VirTra, Inc. (VTSI) Q3 2020 Earnings Report, Transcript and Summary

Good afternoon, and welcome to VirTra's third quarter 2020 earnings conference call. My name is Christie, and I'll be your operator for today's call. Joining us for today's presentation are the company's chairman and CEO, Bob Ferris; and CFO, Judy Henry. Following their remarks, we will open up the call for questions from VirTra's institutional analysts and investors. Before we begin the call, I would like to revise VirTra's safe harbor statement that includes cautions regarding forward-looking statements made during this call. During this presentation, management may discuss financial projections, information, or expectations about the company's products and services or markets or otherwise make statements about the future, which are forward-looking and subject to a number of risks and uncertainties that could cause actual results to differ materially from the statements made. The company does not undertake any obligation to update them as required by law. Finally, I would like to remind everyone that this call will be made available for replay via a link in the investor relations section of the company's website at www.virtra.com. Now I would like to turn the call over to VirTra's chairman and CEO, Mr. Bob Ferris. Sir, please proceed.

Thank you. Good afternoon, everyone, and thank you for joining us today for VirTra's third quarter 2020 earnings call. I'm also joined by Judy Henry, our CFO. 2020 has been a volatile year to say the least. But if the last 3 quarters have demonstrated anything for VirTra, it's that we are highly adaptable organization with an incredibly robust customer base. We serve a need that is integral to the well-being of all of us, improving the training and therefore, performance of law enforcement and military personnel through highly effective simulation training. With our talented personnel and tenacity for success, we've adapted well to changing circumstances and ensured our vital mission continues relatively unimpaired. In fact, despite the significant challenges we faced due to COVID-19, we were able to achieve about the same revenue in the first half of 2020 as we did last year. Bear in mind, our third quarter results in 2019 were quite good. In fact, Q3 last year was the second best quarter in the 27-year history of our company, a very high R&D. As those of you have seen our earnings release, you already know, despite the pandemic, which has particularly complicated our installation process, our third quarter results were essentially in line with our results a year ago. For the third quarter, our revenue was $6.4 million. We earned positive net income, which drove EPS of $0.11, and we earned $1.6 million in adjusted EBITDA. As a result, we are in a very similar position this year as we were at the same time last year when there were no travel restrictions or pandemic. Yet, the silver lining for VirTra is that despite the strong revenues, we also increased our backlog. As of September 30, 2020, our backlog was $14.4 million, which is $3.1 million higher than it was at this time last year. Financial results of the third quarter underscore a theme consistent with second quarter. VirTra continues to sell and service the essential needs of our customers despite the obstacles created by COVID-19. However, unlike Q2, we were able to ship and install product to domestic customers more effectively this past quarter as various state lockdowns lifted as regulatory guidelines became less restrictive and as we and our customers became more proficient at navigating the obstacles. Let me be clear, VirTra is not immune from business challenges unique to 2020. Trade shows, which are a large focus for us each year, and particularly in Q3 and Q4, are obviously canceled or converted to online portals. International orders, more so than domestic ones, have been delayed due to additional complications with continued international travel restrictions. However, I've said this in the past, and it continues to be true that as far as we know, we have not lost sales directly from COVID-19. And our ability to exceed last year's pace when taking into account our backlog indicates that despite installation headwinds this year, sales have accelerated. We highlighted a few of our more important sales with press releases this quarter that are worth mentioning today. The first is the $1.5 million order we received from the U.S. Department of Homeland Securities Federal Law Enforcement Training center or FLETC. FLETC provides career long training to law enforcement professionals in more than 90 federal agencies and is the nation's largest provider of law enforcement training. They became a VirTra customer in October of last year. And with the second order, our simulators will be installed at all 4 of their training centers by the end of this year. Given FLETC's reputation, their choice to double down on their partnership with us, sends a strong signal to prospective customers. Our partnership with FLETC provides us with a concentrated channel through which we can reach and educate a wide range of police agencies. And it serves as a great example of how VirTra is able to grow our brand awareness with those who could influence purchasing decisions. During the quarter, we also received an $863,000 order from the U.S. Customs and Border Protection, a long time and large customer for VirTra. This order was for simulation training products and services and, worth noting, it included some of our newer drop in recoil kits. Those of you who have followed our story for some time will know that VirTra has long been the leader in judgmental use of force and de-escalation simulation training. But maintaining that reputation and expanding market share requires constant innovation. Innovation is a part of our DNA and is often at the heart of our competitive advantage. It's always rewarding to see long-term satisfied VirTra customers upgrade to the latest tools to provide their officers with the best train available. Our third press release this year relates to a new partnership we have with a company called Infoscitex, or IST. But since this discussion relates directly to some of the larger growth opportunities in the military market, I'm going to save that discussion for my closing remarks. For now, I'm going to turn the call over to our CFO, Judy Henry, to provide an overview of the financial results for the third quarter of 2020. Judy?

