or through an export license exception or general export authorization/license.

In addition, as a provider for the US Government, we may be subject to numerous laws and regulations relating to the award, administration and performance of US Government contracts, including the False Claims Act. Non-compliance found by any one agency could result in fines, penalties, debarment, or suspension from receiving additional contracts with all US Government agencies. Given our dependence on US Government business, suspension or debarment could have a material adverse effect on our business and results of operations.

Employees

As of the date hereof, we employ worldwide approximately 110 people, of which 11 hold management positions. A large majority of our employees have a background in science, technology and engineering, with a substantial part being educated to degree and PhD level. None of our employees are employed under a collective agreement and we have not experienced any organized labor difficulties in the past.

ITEM 1A. RISK FACTORS

Not required for smaller reporting companies.

ITEM 1B. UNRESOLVED STAFF COMMENTS.

None.

ITEM 2. PROPERTIES

Orlando, Florida

Our corporate offices are co-located with our subsidiary Coda Octopus Products, Inc. in Orlando where we lease premises on a month to month basis at $1,882 per month.

In addition, Coda Octopus Products, Inc., owns a property which it acquired in February 2016. This property is being used by staff who are assigned or seconded from other parts of our Organization to our Florida Office to assist with R&D projects and/or to provide training or demonstration of our products from time to time.

Salt Lake City, Utah

Coda Octopus Colmek operates from its premises which comprises 16,000 square feet and includes production and R&D Facilities. These premises are owned by Coda Octopus Colmek.

Edinburgh, Scotland

Current Premises

In order to consolidate our activities which were spread over three premises in Edinburgh, on or around January 31, 2017, Coda Octopus Products Ltd acquired a property in Edinburgh, comprising manufacturing facilities, research and development space and offices. The purchase price of the property was the equivalent of $1,512,280 and was paid for in cash. The property is situated in a business park close to Edinburgh Airport and Port Edgar and the Firth of Forth which is ideally located for conducting trials and demonstrations of our products. This new facility has 12,070 square feet of net internal space. This property was reconfigured and upgraded for our specific use and Coda Octopus Products Ltd moved its operation to these new premises on or around May 2017.

Offices which we are actively seeking to sub-let for the remainder of the lease terms.

Our wholly owned United Kingdom subsidiary, Coda Octopus Products Ltd, leases office space comprising 4,099 square feet in Edinburgh, United Kingdom. These premises were used as offices and we are actively seeking to sub-let these premises for the remainder of its term. If we are not successful we will need to pay the rent and other costs associated with these premises up to February 28, 2019 along with any agreed dilapidations. The annual rent is fixed for the duration of the lease at the British Pounds equivalent of $54,130 (the rent is stated in British Pounds and is therefore subject to exchange rate fluctuations).

Production and Repair Services Facilities

The lease for these premises has expired on November 14, 2017 and we are currently negotiating dilapidations with the landlord of these premises. These premises were leased and used by our wholly owned United Kingdom subsidiary, Coda Octopus Products Ltd for production workshop space comprising 2,450 square feet in Edinburgh, United Kingdom. The annual rent was the British Pounds equivalent of $26,950 (the rent was stated in British Pounds and is therefore subject to exchange rate fluctuations).

Perth, Australia

We have a short-term lease for office space comprising 1000 square feet in in Perth, Australia. The lease expires on April 8, 2018. The annual rent is fixed for the duration of the lease at Australian Dollars equivalent of US$11,440. We do not intend to extend this lease upon its expiration.

Portland, Dorset, England

Martech leases premises from Coda Octopus Products Limited. These premises are located in the Marine Center in Portland, Dorset, United Kingdom, are owned by Coda Octopus Products Ltd and comprise 9,890 square feet. The building comprises both office space and manufacturing and testing facilities. The lease, which is for a period of 5 years, provides for an annual rent of the equivalent of $51,000 (the rent increases by 3% annually and is stated in British Pounds and is therefore subject to exchange rate fluctuations). These premises give easy access to marine facilities such as testing vessels etc.

Bergen, Norway

Our wholly owned Norwegian subsidiary, Coda Octopus R&D AS, re-located its facilities on November 30, 2016 and now leases a small facility comprising approximately 300 square feet of office space in a business center. We pay $2,350 on an annual basis (the rent is stated in Norwegian Kroner and is therefore subject to exchange rate variation). This is as a result of the transfer of the production and servicing of the Echoscope^® to Edinburgh, UK. The facility now serves as a research and development center for hardware development of our flagship product utilizing our purpose-built laboratories.

All non-US Dollar denominated rents are stated according to prevailing exchange rates as of the date of each respective lease agreement.

ITEM 3. LEGAL PROCEEDINGS.

From time to time, we may become involved in various lawsuits and legal proceedings which arise in the ordinary course of business. However, litigation is subject to inherent uncertainties, and an adverse result in these or other matters may arise from time to time that may harm our business. We are currently not aware of any such legal proceedings that we believe will have, individually or in the aggregate, a material adverse effect on our business, financial condition or operating results.

