Coda Octopus Group, Inc. - Annual Report: 2018 (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, 2018

[  ] 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)

9100 Conroy Windermere Road, Suite 200, Windermere, Florida, 34786

(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”) designs, and manufactures products for the subsea market including its patented flagship range of real time 3D sonar solutions (“Products Segment”). The Company also supplies engineering services. A significant part of the customer base for our engineering services comprise prime defense contractors (“Services Segment” or “Marine Engineering Business”).

The Products Segment has been designing, manufacturing and selling products to the subsea market for close to 25 years. These products are used primarily in the underwater construction market, the offshore wind energy industry, oil and gas exploration, complex dredging, port and harbor security, defense, mining of 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, underwater construction companies, defense companies and bodies, universities and research institutions. Our sales are conducted primarily in the US and the UK directly through our wholly owned subsidiaries and through our global network of independent agents and/or distributors. The Product Segments also includes a rental model under which it rents or leases its products with or without specialist engineering services, depending on our customers’ requirements.

The Services Segment supplies engineering services primarily to prime defense contractors. The parts  engineered and supplied to these customers form part of broader mission critical integrated defense systems, such as the Close-In-Weapons System (CIWS). The Services Segment established its business in 1977 and has been supporting a number of significant defense programs for over 30 years, including Raytheon’s CIWS and Northrop Grumman’s Mine Hunting Systems Program. The Services Segment’s business model entails designing small runs of prototypes for defense programs which typically lead to contracts for the manufacture, repair and upgrade of these parts. This business model ensures recurring and long tail revenues since we supply parts to these programs typically for the life of the program. 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”. 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^®”. We believe that 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”. Coda Octopus R&D AS is now a dormant entity and all of its business activities (research and manufacturing) have been transferred to our Edinburgh based subsidiary (Coda Octopus Products Limited).

The acquisition of OmniTech AS 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. 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”), an English corporation established in 1988, which provides bespoke engineering solutions in the fields of electronic data acquisition, transmission and recording. Martech are suppliers to prime defense contractors, among others. It also supports some of the engineering and development requirements of the Products Segment. 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 established in 1977 and which is 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 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.

Both Martech and Colmek have the same business model, provide similar engineering services and sells to similar customer base (one is UK focused and the other is US focused).

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 and represented on this basis.

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 into various sectors 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.

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 due to its unique capabilities, 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 significant 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”) and fifth generation (5G) real time 3D sonar solutions for various market applications and varying price points. Our 4G/5G products will be aimed at expanding our market share by introducing more applications-focused products. In respect of our 4G/5G of products, we are pursuing an 18 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) and is more competitively priced. 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 are launching the deep-water variants within our 4G series in the first quarter of fiscal year 2019 and in second and third quarters we intend to launch the algorithm and software enhancements to our 4G/5G series and our new processing capability which is far superior to our 3G processing engine. This will be marketed under the name CodaOctopus^® PIPE (Parallel Intelligent Processing Engine).

We believe that the development strategy and investments we are making in advancing our technology will help to standardize real time 3D solutions in the subsea market and grow the number of applications for this technology, particularly for defense applications. However, these are complex products and we can give no assurance that we will be successful in realizing commercially viable products or that we will not encounter technical glitches which may involve significant costs or other consequences or that our goals of increasing our market share will be realized.

We believe that our patented technology is superior to the current sonars on the market including the multibeam which is the standard technology, 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, 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. This therefore prevents downtime (and 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. Furthermore, our claims that our technology is superior to other sonar technology on the market were validated in a recent study done by the US Department of Transportation’s Federal Highway Administration under which our real time 3D sonar technology was assessed as best in its class for bridge inspections.

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. One of our main patents, “a method of producing a 3D image”, will expire June 1, 2019. However, in 2018 we filed a number of regular and also provisional patent applications, that, if granted, will afford significant protection around our products. Furthermore, despite the aforementioned method patent expiring we still have a number of significant patents around our real time 3D sonar series including our “volume rendering of 3D sonar data” and our “method of rendering volume representation of sonar images” and our recently granted patent “object tracking using sonar imaging” which sits at the heart of our method for generating a real time representative 3D image. Our technology is complex and is protected at both the hardware, algorithm and software level.

