VirTra Inc (VTSI) 2018 Q4 法說會逐字稿

Good afternoon. Welcome to VirTra's Fourth Quarter and Full Year 2018 Earnings Conference Call. My name is Hector, and I will 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. (Operator Instructions)

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 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.

Good afternoon, everyone, and thank you for joining us today. After the market closed, we issued our financial results for the fourth quarter and full year 2018 in a press release, a copy of which is available in the Investor Relations section of our website.

I'll begin by discussing the health of our market in general and then VirTra specifically. Next, Judy Henry, our CFO, will discuss the details of our financial performance for the quarter and the year. I'll then provide some additional comments and open it up for questions.

Let's begin with the law enforcement market. 2018 witnessed the largest demand we've seen for police training simulators, and the beginning of 2019 seems to continue this upward trend. We think there are 3 main drivers of this continued growth that are worth mentioning.

First, more and more agencies realize they must provide effective training for their officers in order to properly prepare them for potential life and death decisions. As we all know, police use-of-force decisions are front page news. Simulation training is one of the very best tools to safely and cost effectively certify police on critical policies and skills.

Second, the technology we utilize in our products, from computers and graphic cards to simulated weapons, continues to become more powerful, more immersive and more affordable with each passing day. We are able to build increasingly better simulators with expanded potential to solve a growing number of critical training needs.

And third, decision-makers and operators are becoming more and more open to technological solutions. A growing segment of professionals in charge of training and agency budgets are beginning to embrace technological solutions because of their personal use of technology, along with the other trends I just mentioned. In fact, the cycle seems to reinforce itself.

We think the future is very bright for VirTra's law enforcement training simulators. We also see very similar demand growth in markets beyond just law enforcement, such as the military market.

As most of you know, our mission at VirTra is to improve and save lives through uniquely effective high-tech products, and over the years, we've established ourselves as the industry-leading experts in simulation and de-escalation training for law enforcement. As we reflect on how we executed our mission in 2018, it's clear we have made great progress during the year, and we are now in the strongest position in our company's history to successfully carry out that mission going forward and expand it. As we invest into future growth, we also produced strong financial results, our top line increasing 9% year-over-year to a record $18.1 million, gross profit increasing 8% to $11 million and adjusted EBITDA increasing 8% to $1.9 million, demonstrating not only improvements over the prior year but also the leverage in our model.

Operationally, 2018 was an incredibly productive and transformative year for VirTra. Prior to 2018, it was obvious that VirTra needed to register with the SEC and have our stock trade on either the QX market or the NASDAQ market. Given the similar cost between the 2, after registration with the SEC is complete and the added benefits and credibility the NASDAQ exchange provides, we opted for the NASDAQ capital market, where our stock began trading 1 year ago. This move was a crucial step in the pursuit of our long-term strategy to scale the company and expand our audience of potential investors and analysts. On top of this, being listed on NASDAQ also benefits us from a commercial perspective as well, giving our valued customers and prospects and partners added confidence in the viability and sustainability of our organization.

Over the course of the past year, we also secured several large contracts with both new and current customers. As we've outlined on previous calls and in press releases, we were awarded multiple additional orders from the Department of State under the IDIQ contract, which expanded our footprint into new countries and previously untapped markets. In June, we reported that we were deploying simulators with the Dallas Police Department, the San Francisco Police Department and the Southern Desert Regional Police Academy, which are 3 of the largest law enforcement agencies in the U.S. As a result of these deployments as well as several others, we not only witnessed another consistent year of top line growth, but we expanded our international footprint to 29 countries by year-end.

During 2018, we also made significant progress improving and forming new strategic partnerships. To date, we have secured 8 strategic partnerships, including Force Science Institute, Vistelar, Haley Strategic, Trijicon, National Sheriffs' Association, National Law Enforcement Center on Animal Abuse, Office of the Utah Attorney General and Southwest Autism Research & Resource Center. Each of these partnerships contributes to our company's long-term growth strategy and competitive advantage.

