Kraken Sonar (PNG.V): A Niche Play in Underwater Technology with Significant Upside as it Scales

Quick Facts: Company is at an "inflection point" that the market is not picking up on as it is about to scale its technology into a new product line that will generate significant revenues and gross margin; Management and Employees own roughly 60% of outstanding shares; very tight share structure with 90 million fully diluted shares but a float of only 13.3 million shares as Management and Employees own roughly 60% and several major holders control a majority of the issued warrants; Debt-free with sufficient cash.

Disclosure: I am long shares of PNG.V with a cost basis of $0.15. Members were informed on September 30th of my purchase. 

Company Overview

Kraken Sonar is an underwater technology company that has developed superior sonar and acoustic sensors for military and commercial applications. Such applications include mining the ocean floor for mineral resources, military applications that include searching the seafloor for mines and collecting enemy intelligence, commercial surveying, oil and gas industry applications including underwater pipeline surveys, salvage sunken treasures on the ocean floor, among other applications. The company has made it no secret that their vision is to develop a superior underwater navigation system for the Unmanned Underwater Vehicle (UVV) market and to develop their own UUVs. 

It's worth understanding how the company came into existence because that is part of its appeal. Karl Kenny, the current CEO of Kraken, co-founded a company early in his career called Telepix Imaging, which he eventually sold for over $50 million. He then co-founded a company called Marport Canada and served as its CEO/President until 2011. Marport ultimately struggled because of the inability to collect on a fairly significant lawsuit judgement relating to a portion of Marport's IP. In 2009 a Private Equity firm stepped in to inject capital into the company and they brought in their own Executive Team. Karl got shifted to the R&D team where he worked on new products for the company. Karl eventually spun off the R&D unit (in 2012), which today is known as Kraken. A group of engineers and some IP was included in the spin-off as well.

The interesting part of how Kraken evolved is that a significant part of the the company's initial products and services came about through the R&D dollars of Marport, not Kraken.

The company began trading on the TSX in February 2015.


Share Structure

When I first started researching Kraken I was concerned about the approximately 90 million fully diluted share count. But after further understanding the share structure it actually is pretty darn good. 

As you can see in the chart above, of the 90.3 million fully diluted shares, insiders and employees own roughly 56 million of the shares, approximately 57% of all outstanding shares. Additionally, we learned through our due diligence that the warrants are in very strong hands, with one warrant holder owner holding roughly 50% of all outstanding warrants. As a result, the float is only roughly 13 million shares.

In conclusion, we are very comfortable with this share structure. 


The Company's Products


Kraken's primary product at this time is its Synthetic Aperture Sonar (SAS) product called AquaPix. Aquapix provides extremely high resolution underwater images for military application. Aquapix provides a 10x increase in area coverage over the legacy types of systems...all of these equals more area surveyed at a much higher resolution in less time. Because of this, not only has the military starting utilizing this technology but it's applications have expended to shipwreck searches, scientific purposes, and oil and gas reasons such as pipeline surveys and dredge monitoring. 

In 2013 the company successfully completed trials with the U.S. Navy Naval Undersea Warfare Center validating its superior SAS technology (Aquapix). This was a significant achievement for the company and one in which set the stage for the company to earn the respect of potential customers around the world. 

Below is an example that shows the superior resolution of Kraken's SAS technology compared to that of the legacy systems: 

The Aquapix is a low cost alternatives to other similar products, sometimes many multiples lower. The reason for this is likely because of Kraken's lower overhead costs as a company and their ability to deliver products and technologies to the market faster than a much larger company could. It also speaks to the quality of their management and team members. 


The newest product released by Kraken is called Aquatrak correlation velocity log (CVL). Released in April of 2015, simply stated, Aquatrak is an underwater navigation system that was designed and developed over a 3 year period in order to replace an technology called Doppler Velocity Log (DVL) that has been on the market since the early 1980s. Kraken overcame existing technology barriers in developing Aquatrak as a highly accurate long range underwater navigation system that is capable in operating in very deep waters. 

When Kraken released Aquatrak, the press release that accompanied the news was very interesting. What I enjoyed the most when reading it was the very last, two-word sentence by CEO Karl Kenny! It definitely provides a hint to his competitive nature.

Sales of Aquatrak are scheduled to commence in Q4 2015 via a multi-year distributor arrangement that the company entered into with Tritech International. Tritech will manufacture, sell, and provide all facets of support for Aquatrak.  Obviously, the benefit of this arrangement is there is essentially no overhead for Kraken and they will realize a royalty on a per sale basis. Should sales of Aquatrak be significant, which the company expects, it could quickly allow Kraken to reach profitability. The royalties earned will go directly to the company's bottom line. 


Kraken's Unmanned Underwater Vehicle (UUV)

Earlier this year, in July, the company announced plans to develop a towfish which the company has coined as "KATFISH". A towfish is an UUV tethered to a ship and towed below the water's surface. The product is expected to launch in early 2016. 

