Good afternoon, and welcome to VirTra's Second Quarter 2022 Earnings Conference Call. My name is Laura, and I will be the operator for today's call. Joining us for today's presentation are the company's Chairman and Co-CEO, Bob Ferris; Co-CEO, John Givens; and Chief Accounting Officer, Marsha Foxx. Following their remarks, we will open the call for questions for VirTra's institutional analysts and investors. Before we begin the call, I would like to provide VirTra's safe harbor statements 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 co-CEO, Mr. Bob Ferris. Sir, please proceed.

Thank you, Laura, and thank you, everyone, for joining us this morning. Before the market opened today, we issued a press release that provided our financial results for the second quarter and six months ended June 30, 2022, along with highlighted business accomplishments. We also filed our 10-Q with the SEC, which is available for a review at your discretion. The first half of 2022 has been a strong start for VirTra, putting us on track for another year of record revenues as total revenue in the first half of 2022 was up over 50% from the comparable period in 2021, which was our highest revenue period in our history. The operational momentum we are capturing is noteworthy as we continue to penetrate our key growth markets in commercial, government and international. Additionally, this growth has been achieved while generating profits as adjusted EBITDA grew 33% in the first half of the year, and we remained profitable on a GAAP net income basis. The strong growth is being largely driven by the international commercial markets. You might notice that our government sales is down slightly, but keep in mind that normally the high season for us to receive new government orders is during the third quarter, and our sales pipeline is strong. Internationally, revenue in the first half of 2022 increased 125% from the prior year comparable period, but this was due to an unusual circumstance. As we have discussed on past calls, the international business was negatively impacted in 2020 and 2021 due to COVID-related travel restrictions. With travel restrictions now largely removed and international business travel resuming, we have been better able to sell our products and services internationally, which is manifesting itself in our 2022 results. With this momentum now reestablished, we are optimistic about our continued…

Thanks, Bob. Thank you. I'd like to focus my remarks today on the first 100 days or so at VirTra, and tell you that we've been very busy, day, night, weekends. As discussed on our last conference call, which was my first since joining the company, I felt we needed a presence in Orlando, Florida if we wanted to significantly expand our ability to capture the opportunities within the military market. Orlando is known as a worldwide epicenter for modeling and simulation industry for the military. There are 4 major military branches. All have procurement centralized out of Orlando, where they manage multibillion-dollar portfolios, including PEO STRI for the U.S. Army, PM TRASYS for the U.S. Marines, AFAMS for the U.S. Air Force and NAVAIR for the U.S. Navy. So in my experience, if you don't have a physical presence in Orlando to easily demonstrate your products and conduct on-site meetings, you're going to have a real hard time penetrating those markets. As you might guess, all the major defense contractors have offices in Orlando for this very reason. Since I've joined, we have leased a building right in the heart of this action. It's already up and operational, and we have a respected and seasoned program manager based in Orlando, and expect to add business development and other personnel in the coming months. We have virtual equipment on site. We've already completed demos and expect to be actively conducting regular demonstrations with military personnel over the remainder of the year. To succeed in the military space in the military market, I believe we need three key ingredients. First and foremost, you need a great product offering, which VirTra clearly possesses. The other two are present in Orlando and relationships to facilitate buying support for your product within the military.…