Thank you, Bob, and good afternoon, everyone. Our total revenue for the third quarter of 2020 was $6.4 million. This was a 4% decrease from $6.7 million of revenue we recognized in Q3 of last year. For the 9 months ended September 30, 2020, our total revenue was $12.5 million. This was a 2% decrease from the $12.8 million we recorded in the first 9 months of last year. The decrease in revenue for the 3 and 9 months ending September 30, 2020, was a result of a reduction in the number of equipment installations due to COVID-19 travel restrictions compared to the same period in 2019. Our gross profit for the third quarter of 2020 increased 6% to $4 million or 61.9% of revenue from $3.8 million or 55.9% of revenue in the third quarter of 2019. The increase in gross profit was primarily due to the product and service mix, reduced direct material costs, warranty costs, and lower travel costs. For the first 9 months of the year, our gross profit increased 1% to $7.1 million or 57% of total revenue from $7.1 million or 55.2% of total revenue. The slight increase in gross profit was primarily due to sales volume and product mix, which tends to remain fairly consistent as a percentage of total revenue when compared annually. Our operating expense for the third quarter of 2020 was $2.7 million, a 10% increase from the $2.5 million we reported in Q3 of last year. For the first 9 months of 2020, our operating expense increased 1% to $7.3 million from $7.2 million in the same period a year ago. The increase in operating expense for the 3 months ending September 30, 2020 was due to a $266,000 impairment in the investment in That's Eatertainment Corp., known as TEC, recorded as an operating expense. The 9-month period also included a $406,000 impairment in the investment of TEC recorded as an operating expense, which was also offset by reduced selling, general administrative costs from COVID-19 restrictions on travel and trade shows. Turning to our profitability measures. Income from operations for the third quarter of 2020 was $1.2 million, in line with income from operations of $1.2 million in the third quarter of last year. For the first 9 months of 2020, loss from operations was $115,000, slightly above the loss from operations of $94,000 we reported for the first 9 months of 2019. Our net income for the third quarter of 2020 totaled $868,000 or $0.11 per diluted share. This compares to net income of $937,000 or $0.12 per diluted share in Q3 of last year. For the 9 months ended September 30, 2020, our net loss totaled $123,000 or $0.02 net loss per diluted share compared to a net loss of $10,000 or $0.00 net loss per diluted share in the comparable period a year ago. Our adjusted EBITDA and non-GAAP financial measure improved to $1.6 million in the third quarter of 2020 compared to adjusted EBITDA of $1.4 million in Q3 last year. For the first 9 months of 2020, our adjusted EBITDA was $615,000 compared to adjusted EBITDA of $339,000 in the first 9 months of 2019. Turning to our bookings and backlog. We define bookings as the total of newly signed contracts and purchase orders received in a given time period. For the 3 months ended September 30, 2020, we received bookings totaling $6.5 million. We define backlog as the accumulation of bookings from signed contracts and purchase orders that have not been started or uncompleted performance objectives. Therefore, they cannot be recognized as revenue until it's delivered in a future period. Backlog also includes extended warranty agreements and step agreements that are considered deferred revenue recognized on a straight-line basis over the life of each respective agreement. As of September 30, 2020, our backlog was $14.4 million, which was up 27% or $3.2 million from the $11.3 million we reported a year ago and up from $14.3 million at the end of June 30, 2020. Finally, to our balance sheet. At quarter end, we had approximately $4.1 million in cash and cash equivalents, which was up from $3.3 million in cash and cash equivalents and certificate of deposits at the end of the period ended December 31, 2019. Accounts receivable and unbilled revenue combined to total approximately $6.2 million at quarter end compared to $5.9 million at December 31, 2019. From a working capital standpoint, we ended the second quarter 2020 with $7.7 million in working capital compared to $7.2 million in working capital at December 31, 2019. For additional details of our financial results, please reference our 10-Q, which was filed earlier today. That concludes my prepared remarks. I'll turn it back over to Bob.