As some of you know, law enforcement is a fraternal community that places a great deal of emphasis on reputation and personal recommendations. So when selling to agencies, it's not only important to have the highest quality product and service available, but it's also imperative to have trust and a solid reputation of the law enforcement community as well.

While we've been successful bolstering versus reputation, producing the highest quality simulation and recoil products in the market for over a decade, each of our strategic partners adds another reason to go with VirTra for agencies seeking maximum effectiveness in training.

Additionally, our strategic partners are crucial to our product development. They help us test, develop and improve both new curriculum and new training scenarios. V-VICTA, for example, which we launched in the third quarter, was heavily influenced by the feedback and expertise of our partners. So to sum, these partnerships remain a key resource to ensure we remain an industry leader in the space and assist us in breaking into new markets by lending additional credit to our reputation.

Ultimately, the operational progress we made in 2018 and the financial success we realized as a result of that progress demonstrate that we are consistently becoming more effective at realizing our primary mission of improving and saving lives through uniquely effective high-tech products. And while we remain focused on our core values, we also recognize that in order for us to maintain our industry leadership and to scale our business to new levels, it is imperative for us to expand our presence in markets adjacent to law enforcement. So to that end, we've begun to bolster our technological capabilities to meet the needs of other markets.

Future military needs require drop-in recoil kits for simulated weapons. Our recent strategic purchase of Tiberius patent portfolio, which I'll discuss in more detail, combined with VirTra's existing drop-in recoil kit technology could perfectly match some of these needs.

We outlined our new strategy in the press release we issued in January to strengthen and diversify our current business by bolstering our technological capabilities. As I'll discuss in more detail, we've been strategically putting our resources to work on high-ROI opportunities that can pay dividends not only today but down the road as well. We've invested in the development of new products, new scenarios and new sales strategies that we believe will be fundamental to scaling our business over the long run. And in the interim, we've been working to reward our long-term and loyal shareholders by repurchasing company stock in the open market.

Now before I dive into more specifics of the strategy and the operational progress we've made in this start of the year, I'd like to turn the call over to our CFO, Judy Henry, to walk us through our financial results for the quarter and the full year 2018. Afterwards, I'll jump back on to talk more about our progress as we look to 2019. Judy?

Thank you, Bob, and good afternoon, everyone. Turning to our financial results.

Our total revenue for the fourth quarter of 2018 was $2.5 million. This was a 7% increase from the $2.4 million of revenue we recognized in Q4 of last year. For the full year ended December 31, 2018, our total revenue increased 9% to a record $18.1 million from $16.5 million last year. The increase in total revenue for both the quarter and the year was due to additional sales of simulators, accessories, licensing fees, warranties and other services.

Our gross profit for the fourth quarter of 2018 increased 2% to $1 million or 37.8% of total revenue from $0.9 million or 39.5% of total revenue in Q4 of last year. For the full year, our gross profit increased 8% to $11 million or 61.1% of total revenue from $10.2 million or 61.9% of total revenue. The gross margin variation for each period resulted from differences in the type and quantity of systems and accessories sold.

Our net operating expenses for the fourth quarter of 2018 increased 14% to $2.8 million from $2.5 million in Q4 of last year. The increase in net operating expenses in the quarter was primarily the result of increases in accounting, legal, consultants and bad debt expense. For the full year, our net operating expense increased 13% to $10 million from $8.9 million in the same period a year ago. The increase for the full year period was due to increases in general and administrative expenses; an impairment loss on investment in tech, formerly known as MREC, which was recorded as operating expense; plus increased professional services, including nonrecurring legal and public company expense directly related to our qualification, SEC registration and NASDAQ listing in March of 2018.

Turning to our profitability measures. Loss from operations for the fourth quarter of 2018 was $1.9 million compared to a loss of $1.5 million in Q4 of last year. For the full year, income from operations was $1 million compared to $1.3 million for 2017. Our net loss for the fourth quarter of 2018 totaled $1.1 million or negative $0.13 per diluted share. This compares to net income of $470,000 or $0.06 per diluted share for Q4 of last year. We recognized an income tax benefit of $772,000 in Q4 of 2018 compared to $2.6 million in Q4 of the prior year.