ITEM 4. MINE SAFETY DISCLOSURES.

Not Applicable.

PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Our common stock has been traded on the Nasdaq Capital Market under the symbol “CODA” since July 19, 2017. Prior thereto, it had been quoted on the OTCQX since February 8, 2017 under the symbol COGI, and prior thereto, on the OTC Pink under the symbol CDOC. The following table sets forth the range of high and low bid prices of our common stock as reported and summarized on the Nasdaq, OTCQX or OTC Pink, as applicable, for the periods indicated. These prices are based on inter-dealer bid and asked prices, without markup, markdown, commissions, or adjustments and may not represent actual transactions.

On January 11, 2017, we effected a one for fourteen (1 for 14) reverse stock split of our issued and outstanding common stock. All share prices below have been adjusted retroactively to account for the reverse stock split.

We have not declared or paid any cash dividends on our common stock, and we currently intend to retain future earnings, if any, to finance the expansion of our business, and we do not expect to pay any cash dividends in the foreseeable future. The decision whether to pay cash dividends on our common stock will be made by our board of directors, in their discretion, and will depend on our financial condition, operating results, capital requirements and other factors that the board of directors considers significant.

Recent sales of unregistered securities

None that are required to be disclosed herein.

ITEM 6. SELECTED FINANCIAL DATA

Not applicable.

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OPERATIONS

Forward-Looking Statements

The information herein contains forward-looking statements. All statements other than statements of historical fact made herein are forward looking. In particular, the statements herein regarding industry prospects and future results of operations or financial position are forward-looking statements. These forward-looking statements can be identified by the use of words such as “believes,” “estimates,” “could,” “possibly,” “probably,” anticipates,” “projects,” “expects,” “may,” “will,” or “should” or other variations or similar words. No assurances can be given that the future results anticipated by the forward-looking statements will be achieved. Forward-looking statements reflect management’s current expectations and are inherently uncertain. Our actual results may differ significantly from management’s expectations.

The following discussion and analysis should be read in conjunction with our financial statements, included herewith. This discussion should not be construed to imply that the results discussed herein will necessarily continue into the future, or that any conclusion reached herein will necessarily be indicative of actual operating results in the future. Such discussion represents only the best present assessment of our management.

General Overview

We operate two distinct business segments. Our Products Segment designs and manufactures patented real time 3D sonar solutions and other leading products for subsea applications (“Products Segment”). Our Services Segment supplies engineering services to prime defense contractors (“Services Segment”).

Our products are used primarily in the underwater construction market, offshore oil and gas, offshore wind energy industry, and in the complex dredging, port security, mining and marine sciences sectors. Our customers include service providers to major oil and gas companies, law enforcement agencies, ports, mining companies, defense bodies, research institutes and universities.

Our Services segment supplies engineering services mainly to prime defense contractors such as Raytheon and Northrop Grumman. We have long-standing relationships with prime defense contractors. We support some significant defense programs by supplying and maintaining proprietary parts through obsolescence management programs. These services provide recurring stream of revenues for our Services segment.

Historically, the Products Segment generated approximately 70% of our revenues. However, during the last three fiscal years prior to the 2017 period, the Products Segment has generated around 50% of our overall revenues, with the Services Segment growing at a faster pace. However, during the 2017 period, due to the new US administration’s failure to approve the defense budget, many projected sales did not materialize. As a result, the Services Segment revenues fell from 50% of our overall revenues to 39% in the 2017 with the Products Segment generating 61% of revenues in the 2017 period as compared to 50% in the 2016 period. Although the Products Segment generated 61% of the overall revenues in the 2017 period, it is still adversely affected by the contraction in the oil and gas (O&G) industry. Furthermore, due to the effort by O&G companies to restructure their operations, the climate in which we sell is fiercely competitive thus impacting on revenues and gross margins.

Nevertheless, we believe that our unique and patented real time 3D solutions are a significant advancement on the current technology available in the subsea sonar imaging market due to its real time capability providing real time volumetric data of underwater targets in low or zero visibility conditions and its capability to image moving objects in the subsea environment. Furthermore, because the technology provides real time imaging of the underwater environment, it enhances safety significantly and delivers substantial productivity gains to our customers, thus reducing their costs. In addition, our real time 3D solution is emerging as the preferred solutions for subsea asset placements because of the technology’s unique ability to image moving targets (such as Accropodes™, X-Blocs, Antifers block placements, mattress placements, landing of installations on the seabed and the like). Due to the decline in the price of oil, many O&G companies are seeking cost effective solutions for their operations. We believe that our real time 3D solution has the potential to revolutionize the technology used in underwater operations particularly where real time visualization is required or zero or low visibility conditions prevail. We also believe that with the proliferation of underwater drones our technology has significant application for the imaging sonar defense market (which is worth billions of dollars annually) as it is the only available off the shelf technology that can image moving targets (such as underwater vehicles) in the water.