Thanks, Judy. As we've discussed on prior calls, VirTra began as just an idea and then after years of hard work became the gold standard for effective simulation training for police. What's incredibly exciting is to see it happening again. You see by leveraging millions of dollars of already invested by VirTra, military clients could benefit from our technology. They could realize higher realism and training at higher levels of durability and with lower costs than in the past. This is very possibly the largest growth opportunity presented to our business. This is also exactly the kind of thing that excited Mitch Saltz. His courage to start new enterprises or take over Smith & Wesson and turn it into one of the greatest success stories in American business was nothing short of amazing. As you likely know, an independent VirTra board member, Mitch Saltz passed away this year. The entire VirTra community has been mourning his loss, and our thoughts and prayers remain with his family and loved ones. Mitch believed that when VirTra created the best simulators in the world, then we owed it to the world to train not just police but also war fighters, and we plan to accomplish this noble goal. In the last quarter, we've made substantial progress positioning VirTra to grow our business in the military market. The $1.9 million contract we won as a result of our partnership with Infoscitex, or IST, I mentioned a few moments ago, is a great example of a key foothold we're establishing with the military. IST is a subsidiary of DCS Corporation, which previously won a $135 million contract to support the Air Force Research Laboratory's Airmen Decision Making and Interface, REsearch, or ADMIRE, program. The purpose of the contract is to develop technology that improves our military war fighters' decision-making, marksmanship skills, and others. Through our partnership, we're providing a critical and unique piece to the puzzle. It is made possible by building upon VirTra's award-winning technology. We're working to develop next-generation training content with the expected result of unveiling the most effective simulation system for skill improvement the world has ever seen. Never before have our aspirations been so high and the support we are receiving from the DoD so complete. The revenues from this project are important, but what's paramount is what it says about the military's appetite for our solutions and technical know how. They use this contract vehicle to bring us on board and work together on new capabilities. There are obviously no guarantees, but this work shows the value we can offer to the federal government, and it could help accelerate our penetration into the military market, especially when major milestones are reached. To ensure our strategic approach to the military market is sound, we require those with proven track records and decades of experience. Last year, we engaged JL O'Connell & Associates, a highly regarded business development firm to help our efforts in the military market. And last week, we added John Givens, one of the very best military simulation experts in the country to our board of directors. John's an incredibly well-regarded and accomplished simulation industry executive who started with an idea and built one of the most prominent simulation training companies in the world. We're confident that his expertise in simulation training and, in particular, his experience with the military market will be of great value to our organization as we make a more concentrated push into the military. We're honored and very excited to have him on board. Matt Burlend and I have a combined total of about 30 years' experience in the police simulation training market, whereas John has about 20 years in the military simulation market and is a world-class addition to our board. I'd like to now move our attention towards the end of 2020 and the start of 2021. As you can see, our 9-month financial results are in line with where we were a year ago despite the pandemic. And while we had quite a hill to climb last year, we were able to achieve a rare business achievement, our 14th consecutive year of top line growth. There's no guarantee that we'll be able to continue that trend this year, given the state of the world, but we are cautiously optimistic that it is possible. We have the same grid and commitment to excellence this year as we did last year, and our team has certainly proven our ability to deliver under pressure. We have a larger backlog than we did a year ago. And during the third quarter, our hardworking sales team generated $6.5 million in bookings, the majority of which will likely be converted into revenue in the fourth quarter. As I said at the start of this call, the pandemic and our customers and government's response to it could materially impact our ability to install product and therefore, recognize revenue. We've seen lockdowns hit Europe in recent weeks. And should that happen in the U.S., we could certainly find ourselves in situations that echo the challenges we faced during the second quarter. Regardless of whether installation headwinds pick up, the fact remains that the long-term prospects for our business remain better than ever before. VirTra has proven a remarkably stable company with a clean balance sheet and a history of successfully navigating challenging economic environments. We have $4.1 million in cash, no debt other than the PPP loan, which we expect to be fully forgiven, and financial progress that essentially matches this time last year, but with new sales exceeding last year. We remain cautiously optimistic that we will end the year on a positive note due to the quality and mix of our backlog and the exceptional work our team continues to put in every day. And with that, I'm going to wrap up my personal remarks, and we'll open the call up for your questions. Operator, please provide the appropriate instructions.

The floor is now open for questions. [Operator Instructions]. Our first question comes from Jaeson Schmidt with Lake Street.

Bob, I know you're remaining mindful of sort of the macro backdrop here in Q4. Just curious if you think Q3 potentially benefited from customers sort of pulling in orders to get in ahead of some potential noise, whether it be the election, whether it be spiking COVID cases, et cetera.

Yes. Great question. I think that there's definitely some potential there, but realize in years past, they've also had those kind of concerns. So even though there is an election year, if you go back 4 years in VirTra's history, there wasn't an unusual event. So I do think, though, that there was some of that, but I do think it is kind of in line with the way it's been handled in years past.

Okay. That's helpful. And then you've always talked about the military market being a significant opportunity for you guys. What do you think is really driving sort of some of the traction you've been seeing recently?

Well, can it be as simple as a result of a lot of hard work by very talented people? We've been working on the military market for many years. We've focused on it specifically of late. But really, we've -- our first products released in 2004, had designs built into them and ambitions around the military market. Now we ended up finding a lot more success in the police market right off the bat in 2004. The military market, though, is known for taking much longer to develop, to find the right contacts, to get the right opportunities. It just generally takes more time. So I do think though that the military recently has gone through a major transformation where they're really looking at how does immersive virtual reality transform the way that they train. And in doing that, they really have focused on the idea of point of need training, meaning how do we get simulation products into the hands of the actual war fighters and not have it be a situation where war fighters have to travel to a simulation center once every 6 months and get some training. And so that shift is, I believe, has really opened up opportunities because VirTra has done a lot of products from our electric return fire device that simulates return fire or threatfire to our drop in recoil kits that work with actual firearms and can create this lock back at 30 rounds. So if you're shooting an M4, it locks back when you would be out of ammunition, for proper training and avoiding training scars. So -- and I also think maybe the military of today is a little more open for innovative commercial companies that have products that have been refined in the commercial sector that actually have a lot of applicability to the training within the military sector. So if you look at the OTA awards, that's other transactional authority, being executed by military, that whole idea of OTA is around the concept of getting innovative companies that traditionally have not been a large supplier to the defense department, getting them into the queue. And if they have a great product at a great price for the military, then taking advantage of that opportunity. So our philosophy is that we want the military to see VirTra as an area where they can take advantage of an opportunity where they can leverage what we've already accomplished and then possibly tweak it a little for their need, but ultimately end up with an incredible product that exceeds what they've done in the past. And I think a lot of the military decision-makers are on board with that concept.

Okay. I appreciate that color. And then last one for me, and I'll jump back in the queue. Curious if you could update us on what you're seeing in the STEP program and if you're seeing any traction there?