Sales and Marketing

We market the Echoscope^® both as a stand-alone sonar device and as a fully integrated system. The fully integrated system is our premium product and is marketed 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 sonar products which is based on our new technology advancements are smaller, lighter, with less power requirements presents 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 lease our technology with associated services. Leased equipment is typically supplied with our expert engineers who either operate the equipment or train our customers. The rental option represents an increasingly important market and also provides access to the technology by a broader range of end users who typically prefer leasing over purchasing such as large oil and gas companies.

We have an internal sales and marketing team which is engaged in marketing and selling our products including our real time 3D sonar technology. We also have a network of independent global sales agents.

Products

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

Real Time 3D Sonar

Our real time 3D imaging sonar technology generates most of the revenues for our Products Segment and we believe that it 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:

Our fourth-generation/fifth generation of products consist:

Our 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 or Autonomous Surface Vehicles (ASV). A brief description of our main line of products is set forth below. We offer many other similar products in various sizes with diverse capabilities.

Our 4G/5G of products are based on our new technological advancements and are smaller, lighter and have less power requirements. Once we launch our new algorithms and new software platform for our 4G/5G products, our 4G/5G products will also have better performance and capabilities.

Software Products

Our Software development capability is an important part of our success and forms an important part of our strategy to maintain our lead in designing, manufacturing and selling state-of-the-art real time 3D solutions.

Our software products are sold through a perpetual software license in combination with our real time 3D sonar solutions. During the first 12 months after purchase, the customer benefits from our technical support services. After the first year, ongoing technical support services may be 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.

Our software packages are feature rich and include patented techniques in a number of our modules. In general, our software package contains 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 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). We anticipate our revenues from this line to increase.

Fourth and Fifth Generation (4G and 5G) Real Time 3D Sonar Products

During the last 30 months, we have invested a significant part of our research and development resources on developing our 4G/5G real time 3D solutions for various market applications and varying price points.

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 and is more competitively priced. 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. In fiscal year 2018, most of our sonar sales were around this new product, Echoscope^4G® Surface.

In calendar year 2019, we expect to roll out the new iteration of our 4G/5G products to include:

In 2019 we anticipate that all our sonar technology will migrate to our 4G/5G Platform which benefits from both the revised form factor on the hardware side and the smart algorithm on the software side (allowing for vastly improved performance) and capability to address the emerging autonomous underwater vehicle including sea drones.

Data Acquisition

We started our business in 1994 designing and developing the CodaOctopus^® GeoSurvey software package for acquisition and processing of sidescan sonar data. 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.

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.

We continue to advance this range of product and in 2018 we launched our first product based on Artificial Intelligence Techniques which allows us to automatically identify boulders on the sea bed (“Survey Engine Automatic Object Detection”). This new product presents a real opportunity to radically change work flow process for post-processing and analyzing side scan sonar data to assess, amongst other things, the suitability of an area for exploration and construction activities (O&G installations, pipeline and cable laying activities). This is in its early stage of roll out but has sparked significant interest. Furthermore, this technology is extensible and we intend to develop our Mine Detecting capability. This is an area where we are investing our research and development efforts.

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.

CodaOctopus^® 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 CodaOctopus^® DA4G 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 families) has 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. 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.

We are aiming to launch our fourth-generation of Motion Sensing Products (F280^®) in March 2019. The new hardware motion sensing products will be based on more advanced technology and new software. It is also highly complemented to our real time 3D sonar series and they are packaged together to provide a more comprehensive solution to our customers.

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 9001:2015.

Marine Engineering Businesses (“Service Segment”)

Our Marine Engineering Businesses comprise Colmek based in Salt Lake City and Martech based in the United Kingdom.