This is a significant product launch for Kraken for the following reasons:

  • It would successfully complete the company's objective of becoming a "sensor to systems" company. With the launch of KATFISH, Kraken will be able to provide an entire set of systems (Aquapix and Aquatrak) packaged in a single underwater vehicle. 
  • The price tag for the KATFISH will be in the ballpark of $1.5 million. While the UUV market is competitive, Kraken has significant advantages in price and technology, as a similar unit from another competitor could easily be priced at $2.5 million or more. 
  • Successful execution will provide significant revenues and margins to the company (See Investment Thesis section below for more).


Brief Overview of Financials and Revenue Growth thru 2014

Since the company's existence, revenues have grown from approximately $20k in 2012 to $2.53 million in 2014. The company expects sales to grow an additional 100% in 2015 and approximately 75% in 2016. However, for reasons I will explain in the "Investment Thesis" section below, I believe these sales projections are potentially grossly understated.

Kraken has no debt and has approximately $900k of cash on the balance sheet. The company's cash burn rate is approximately $150k/quarter. With continued sales of Aquapix in addition to earning royalties on sales of Aquatrak and future revenues related to KATFISH, I do not foresee a situation where the company will need to raise capital. 

The company has not yet had a profitable quarter. In fact, losses for Q2 2015 came in at roughly $330k, with a Q1 loss of over $800k. A significant amount of the losses that the company is posting are related to one-time charges related to the reverse takeover transaction completed in early 2015 which enabled Kraken to become a publicly traded company. As part of this transaction, 8 million options were granted which cost the company $1.2 million in 2014. Subsequently, Kraken recognized another $750k in expenses related to the reverse acquisition in Q1 2014. 

As the costs relating to the reverse takeover dissipate, the overall financial picture will look much better as operating margins will expand from their current level of roughly 21%. In addition, the company expects product margins to come in around 55% and EBITDA margins to come in around 25%. 


Investment Thesis

Kraken is truly in what I would consider a "sweet spot" for an investment at this time. It's the type of investment opportunity that I search far and wide for. You have probably heard the term "inflection point" before, which is exactly where Kraken sits at the moment. If you haven't heard the term "inflection point" used in the context of a company, simply think of it as a "significant turning point". 

Here is why I like Kraken so much at this moment in time:

  • The company has a significant opportunity in the near future to begin securing sales for its UUV product, KATFISH. Keep in mind that KATFISH will have a pricetag of approximately $1.5 million that will generate roughly 55% gross margins for the company. I believe that there are two potential scenarios here for Kraken:
    • Kraken may take the same approach it did with Aquatrak and will enter into an agreement with a manufacturer and distributor that will allow the overhead to be shifted to the distributor and away from Kraken. Kraken would then receive a significant royalty on the sale of the KATFISH. 
    • Kraken will handle all manufacturing and distribution itself, requiring 25-30% upfront payment by the customer. With gross margins expected of 55%, that is a significant upfront payment that will immediately hit the company's bottom line. 
  • Based on my research and understanding, it is likely that a customer will not just order one KATFISH because of the possibility of losing one during a deep underwater expedition. Typically, based on what I have learned, is that 2 units are part of an initial order for that very reason. 
  • The company expects a 2-month timeframe to manufacture a KATFISH after receipt of the initial down payment from the customer. However, the first KATFISH build will likely require 8-10 months. 
  • Kraken's agreement with Tritech for the manufacturing and sales of Aquatrak should begin to pick up traction in Q4 2015. I expect that we will see announcements in the near future that provide an update as it relates to sales activity of Aquatrak.
  • It is highly likely that the company will receive R&D funds from the Canadian government over the course of the next 3-6 months. These funds would hit the company's balance sheet immediately upon receipt, shoring up any deficiencies that may exist and helping to fund additional R&D that the company will engage in. 
  • Warrants are creating an overhang on the ability of the stock price to appreciate significantly. However, I believe that once these options start being exercised then not only will the company have more cash on their balance sheet but also less warrants will likely create less drag on the stock price.



There are some obvious risks for Kraken, including the following:

  • Signifcant competition exists in the UUV market. Kraken will have to validate its product and technology while being extremely favorable with pricing (which they will be). Kraken has already validated its strong technology on the sensor side, so they have a very strong reputation already. This will play favorably into their ability to sell into the UUV market. 
  • Revenues are non-recurring and lumpy. I would like to see some recurring revs to create a bit more consistency in quarterly results, but the fact of the matter is that orders will hit their books at different times and as long as they are executing I can certainly see past any lumpiness in revs from quarter to quarter. 



As Kraken moves from "sensors to systems", it finds itself at a true "inflection point" as one simple sale of a KATFISH unit could drastically change the balance sheet (and size) of the company. However, the opportunity exists for significant sales of KATFISH as Kraken has a great reputation in the industry for price and technology. The company also has Aquatrak which will gain traction in the months ahead as Tritech begins to secure sales and issues royalties to Kraken. Add in the impact that future R&D credits could have on the company and opportunity presents itself for significant upside return. 

Disclosure: I am long shares of PNG.V with a cost basis of $0.15. Members were informed on September 30th of my purchase.