Thank you, John, 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, 2022. Our total revenue for the second quarter of 2022 was $8 million. This was a 52% increase from the $5.3 million of revenue we recognized in the second quarter of last year. For the six months ended in 2022, total revenue increased 52% to $14.8 million from $9.7 million in 2021. The increase in revenues for the three and six months ended June 30, 2022 resulted from an increase in the number of simulators and accessories completed, delivered and revenue recognized compared to the same period in 2021. Our gross profit for the second quarter of 2022 increased 51% to $4.7 million from $3.1 million in the second quarter of last year. Gross profit margin for the second quarter of 2022 was 59%, which was slightly lower than the 60% in the second quarter of last year. For the 6 months ended in 2022, gross profit increased 48% to $8.4 million from $5.7 million in the 6 months ended in 2021. The increase in gross profit was driven by an increase in the number of simulators and accessories completed, delivered and revenue recognized compared to the same period in 2021. Gross profit margin for the 6 months ended in 2022 was 57%, which was slightly lower than the 59% for the 6 months ended in 2021. Our net operating expense for the second quarter of 2022 was $3.7 million compared to $2.3 million in the second quarter last year. For the 6 months ended in 2022, net operating expense was $6.7 million compared to $4.3 million for the 6 months ended in 2021. The increase was primarily due…

Thanks, Marsha. Before I dive into my closing remarks, I want to spend a moment to discuss the departure of our Chief Operating Officer and Director, Matt Burlend, which we announced in our earnings release. Matt departed VirTra earlier this week after more than 20 years with the company, working his way up from an engineer to COO. Matt is credited with a long list of major accomplishments at VirTra and for the market. Matt was a key contributor to the growth and success of VirTra over the years, and we wish him all the best as he pursues new opportunities. To be clear, his departure was not the result of any disagreement with the company or any matters relating to its operations, policies or practices. We will not seek an immediate replacement for Matt at the company level, but we will plan to fill his Board vacancy in due course. I'd next like to spend a minute to recap our gross margin progression thus far in 2022. If you recall, gross margins in 2021 and the second half of 2021, in particular, were negatively impacted short term by our pursuit of a strategically important military contract that we believe will situate us well for certain future military business going forward. We thought of this as pay R&D and a short-term dynamic as we progress through that contract. Additionally, inflation through higher labor, materials and travel costs further impacted margins in 2021. So as we adjusted our business to deal with the inflation and move past that strategic military contract, we have seen gross margins return closer to our historical range. While margins will continue to fluctuate quarter-to-quarter, we are encouraged by the fact that gross margins in the first half of 2022 were 57%, very close to last year's 59% despite the inflationary headwinds everyone's familiar with. This is also a significant improvement from the 47% gross margin we recorded for full year 2021. Now looking ahead for VirTra, I think we are in the best shape we have ever been. Our growth opportunities remain extremely robust, bolstered by our co-CEO, John Givens', proven abilities in the military market. Our balance sheet remains robust and our internal operations are being streamlined to facilitate maximum scale and operational efficiencies. In Arizona, our move to our new headquarters in Chandler continues to be on track for a full move-in by the end of the year. As we have stated before, the state-of-the-art facility provides us with a larger and more centralized footprint and greater operational efficiencies. Coupled with our recently established Orlando presence, we have a growing capability to demonstrate our advanced training simulation offerings to the industry. 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 the appropriate instructions.

[Operator Instructions] Our first question comes from the line of Richard Baldry with ROTH.

Maybe a question for John. In the military market, can you talk about the cadence of seasonal bookings that you saw maybe at Bohemia prior? Is there a distinct seasonality to it? And what kind of scale do you think the company has to get up to before that seasonality would impact? I assume when you're early in something, maybe you can outgrow seasonality for a year or two.

Yes, that's a two-part question. So when it comes to the seasonality, the way military contracts work, they're usually issued as a base with four years of options for a five-year contract. Very, very, very rarely do they cancel option years once you've won the contract. It's usually to protect them, for a nonperforming company. So when you talk about seasonality, typically, September 30 is their end of year. So everyone is trying to spend their money and get things on contract so they don't de-obligate funding from all these different entities. So that seasonality you'll see in September, but then it kind of oscillates depending on when contracts are let and when they're ending their five-year contract run. The one big difference that we're going to take advantage of is the government. Because of shortage of their staff and those things, they've decided that they'll start working on 7- and 10-year contracts with like a three or four-year base. That's what we're going to take opportunity on. The second part of the question is, when I talk about scalability, internally, VirTra has done an amazing job on developing R&D smaller. We haven't done anything where we -- I call them cookie cutter, basically. We'll build one set of equipment, software or a capability for one customer, and we're able to resell it over and over again. VirTra wasn't set up in their org chart to be able to handle that type of cadence. So that's what the reorg was all about. I hope that answered the question.