Since introducing this product, we have made progress in getting our core real time 3D technology, the Echoscope^®, adopted by a significant number of ports in the USA (the CodaOctopus^® Underwater Inspection System (which integrates our Echoscope, motion sensing product and hydrographic pole) where it is used for port and harbor security. In 2015 we secured the first sale of our Underwater Inspection System to a foreign government body in East Asia and in 2016 we sold two additional full system to this body. We hope to sell additional systems into this government body as part of their technology upgrade program for the next three years.

We have also made progress in expanding the markets (and applications) for our real time 3D sonars. Recently, we have sold a number of systems to mining companies. Increasingly, our customers involved in offshore wind energy and renewables are adopting the technology as the primary tool for scour management, subsea cable installation and associated cable protection tasks.

In addition, in recent years we have started to rent our real time 3D solutions with engineering services. Given the contraction in capital expenditures budget in the O&G market, rentals are increasingly becoming an important part of the composition of the Company’s revenues and these O&G operators are more prepared to utilize operational budgets. Furthermore, our rental offering generally yields a higher gross margin for the Company.

Our business is affected by a number of factors including those set out below: 

Further areas of impact include:

Critical Accounting Policies

This discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements that have been prepared under accounting principles generally accepted in the United States of America (“GAAP”). The preparation of financial statements in conformity with US GAAP requires our management to make estimates and assumptions that affect the reported values of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported levels of revenue and expenses during the reporting period. Actual results could materially differ from those estimates.

Below is a discussion of accounting policies that we consider critical to an understanding of our financial condition and operating results and that may require complex judgment in their application or require estimates about matters which are inherently uncertain. A discussion of our significant accounting policies, including further discussion of the accounting policies described below, can be found in Note 2, “Summary of Accounting Policies” of our Consolidated Financial Statements.

Revenue Recognition

Our revenue is derived from sales of underwater technologies and equipment for imaging, mapping, defense and survey applications and from the engineering services which we provide. Revenue is recognized when evidence of a contractual arrangement exists, delivery has occurred or services have been rendered, the contract price is fixed or determinable, and collectability is reasonably assured. No right of return privileges are granted to customers after delivery.

For arrangements with multiple deliverables, we recognize product revenue by allocating the revenue to each deliverable based on the relative fair value of each deliverable, and recognize revenue when equipment is delivered, and for installation and other services as they are performed.

Our contracts sometimes require customer payments in advance of revenue recognition. These amounts are reflected as liabilities and recognized as revenue when the Company has fulfilled its obligations under the respective contracts.

For software license sales for which any services rendered are not considered essential to the functionality of the software, we recognize revenue upon delivery of the software, provided (1) there is evidence of a contractual arrangement for this, (2) collection of our fee is considered probable and (3) the fee is fixed and determinable.

For arrangements that are generated from time and material contracts where there is a signed agreement and approved purchase order in place that specifies the fixed hourly rate and other reimbursable costs to be billed based on material and direct labor hours incurred, revenue is recognized on these contracts based on material and direct labor hours incurred. Revenues from fixed-price contracts are recognized on the percentage-of-completion method, measured by the percentage of costs incurred (materials and direct labor hours) to date to estimated total services (materials and direct labor hours) for each contract. This method is used as expenditures for direct materials and labor hours are considered to be the best available measure of progress on these contracts. Losses on fixed-price contracts are recognized during the period in which the loss first becomes apparent based upon costs incurred to date and the estimated costs to complete as determined by experience from similar contracts. Variations from estimated contract performance could result in adjustments to operating results.

Rental Revenue is recognized monthly over the term of the rental period.

Recoverability of Deferred Costs

We defer costs on projects for service revenue. Deferred costs consist primarily of direct and incremental costs to customize and install systems, as defined in individual customer contracts, including costs to acquire hardware and software from third parties and payroll costs for our employees and other third parties.

We recognize such costs in accordance with our revenue recognition policy by contract. For revenue recognized under the completed contract method, costs are deferred until the products are delivered, or upon completion of services or, where applicable, customer acceptance. For revenue recognized under the percentage of completion method, costs are recognized as products are delivered or services are provided in accordance with the percentage of completion calculation. For revenue recognized ratably over the term of the contract, costs are recognized ratably over the term of the contract, commencing on the date of revenue recognition. At each balance sheet date, we review deferred costs, to ensure they are ultimately recoverable. Any anticipated losses on uncompleted contracts are recognized when evidence indicates the estimated total cost of a contract exceeds its estimated total revenue.

Stock Based Compensation

We recognize the expense related to the fair value of stock based compensation awards within the consolidated statements of income and comprehensive income. We use the fair value method for equity instruments granted to non-employees and use the Black-Scholes model for measuring the fair value. The stock based fair value compensation is determined as of the date of the grant or the date at which the performance of the services is completed (measurement date) and is recognized over the periods in which the related services are rendered.