These two operating entities supply parts that form part of mission critical integrated defense 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 to 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 9001:2015.

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 chemical 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. Since the inception of this program, Martech has sold units having a total contract value of $2.4m.

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 and since the major fire incident “Grenfell Tower Disaster” it has increased its lead in this market. Its FireSafe Products are increasingly becoming a significant part of its business.

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 9001:2015.

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. 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.

During fiscal year 2018, Colmek continued to increase the number of new significant defense programs and was awarded two development contracts. Once the prototype phase is completed, we expect to become long term manufacturing contracts for Colmek.

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 $2,700,000.

Thermite ^® Rugged Visual Computers

We have now designed and developed our next generation of the Thermite^® “Octal”. The new Octal is in trials with a number of new customers who fit the profile of large quantity purchasers with repeat and long-term requirements for this product.

Sentiris^® AV1 XMC

Since acquiring the Sentiris^® (as part of the Thermite acquisition), we have successfully completed the first article inspection (“FAI”) approval phase and are now in the production phase. We have received orders for approximately $1,200,000 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.

Other products offered by Colmek include subsea telemetry and 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 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). 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 around our sonar products including a patent covering combining two or more acoustic images to produce a composite image. This covers the real time acoustic image generation element of what we do, and we believe it provides us with a competitive advantage. One of our main patents, “Method of Producing a 3-D Image”, will expire in June 2019. We have in fiscal year 2018 filed further regular and provisional patent applications around our 4G/5G of technology which, if granted, will afford significant patent protection. In the mean-time even with the expiration of our Method Patent in June 2019, we have other significant patents around our technology. Furthermore, our technology is a combination of hardware, algorithm, software – for which we have patents and trade secrets covering.

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^®, F280^®, Echoscope^®, Echoscope 4G^®, Survey Engine^®, Dimension^®, DAseries^®, CodaOctopus^® Vantage; CodaOctopus^® UIS; CodaOctopus^® USE, Sentiris^® and Thermite^®.

We also use the following trademarks: CodaOctopus^®F170, CodaOctopus^®F175, CodaOctopus^®F190, CodaOctopus^® UIS CodaOctopus^® TEAM and CodaOctopus^® TLS.

In addition, we have registered a number of internet domain names including www.codaoctopus.com; www.codaoctopusgroup.com; www.colmek.com and www.martechsystems.co.uk.

Research and Development

During the fiscal years ended 2018 and 2017, we spent approximately $2.6 million and $1.4 million, respectively, on mainly developing our real time 3D sonar technology (our Products Segment), our new Motion Sensor F280^®, our Artificial Intelligence Algorithm (Automatic Boulder Detection) 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 115 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 $5,176 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, USA

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

Edinburgh, Scotland, UK

Current Premises

Coda Octopus Products Limited (Edinburgh based) operates from its premises comprising 12,070 square feet of internal space and includes production, R&D Facilities and office space. These premises are owned by Coda Octopus Products Limited.

Offices which we will surrender on or around February 28, 2019

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. 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). We have now completed the agreed schedule of agreed repair and reinstatement work with the existing landlords and intend to surrender the said premises on or around February 28, 2019. All rents and rates will cease thereafter.

Portland, Dorset, UK

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. The lease expires on or around December 31, 2018 and by mutual agreement was extended for a further 2 years. It was agreed between the parties that Martech will be allowed a rent-free period of 2 years.

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

On or around November 16, 2018, pursuant to the terms of a private placement consummated on January 29, 2018, the Company issued 23,965 shares of common stock for a purchase price of $105,446 (or $4.40 per share) representing the exercise of certain pro-rata rights by the said investors of the private placement which were triggered by the exercise of the conversion rights by the Series C Preferred Stock holders on or around October 31, 2018.

On October 31, 2018, the Company issued an aggregate of 200,000 shares of common stock (based on a conversion price of $5.00 per share) to holders of shares of the Company’s Series C Convertible Preferred Stock in connection with the conversion and retirement of such preferred stock. No cash was paid in this transaction.