For the full year ended December 31, 2018, our net income totaled $0.8 million or $0.10 per diluted share compared to $3.3 million or $0.39 per diluted share in 2017. We recognized an income -- a provision for income tax of $310,000 for year 2018 compared to a tax benefit of $2.5 million in 2017. The noncash nonrecurring income tax benefit of $2.5 million recognized in Q4 of 2017 was related to a reversal of our previously established valuation allowance, partially offset by the effect of a change in the federal income tax rate due to federal income tax reform applied to our deferred tax assets and miscellaneous state income taxes.

Our adjusted EBITDA loss, a non-GAAP financial measure, in the fourth quarter of 2018 totaled a loss of $1.4 million. For the full year 2018, our adjusted EBITDA increased 8% to $1.9 million from $1.8 million in 2017.

Turning to our backlog, which consists of bookings for signed contracts in place for which delivery is scheduled for a future date or has not yet been scheduled and revenue has not been earned or recognized. Backlog includes all products and services, including extended warranties. At year-end, our backlog totaled approximately $6.8 million.

Turning to our balance sheet. At year-end, we had cash and cash equivalents and certificates of deposits totaling $6 million. From a working capital standpoint, we ended 2018 with $6.7 million in working capital, an improvement of approximately $1 million from the end of the prior year.

And finally, after November 14, the date the window opened for -- opened after we reported Q3 results, we repurchased $382,000 of our common stock. In January of this year, our Board of Directors increased the amount authorized under the stock repurchase program from $1 million to $2 million. We have purchased an additional $261,000 of common stock since year-end, bringing the aggregate amount of common stock repurchased since mid-November to approximately $643,000.

That concludes my prepared remarks. I'll now turn it back to Bob.

Thanks, Judy. VirTra has a rich history of innovation. We were pioneers in the AR/VR space, which we entered in 1993, and we are first to market with affordable and immersive training simulators in 2004. Our recent announcements continue this tradition. We believe that innovation is key to maintaining our reputation and growing our presence in the premier solution for effective training to multiple markets.

However, innovation is not regulated to just new simulators that is crucial to all aspects of our business. For example, VirTra is now the first and only company in the world with nationally certified training content. In February, we launched new certified curriculum called High Risk Vehicle Stop or HRVS. This curriculum is the latest addition to V-VICTA, which we launched in the third quarter of last year. As a reminder, this program enables law enforcement agencies to effectively teach, train, test and sustain departmental training requirements.

The genesis of this new curriculum is very similar to that of our other simulator products and scenarios. We recognize that due to the complications that arise with role playing, traditional training methods for high-risk vehicle training can be both labor- and resource-intensive. HRVS provides a safer, more economical and more efficient alternative to current training methods. Though this product is still in its infancy, we've already seen strong demand and received positive reviews from customers.

In addition to HRVS, we recently acquired a patent portfolio from Tiberius Technology to enhance the realism of our already industry-leading recoil kits as well as create new state-of-the-art training equipment. Some of the enhancements enabled by the strategic technology acquisition include simulating running out of ammunition as well as mechanical jamming that does not require batteries or electronics.

It's easy to understand the need for these upgrades and how relevant they are to our products. If trainees never practice dealing with the technical issues related to their weapons while under duress, they may lack the dexterity and the mental presence to deal with these issues in a real-life situation where it matters most. And many of this type of training cannot be done with live firearms.

As I mentioned earlier, these enhancements are highly demanded by the military, and we believe they will be a key differentiator for us as we work to move more into that space. What's also great about this particular purchase is that the patent portfolio has strong potential in the law enforcement market as well. It's versatile and applicable to a range of customers.

Last week, we announced the addition of a driving simulator to our product line. Unfortunately, for competitive reasons, we are not currently in a position to share more details about this exciting new product. However, as evidenced by our recent $1.9 million contract with the Department of State for the Republic of Mexico, we've already seen impressive demand from customers. Hopefully, we'll have more specific updates to share on this program this year so please stay tuned for additional details.