Income Taxes

The Company accounts for income taxes in accordance with Accounting Standards Codification 740, Income Taxes (ASC 740). Under ASC 740, deferred income tax assets and liabilities are recorded for the income tax effects of differences between the bases of assets and liabilities for financial reporting purposes and their bases for income tax reporting. The Company’s differences arise principally from the use of various accelerated and modified accelerated cost recovery system for income tax purposes versus straight line depreciation used for book purposes and from the utilization of net operating loss carry-forwards.

Deferred tax assets and liabilities are the amounts by which the Company’s future income taxes are expected to be impacted by these differences as they reverse. Deferred tax assets are based on differences that are expected to decrease future income taxes as they reverse. Correspondingly, deferred tax liabilities are based on differences that are expected to increase future income taxes as they reverse. Note 7 to the Consolidated Financial Statements discusses the amounts of deferred tax assets and liabilities, and also presents the impact of significant differences between financial reporting income and taxable income.

For income tax purposes, the Company uses the percentage of completion method of recognizing revenues on long-term contracts which is consistent with the Company’s financial reporting under U.S. generally accepted accounting principles.

Intangible Assets

Intangible assets consist principally of the excess of cost over the fair value of net assets acquired (or goodwill), customer relationships, non-compete agreements and licenses. Goodwill was allocated to our reporting units based on the original purchase price allocation. Goodwill is not amortized and is evaluated for impairment annually or more often if circumstances indicate impairment may exist. Customer relationships, non-compete agreements, patents and licenses are being amortized on a straight-line basis over periods of 2 to 10 years. The Company amortizes its limited lived intangible assets using the straight-line method over their estimated period of benefit. We periodically evaluate the recoverability of intangible assets and take into account events or circumstances that warrant revised estimates of useful lives or that indicate that impairment exists.

The first step of the goodwill impairment test, used to identify potential impairment, compares the fair value of the reporting unit with its carrying amount, including goodwill. If the fair value, which is based on future cash flows, exceeds the carrying amount, goodwill is not considered impaired. If the carrying amount exceeds the fair value, the second step must be performed to measure the amount of the impairment loss, if any. The second step compares the implied fair value of the reporting unit’s goodwill with the carrying amount of that goodwill. At the end of each year, we evaluate goodwill on a separate reporting unit basis to assess recoverability, and impairments, if any, are recognized in earnings. An impairment loss would be recognized in an amount equal to the excess of the carrying amount of the goodwill over the implied fair value of the goodwill.

Consolidated Results of Operations

We operate two distinct business segments. Our Marine Technology Business designs and manufactures patented real time 3D sonar solutions and other leading products for subsea applications (“Products Segment”). Our Marine Engineering Business supplies engineering services to prime defense contractors (“Services Segment”).

Our Products Segment sells its products and associated services to the offshore wind energy, dredging and marine construction, marine and port security, mining including deep sea mining, marine sciences sector and oil and gas sector. This segment generated approximately 61% and 50% of our total revenues for the fiscal years ended October 31, 2017 and 2016, respectively.

Our Services Segment largely sells its services into prime and sub-prime defense contractors. This segment generated approximately 39% and 50% of our total revenues for the fiscal years ended October 31, 2017 and 2016, respectively. This segment continues to be an important part of the Group’s revenues plan and, in particular, our subsidiary Coda Octopus Colmek.

Comparison of fiscal year ended October 31, 2017 (“2017 period”) to fiscal year ended October 31, 2016 (“2016 period”)

Throughout this discussion, “the 2017 period” means the fiscal year ended October 31, 2017. Similarly, “the 2016 period” means the fiscal year ended October 31, 2016.

See Segment information below for a full breakout of the financial performance of each Segment for the 2017 and 2016 periods, respectively.

The information provided below pertains to the consolidated analysis of both segments (Products and Services) operating in our Group.

Revenue: Total revenues in the 2017 and 2016 periods were $18,025,173 and $21,118,319, respectively, representing a 14.6% decrease in the 2017 period.

The reason for the decline in our revenues during the 2017 period is the delay by the new US administration in approving defense spending (and budget). This has resulted in prime defense contractors not finalizing contracts with Coda Octopus Colmek (a part of our Services Segment) that were anticipated in our Business Plan for the 2017 period. Accordingly, during the 2017 period, revenues generated by our Services segment were $7,038,905 as compared to $10,534,178 during the 2016 period (a decline of 33.2% (See break out in Segment Analysis on page F-25 of this report)). Although these opportunities which were projected in the 2017 period have not gone away, this segment continues to be impacted by the uncertainty around the timescales for the approval of the defense budget by the new administration.

Our outlook for this segment in the first quarter of fiscal 2018 is that its results will be significantly impacted by this ongoing delay, thus resulting in an overall decline in the Group’s revenues during the first quarter of 2018 fiscal year.

During the 2017 period, the Company had one customer from whom it generated sales greater than 10% of net revenues. Revenue from this customer was $4,036,591, or 22% of net revenues during the period. Total accounts receivable from this customer at October 31, 2017 was $289,571 or 21% of accounts receivable.