Okay. And maybe in the regular police market, the traditional market. Can you talk about what you're seeing in the backdrop there? Bookings were off a bit year-over-year. Is there something happening in budgets? Or is it just timing? Just so we can kind of get a better grasp for what maybe the second half has for that.

Bob, I can give a quick -- go ahead, Bob. I'll let you.

Yes. So the bookings -- I was curious if someone might ask that question. With COVID impacting our abilities to schedule installs, we had unusually high backlog, kind of basically products stacked up. And so now, with COVID-19 limitation subsiding, we've been able to clear out, and our team did a great job in moving orders into actual delivered ship products, signed for products. And so our revenue, we were able to recognize an increase, but that did take some out of our backlog. So our backlog is going to decrease. So there's always that healthy balance of how much backlog do you have and how much of it you're able to convert to revenue in any given quarter, and I think that, that's improved. The other comment on that is that we do normally -- remember, we do -- we are the principal supplier for federal law enforcement in the United States. So federal law enforcement, they normally are on that federal budget cycle that John mentioned. Military is off and on. And so federal law enforcement, where we get quite a bit of our revenue on the police side of the house, that is something that hits us more so in third quarter than pretty much any other quarter normally. That's when they commit their funds, and that's when we take on new sales orders there. So I think those -- we are always monitoring that carefully and we always feel like there's areas where we can do a better job. And John, just to be clear, and one reason John was ready to jump in on that question too is, John -- even though we talk about John's military market expertise, which is pretty close to second to none, from my 29 years in the simulation industry, he is actually actively involved in VirTra at the highest level for both sides. He is in communication and directing our sales efforts in law enforcement, as well as military, as well as he's working operationally. So don't think of this as Bob is working law enforcement and John Givens is working military. And I think some would assume that based on John's amazing pedigree in the military side of the business. So just to be clear, John and I are working with different areas of VirTra, but at not in a market-delineated fashion.

Okay. And then in terms of sort of operational steadiness, can you maybe talk about are the ERP systems in a steady state that you feel like keeping up with filings should be pretty easy essentially going forward? And then inventories have stepped up to a much higher level. I assume a lot of that is to do with increasing orders and some safety stocks for COVID lagging reasons. So overall, do you feel like you're in a more smooth execution positioning now?

Well, as much as we can be, given that we're still moving and setting up our main facility, so we have -- our target is to have full integration in our new headquarters by the end of this year, and John Givens actually has been on the ground here physically helping move stuff. He's a hands-on -- he's a surprisingly hands-on guy for his track record in the market. So we've been -- so there's that. The ERP system, as we said before, is an evolving part of our company. So it is not done as of today. But as far as answering your question about the scaling, we absolutely are looking to ensure that we have scalability for the company and we are -- so we are definitely looking at how we make sure and have no future delinquencies. We plan to not have that happen again. We think that was a symptom of doing a lot of changes at once that could have been done in a more streamlined fashion. And that's where a lot of John's changes have started to be implemented with an eye to how do we avoid those delays in filing. So yes, we're planning to continue with being an on-time filer as we have for years and years previous to the ERP implementation.

Bob, I would like to add one thing to that. So while the ERP is not perfect, we have identified all of the miscomings of the system and have implemented manual processes that are being implemented into the ERP as we speak. So we're not skipping a beat at all. Finance reports to me. We're going to make every single filing going forward because we have a higher visibility now that those processes are in place.

