VirTra, Inc. (VTSI) Q2 2021 Earnings Report, Transcript and Summary

Good afternoon, and welcome to VirTra's Second Quarter 2021 Earnings Conference Call. My name is Jess 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 Chief Accounting Officer, Marsha Foxx. Following their remarks, we will open the call for questions from VirTra's institutional analysts and investors. Before we begin the call, I would like to provide 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, 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, operator. And thank you everyone for joining us this afternoon. After the market closed today, we issued our financial results for the second quarter and six months ended June 30, 2021. As you can see from our release, we delivered strong results across the board in the second quarter, highlighted by 90% increase in total revenue and a 99% increase in gross profit. Our continued focus on driving profitable growth also enabled us to deliver another quarter of positive net income and adjusted EBITDA, which totaled $1 million, or 19% of our total revenue. Demand for VirTra's world class training solutions continues to build as reflected by the 6% sequential and 19% year-over-year in our backlog, totaling a record $17 million at quarter-end. Our strong financial performance in Q2 also demonstrates our team's consistent operational excellence, as well as the value and effectiveness that VirTra's products provide to our end users and partners. Our results also reflect the continued execution of key strategic initiatives to drive business scale. I'm very proud of the exceptional team we have assembled at VirTra who continue to perform despite the ever-changing COVID-19 limitations. Before I go into more detail about our operational initiatives and progress within the context of our growth strategy, I'm going to turn the call over to our Chief Accounting Officer, Marcia Foxx, to walk you through our financial performance for Q2 and the first six months of 2021. Marsha?

Thank you, Bob. And good afternoon, everyone. It's a pleasure to be speaking to you today to review our financial results for the second quarter and six months ended June 30, 2021. Our total revenue for the second quarter of 2021 was $5.3 million. This was a 90% increase from the $2.8 million of revenue we recognized in Q2 of last year. For the first six months of 2021, total revenue increased 59% to $9.7 million from $6.1 million for the first six months of 2020. The increase in total revenue for both the second quarter and the first six months of 2021 was due to an increase in the number of simulators and accessories completed and delivered, and therefore revenue recognized compared to the same periods in 2020. Our gross profit for the second quarter of 2021 increased 99% to $3.1 million from $1.6 million in Q2 last year. Gross profit margin for Q2 2021 was 59.7%, an improvement compared to 57% in Q2 last year. For the first six months of 2021, gross profit increased 80% to $5.7 million from $3.2 million for the first six months of 2020. Gross profit margin for the first six months of 2021 was 58.8%, an improvement compared to the 51.9% in the same period last year. The improvement in gross profit and gross profit margin for both the second quarter and the first six months of 2021 was due to decreased costs and a more favorable product mix of systems, accessories and services sold. Our net operating expense for the second quarter of 2021 was $2.3 million compared to $2.4 million in Q2 last year. For the six-month period, net operating expense was $4.3 million compared to $4.5 million for the first six months of 2020. The decrease in net operating expense for Q2 and the first six months of 2021 was primarily due to the impairment write-down in 2020, offset by an increase in software license fees in 2021. Turning to our profitability measures. Our income from operations in the second quarter of 2021 totaled $821,000 compared to a loss of $822,000 in Q2 last year. For the six-month period, operating income was $1.4 million, an improvement compared to an operating loss of $1.3 million for the first six months of 2020. Net income for the second quarter of 2021 totaled $529,400 or $0.05 per diluted share, an improvement compared to the net loss of $601,300 or a loss of $0.08 per diluted share in the second quarter of 2020. For the six-month period, net income totaled $1.2 million or $0.13 per basic and diluted share, an improvement compared to a net loss of $990,700 or a loss of $0.13 per basic and diluted share for the first six months of 2020. Adjusted EBITDA, a non-GAAP metric, for the second quarter of 2021 totaled $1 million, an improvement from a loss of $579,200 in Q2 last year. For the first six months of 2021, adjusted EBITDA totaled of $1.8 million, an improvement from a loss of $978,300 for the first six months of 2020. Turning to our bookings and backlog. We define bookings as the total of newly signed contracts and purchase orders received in a defined period. For the six-month period ending June 30, 2021, we received bookings totaling $13.5 million. Furthermore, we define backlog as the accumulation of bookings from signed contracts and purchase orders that are not yet started or uncompleted and cannot be recognized as revenue until delivered in a future period. Backlog also includes extended warranty agreements and step agreements that are deferred revenue recognized on a straight line basis over the life of each respective agreement. As of June 30 2021, our backlog totaled $17 million, which was up 6% from the prior quarter and 19% from Q2 last year. Finally to our balance sheet. As of June 30, 2021, we had unrestricted cash and cash equivalents of $23.8 million compared to $5 million at the end of the prior quarter. From a working capital standpoint, at the end of Q2, we had $27.7 million in working capital, an improvement from $10.8 million at March 31, 2021. For additional details of our financial results, please reference our Form 10-Q, which was filed earlier today. That concludes my prepared remarks. I'll now turn it back to Bob.