We believe great products are crucial for the long-term success of our mission and our business, but the reality is that great products require great people. As we look to further scale and grow our business, we believe it's so important to find like-minded, innovative individuals who are able to bring a new perspective and skill set to our team. Steve Handel, our new Vice President of Program Management, fits that bill perfectly.

Steve is an industry veteran with nearly 20 years experience in the technology sector. He most recently managed weapons development at Axon Enterprise, where he oversaw the development of Axon's recently released TASER 7 Conducted Energy Weapon or CEW. This new product is considered Axon's most effective TASER weapon to date, and its total addressable market has been estimated at $1.8 billion.

Much of Steve's relevant background is highlighted in the press release we issued on Monday, for those of you who are curious about his additional credentials and history. He has a proven track record of innovation and success at the highest levels of our industry. We're very excited to have Steve onboard and are confident that his passion, talents and expertise will be of immediate value to our company.

In February, we announced perhaps the most innovative and significant change of our business model in our history, which we believe has great potential to elevate our company and benefit our shareholders. We have added a subscription option called STEP, which stands for subscription, training, equipment and partnership. The VirTra team has been working diligently over the past 18 months in secret to develop this program, and we were very excited to have announced it just a few weeks ago.

Please realize that the skills that we focus on at VirTra are perishable. Like most things in life, if you don't use it, you lose it. So it is imperative that the users of our systems have consistent access to our training tools. However, not all departments can afford the upfront capital investment of outright purchasing one or several of our simulators. STEP drastically reduces those upfront costs, thereby allowing more people to access the tools they need to sustain and improve these crucial skills.

STEP allows for quicker deployments, easier upgrades and more accessibility. It enables more agencies to benefit from our systems, software, interactive courseware, training academy and patented accessories in a more cost-effective manner than previously available. By lowering the barriers to entry, we believe there is an opportunity to have more officers, military personnel and civilians using our products.

From a social utility perspective, the more people we have trained on these systems, the more effective those individuals will be and the safer all of us will be. From an operational and investment perspective, the improved accessibility and the potential increase in the number of users means we have created an opportunity to increase our total addressable market in a significant way.

In addition to increasing our TAM, STEP is significant because it has the potential to dramatically increase our recurring revenue. Historically, we've received recurring revenue from maintenance contracts and our strategic investment in Modern Round, but those revenues have been a small percentage of our overall revenue. With the introduction of STEP, we believe there is an opportunity to significantly increase that percentage. Over the long term, STEP could make our business more consistent, more predictable and more profitable.

While we're optimistic about our expanded revenue model, we have no intention of prohibiting a customer's ability to purchase our simulators outright, which has proven to be an effective sales strategy throughout the course of this company's history. For a variety of practical and strategic reasons, many agencies prefer to purchase simulators outright. So going forward, it's our intention to offer these 2 purchase vehicles in tandem. By doing so, we're well positioned to both improve the predictability of our revenue and simultaneously capitalize on large purchase orders from customers. Essentially, we're now more flexible and able to accommodate the needs of a larger and more diverse base of customers.

Of course, we just launched the STEP program, and we expect it will take some time before we begin seeing substantial positive effects from its implementation. However, we are very optimistic about the program's potential for VirTra and our shareholders.

While we've already implemented these improvements and in many cases, they have garnered substantial interest, we recognize that many of the benefits from these recent changes will take time to come to fruition. So in the interim, as Judy mentioned, we repurchased company stock in the open market as a means of returning value to our supportive shareholders, and it's our intention to act opportunistically on the repurchase program going forward.

In summary, 2018 was a pivotal year for our business. Not only was the year significant due to our continued top line growth and profitability, but the operational progress, sometimes behind the scenes, we made, including uplisting, creating certified curriculum, product development and winning several significant contracts, placed us in a strong position to begin implementing substantial changes and improvements in the start of 2019. As we look to the coming year, we are optimistic that we will only continue to improve and grow. We've rolled out several new products and services recently which have received incredible reviews from current and new customers and which we believe will be so important for us to scale. We're extremely excited about the coming year and to start to see results from our new initiatives.