And last for me is if we look to the first half of last year, military is pretty negligible. If you look in the past 9 months, you're 1/3 to at times over 40% of revenues, and I assume that's basically the U.S. market. If you think about 18 months out from now, I mean, is that a larger market, a larger component inside the business now than the police side is? Have you had some early wins that were sort of backed up that maybe make it run rate higher than you would expect on a long-term basis? How do we think about the mix longer term?

Well, the longer term, it will be a large part of the company's business. In the short term, we're still prepping the company for those type -- like there are certain requirements that each one of the products have to meet with drop test. There's a myriad of those. And one of the projects that Bob has mentioned on previous calls has helped us get there. We go back to the cyclical nature is when you look at that market space, it's a very large market, and there's a lot of different opportunities where VirTra is a subcontractor to a much larger prime, and we already have all those relationships. And in the past, those relationships weren't there and the presence in Orlando wasn't there. And that was the 2 -- as I mentioned, two significant key factors of why VirTra hasn't captured that data. There's almost a need to be there with those buyers because not only is the acquisition in Orlando, but every one of the proponents in the business, like whoever is going to be using the equipment comes to Orlando to speak with and to guide the acquisition officers. So we see that as being there and having a key program manager there and the size of that market and the aging equipment in the sweet spot that VirTra fits is going to do nothing but drive the business higher. One of those contracts or 2 of those contracts could be 1/3 of VirTra's earnings in a year. And that's what we're targeting.

Our next question comes from the line of Allen Klee with Maxim Group.

Yes. The question is on your operating expenses and the G&A jump in the quarter. Can you give us some color of how much of that you would say is growth initiatives are onetime related? And following up on that also, the 10% cut of staff, can you quantify what that means, too?

I'll start with the last part of that question, Allen, and thanks for asking that. The 10% cut in staff is part of the restructuring. It do not -- it will likely be replaced with a QA department that the company doesn't currently have. So that function will offset cost savings on that. Like John said in his remarks, this reorganization was not specifically a cost reduction strategy. It was an optimization strategy for the prep for scaling. So if we get some cost savings as a result of that, that is just a side effect of the effort. The real key to the effort is optimization, efficiencies, elimination of redundancies. We absolutely abhor waste. We don't want to waste any resources or have a function that's redundant and wasteful. So that is definitely part of it, but also just prepping for scale is really the bigger part and having a really world-class QA part of the company that's really needed as we move into the military market, more so, is a key aspect of that whole reorganization effort. It's difficult for us to answer the other part of your question at this time. We don't have perfect visibility into the future on that, but we do think that our SG&A is appropriate for where we're at. We do have -- we are doing a bit more R&D that we can't give a lot of details on. That's our policy when it comes to R&D efforts. But we have stepped up our R&D spending and efforts because we see some opportunities in different markets for that. But the SG&A, we think, is appropriate. We do think it is a bit -- there are parts of that, that are more onetime because of the move and different costs associated with the fact that we have an Orlando facility, we have a mortgaged Phoenix facility. We have leased facilities and that are -- so we currently have a vacant lease facility that we're working on subleasing, but we're going to centralize those facilities together, and that should allow us to have a more efficient ongoing presence as a company and actually have a more streamlined SG&A going forward for what we get out of our SG&A, if that makes sense.

My last question is, as we're approaching the September budget fiscal year-end for the government and for law enforcement and the military, can you give us some qualitative comments of how conversations are going on in deals in the pipeline and how you feel about opportunities?

I'm sorry, I didn't quite catch all of that. Can you repeat the question?

Basically, comment on how you feel about the September budget flushes from your customers in terms of the pipeline of opportunities you have and your potential to win some of them.

Yes, we're very excited with our sales pipeline. I wish I could get into greater detail than that. We are very excited about it. But somebody who's been in this for 29 years, until it crosses the finish line, it's not done. So while we are optimistic and excited, we still are paranoid and hard working. So that might be the best way to explain it.

Our next question comes from the line of Jaeson Schmidt with Lake Street Capital.