All securities were issued pursuant to an exemption from the registration requirements of the Securities Act of 1933, as amended, under Section 4(2) thereunder as they were issued in reliance on the recipients’ representation that they were accredited (as such term is defined in Regulation D), without general solicitation and represented by certificates that were imprinted with a restrictive legend. In addition, all recipients were provided with sufficient access to Company information.

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: Products Segment and Services Segment

Our Products Segment designs and manufactures products for the subsea market including our range of flagship patented real time 3D sonar solutions (“Products Segment”). These 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 (“O&G”) companies, law enforcement agencies, ports, mining companies, defense bodies, research institutes and universities.

Our Services Segment supplies engineering services to prime defense contractors (“Services Segment”) such as Raytheon and Northrop Grumman. We have long-standing relationships with prime defense contractors and we use these credentials to secure more business. We support some significant defense programs by supplying and maintaining proprietary parts (or parts which we are preferred suppliers of) through obsolescence management programs. These services provide recurring stream of revenues for our Services segment.

In recent years, the Products and Services Segment have each generated 50% of our revenues. As a general rule, however, the Product Segment yields a higher Gross Profit Margin than the Services Segment. In both 2017 and 2018 fiscal years the Services Segment revenues and Net Income were substantially down and off plan due to the failure of new US Administration to pass a defense budget. This impact continued in 2018 on the Services Segment. In 2018 fiscal year therefore, Products Segment generated 64% of the Company’s consolidated revenues and the Services Segment generated 36%. We consider this to be atypical and would anticipate in 2019 fiscal year Services Segment revenues will be more in line with 50% of our overall revenues.

The Services Segment has now started to receive the backlog orders that were due in both fiscal years 2017 and 2018 and have now contracted a backlog of $2,504,380 (for the 2017/2018 orders) and we expect the further outstanding backlog to be contracted in the first half of 2019. Our biggest risks for the 2019 fiscal year for this Segment is that of timely execution of its mounting backlog of orders. The current level of this Segment’s order book is approximately $7.2m.

Although our Products Segment continues to be affected by the contraction in expenditures in Offshore O&G activities, we have continued to find new markets for our subsea products, mainly our real time 3D sonar series and the launch of our Echoscope^4G® Surface saw an increase in the number of units sold. We also continue to become a key sensor in Offshore Wind Energy where our technology is used for real time 3D visualization of the cable pull in points and cable touch down point. Our increased efforts including expenditures in research and development is designed to capture new markets in the subsea defense space where new technologies such as underwater drones present new challenges for governments. We continue to believe that our real time 3D sonar technology is significant for the subsea defense market which is worth billions annually. 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 – both static and moving - in low or zero visibility conditions.

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 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 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:

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 revenue by allocating the total consideration to each deliverable based on the relative fair value of each deliverable. Revenue from equipment and software sales are recognized when delivered, and revenue for installation and other services are recognized 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.

On November 1, 2018 the Company will adopt Accounting Standards Codification ASC 606, Revenue From Contracts with Customers (ASC 606). While terminology and requirements change in ASC 606, we believe that our existing revenue accounting is compliant with ASC 606 and that our accounting for revenue will not change. Accordingly, our disclosures about our revenue in accordance with ASC 606 will expand to comply with the new requirements, including expansion of quarterly revenue reporting requirements.

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 Topic 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. GAAP.

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 15 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 Company will early adopt Accounting Standards Codification 2017 – 04, Simplifying the Test for Goodwill Impairment, which permits the Company to impair the difference between carrying amount in excess of the fair value of the reporting unit as the reduction in goodwill. ASC 2017-04 eliminates the requirement in previous GAAP to perform Step 2 of the goodwill impairment test.

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 fair value of the reporting unit.