Gross Margin: Margins were 66.4% in the 2017 period (gross profit of $11,967,725) compared to 59.9% (gross profit of $12,652,997) in the 2016 period representing an increase of 6.6 percentage points. The increase in gross margin reflects the different mix of sales in the 2017 period, in particular, the Products Segment generated more revenues than the Services Segment and the Products Segment in general yields a greater gross margin on the sale or rental of its products.

Research and Development (R&D): R&D expenditures increased by 36.2% from $1,013,125 in the 2016 period to $1,380,381 in the 2017 period and was in line with our budgetary plans for the 2017 period.

The increase in our R&D expenditure in the 2017 period reflects an increase in our R&D expenditure in the Services Segment.

R&D expenditures in the Products Segment decreased by 9.2% from $1,013,125 in the 2016 period as compared to $919,863 in the 2017 period. In the 2018 fiscal year however, we would anticipate this category of expenditures to increase substantially in the Products Segment as we are investing in the advancement of our fourth generation of products (“4G”) and to this end, we plan to recruit up to 14 new members of staff in this segment as part of our efforts to advance our product development program. Our goal will be to bring more competitively priced and technologically advanced products in this range to the market under a 12-18 months product roll out plan. The first of our series of products in our 4G of products was launched on January 16, 2018. Nevertheless, it should be noted that we may incur significant research expenditures without realizing viable products or we may not be successful in the launch of new products.

R&D expenditures in the Services Segment were $460,518 in the 2017 period compared to nil in the 2016 period. These expenditures were in line with our budgetary plans as we are investing significantly in the refreshing the Thermite^® range of products which is a significant part of our growth strategy (Services Segment). The Thermite^® is a product which we acquired from Quantum 3D in 2014 and it has a prestigious customer base. We believe that the technically refreshed Thermite presents a substantial opportunity to grow this part of our business.

Selling, General and Administrative Expenses (SG&A): SG&A expenditures for the 2017 period increased to $6,769,327 from $6,101,227 for the 2016 period, an increase of 11.0%. The increase in our SG&A expenditures in the 2017 period is broadly attributed to the increased costs associated with becoming a SEC reporting company and listing on the NASDAQ exchange. Approximately $100,000 of the increased amount in our SG&A expenditures constitutes non-recurring costs associated with these activities.

Key Areas of SG&A Expenditure across the Group for the year ended October 31, 2017 compared to the year ended October 31, 2016

Although there is a modest decrease in Wages and Salaries we would expect in the 2018 fiscal year this category to increase to reflect the investments we are making in bringing in more staff to expedite the advancement of our 4G products which we are developing.

The increase in our Legal and Professional Fees in the 2017 period is attributed to the increased costs associated with becoming a SEC reporting company and our listing on the NASDAQ.

Upon surrender of our leased properties in Edinburgh, we would anticipate that the category of expenditures constituting “Rent” will decrease significantly.

We also expect that the category Marketing expenditures in the fiscal year 2018 will increase to reflect increased marketing efforts on our new generation of products both in the Products and Services Segment. Furthermore, the Products Segment will be demonstrating our products at the biggest Industry event in 2018 (“Oceanology 2018) and there are significant costs associated with these activities.

Operating Income: Operating Income for the 2017 period declined by 31.1% and was $3,818,017 as compared to $5,538,645 in the 2016 period.

The decrease in Operating Income in the 2017 period compared to the 2016 period is attributed to the decline in our revenues by 14.6% for the reasons discussed earlier, in conjunction with material increases in both our SG&A expenditures and our R&D expenditures by 11.8% and 36.2% respectively, in the 2017 period.

Interest Expense: Interest expense during the 2017 period was $597,011 compared to $856,432 during the 2016 period, representing an overall 30.3% decrease.

This category of expenditure is related to interest payable under (i) Senior Secured Convertible Debentures (SSCD) which was entered into on or around February 21, 2007, where we paid six months of interest payments in the 2017 period. The amounts outstanding under the SSCD were repaid in full on or around April 28, 2017; and (ii) newly entered into Senior Secured Debentures with HSBC NA on or around April 28, 2017 and where we have paid six months interest in the 2017 period and (iii) interest payable on loan by the CEO to one of our subsidiaries, Coda Octopus Colmek. The reduction is due to the cancellation of the previous SSCD which attracted 8.5% interest per annum and the introduction of a more favorable interest rates of 4.56% now in place under the HSBC Senior Secured Debentures. Going forward on an annualized basis we would anticipate annual interest expenditures on the HSBC NA Debentures to fall and will be approximately $285,000 (in 2018) and $182,000 (2019), as under the repayment terms we are also repaying principal amounts. The amortization schedule for this loan is set out in Note 8 of the audited Consolidated Financial Statement of October 31, 2017 and 2016.