I just want to follow up on some of the previous questions. And I mean, we're halfway through the September quarter here. And obviously, everyone sort of alluded to potential from seasonality in the government space. Can you just talk about how order patterns have tracked so far this quarter?

Yes. Thanks, Jaeson. We're always monitoring that carefully. And it is -- certain things like sequestration that we've had or budget grid locks are things that we monitor and can be very concerning to us. Fortunately, as of right now, those normal headwinds that we sometimes face in on the government side of our business, which is the bulk of our business, we're not seeing any major issues in that regard. Police budgets do fluctuate, and there was that period of time where there was the call for defunding the police. That was a minority -- really a minority view that some people were getting headlines of saying -- of stripping police departments of their funding. It seemed like that ended up fading away and what replaced it was actually fund the police more so and get them better training. I think VirTra has been a recipient of some of that attitude. We are hopeful that, that attitude continues. We really believe that police departments are making the right choice when they buy the world's most realistic rehearsal tool for life and death scenarios. So please have the chance of making a mistake in a simulator and not making a mistake in real life with dire consequences. We think that makes sense with or without headlines of the need for police to be trained at the highest level. We really think that saving money on training simulators or trying to use a VR game headset and trying to do training with something that's not professional training and that you often have trainees kind of take off and laugh at and consider it as not good use of their time with their limited training budget and limited training time, we think that those are potentially poor decisions that we want government…

Okay. I really appreciate that color. And just want to make sure I fully understand if I heard correctly. So the 10% headcount reduction, you don't anticipate that to lead to any sort of significant savings given that it's going to be sort of backfilled with this new department. Is that how we should think about it?

Generally, yes. I mean, there may be some, but our focus is our reputation in the market. We need to succeed for our clients, each and every client. We want successful installation. We want high quality. We're spending more money on components for our product to make sure we're the higher quality standard out in the industry. So yes, there may be some decrease, but I would not, if you're looking to model VirTra, you shouldn't model VirTra as like on a road of just slashing our SG&A, especially if doing so would endanger our reputation or our performance or our ability to scale. But again, we do -- there could be some savings as a result of it, but it would be -- part of that would be replaced by new hires and new department that makes sense going forward.

Okay. Got it. And I know you mentioned or some of the funded R&D that hurt gross margins earlier. But can you just sort of discuss some of the dynamics that are driving the better gross margins in the commercial space?

Yes. I mean, it's really almost like a return back to normal than any initiative. And the return back to normal is related to that strategic military contract. We recognize that VirTra is not the company that's, for the last 20 years, won all the military simulation contracts. We are not that company. But we are the company that dominates law enforcement, federal law enforcement training and there's tremendous overlap between those products and the products that the military needs. So yes, we do think that the way that we make our products and it's going to fit very well for the military moving forward. But yes, we're anticipating that we will be seeing a lot of positive results from the fact that we might have done a military project at a considerable discount than we would normally charge for our products just to make sure we got our foot in the door, to make sure that we got the product developed to the way the military would want it and almost likely to pay the R&D project where we would have spent our own money to go do it, but we were able to actually get it offset or funded by a customer, which is -- you may know our history, we're a company that really began with bootstraps and we're normally a company where if we want to put money in our bank, we need to go make profitable products and have earnings, and that's how we do it. And we have raised some money, but our background as a company has really been make a compelling product that people want, make it at a profit. And our innovative products over the years have often been those products where we make our most profit because they're really contributing something unique to the market and they become indispensable for our customers. And that's when we seem to be at our best, and that's what we're focused on and why we took that military contract for a much different and a much lower profit margin than historically we do.

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

Thank you, Laura. Well, we really appreciate everyone for taking time to join us today. Please know we are dedicated more than ever to building shareholder value and building the world's most effective simulation training products so that the war fighter and the law 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 Second Quarter 2022 Earnings Conference Call. You may now disconnect your lines at this time. Thank you for your participation. Enjoy the rest of your day.