Thanks, Marcia. The demand for VirTra's world class training solutions continues to swell. And our ability to fill that demand and to continue to grow remains mission critical. In many ways, our success over the last 20 years is the result of our organization's flexibility and adaptability, attributes that have allowed us to build a world class team, customer base, and training systems, while facing various challenges. While flexibility and adaptability will continue to serve as the foundation for VirTra going forward, we are at a critical point in our growth trajectory that requires us to take measured steps to drive even greater business scale. You've heard me talk about scale on prior calls, and we have certainly made meaningful progress in our efforts to build financial scale, organizational scale and operational scale. Over time, we project that these efforts will enable us to deliver more value to our end users and shareholders and, ultimately, greater success on our goal to save and improve lives through truly effective training simulator product lines. In terms of financial scale, in April, we bolstered our balance sheet by successfully executing an $18 million equity capital raise. Now with more than $23 million of cash on our balance sheet, we have the resources to accelerate growth by more effectively capitalizing on larger opportunities in both the police and the military markets. As we pursue larger and larger opportunities, it's important that our organization and infrastructure are built to absorb it. An integral part of this is our human capital. VirTra's ongoing success in large part is a reflection of our talented people and valued partners. VirTra has worked alongside some of the most gifted people in our industry long before de-escalation training made the headlines. In fact, one out of every three VirTra employees is a veteran or retired law enforcement officer, who understand their crucial need for realistic training. These individuals fundamentally believe in effective training, which provides us with the critical insights to deliver value to our end users. As our top and bottom lines have expanded, so has the need to scale the human capital of our organization. Our expansion extends across many departments from increases in our operations and production to increases in staff creating our remarkable training content and next generation products. Today, our organization spans approximately 119 talented individuals dedicated to realizing VirTra's mission. We have the strongest and most talented team in our company's history, who collectively provide us with the knowledge base and know-how and reach to capitalize on the growth opportunities in our pipeline. As it relates to our infrastructure, our in Q1, we began the upgrade of our ERP or enterprise resource management system to significantly improve our business processes, logistical systems, and internal controls. While the implementation of a new ERP system may not seem significant on the surface, it is in fact a major milestone in positioning VirTra for higher growth and greater scale in the years ahead. With our financial and organizational improvements underway, our focus is on building operational scale. More specifically, this involves increasing our manufacturing efficiencies and production capabilities to meet not only the demand today, but the anticipated demand in the future. This is an ongoing process borne out of our continued success and I look forward to sharing further updates with you in the near future. During the second quarter, we received an $800,000 delivery order under the five-year single awardee IDIQ or indefinite delivery indefinite quantity contract from US Department of Homeland Security for US Customs and Border Protection. Since September, we have provided Customs and Border Protection with video-based simulators and custom content for its training facilities. We anticipate generating continued revenue from the IDIQ for the next two years, which could be up to $5 million over the five-year contract for just this one IDIQ. Continuing to assist Customs and Border Protection with their training is proof of the value and efficacy of our products. As a vital necessity to our country, CBP agents and officers must have effective tools to ensure the development and retention of their skills, and VirTra is proud to be their solution of choice. US Customs and Border Protection is just one of the many domestic and international law enforcement agencies that have deployed our systems, accessories and curriculum. Along with best-in-class customer service and unparalleled technology, including the world's first 300 degree small arms simulator and innovative and patented recoil kits, it is no surprise that the finest military and law enforcement agencies in the US and globally continue to select VirTra. Our partnerships with larger companies that have existing relationships with the right military decision makers continues to gain traction. While we are eager to share more about current programs and prospects, as I mentioned on our last call, due to the sensitive nature of many of our relationships, we are prohibited from disclosing details related contracts. VirTra's approach continues to be to put the business first and we believe actions and results speak louder than words. We say as much as we can when we can, but there are instances in which we are prohibited from disclosing specifics. Unfortunately, this remains one of those instances. At a high level, VirTra provides advanced training systems to best prepare the military for real life incidents, including servicemembers to better protect our country and return home safely. Much of VirTra's investment in the simulation training improvements that have taken the police training market by storm also improve military training. Our military training simulation product lineup now contains drop-in recoil conversion kits that support form, fit and function closely matching the real weapon, the most effective de-escalation scenarios in the industry, state-of-the-art simulator ballistics with a full marksmanship suite, the ability to quickly author photo realistic scenarios, custom courses of fire, military weapons qualification courses and much more in development. These capabilities are unique to VirTra and are the reason for why we remain confident in our ability to extend our competitive moat and capitalize on the abundant opportunities within our markets. In summary, the second quarter was strong across the board. As we look ahead, our business has never been better positioned to grow and scale than it is today. Our pipeline is expanding, our sales are accelerating, and the need for effective training that enhances skills and saves lives is increasing. Our financial and operational success in the first half of the year, coupled with the operational measures we're executing, has us on track to deliver accelerated and profitable growth in 2021 and beyond. And with that, I'm going to wrap up my prepared remarks and we'll open the call up for your questions. Operator, please provide appropriate instructions.