Other Income: This category was $121,278 in the 2017 period as compared to $172,090 in the 2016 period representing a decrease of 29.5%. The make-up of this category is UK Value Added Tax rebates from purchases made outside of the European Union by our UK operations and is subject to fluctuations as it usually reflects Value Added Tax rebates (equivalent of the US Sales Tax) from purchases made outside of the European Union by our UK operations and changes according to the level of purchases we make outside of the European Union in the period.

Net Income for the year ended October 31, 2017 compared to the year ended October 31, 2016

Net Income for the 2017 period was $3,339,663 compared to $4,930,548 for the 2016 period, representing a decrease of 32.3%. Net Income fell due to the significant decline in our revenues in the 2017 period in conjunction with material increases in both our SG&A and R&D expenditures for the 2017 period. See earlier discussions in MD&A Section for the reasons revenues declined in the 2017 period and SG&A & R&D expenditures increased. The decline in revenues also resulted in the Services Segment breaking even in the 2017 period (See Segment Analysis section of this report) combined with material increases in both our SG&A and R&D expenditures in the 2017 period. See earlier discussions in the R&D and SG&A section of this MD&A report.

Comprehensive Income for the year ended October 31, 2017 compared to the year ended October 31, 2016

For the 2016 period we suffered a significant loss of $2,710,953 in foreign currency translation adjustments of the values of our UK assets included in our financial statements due to the depreciation of the value of the British pound, a part of the so-called Brexit effect. For the 2017 period we recorded a gain of $299,006 on foreign currency translation adjustments due to the British pound strengthening against the US dollar over the 2017 period.

Since the UK decided to leave the European Union the British pound has been falling significantly against the US dollar (see Note 2 paragraph n of Notes to the audited Consolidated Financial Statements for October 31, 2017 and 2016 for fuller information regarding our Foreign Currency Translation policy).

Segment Analysis

We are operating in two reportable segments, which are managed separately based upon fundamental differences in their operations. Segment operating income is total segment revenue reduced by operating expenses identifiable with the business segment. Overhead includes general corporate administrative costs.

The Company evaluates performance and allocates resources based upon operating income. The accounting policies of the reportable segments are the same as those described in the summary of accounting policies.

There are inter-segment sales in the table below which have been eliminated from our financial statements. However, for the purpose of segment reporting, these are included in the table below only.

The following tables summarize certain balance sheet and statement of operations information by reportable segment for the financial years ending October 31, 2017 and 2016, respectively.

The Company’s reportable business segments operate in three geographic locations: the United States, Europe and Australia.

Information concerning principal geographic areas is presented below according to the area where the activity is taking place for the years ended October 31, 2017 and 2016 respectively:

Liquidity and Capital Resources

At October 31, 2017, the Company had an accumulated deficit of $36,982,937, working capital surplus of $11,140,403 and stockholders’ equity of $13,827,420. For the period then ended, the Company generated cash flow from operations of $4,840,392.

We believe that our current level of cash and cash generation will be sufficient to meet our future short- and medium-term liquidity needs. At October 31, 2017, we had cash on hand of approximately $6.9 million and both billed and unbilled receivables of approximately $4.1 million. Our current cash balance represents approximately one-year of Selling, General and Administrative Expenses. The Company continues to critically evaluate the level of expenses that we incur and reduce those expenses as appropriate. See also Note 15 - Subsequent Events in our audited Consolidated Financial Statements - covering the recent private placement transaction completed on January 29, 2018. The proceeds will increase our liquidity and working capital resources.

Our main liquidity issues are funding of our research and development program (“R&D”) which requires significant expenditures in bringing on new skills and resources and incurring non-recoverable and non-recurring engineering costs for researching, developing and prototyping products; and managing our currency exposure because of our operations in the United States, the United Kingdom and Australia and servicing our senior security debentures.

Our Colmek subsidiary received a $1 million loan from the CEO of Coda to fund the purchase of long lead-time inventory (which are typically on between 12- 32 weeks lead time cycle) in order to be able to comply with delivery dates for contracts when they are secured. The repayment date of this loan has been extended to November 30, 2018.

Substantially all our properties are owned by the Company and there are no mortgage obligations on those properties.

We have a significant concern about adverse currency fluctuations and the effect that those currency fluctuations have on our operations and profitability. As mentioned previously, the United Kingdom’s potential exit from the European Union (“Brexit”) has had a significant negative effect on the value of the British pound versus the U. S. dollar. A significant portion of our business is in the United Kingdom and the substantial decrease in the value of the British pound is reflected in lower revenues for our product sales. In addition, all our loans are denominated in U. S. dollars, which means that the dollar value of those loans has effectively gone up since these are partially serviced with British Pounds. While we have chosen not to hedge any of our currency exposure, we continue to evaluate the need to do so and will consider a hedging strategy when, and if, appropriate.

Operating Activities

Net cash generated from operating activities for the year ended October 31, 2017 was $4,840,392. We recorded net income for the period of $3,339,663. Other items in uses and sources of funds from operations included non-cash charges related to depreciation and amortization and stock based compensation, which collectively totaled $1,057,684. Changes in operating assets increased net cash from operating activities by $1,224,062 and changes in current liabilities decreased net cash from operating activities by $701,784.

Investing Activities

Net cash used by investing activities for the year ended October 31, 2017 was $2,043,055 due to the sale and purchase of fixed assets.

Financing Activities

Net cash used in financing activities for the year ended October 31, 2017 was $1,846,571 as a result of paying down the debt of the Company and redeeming the Series C preferred stock.

Secured Promissory Note

On April 28, 2017, Coda Octopus Group, Inc. (the “Company”) together with its wholly owned US subsidiaries, Coda Octopus Products, Inc. and Coda Octopus Colmek, Inc. (together, the “Subsidiaries”), entered into a loan agreement with HSBC Bank NA (the “Lender”) for a loan in the principal amount of $8,000,000 (the “Loan”). The annual interest rate is fixed at 4.56%. Commencing on May 28, 2017 and continuing on the 28th day of each month thereafter, the Company is required to make monthly principal and interest payments of $149,350 until April 28, 2022 (making our annual payments under this Note $1,792,200). In addition, within 30 days after the delivery to the Lender of the Company’s annual audited consolidated financial statements, the Company is required to make an annual principal payment of $700,000 during the term of the Loan. Such annual payments will reduce the balance of the principal outstanding. As a result, it is expected that the Loan will be repaid within a period of approximately 45 months. The Loan may be prepaid in whole or in part at any time subject to a break funding charge as detailed in the promissory note evidencing the Loan.

The obligations in connection with the repayment of the Loan are secured by all assets of the Company and its Subsidiaries. In addition, the repayment of the Loan is guaranteed by three of the Company’s overseas subsidiaries. 

The proceeds from the Loan were used to repay in its entirety the outstanding principal balance of $8,000,000 under secured debentures (the “Debentures”) that were issued by the Company in February 2007 and that were most recently held by CCM Holdings, LLC. (“CCM”). In addition, accrued and unpaid interest under the said Debentures of approximately $1,133,261 was satisfied through the issuance to CCM of 1,000 shares of Series C Convertible Preferred Stock, par value $0.001, with a stated value of $1,000 each (the “Preferred Stock”). The Company paid the balance in cash.

As of October 31, 2017, the Company is indebted to the lender in the amount of $7,279,353. See Note 8 to the audited Consolidated Financial Statements.

Private Placement

On January 29, 2018, the Company consummated the sale and issuance of 1,125,950 shares of its common stock in a private placement of shares of common stock at $4.40 per share (the “Offering”).  Total gross proceeds from the Offering were $4,954,180.  The purchase price per share was based on a 10% discount of the volume weighted average price (VWAP) of the common stock on the Nasdaq Capital Market for the 30-consecutive trading-day period ending on January 22, 2018.

Under the terms of the Offering, the Company is required to file a re-sale registration statement prior to May 30, 2018 with respect to the shares issued in the Offering.  For a period of 36 months, the investors also have the right to purchase, based on their pro-rata ownership of common stock, shares (or securities convertible into shares) offered in subsequent offerings, subject to certain limited exceptions.

Foreign Currency

The Company maintains its books in local currency: US Dollars for its US operations, Pounds Sterling for its United Kingdom operations, Norwegian and Danish Kroner for its Norwegian and Danish operations respectively and Australian Dollars for its Australian operations.

For the fiscal year ended 2017, 42% of the Company’s operations were conducted inside the United States and 58% outside the United States through its wholly owned subsidiaries. As a result, fluctuations in currency exchange rates may significantly affect the Company’s sales, profitability and financial position when the foreign currencies of its international operations are translated into U.S. dollars for financial reporting. In addition, we are also subject to currency fluctuation risk with respect to certain foreign currency denominated receivables and payables. Although the Company cannot predict the extent to which currency fluctuations may affect the Company’s business and financial position, there is a risk that such fluctuations will have an adverse impact on the Company’s sales, profits and financial position. Because differing portions of our revenues and costs are denominated in foreign currency, movements could impact our margins by, for example, decreasing our foreign revenues when the dollar strengthens and not correspondingly decreasing our expenses. The Company does not currently hedge its currency exposure. In the future, we may engage in hedging transactions to mitigate foreign exchange risk.

The translation of the Company’s UK operations’ British Pound denominated balance sheets and results of operations into US dollars was affected by changes in the average value of the US dollar against the British Pound. The average exchange rate during the 2017 period was $1.2829 USD to the GBP against $1.3860 during the 2016 period – a depreciation of the value of the GBP against the USD of 7.4%.

The translation of the Company’s Australian operations’ Australian Dollar denominated balance sheets and results of operations into US dollars was affected by changes in the average value of the US dollar against the Australian Dollar. The average exchange rate during the 2017 period was $0.7626 USD to the AUD against $0.7429 during the 2016 period – an appreciation of the value of the AUD against the USD of 2.6%.

