TransAct Technologies Incorporated (TACT) Q3 2016 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the TransAct Technologies Third Quarter 2016 Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions]. As a reminder, this conference is being recorded. I would like to introduce your host for today’s conference, Jim Leahy. You may begin.

Thank you, Leeann. Good afternoon, and welcome to TransAct Technologies 2016 third quarter conference call. Joining us today from the company are Chairman and CEO, Bart Shuldman; and President and CFO, Steve DeMartino. Today’s call will include a discussion of the company’s key operating strategies, progress against these initiatives and details on the third quarter financial results. We will then open the call to participants for questions. As a reminder, this conference call contains statements about future events and expectations, which are forward-looking in nature. Statements on this call maybe deemed as forward-looking and actual results may differ materially. For a full list of risks inherent to the business and the company, please refer to the company’s SEC filings, including its reports on Form 10-K and 10-Q. TransAct undertakes no obligations to revise or update any forward-looking statements to reflect events or circumstances that occur after the call. Today’s call and webcast will include non-GAAP financial measures within the meaning of SEC Regulation G. When required, a reconciliation of all non-GAAP financial measures to the most directly comparable financial measure calculated and presented in accordance with GAAP can be found in today’s press release as well as on the company’s Web site. At this time, I would like to turn the call over to Bart Shuldman. Bart?

Thank you, Jim, and welcome to everyone for joining us on this afternoon’s conference call and webcast. This afternoon, we reported 2016 third quarter revenue of 14.5 million, operating income of 1.2 million and EBITDA of 1.6 million. Steve will review the financials in more detail in a few minutes, but first I would like to provide some high level comments about the quarter and about our business prospects for the balance of the year. As I mentioned during my prepared remarks last quarter, TransAct celebrated its 20th anniversary as a public company when we rang the NASDAQ closing bell in late August. Over the course of more than 20-year history, TransAct has developed into an innovative provider of print technology and software-based solutions that use printers as an output to a variety of high-growth industries; including casino and gaming, food safety, point-of-sale automation, lottery, oil and gas exploration and mobile. In addition, we have continually adapted to the various changes seen in our markets during that time. Today, food safety is our most exciting long-term opportunity. Our food safety terminal business is centered on our line up of three AccuDate terminals; the AccuDate 97, the AccuDate PRO and the AccuDate XL. This fully featured suite of products provide TransAct with the ability to serve the entire range of food service operators, from the smallest quick service and convenience store operators to nationwide chains that operate hundreds of full service restaurants and/or thousands of individual quick serve and fast casual store locations. Our solutions address the variety of operational challenges that exist in the industry. The AccuDate 9700 targets those restaurants and other food service establishments that primarily want a solution for food rotational labeling. The AccuDate PRO is the center of the kitchen terminal solution with enhanced features such as WiFi network and video capability with features and functions and technology that can be used to help with many operational needs. And the AccuDate XL delivers a fully integrated solution that connects to the cloud, then integrates with CrunchTime’s industry-leading back office cloud-based software solution and also other Android-based solutions that software developers are targeting for back-of-the house operations. With this full suite of products, restaurant and other food service companies are looking to use TransAct AccuDate terminals for more than just food rotational labeling. Our sales and engineering teams are working hard with restaurant and food service customers and customizing our solutions to their needs to ensure that the AccuDate terminals they deploy fit perfectly into the back-of-the house operations. We believe this is important, particularly as a customized solution ultimately becomes a valued solution and in a sense makes TransAct their partner. Along these lines, we are working with several high profile restaurant and food service operators and AccuDate terminal solutions that make the terminal an integral part of the restaurant operations. We remain highly encouraged that restaurant operators are intently focused on protecting their customers from foodborne illnesses to enhanced safety of their kitchen operations. These issues have shown a keen ability to snowball and creates substantially negative publicity for business and brands as seen in several recent high-profile cases. Furthermore, and another avenue for sales of our solutions, the macro choppiness of the restaurant industry is driving restaurant and food service companies to more fully evaluate new technology solutions in the back-of-the house to help streamline operations and ultimately reduce their operating costs. We believe this is an important selling point for our new AccuDate terminals and as such, we expect the food safety business to be a key driver of our success long-term. You know, if I look back over the last several years, we started in the food safety market with the AccuDate 9700 for McDonald's. The successful venture brought TransAct into the food rotational labeling market helping McDonald's and then others to automate their back-of-the house labeling needs. Now fast forward to today. We have developed other terminals that can be used by restaurant operators and any establishment that prepares food to help with a lot of their back-of-the house operational needs. With the AccuDate PRO and AccuDate XL, TransAct terminals have the potential of becoming a multiuse product with multiple installations per restaurant to help with food rotational labeling and then so much more. Shifting gears, our POS automation business grew nicely in the third quarter as we continue to benefit from McDonald's ongoing global technology and menu initiatives. McDonald's remains a marquee customer and we believe their demand for the Ithaca 9000 printers will continue. We also saw growing traction for Ithaca kiosk printers in a variety of food service applications. On the casino and gaming front, we demonstrated our clear long-term commitment to the industry with our showing at the Global Gaming Expo in Las Vegas late in the third quarter where we introduced a variety of new products to bolster and drive further share of growth. Our new Epic Edge casino ticket printer was very favorably received as it highlighted TransAct’s ability to solve an ongoing problem, namely improving bill validator performance through the delivery of higher print quality receipts. In addition, the Epic Edge printer will help reduce casino operators’ paper cost as it enables printing on a shorter ticket. The market response [ph] was extremely positive and I read some industry reports after the show that highlighted our new printer and the technology leadership TransAct has made. We also introduced two new versions of our Epicentral promotional and bonusing print system, including Epicentral SE, which will enable the new printed promotional coupon capabilities featured in an upcoming version of Bally's CMP casino management system. However, casinos that visited our tradeshow booth took notice of the Epicentral SE capabilities and we believe other casino software systems will begin to integrate with Epicentral SE. Despite our ongoing leadership in the global casino market, I want to caution our investors that this business remains challenged on a macro basis. Despite somewhat sluggish domestic sales, international sales were particularly strong in the quarter including the benefit from two property openings in Macau. We believe that we can continue to take market share based on our ongoing product innovation, but note that operating capital budgets are constraint and likely to remain so for the near future. Our lottery sales were up over the prior year and higher order volumes and we expect fourth quarter 2016 sales at a similar level. The addition of our new Epic 3000 lottery printer to our solution lineup provides a long-term growth opportunity for this business over time. The oil and gas market environment for Printrex is no secret, as continued weakness in oil and gas prices significantly impact the sales of our print solution for oil and gas, well drilling and exploration activity. As we have said in the past several quarters, we are managing the business for near-term profitability as we wait out a dramatic decline in oil and gas prices. Overall, we were pleased with our financial performance in the third quarter of 2016 and expect similar trends in the fourth quarter as we close out the year. Before turning the call over to Steve, I want to highlight an important factor we believe investors should consider when thinking about some of our business lines. It is important to note that TransAct's transformation and growth has been built in the back of the cash flow generated by our industry-leading casino gaming and lottery market. These markets help to deliver attractive levels of cash flow which we then can deploy to invest in new innovations and new opportunities, such as food safety and ongoing enhancements to Epicentral to meet evolving industry needs. A diverse product set is vital to our long-term success and is notable that we have developed new products that enable us to diversify into new markets and address new large opportunities. Our new product innovation is completely funded from internal cash and at the same time, we’ve been able to consistently return capital to shareholders through our regular quarterly dividend and share repurchase activity. With that, I’ll turn the call over to Steve for a deep review of the 2016 third quarter results, after which I’ll make some summary remarks before we open up the call to questions and answers. Your turn, Steve.

Thanks, Bart. Good afternoon, everyone. 2016 third quarter net sales were 14.5 million compared to 14.2 million in the year ago quarter. As Bart mentioned, we saw strong sales in our POS automation business and increasing interest in our AccuDate line of food safety terminals. During the quarter, we also completed a new installation of our Epicentral software-based promotion and bonusing print system and furthered our technology leadership position in the global casino gaming industry with new product introductions at the G2E show. Looking at our sales by market for the third quarter; food safety sales were $1 million, down 12% or $138,000 from last year's third quarter. While sales were down year-over-year and on a quarterly sequential basis, we continue to expand the total market opportunity for our food safety products while we work the current pipeline of opportunities. As we have said, we envision a multiyear rollout of our AccuDate terminals and believe the heightened focus on food safety in an operational cost efficiency across the food service industry will drive long-term growth. Thus, while TransAct is still moving through the early stages of defining and developing this new automated food safety market; near-term, year-over-year or sequential revenue comparisons will not be the optimal way to gauge our success in this business. POS automation and banking sales were up 27% or $600,000 to 2.9 million in the 2016 third quarter, as we again benefited from exceptionally strong sales of our Ithaca 9000 printer to McDonald's in support of their continued rollout of new menu and technology initiatives across the restaurant footprint worldwide. Given the traction for this product at McDonald's, we believe this current trend will continue through the remainder of 2016 and into 2017. Casino and gaming sales were up 28% year-over-year or 1.2 million to 5.6 million in the third quarter of '16 even though the global market for casino and gaming printers remains choppy. Reversing a trend seen in the first half of the year, during the third quarter we saw very strong international growth over the prior year, as sales of casino and gaming printers to our European distributor returned to more normalized levels and we also benefited from two property openings in Macau. However, domestic casino and gaming printer sales remain subject to the continued choppiness in the market and were down slightly from the prior year period. On the software side, we completed one new installation of our industry-leading Epicentral software system for an international casino customer during the quarter. Lottery sales were up 24% to 2.2 million from 1.8 million in the third quarter last year, as we saw higher IGT sales volumes. Looking to the fourth quarter '16, we expect lottery sales to be largely in line with the third quarter’s sales level. Printrex product sales were $67,000 compared to approximately $225,000 in the year ago quarter, as severely depressed oil and gas prices continued to have a negative impact on oil and gas drilling activity. We continue to believe Printrex sales will remain under pressure through the balance of '16 and into '17, and as a result we’ll continue to run this business in a way that aligns our cost with the current revenue level. Finally, TSG sales were down 38% year-over-year to 2.7 million. TSG was impacted by lower domestic spare parts sales, as we experienced an unusually high level of spare sales to IGT in the prior year quarter that didn’t repeat. In addition, service and consumable sales were somewhat lower including continued declines in sales of Printrex color printer consumables as the Printrex business remains under significant pressure from the low oil and gas prices. Gross margin for the third quarter declined to 40.9% from 44.4% in the third quarter of '15. As with our 2016 second quarter, we experienced an unfavorable sales mix as we essentially replaced high-margin spare part sales to IGT with lower margin Ithaca 9000 printers sales to McDonald's in the quarter which resulted in a decline in our overall reported gross margin compared to the prior year. Over the long term, we continue to believe our gross margin will benefit as the revenue mix shifts towards higher margin opportunities in the food safety industry even as sales of Ithaca 9000 and POS printers for McDonald's remain at relatively high levels in the near term. As we’ve said in the past, we believe TransAct’s blended gross margin can climb over time to the mid-to-high 40% range and even reach 50% given the right sales mix. Total operating expenses for the third quarter '16 were relatively consistent at 4.7 million, down just 1% from a year ago. Engineering, design and product development expenses for the third quarter were up $367,000 or 48% year-over-year. As with the first half of the year, during the third quarter we continued our investment in support of our Epicentral and AccuDate products with a particular and growing focus on the development and enhancement of software that enables both of these product lines. Selling and marketing expenses for the third quarter were down by $329,000 or 15% to 1.8 million on lower commissions related to lower sales volumes year-over-year, as well as lower travel expenses and other efforts to reduce expenses. G&A expenses for the third quarter were 1.7 million, down 5% from the year ago period due largely to lower incentive compensation expense. Operating income for the third quarter of '16 was 1.2 million or 8.5% of sales compared to operating income of 1.6 million or 11% of sales in the year ago quarter. Both GAAP and adjusted diluted EPS for the 2016 third quarter were $0.12 compared to GAAP and adjusted diluted EPS of $0.13 in the year ago period. Adjusted EBITDA for the third quarter of '16 was 1.7 million compared to 2 million in the third quarter of last year. Turning to the balance sheet. We ended the quarter with 2.2 million in cash and still no debt outstanding. We returned a total of approximately 1.6 million of capital to shareholders during the 2016 third quarter through our quarterly cash dividend of $0.08 per share and then repurchased of approximately $1 million of TransAct stock at an average price of $7.71 per share. Year-to-date, through our third quarter of '16, we repurchased a total of 413,000 shares for $3.2 million which means we've now bought back nearly 5% of our total shares outstanding since the start of the program just this year. The repurchases we made during 2016 were pursuant to the $5 million authorization we announced in late February under which we have 1.7 million remaining as of end of the third quarter. With that, I’ll give the call back to Bart for some closing remarks.

Thanks, Steve. Great analysis of our finances and what’s going on with sales and expenses in the business, so I thank you. As we close out 2016 and prepare for 2017, we believe TransAct has an exciting future ahead of us and we look forward to delivering of our promise of continued evolution in innovation. We really are creating this back-of-the house automation in food safety technology. And I really want to thank the hard working people at TransAct for their efforts, which have allowed the company to really expand into these high-growth, high-margin businesses. This has not been easy. There’s been a lot of work and a lot of technology and actually a lot of new people that we've added to be able to reach the level of complexity and solutions that our customers are asking of us. Their excitement in the product, especially on the engineering side, has just been amazing for me to watch and our sales people in bringing in these opportunities and working with these customers on how to pretty much automate their back-of-the house operations. It's quite exciting. Of course, I’d like to thank our shareholders for your continued support as we further transform and grow our business. This is not what I’d call the easiest times right now in this worldwide economy. Oil prices dropped pretty significantly today. We’ve got a pretty tough election out there. The macro environment is not all that great. And I really thank our shareholders for supporting us as we really transform TransAct into a total different business. I hope you remain as excited as we do. Operator, we’re ready to take on some questions.

[Operator Instructions]. Our first question comes from Kara Anderson with B. Riley & Company. Your line is open.

Hi. Good afternoon. Thanks for taking my question or questions. Let me start on food safety, and I know it’s not great to look at this on a quarterly basis as you said, but if you think about what you did in Q2 and what you did in Q3, can you talk about the strength in Q2 relative to Q3 whether it was due to a single of a bigger rollout or a broad based strength? And then if we saw somewhere the negative impact of that in Q3. Thanks.

Yes, a great question Kara and thank you. Thank you for joining us today. What’s happening with the business and I’m trying to create kind of what we see and what’s happening. As we entered the business with the 9700, which was truly a food rotational labeling system, multiple sized labels. You want to print what the expiration date is of lettuce or hamburgers or chicken. And as we have progressed this year, a lot of the projects have moved from the 9700 to the PRO and the XL. And the reason why – and that’s what we saw pretty much in Q2 and Q3, because Q2 still saw some pretty heavy 9700 business and in Q3 we started to see customers really move from the 9700 to the PRO. And that’s really happening because of the customer’s desire to see how much more this technology can do in regards to their operational needs in the back-of-the restaurant. And as they got to know the product and started asking questions, hey, by the way we do this; can we somehow use the terminal to do that? Our sales team said, yes, but you got to kind of move over to the PRO, because the 9700 was never designed to do that. And so what we’re seeing is this transfer of a lot of opportunities from 9700s to PROs and then actually eventually to XLs. We actually have certain customers, if you can believe this, bought the 9700; had told us they’re going to buy the PRO, use it for a year or two and then actually turn over to the XL once their integration of the software that they want to use is done. And the true automation of the back-of-the house occurs. But they’re willing to go from the 9700 to the PRO to the XL. So we’re really seeing this movement by the restaurant companies and food service operators to use the terminal for more and more applications in the back-of-the restaurant. Now short term, it does exactly what we saw in the third quarter. Wow, okay, sales were down a little versus Q2. Long term what it does for us is say, we’ll go from one terminal to three terminals per store. We got from one price point to a higher price point that has recurring revenue built into it. So the long-term prospects of the business truthfully has never been better. But as these restaurant companies – and we’re working at the headquarter level. As these restaurant companies really look at the technology and really look at how they can automate the back-of-the house, they’ve discovered the PRO and the XL. So we are seeing this kind of migration, this switch. And again, you saw it in Q3. By our projections we basically hit our 9700 numbers but they started to switch over to PROs and the work that our engineers are doing at adding these features is underway and in fact in certain locations under tests. And we’re optimistic that those tests turn to orders and then we start seeing the pickup and again, a higher margin, higher price and also recurring revenue business. So, it’s kind of an exciting story but you see kind of the changes in the number as we go from Q2 to Q3.

So if I’m understanding correctly, it essentially lengthens the sales cycle a bit when they decide to make that switch?

No doubt.

Okay.

It’s providing a solution that locks us into the customer on many different levels. So, yes, it definitely has lengthened the sales cycle, no doubt.

Okay. And then shifting to Epicentral, I think previously you guys had commented that you expected two installations for the balance of this year. We saw one in the quarter. Are you still expecting one more in Q4?

We are. We have one customer that’s a bit challenging and we would like to see that order hit this quarter. I think the prospects are high but again, it’s a bit of a challenging customer for us and we’ll see what happens. I think the story of Epicentral is really what Bally asked us to do and now we’re seeing other casino software companies come to us in regards to using their bonusing engine, but their bonusing engine didn’t have any print capability, coupon capability and watching as some of the software companies utilize this new Epicentral SE. And that’s kind of exciting for us because they go out and sell the features of their bonusing system and then say, by the way we can turn them into printed coupons and we’ll bring in TransAct to do that.

In a way, would you think that the Epicentral SE would cannibalize potential sales for the full Epicentral suite or – I mean even if does that, is that okay given the market opportunity might be greater by integrating with these operators?

That’s another great question. It could. The pricing difference is not that big but it could. What we have done with customers, we have one in particular that we’re working with. They like what they can get from the SE. But the questions then becomes, hey, I’m limited by the amount of promotions I can do with the software I have. If I add in your Campaign Center, which is really the one thing that we take out of Epicentral SE, can I do more? And that’s where the conversation goes, of course you can. Because now we are so tied into the system and see the real-time transactions based on the information that they are now providing us, again the amount of promotions becomes almost endless. So then once they get hooked on the couponing and the rise in revenue that they’ll get from that, they’re realizing that there’s just so much – they’re limited by how many coupons they can do. And then we believe that they’ll come to us and say, hey, we want the Campaign Center. Sell us that, because we can do more. So we think it’s kind of an introduction and then we go in, and once they get hooked on the couponing – we’ve got one casino that went live a couple of months ago and they’re seeing really dramatic increase in revenue. They were going to run 1,000 coupons a day and now they’re running 3,000 a day because they’ve seen the revenue growth. We really want them to get hooked on coupons and then come to us and say, look, we want to do more so we need your Campaign Center.

That’s a casino that you had already utilized in Epicentral SE?

No. What we did is we’ve been meeting with the customer on the Epicentral SE. And they’ve come to us and said, look, we know we’re limited. How do we do more? And that’s when we said, well, you got to go to the full suite. And we believe that our first order could be SE but it could be the full suite of product, because they’re really wrestling with the limitation they have by just doing the SE.

Okay. And then also in the casino and gaming market, I know you commented that international is stronger and you benefit from two casino openings in Macau. How was your ship share fairing versus your competitors?

What we use, Kara, is – the only way for us to look at it is what the OEMs or what the slot manufacturers say in their earnings report and are they up or down, and then we can compare it to us. There’s no real statistic out there. If not holding share, growing share especially on the international side, because we won one casino that we’ve never had before, casino group, and this is our first casino within the casino group that we won. So we think we’re growing share. But that’s our opinion. There’s no industry information but we’re doing fine. And our Epic Edge was just a real homerun at the show for those that were there could experience the response of the market. There’s one guy in particular that is well known in the industry and came over to me – I think it was like Wednesday late afternoon and just came over and said, Bart, congratulations, you did it. You’ve really overtaken the competition that’s out there in technology, in support of the industry. I wouldn’t minimize the fact that our printer printing at 300 dpi really improves ticket acceptance in bill acceptors. And that’s been a real issue for casinos. They’re reading the bar code and in certain cases, it could be 90%, 92% read rate that could potentially go to 97%, 98% or 99%, and that’s a real homerun for the casinos. So just the fact that we would go in that direction and think about the casino and providing a solution, we just didn’t come out with – our competitor came out with a fix to their product. They didn’t come out with anything new. They’ve had quality reliability issues for years. We came out with a solution for the industry. We came out with a 300 dpi printer that will speed up the transaction and make the transaction more accurate. We came out with a flexible printer paper configuration that in some cases we have casinos that said, you know what, if we run a tournament, we want to use the Edge because in that location we’ll use the smaller paper, so we know who the tournament winners are. We got jurisdictions to have both VLTs and casinos and they’ve said to us, you know the VLTs will probably use the smaller ticket and the casinos will use the bigger ticket so we can know the difference between where the players have come from. And the response was just wonderful. So we really think that we’ve focused on the industry and solutions versus just focusing on fixing a printer that had reliability issues. So we’re very pleased where we are in what currently is kind of a choppy and difficult market.

All right. And then last question for me and then I’ll let somebody else take a shot. I think it’s been maybe a year since the exclusivity agreement with IGT has gone away. Have you made any progress on any business outside of IGT?

No. We’ve got a lot of irons in the fire. That’s going to be a long-term process because it’s not only the fact of the integration of the product but a lot of companies six months ago bid on contracts that will close a year from now. So if and when they integrate the product, those bids won’t – we won’t see the revenue for at least a year after that. So the bid packages are out a year ahead of time. So we’re not expecting – and we’ve said this the whole time, this is not something that’s going to be dramatic to the business. Food safety is going to be dramatic to the business. Epicentral will add significant margin and revenue to the business. The fact that we’ve been given the opportunity to sell our lottery technology around the world is a great opportunity, but it’s a long play. And it’s not only from the integration and installation, but then we got to get into the bid packages. And so it’s a long-term – if you want to talk about a long-term sales cycle, that’s a long sales cycle.

Okay, fair enough. Thank you.

You got it.

[Operator Instructions]. At this time, I’m showing no further questions. I would like to turn the call back over to Bart Shuldman for any closing remarks.

Thank you. Thank you everyone for joining us on the call this afternoon. To my friends in Chicago, good luck. To my friends in Cleveland, good luck. Tonight somebody will win the World Series after so many years of being left high and dry. I also look forward to select [ph] endings, so we can get back to focusing on other things. We do look forward to reporting back to you on further progress of our business when we report our fourth quarter results in early March. The fact that I won’t be talking to you for a couple of months, I do wish you and your family a happy and healthy and safe Thanksgiving. And also and probably the first time I’ll say it, a happy and healthy New Year. So we’ll talk again. Thanks for joining us today.

Ladies and gentlemen, thank you for your participation in today’s conference. This concludes the program. You may now disconnect. Everyone, have a great day.