[Operator Instructions]. We'll go first to Jaeson Schmidt with Lake Street.

Congrats on the continued momentum. Bob, I just want to start with sort of that momentum you have been seeing. I'm just curious if you could talk about the order patterns you've seen so far this quarter. I know you don't provide guidance, but how should we think about some of the dynamics here in Q3, especially with seasonality regarding the government's fiscal year-end?

We're quite pleased with the robust sales pipeline that we have. But there is a but on that. It is very difficult for us to judge exactly when pipeline will turn into orders, and then orders turn into recognized revenue, i.e. when we actually are allowed to deliver and install. Still having some COVID-19 limitations. So, we're still facing some challenges at times on installing equipment, thereby being able to recognize revenue. But, overall, we've been pleased on the local and state police departments. Their budgets seem to be going fine. They seem to be able to place orders. But of course, that can change. But as of right now, it seems like the government agencies are executing on the idea of adding training technology that can help them achieve their goal of keeping their officers and the public safe. So, overall, we're pleased, but we monitor that very closely.

Just following up on those comments on budgets, wondering if you could expand on what you're hearing from your customers regarding their budgets. I think there was a lot of concern that COVID was going to do some pretty heavy damage to forthcoming budgets, but now you have some federal funding initiatives and then the different dynamics, whether it be Defund the Police movement, rising crime, and certainly some of these budgets are in focus now. So, just curious, the commentary you're hearing from customers.

It ranges. And we have some customers who have no budget issue. I would say that the biggest area for our sales team is to be able to demonstrate our product to the client, if at all possible, and have them spend the time to look at what training product do I want. And if they actually try out our product and then try out alternatives to our product, that's the most important thing for us in winning sales, when you're actually able to see the training efficiency of what we provide and then compare that head to head versus other options, the decision becomes clear. And so, that's probably the biggest issue is, is convincing them that they need training. First of all, some of them are already convinced that they need it. And then the second thing is, okay, if you if you do realize you need to train, then who do you use to train. And I think VirTra, as of today, has a lot going for us to be that choice, particularly if they actually try out the product, which we always encourage them to do because this is a very important purchase. It's usually one of their key training purchases, and it has a huge ripple effect throughout their organization. If they buy a mediocre simulator, it sort of sets the tone for the entire organization and their approach to policing. And if they choose a high level product, it's as if they're holding themselves to a higher standard, which I think a lot of police agencies in America believe is the right course for them. So, yes, I would say that is the most important aspect of police budgeting is that VirTra makes sure that they take the time to make a good decision on where they spend their money.

Just the last one for me, and I'll jump back in the queue. You mentioned COVID maybe creating some friction from the install side. But are you seeing any constraints from the supply side, specifically any components you can't source?

About nine months ago, we began adding extra inventory of components that we felt might get constrained, and that served us well, but we're constantly monitoring that. I can say that that, as of today, we have not been unable to ship a product due to those constraints. In other words, we've not been missing a component from Asia that is stopping us from being able to ship. But that is something that we are aggressively monitoring and actually already did some proactive work along those lines and will continue to be proactive in stocking items that we feel could be dangerous for us to run out of in the future, if that makes sense.