That being said, from a high-level perspective, you can see the vision of this company has only grown beyond just firearm simulators. We continue to believe that the best way to drive shareholder value in the long run is to remain focused on improving and saving lives by providing effective high-tech products in the most efficient manner possible to satisfy customers. The initiatives we executed in 2018 give us confidence that 2019 will prove to be another year of great growth and profitability with an even more exciting future as we continue to expand our product and service offerings.

And with that, we're ready to open the call for your questions. Operator, please provide the appropriate instructions.

(Operator Instructions) Our first question comes from the line of Jaeson Schmidt with Lake Street Capital Markets.

Bob, just want to start with the STEP program. I know it's fairly recent since you introduced it, but just curious how the feedback from your customers has been so far and if this was a situation where you -- where cost was really prohibiting a lot of your customers from ordering a system from you so you guys are proactively getting out in front and offering this type of payment system.

So to answer your question, the reaction has been extremely positive. We actually have noticed an uptick in lead -- actual lead generation, and so it's -- and we've also actually already closed some programs on STEP.

It's interesting, by offering this opportunity for our customers, some of them are able to tap into operating budgets versus capital expense budget. So we didn't -- we knew that, that was a potential advantage of doing this, and we're starting to see it. So sometimes, it is also the cost that you mentioned, where just eliminating a large upfront cost allows certain people to come onboard and possibly get a little more training equipment than they would afford if it was all going to be a capital expense upfront.

So we're -- those 2 factors are very encouraging. Anecdotally, I heard of one situation where a customer was interested in buying and they were expecting in a year -- over a year from now. And once they found out about the STEP program, they wanted to get on the STEP program right away because it's something they could get approved. And so I think they were anticipating like a 2-year horizon. And so we do think there's a chance that we'll be able to shorten sales cycles significantly with the STEP program due to its easier logistics and faster approval process within government agencies. So we think we could see some cycle improvement with that.

Okay. That's helpful. And I know you mentioned you're limited in what you can say regarding the driving simulator opportunity, but this is a pretty sizable market opportunity and I mean, something that I think hasn't been discussed previously. Can you just help us think about the size of this market or the customer opportunity, customer engagements in the pipeline just so we have a sense of how this potentially could impact growth going forward?

Yes. So within police departments, 2 main areas that they often will look for simulation training, one is driving and one is firearms or de-escalation training. So this squarely affects one of those 2 markets obviously, which previously VirTra had no offering for at all. So when it comes to this market space as well, we -- the IDIQ that was mentioned, the Department of State IDIQ does provide for both firearm simulation training and it provides for driver training. So it's also impactful going forward for future contracts that we would have a product that will meet the requirements, and our expectation is to exceed the expectations of the customer.

So as far as going forward, we've had some of our customers contact us and say, "Listen, we absolutely love your firearm simulation. We love the way you guys approach simulation and the way you approach customer service, but we really want to buy a driving simulator from you as well." And so this could very well help with providing them an option that's under the VirTra brand, and that would be a product that they also would like to keep under the same company as their firearm training simulation -- simulator.

So a lot of the simulation technology used on the vehicle simulation was informed by all of our extensive background going back to '93 in this market space. So we're able to leverage a lot of our simulation expertise on the product. And so it -- besides that, it is difficult for us to exactly predict. Driving simulation budgets are new to us, and we're still learning our way around that.

Okay. And the last one for me and I'll jump back in the queue. How should we think about OpEx trending in 2019?

I don't know, maybe Judy would like to answer that one.

Well, we do have a lot of initiatives on the horizon, including increased R&D, and would expect continuing increase in operating costs as we change facilities a little bit to accommodate our growth and bring on required staff as well as then just meet the projects and the various initiatives that we have.

Yes. Let me jump in on that. So VirTra, several years ago, we purchased a machine shop, and it's one reason we believe we've been able to maintain healthy profit margins, where we bring in raw stock of metal and turn it into some of our proprietary accessories and things.

So that was several miles away, was the location of the business we bought. We are now just actually, today, opening up -- or this week, we're finishing a location that is not adjacent but in the same parking lot. It is one suite away from VirTra's stand-alone, 40,000-foot building in Tempe. This machine shop is a...