Fiscal Year 2018 Consolidated Results of Operations

We operate two distinct business segments. Our Marine Technology Business designs, manufactures, sells and rents patented real time 3D sonar solutions and other leading products to the subsea market (“Products Segment”). Our Marine Engineering Business supplies engineering services (from design, prototyping to manufacturing) to mainly prime defense contractors (“Services Segment”).

Our products and associated services are sold and/or rented to the offshore wind energy, dredging and marine construction, marine and port security, mining including deep sea mining, marine sciences sector and O&G sector. During the fiscal years ended October 31, 2018 and 2017, respectively, the Product Segment generated 64% and 61% of our total revenues.

Our Services Segment designs and supplies engineering services largely for prime and sub-prime defense contractors.

During the fiscal years ended October 31, 2018 and 2017, respectively, the Services Segment generated 36% and 39% of our total revenues.

Comparison of fiscal year ended October 31, 2018 (“2018 period”) to fiscal year ended October 31, 2017 (“2017 period”)

See Segment information below for a full breakout of the financial performance of each Segment for the 2018 and 2017 periods, respectively.

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

Revenue:

We suffered a small decrease in revenues in the 2018 period compared to the 2017 period. This is largely due to the Services Segment not achieving its revenue plan for fiscal year 2018 because of the delay in securing anticipated annual defense contracts resulting from the delay in the US Administration approving its defense budget. During the fiscal year ended 2018, the Products Segment generated revenues of $11,499,416 and Services Segment $6,570,013. During the 2018 period the Products Segment revenues grew by 4.2% over the 2017 period and the Services Segment revenues declined by 6.7% over the said period.

The Services Segment has now contracted backlog orders in the amount of $2,504,380 in respect of 2017 and 2018 and we expect the further outstanding backlog to be contracted in the first half of 2019. This Segment currently has an order book of $7.2m.

During the 2018 period, the Company had one customer from whom it generated sales greater than 10% of net revenues. Revenue from this customer was $2,882,761 or 16% of net revenues during the period. Total accounts receivable from this customer at October 31, 2018 was $24,993 or 1% of accounts receivable.

Gross Margin:

The increase in gross margin reflects the different mix of consolidated sales in the 2018 period. In particular, the Products Segment, which generally yields a higher gross profit margin generated more revenues than the Services Segment. Furthermore, the Products Segment’s gross profit margin is affected by the mix of outrights sales versus rentals. Rentals also yield a greater gross profit margin than outright sales. Within the mix of sales for the Products Segments there is an increase percentage relating to rentals and sale of newly launched 4G Products.

Research and Development (R&D):

The increase in our R&D expenditure in the 2018 period mainly reflects an increase in our R&D expenditure in the Products Segment.

R&D expenditures in the Products Segment increased by 122.7% from $919,863 in the 2017 period to $2,048,285 in the 2018 period. This increase is in line with our budgetary plans and is a reflection of the increased activities in developing our 4G/5G of products.

Our goal will be to bring more competitively priced and technologically advanced products to the market under a 12-18 months roll out plan. The first of our series of products in our 4G of products was launched in January, 2018, and we expect to launch further products within our 4G/5G series of sonar throughout 2019.

R&D expenditures in the Services Segment were $523,429 in the 2018 period compared to $460,518 in the 2017 period, an increase of 13.7%. These expenditures are 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 and we have now completed the first development of the new Thermite^® Octal and have received the first orders from 2 significant customers for trial versions. Thermite^® enjoys a prestigious existing customer base which we intend to re-engage with this new Thermite^® Octal.

In general, we expect R&D expenditures to continue to increase in the 2019 period for the reasons explained above. Notwithstanding this increase, it is the Company’s current belief that it can fund these activities from its operating income.

Our products are complex and, despite the increase in our R&D expenditures, we can give no assurance that we will realize our stated goals. We may incur significant R&D expenditures without realizing any commercially viable products or there may be glitches with our product launch.