The translation of the Company’s Norwegian operation’s Norwegian Kroner (NOK) denominated balance sheets and results of operations into US dollars has been affected by the currency fluctuations of the US dollar against the NOK from an average rate of $0.1189 during the 2016 period, to $0.1206 during the 2017 period - an appreciation of the value of the NOK against the USD of 1.4%. These are the values that have been used in the calculations below.

We have not included the Danish kroner in this schedule as there were no operations in the Danish subsidiary during the 2017 period.

The impact of these currency fluctuations on the 2017 period is shown below:

This table shows that the effect of constant exchange rates, versus the actual exchange rate fluctuations, decreased net income for the year by $173,835 and increased net assets by $916,891. All of these amounts are material to our overall financial results.

As a result of the decision by British voters to leave the European Union, we expect economic uncertainty to increase until the negotiations for the British exit have been completed and the relationship between the UK and the EU has been solidified. This uncertainty will most likely continue to have a profound effect on the value of the British Pound. Since approximately 50% of our revenues are transacted and generated in that British Pound, we expect our revenues to continue to be impacted by the adverse movement of the British Pound against the US Dollar. We also expect our direct costs of sales for components sourced outside of the UK for our UK operations to increase. Furthermore, our balance sheet will be affected since a significant part of our assets (fixed and current) are held in British Pounds by our UK subsidiaries.

Off-Balance Sheet Arrangements

We do not have any off balance sheet arrangements.

Inflation

The effect of inflation on the Company’s operating results was not significant during the 2017 period.

Seasonality

Results of operations for our products segment are impacted by the offshore drilling season. During the winter months, when less offshore drilling takes place, demand for our oil and gas related technology is typically at its lowest.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Reference is made to the Index of Financial statements following Part III of this Report for a listing of the Company’s financial statements and notes thereto.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

ITEM 9A. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file under the Exchange Act is accumulated and communicated to our management, including our principal executive and financial officers, as appropriate to allow timely decisions regarding required disclosure.

The Company’s management, under the supervision and with the participation of the Company’s Chief Executive Officer and Chief Financial (and principal accounting) Officer, carried out an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) of the Exchange Act) as of October 31, 2017. Based upon that evaluation the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of the end of the period covered by this report.

Management’s Report on Internal Control over Financial Reporting

A company’s internal control over financial reporting is a process designed by, or under the supervision of, a public company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles (“GAAP”) including those policies and procedures that: (i) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the company, (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that receipts and expenditures are being made only in accordance with authorizations of management and directors of the company, and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.

Management is responsible for establishing and maintaining adequate internal control over financial reporting. Our management, with the participation of our Chief Executive Officer and Group Financial Officer, has assessed the effectiveness of our internal control over financial reporting as of October 31, 2017. In making this assessment, our management used the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

Based on our assessment and the criteria discussed above, the Company has concluded that, as of October 31, 2017, the Company’s internal control over financial reporting was ineffective due to the reasons described below.

We identified material weaknesses which are indicative of many small companies with limited staffing levels resulting in inadequate review procedures. We have taken remedial actions by implementing new controls over our review procedures involved in posting and review of our financial transactions.

We are constantly seeking ways of remediating the identified weaknesses and have started the process of introducing some controls in the area we have identified as a material weakness within the Company.

This annual report does not include an attestation report of the Company’s independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s independent registered public accounting firm pursuant to rules of the SEC that permit the Company to provide only management’s report in this annual report.

Changes in Internal Control over Financial Reporting

There was no change in our internal control over financial reporting, as defined in Rules 13a-15(f) under the Exchange Act, that occurred during the fiscal year ended October 31, 2017 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART III

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE

Directors and Executive Officers

The following persons are the executive officers and directors as of the date hereof:

Annmarie Gayle has been our Chief Executive Officer and a member of the Board of Directors since 2011 and our Chairman since March 2017. She is also our Chief Executive Officer for our flagship products business, Coda Octopus Products, Limited (UK) since 2013. Prior thereto, she spent two years assisting with the restructuring of our Company. She previously served with the Company as Senior Vice President of Legal Affairs between 2006 and 2007. Earlier in her career she worked for a major London law practice, the United Nations and the European Union. Ms. Gayle has a strong background in restructuring and has spent more than 12 years in a number of countries where she has been the lead adviser to a number of transitional administrations on privatizing banks and reforming state-owned assets in the Central Eastern European countries including banking, infrastructure, mining and telecommunications assets. Ms. Gayle has also managed a number of large European Union funded projects. Ms. Gayle holds a Law degree gained at the University of London and a Masters of Law degree in International Commercial Law from Cambridge University. She is qualified to practice as a solicitor in England & Wales. Because of her wealth of experience in corporate governance, large scale project management, restructuring, strategy, structuring and managing corporate transactions, we believe that she is highly qualified to act as our Chief Executive Officer.