Just over 5,000 square foot.

5,000 square foot, a suite that we've taken over. I know we did a lot -- I hesitated because we had to do some TIs to it in order to get it ready for our team. So now it's going to -- we believe that's going to accelerate our time to market. It's going to reduce some of our costs on production -- short-term production items, and it's going to just really enhance our alignment between our engineering team and our production of accessories, which is a rather important component of our overall business. So we're just -- it's just going to make us more efficient. It was quite a bit of work by a lot of people to make that happen, but we think that's a real good move for us going forward.

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

This is Joshua Goltry in for Allen Klee. Just to go back to STEP for a moment. I was just curious if these subscriptions were planned to be monthly, quarterly or if the customers are required to pay a year upfront.

We have flexibility on those payment terms. Fortunately, we have a strong balance sheet and government agencies have been very good about paying their bills. So we are -- right now, the STEP program is 12 months of commitment that -- but it can be paid in monthly, it can be paid in quarterly, it can be paid all at once. Any of those are available.

Got it. Okay. Great. And how would you say the margin on those subscription revenues are going to compare to the margins on your traditional equipment sales?

Well, we're -- we do expect the STEP program to grow every month. We're very focused on retaining customers on the program and just keep adding to it. That's definitely our goal. If that were to happen, then the STEP program would start to become a larger and larger chunk of our capital -- I mean, sorry, of our revenue.

So there is some capital expense obviously on the equipment going into the STEP program. They're -- we're still going to need -- we have to work through this with our auditors as well into how it's going to be classified. So we don't right now have a real clear impact. We do think that over the long term, that STEP should be very positive for our overall margins.

Great. And I was wondering if you can just sort of touch upon the outlook for your penetration into the military.

So the military penetration is a combination of factors, some of which are a bit out of our control, some of which are very much in our control. One of the most critical things is ensuring that VirTra's products match up with military needs. That's one reason that the Tiberius patent portfolio was a valuable purchase for us.

So there's -- and then another is making sure we have the right contacts with the right people in making -- in ensuring that VirTra's product mix is working for them. So there's a bit of upfront work necessary. I do know that our success in our federal programs such as CBP, one of our largest customers, and others that are federal, the U.S. Marshals, Secret Service, a lot of those successes we've had on the federal level have made their way to be known by military decision-makers. We think that, that's strong.

If a company can prove that it can deploy millions of dollars of equipment, like we have with federal agencies, it gives military more comfort in being able to award larger contracts. But the timing of the military is very hard to determine. We've seen them be incredibly impatient and want things yesterday. And then we've seen them also come back and slow things down and focus in another area.

We do think from the evidence that the prospects are very good, that the military wants to use drop-in recoil kits, which Tiberius Technology absolutely applies to and those patents and patent pendings. But it also -- we also believe that there's other areas that VirTra could do very well with military.

One of the big issues with that is the military is looking to do point-of-need training, meaning that instead of buying 100 recoil kits for one location where people come in and train at one location, what we've heard is the military is looking at buying thousands and thousands of recoil kits to go -- to actually go to the point of need, to actually go to where the soldiers or war fighters are located. So that could create quite a bit of need. And recoil kits are extremely hard to get both affordable and durable and realistic, where they actually can get some pilot training from that very, very important tool since they need to be dialed in their firearm during training so that they can be dialed into it during actual combat.

Okay. Great. And then just last one. Are you seeing gross margin trending around that 60% to 61% range for 2019?

We're definitely hoping for that, yes.

Our next question comes from the line of William Gibson with ROTH Capital Partners.

Judy, you gave us the dollar amount on shares purchased to date. How many shares did you buy?

So as of December 31, we had actually purchased about 120,000, of which 110,823 were canceled. And at 12/31, 10,707 remained in treasury. Since January of 2019, we've repurchased an additional 68,239 shares.

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

Thank you. This is a very exciting time at VirTra, and we certainly couldn't do it without the support and commitment from our extraordinary employees, customers, shareholders and partners. I believe our best days are ahead of us, and we look forward to updating you on our next call. Thank you, and God bless.