Selling, General and Administrative Expenses (SG&A):

The increase in our SG&A expenditures in the 2018 period is broadly attributed to the increased costs associated with legal and transaction costs pertaining to a private placement consummated in January 2018. In fiscal year 2019, we do not anticipate this category of expenditure to increase as in fiscal year 2018 we incurred non-recurring one-off costs associated with re-organization of our Company to finance our R&D efforts. Approximately $586,436 of the increased amount in our SG&A expenditures constitutes non-recurring costs attributed to employees’ separation payments and a further $90,000 associated with surrendering leased business property in Edinburgh.

Key Areas of SG&A Expenditure across the Group for the year ended October 31, 2018 compared to the year ended October 31, 2017

Although there is a modest decrease in Wages and Salaries category of expenditures, we would expect that in the 2019 fiscal year this category will increase to reflect the investments we are making in our business including in the area of sales and marketing and quality control.

The increase in our Legal and Professional Fees in the 2018 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 in February 2019, we anticipate that the category of expenditures constituting “Rent” will decrease significantly.

We also expect that the category Marketing expenditures in the fiscal year 2019 will increase to reflect increased marketing efforts on our new generation of products both in the Products and Services Segment.

Operating Income:

The decrease in Operating Income in the 2018 period compared to the 2017 period is attributed to the increase of our R&D expenditures by 86.3% ($2,571,714 in the 2018 period compared to $1,380,381) for the reasons discussed earlier in conjunction with revenues remaining flat.

Interest Expense:

This category of expenditures includes interest on the various loans described below.

In the 2017 period, we had a Senior Secured Convertible Debenture which attracted 8.5% in interest. In the 2017 period we repaid this Senior Debenture in full and in the said period paid approximately six months interest payments.

In the 2018 period, interest is attributed to the HSBC Loan and a loan made by our CEO to one of our subsidiaries.

On or around April 28, 2017, we entered into a new Senior Secured Debenture with HSBC NA where we borrowed $8,000,000, the proceeds of which were used to repay the Senior Secured Convertible described above. This new HSBC Debenture attracts a more favorable interest rate of 4.56% per annum. In addition, on March 28, 2018 the Company repaid a portion of the new HSBC Debenture thus reducing the principal outstanding amount under this agreement to $1,917,602 at that date. As at October 31, 2018, the amount outstanding under the HSBC Debenture is $1,524,239. The amortization schedule for this loan is set out in Note 8 of the audited Consolidated Financial Statements of October 31, 2018 and 2017.

Our Interest Expense Category also includes interest payable on a loan by our Group CEO to one of our subsidiaries, Coda Octopus Colmek, Inc.

On a going forward basis, we expect the category of Interest Expense to decrease as on December 2018 we repaid in full the loan to our CEO and the principal amount outstanding on the HSBC Debenture is reducing.

Other Income:

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 before Income taxes for the year ended October 31, 2018 compared to the year ended October 31, 2017

Net Income before Income taxes fell largely because revenues remained flat (due to the delays in the Services Segment contracting certain defense contracts) and our increased expenditures in research and development, which increased by 86.3% (from $1,380,381 in the 2017 period to $2,571,714 in the 2018 period).

Net Income after Income taxes for the year ended October 31, 2018 compared to the year ended October 31, 2017

Net Income after Income taxes increased because the Company has recognized and recorded in the 2018 period the full deferred tax asset of $1,754,169 due to management judgement that based on the Company’s performance the likelihood of utilizing the Company’s Net operating loss (“NOLs”) carry forwards has materially increased and therefore the NOLs are realizable in the future.

Comprehensive Income for the year ended October 31, 2018 compared to the year ended October 31, 2017

Comprehensive Income increased in the 2018 period compared to the 2017 period due to the recognition of deferred tax asset (NOLs) in the amount of $1,754,169. Without this inclusion Comprehensive Income fell by 16.3% in the 2018 period compared to the 2017 period.