Yes. We continue to see traction on the STEP program, but it is a very situational program, meaning that certain agencies, they may already have money queued up and available for an equipment purchase. And so they will go -- proceed with the equipment purchase regardless of us offering a STEP program. We have other customers out there that have no ability to do a capital purchase. They do not have the money. It might be a 1 to 2 to 3 years for them to get budget for the equipment. And so sometimes those groups absolutely are delighted that we have a STEP program option so they can get started with some of our equipment right away. So we're seeing a mix. It's just every group is a little different. I will say that we're noticing some move towards simulation as a service. And so that simulation as a service definitely feeds into the whole STEP concept. And we feel very fortunate that we spent the time 2, 3 years ago to do the research and begin the groundwork needed to have a STEP program that's now entering its second year. And the last I heard, every single customer who had signed up for a subcontract renewed. Every single one, which is a phenomenal track record. And many times, people have other issues of why they might cancel. But right now, every single person who did the 1-year STEP has renewed for a second year, that had begun. So great question. Thank you.

And our next question comes from Richard Baldry with ROTH Capital.

I'm just wondering if you could comment a bit on the linearity of the quarter. Sort of curious at both in terms of the bookings and deployments. So did it start pretty tight in the beginning of the quarter and then kind of open up a lot by the end? Or was it more flattish? And maybe a little color around the beginning of the fourth quarter to date?

Just to clarify, are you speaking to recognize revenue throughout the quarter?

Sort of how well you're able to get out and actually deploy because you had a good revenue quarter and -- but the backlog [indiscernible]. So I'm sort of just curious, I guess, it could be 2 parts. It could be the bookings to sales and how that reacted, but also your ability to get -- where a lot of the deployments are late in the quarter because you were able to gain access to facilities later and how that's working now.

Want me --

-- Yes. If you want to cover that, Judy.

In terms of the bookings, it's very hard to say. They have just come in consistently throughout the quarter. I mean, we've had some larger contracts, and those have been in the works for a while. We have quite a long lead time in our pipeline, especially for some of those larger contracts. And so they just tend to come in the door when all of the items are checked off and the contracts can be issued.

As far as recognized revenue, I do think that those -- that there were moments where we had a little bit more travel available. But that team is in a constant mode of planning. And so that does adjust based on the customer. So really, many times, that's based on how open customers are at, saying, okay, we're ready, shift the equipment. We're going to have people on staff for training. And so -- and then if some -- if one group says, oh, we can't do it, then we pivot and look for another customer who we've completed the products for or can get the products through production and testing in time to meet their deadlines. I think the sales surge that we've had where our sales team has outperformed where we were last year, I think that's given our operation team a lot more flexibility. And even despite the fact that COVID would stop them from doing certain installs, they're able to pivot to another install where they get an opportunity to get it in before the end of the quarter. And so yes, you're right. We have a dual situation where despite COVID, we had a really incredible recognized revenue quarter but then also, we were able to pivot and actually have that be achievable because our sales inflow is very high. So we have a lot of new orders that we can kind of pick and choose from as far as working through the time lines of customers to get them through. And then we also, of course, do have -- international is where we think there are more delays in things where we could have even had a better year this year had it not been for the major headwinds from COVID on the international front, which is more exacerbated than the domestic front.

[Operator Instructions]. Our next question comes from Allen Klee with National Securities.

You said in your remarks that your ability to kind of travel and deliver had improved in 3Q versus 2Q. I'm just curious, how would you say that that is today versus how it was in 3Q?

Yes, thanks. Great question. I -- as of today, it's similar. Third quarter, we didn't -- COVID did not impair us very much on the domestic front, in some cases, not at all. Fourth quarter, it's unknown. So if fourth quarter is similar to third quarter, then we're expecting to have a good finish to 2020. So I have -- we have heard like you -- like everyone's heard and watched the news of surging COVID cases, but also, we've had a lot of the reports that people are getting adjusted to COVID-19 and have found ways to work around it. So it's really to us many times, as you can imagine, it's somewhat particular to the exact customer that we have as to whether or not we're able to install. And then there is the potential of some states requiring negative tests before accepting travelers. And of course, we have no problem with complying with that, but that could also slow us down in fourth quarter. So we're still cautiously optimistic about fourth quarter, but we definitely realize that we could have some efforts hamper. Good news is, is that all that that might mean is a delay in revenue and not a negative impact overall on the company. So we continue to gain a lot of traction throughout the industry with our products and our services, and we see that only potentially accelerating into the future.

When I look at the segments of your revenues, your customized software and customized content scenarios has been growing nicely sequentially over the last 3 quarters. Could you tell us kind of what's going on there and how you think about that particular line?

Yes. I think that's a result of having a large install base of equipment out there. And that's also a result of certain clients requesting very specific customizations from us for their purpose. I think that's just a sign of a healthy company that's got a large install base with some very strong customers that have the interest and the wherewithal to get some customization done to exactly their specifications. And so we certainly support that, and we also support clients who want to use our nationally certified curriculum V-VICTA as it sits. And we have a lot of people who are -- really like the fact that they can get world-class de-escalation from VirTra without having to try to hire a bunch of experts from around the country and figure a lot of things out for themselves that we've done a lot of that hard work for them. So while the custom projects we support, and it is helpful to our company, we also very much support those clients that want to use our library as it comes.

Okay. And you've spoken about your international business and the reasons why it's down year-over-year due to COVID being more of an impact. What -- but how about just the general interest of potential deals that could maybe turn it to something in the future once travel becomes better? Could you comment on that?

Yes. We think that that is actually very healthy and growing. And at a very macro level, I think that has to do with how the world is becoming more and more accepting of technology. Many years ago -- I know this sounds outrageous, but many years ago, there was actually pushback from instructors that thought the only way to train was using light bullets and paper targets and that any other type of training could not be useful. Now, granted, that was 20, 30 years ago, but that was also a time when people were not using smartphones, and there is just a large wave of acceptance and it grows every year with younger and younger instructors and younger and younger mayors and city council people and chiefs of police. There is this acceptance that technology can help in so many ways where it didn't help before. And de-escalation training, the certified curriculum, learning how to handle autism and those with mental issues, all of that type of training officers are often expected to have nowadays, our capability to deliver that is really unparalleled. And I think it's more and more accepted worldwide as technology is essentially more and more accepted and more powerful. Every day, we normally see our -- the components that we have available to use for our approach to simulation training, they get better and cheaper because of all the push of the components, the cost items that we use. So it's a very good macro level story for the future of VirTra. And not just VirTra, but the future of simulation training, I believe, is going to only increase. Also, if COVID remains an issue for years or another biological hazard becomes an issue, VirTra's approach to training is often very friendly to having some level of isolation. So you can get a lot of training done through our technology without having to have a large group of people in one location. So that could also be helpful for -- as a -- on the international stage. Does that answer your question?

Yes. One just small housekeeping question. Did you say that the expense related to your impairment charge was $260,000 and that's one-time in your expenses? And then does this mean anything in terms of how we -- the royalty payments that you get should -- is there any reason why that number should change in the future?

So the impairment is tested quarterly and looked at on a quarterly basis ongoing over the life of the investment. And in terms of the impact on royalty, it is -- it's just the cost basis of carrying on the balance sheet through the investment that we have to review and analyze for impairment and is independent of the royalty. The royalty is based off the calculation of modern around performance, and that's an ongoing quarterly or monthly calculation.

And Allen, yes, it is a onetime expense.

Quarterly.

Yes. No, it's analyzed quarterly.

Yes.

But it is -- you are correct, that is a onetime hit as you could think of it.

At this time, this does conclude our question-and-answer session. I'd now like to turn the call back over to Mr. Ferris for his closing remarks.

As always, we appreciate you all taking the time to join us. On Thursday, we'll be participating in the ROTH Technology virtual event. For those investors and analysts who are attending, we look forward to speaking with you soon. As you know, tomorrow, November 11, we honor the service of all veterans. I ask that we make special effort to keep in our thoughts and prayers the missing, the fallen, and those who right now volunteer to potentially be in harm's way to preserve our way of life. I'd like to remind those who own shares of VirTra that our staff of nearly 100 talented professionals are hard at work building the world's most effective simulation training products so that the war fighter and the peace officer can serve their country, accomplish their mission, and make it home safely. I firmly believe the best days for VirTra are ahead of us. Be safe, take care, and God bless.

Thank you for joining us today for VirTra's third quarter 2020 conference call. You may now disconnect.