We'll take our next question from Rich Baldry at ROTH Capital.

Maybe building on that last question. Could you talk about whether the inventory build sort of over-doubling from the beginning of last year to current, how much of that would be to support your much higher run rate for revenues? And how much is maybe to derisk component shortage concerns?

I think from a dollar standpoint, most of that is just due to the scaling of the business. So, in other words, while we put some money into derisking Asian components or chip-related components, the dollar value of that would be relatively small.

Can you talk sort of overall about or from a very macro perspective, the implementation challenges you're still seeing in a COVID resurgent world, I guess? Do you feel like the seasonality we saw last year where third quarter was pretty strong coming out of some inhibitors from COVID? Is that replicable this year? Is there anything unusual about the second half of this year? Really comparing your first half growth there about 60%, is there also anything in that that's not duplicable in the second half?

That's a difficult one to predict. We're not exactly sure how COVID-19 is going to impact the rest of 2021. We are still seeing limitations caused by COVID-19 on the international front, particularly is still problematic. But even domestically, we can have installs delayed or postponed due to COVID-19 or other COVID-19 related issues. I think I would say that we are – 2021 is seen – in 2020, COVID-19 was very much so mainly a travel and an installation issue with COVID-19. And in 2021, it's expanded into more various issues. So it might be a travel issue or it might be a supplier issue because they had a COVID-19 issue. And so, now we have to go to an alternate supplier or work around a supply interruption. So, 2021 COVID-19 issues, I would just say, are now more complicated and a little less heavy handed. In 2020, it was just almost like complete moratorium on travel for a while. And that was a very heavy handed impact. And that's what you saw in some of the 2020 numbers that we posted. 2021, it's more nuanced. And I'd like to say that that should minimize its impact somewhat, but not really sure. It's a bit of a moving target on that one.

I know you don't guide, but sort of curious. Your first half bookings were up 92% year-over-year, so not just taking the good number from the second quarter, but the full first half. What really drives the difference between longer term – between reported growth and bookings growth? Is there sort of a meaningful long-term separation between those, should they converge over time? Because while your first half growth has been very strong, your bookings are even higher than that. So, I'm sort of just trying to understand how we should think about second half, even up to 2022, against a backdrop of that booking strength.

The bookings for us get a bit complicated because there's a little publicized aspect of VirTra in which part of our revenue is a recurring revenue component that goes out sometimes for years. Sometimes, the customers will buy five years of warranty, for example, at the time of purchase. And then we have to follow very specific guidelines where we have to spread that revenue out for years. So, there's a recurring revenue component. And then, VirTra does not break out that recurring revenue component independent. So, there is some convergence of backlog and bookings into recognized revenue. But it is not a straight line. And it is a bit complicated because included in that are warranties that are three years out in the future. What is not included in that, just to set the record straight, is if we receive an IDIQ, that does not get put into it. So, an IDIQ of $5 million is saying that the government has a vehicle to spend up to $5 million with us over X number of years. We never put that number into bookings that we would have to receive a direct order from that IDIQ. And then, that direct order, saying I want these products and I want them delivered in 60 days, that would then become part of our backlog. And then, when we deliver those within 60 days in that example, then that becomes recognized revenue. So, did that answer your question?

Yeah, it did. The last kind of build on that, it looks like, in my model, the bookings for second quarter were better than any two of your quarters last year combined. I assume that was a record number for the company. And the deferred revenue growth sequentially, I guess, must be tied to that because it's spiked to a pretty dramatic new high, the sequential growth is almost bigger than your total deferred revenues. You'd had up to say a year ago. So, can you maybe talk a little bit about how the deferred revenue should look going forward and sort of the magnitude of that bookings versus any prior record numbers?

Our deferred revenue figures going forward, just like Bob was saying a few minutes ago, where we have certain customers that purchase longer-term warranties and it will flow through our deferred revenue into revenue, the deferred revenue number is going to fluctuate based on exactly when the backlog becomes a true order. It's a really difficult number to actually model. I believe you asked a similar question last quarter, and it's a very difficult number to model.

If it's in backlog, it is a true order. It's an actual order. The only problem would be is that we can't no matter – obviously, if it's a three-year warranty – so someone buys a simulator and buys it with a three year warranty because they've got enough budget to do all of that and that way they don't have to go back and ask for permission, so they do it all at once, then that three-year warranty, we cannot recognize, obviously, until we – and we recognize a little bit every quarter. We've now accumulated so many of those that those are starting to become a decent amount of money that already are credited to us going into that quarter where while we fulfill the warranty obligations during that quarter. So, one thing to keep in mind is we started the subscription program. What the subscription program says you can do a pure recurring revenue model with VirTra in which you pay monthly, quarterly or for the year and it's only a 12-month span. So, you can imagine, maybe somebody before did a three-year purchase with a three-year warranty might now say, well, I'll just do a one year step program. So, then that would actually impact that customer right there which is actually a wonderful customer to VirTra. To have a pure recurring revenue customer is wonderful. But that customer might actually shift out of that being part of the deferred revenue and now shifted into the step income which we don't currently segregate out. So, that's where some of the fluctuations can come in. And then, also, we could just simply have fewer people who order a simulator with a three year warranty or with a five year warranty. There are certain customers who'd like to do that. And maybe they still do. But they order simulators. And then they wait, the simulators get old, and then they later on do another order. And so, there's some time sequences between what customer comes in with what order, with what number of years of warranty, if that makes sense.

And our final question from VirTra's institutional analysts is from Allen Klee with Maxim Group.

Could you talk a little more about the step offering? And maybe like how that's changing as how much it is of your mix. So, just relatively, if you think it's meaningful? And is it growing as a percent of everything that you sell?

Great question, right? He brought up step. So, our subscription model that we launched over two years ago, we continue to offer to the market and we have some folks in the market that have really taken to it. And then, we have some who absolutely want to purchase straight up and we have some who want to purchase like we were just talking and want to include a three or four or five year warranty with their purchase. So, we continue to see all of the above in the door. Marsha and I are delighted to see all of those come in the door and in large numbers and as we try to bring the highest level of training to the police and military. So, we're delighted that it's working. The step program continues to be a very valuable tool for our salespeople. And so, we've heard nothing but compliments on it. In fact, as of today, I am not aware that we have had a single step program stop their service. So, in other words, 100% of every client who started a step program, started a recurring revenue version of our system has stayed on it and has renewed, not one has dropped off. So, we're very pleased with that track record. It is still a relatively small part of our business. So, we're not at a point where half of the orders coming in are subscription orders. But we do see – sometimes there's larger amounts of those orders and sometimes there's fewer. We're still in the process of educating the market for that. So, our market with government agencies generally tend to be slower sales cycles. So, it takes a while for people to become happy step customers and then they tell other people, hey, you should really just do the step program, it's great. That takes time. And that's really a more kind of the most effective sales process, is for the market to tell the other parts of the market that they should do this, but that does take some time. So, bottom line, we're delighted with our subscription model. Very good to see that recurring revenue piece of our business grow. But at this time, it is not separated out independently. At some point, we will very much consider having all of our recurring revenue components separated out potentially, when that makes sense. The moment we do that, of course, it's now hard to compare how we're doing to previous quarters because we have a change in the way we report our financials. And we're cognizant of that. Some shareholders prefer not to have any change, so they can keep doing one to one comparisons. But there may be a point when the value of separating that out warrants separating it out.

My only other question is, in your prepared remarks, you spend a good amount of time talking about plans to scale the company and you talked about your ERP system and how your people are so important. And I know you don't give guidance, but would it be reasonable to imply that this means that operating expense growth rate might be at a higher rate going forward than kind of the run rate that it's been at?

You know that we're a conservative management teams, but, yes, there's the potential that, for certain situations, we might have to spend some money on the capital equipment or on infrastructure beyond just software licenses. We might need some physical machines and things like that. But keep in mind, we are not the sort of company that requires a billion dollar foundry or that sort of CapEx. And we're generally a conservative group. But, yes, there is the potential that our demand for products might exceed our physical equipment at some point, and we want to be ahead of that.

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

Thank you. We really appreciate everyone taking the time to join us today. Thank you for being part of VirTra's journey. We are honored by your continued support and in trusting the team at VirTra with your investment and to realize our mission of saving and improving lives through highly effective simulation training to someday reach every police officer and every warfighter who serves America and our allies. Be safe. Take care. And God bless.

Ladies and gentlemen, thank you for joining today's VirTra's second quarter 2021 conference call. You may now disconnect.