There are a number of reasons for the decline of our Comprehensive Income. In addition to loss of $190,232 in foreign currency translation (as compared to a gain of $299,006 in the 2017 period), Net Income fell by 32% in the 2018 period largely because revenues remained flat while Research and Development expenditures increased significantly in the 2018 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, 2018 and 2017 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, 2018 and 2017, 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, 2018 and 2017 respectively:

The reason for the decline in our Australia revenues is because we restructured our Australian operations in January 2018, whereby most of the sales in this territory are now done by our UK Edinburgh operations. This was done to reduce our overheads associated with sales.

Liquidity and Capital Resources

At October 31, 2018, the Company had an accumulated deficit of $33,748,575, working capital of $14,881,096 and stockholders’ equity of $22,632,781. For the period then ended, the Company generated cash flow from operations of $2,430,649.

We believe that our current level of cash and cash generation will be sufficient to meet our short- and medium-term liquidity needs. At October 31, 2018, we had cash on hand of approximately $7.5 million and both billed and unbilled receivables of approximately $6.3 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.

Our main liquidity issues are: funding our research and development program (“R&D”) which requires significant expenditures in attracting engineering skills and incurring non-recoverable and non-recurring costs for researching, developing and prototyping products; managing our currency exposure; and servicing our senior secured debentures.

Our Colmek subsidiary received on or around October 24, 2016 a $1 million loan from the CEO of Coda to fund the purchase of long lead-time inventory (which are typically subject to a lead time of 12-32 weeks) in order to be able to comply with delivery dates for contracts when they are secured. Subsequent to the year end, this loan and associated interest were repaid in full and all obligations under this loan have now been extinguished.

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, 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 if and when appropriate.

Operating Activities

Net cash generated from operating activities for the year ended October 31, 2018 was $4,988,531. We recorded net income for the period of $3,234,362. 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 $1,206,907. Changes in operating assets decreased net cash from operating activities by $3,557,023 and changes in current liabilities increased net cash from operating activities by $372,122.

Investing Activities

Net cash used by investing activities for the year ended October 31, 2018 was $637,152 due to the sale and purchase of fixed assets.

Financing Activities

Net cash used in financing activities for the year ended October 31, 2018 was $942,382 as a result of paying down the debt of the Company and issuing stock for cash.

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 was 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 was 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 was 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.

On or around March 28, 2018, with the consent of the lender, HSBC NA, we reduced our indebtedness under the loan to HSBC significantly (including the annual amounts of $700,000 which was required under the loan) and as of October 31, 2018, the Company is indebted to this lender in the amount of $1,524,239. We did not incur any penalty or costs for the early pre-payments of these amounts. See Note 8 to the audited Consolidated Financial Statements For the Years Ended October 31, 2018 and 2017. We now anticipate that the remaining balance (principal and interest) will be repaid within 41 months from date of loan.

Private Placement

On January 29, 2018 (“Transaction Date”), 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 of the common stock on the Nasdaq Capital Market for the 30-consecutive trading-day period ending on January 22, 2018. For a period of 36 months from the Transaction Date, 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 2018, 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, balance sheet valuations 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 risks 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, balance sheet valuations 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 2018 period was $1.3420 USD to the GBP against $1.2829 during the 2017 period – an appreciation of the value of the GBP against the USD of 4.6%.

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 2018 period was $0.7534 USD to the AUD against $0.7626 during the 2017 period – a depreciation of the value of the AUD against the USD of 1.2%.

The translation of the Company’s Danish operation’s Danish Kroner (DKK) denominated balance sheets and results of operations into US dollars has been affected by the currency fluctuations of the US dollar against the DKK from an average rate of $0.1535 during the period from March to October 2017, to $0.1590 during the 2018 period - an appreciation of the value of the DKK against the USD of 3.6%.

The Company’s Norwegian subsidiary is now dormant and the limited activities in that subsidiary is not material for the understanding of the impact of exchange rate fluctuations on Company’s results. The Norwegian operations are therefore not included in the below table.

These are the values that have been used in the calculations below.

The impact of these currency fluctuations on the 2018 period is shown below: