Earnings Call Transcript - TACT Q2 2022

Operator, Operator

Greetings. Welcome to the TransAct Technologies Second Quarter 2022 Earnings Conference Call. And please note that this conference is being recorded. I will now turn the conference over to Ryan Gardella, Senior Vice President of Investor Relations. Thank you, sir. You may begin.

Ryan Gardella, Senior Vice President of Investor Relations

Thank you, John. Good afternoon and welcome to TransAct Technologies Second Quarter 2022 Earnings Call. Today, we'll be discussing the results announced in our press release issued after market close. Joining us from the company is CEO, Bart Shuldman; and President and CFO, Steve DeMartino. Today's call will include a discussion of the company's key operating strategies, progress on these initiatives and details on our second quarter financial results. We will then open the call to participants for questions. As a reminder, this conference call contains forward-looking statements about future events and expectations, which are forward-looking in nature. Statements on this call may be deemed as forward-looking, and actual results may differ materially. For a full list of risks inherent to the business and the company, please refer to the company's SEC filings, including its reports on Form 10-K and 10-Q. TransAct undertakes no obligation to revise or update any forward-looking statements to reflect events or circumstances that occur after the call. Today's call and webcast will include non-GAAP financial measures within the meaning of SEC Regulation G. When required, a reconciliation of all non-GAAP financial measures to the most directly comparable financial measure calculated and presented in accordance with GAAP can be found in today's press release as well as on the company's website. And with that, I'd like to turn the call over to Bart.

Bart Shuldman, CEO

Thank you, Ryan, and thank you to everyone joining us on the call today. I'm incredibly pleased with our execution in the quarter and could not be prouder of how the TransAct team worked to navigate these difficult conditions. All the challenging work certainly paid off. Thank you, TransAct team. You accomplished almost the impossible, and I'm so proud of all that you have done. Last quarter, I spoke at length about the challenges that we were facing in the supply chain. And we all know we were hardly alone in dealing with these problems. I assembled a team comprised of engineering, operations, and purchasing, tasked with finding more parts, redesigning products where parts were unavailable but other similar parts were, and then building and delivering the printers to meet customer demand. The team did an incredible job, as you can tell from the top line. But we've only just begun. Our production started to ramp up in May, expanded in June, and is now in full motion in July and August. We delivered many thousands of printers in Q2 and were able to satisfy demand in key markets where our competition could not, namely casino and POS automation. I'm pleased to tell our shareholders that, in the second half of the year, we are on track to deliver near-record numbers of printers to our customers, barring any unforeseen parts issues. We are actively winning share in these markets. We are doing everything in our power to ramp production even more as the demand in the POS and casino markets continues. In addition, as I discussed last quarter, we raised prices and began to implement our cost-reduction plan and expect to see the results of these savings in the current quarter, Q3. The early results have been encouraging, and we believe this was the right move to streamline the organization. The core of our savings was the result of suspending a new product development project during the time when we were all asking, 'Are we in a recession?' While we intend to move forward with that project sometime in the future, we believe now is the right time to move quickly on our cost-control plan and drive towards adjusted EBITDA profitability. This plan, combined with the large sales level we expect to achieve in the second half of 2022, should result in TransAct moving towards adjusted EBITDA breakeven as we move through the year. Steve will clearly go over this in more detail in the financial section. Now let's turn to the markets. In the casino and gaming market, despite some fantastic work and a near-record number of printers produced, we continue to see demand outstrip supply. Our backlog continues to grow, but we're still hand-to-mouth on inventory. As soon as we build, we are shipping to a customer. However, we still managed to produce a large number of printers in the second quarter, and we plan to produce even more in the third and fourth quarters, approaching near-record levels of production and sales in our casino market, again, barring any additional unseen supply issues. Even with the additional production, we expect to sell out all of our printers, as we've been able to take advantage of weakness in major supply issues at a direct competitor to pick up additional market share. I had mentioned in our last call that our first price increase went into effect in March and is now fully reflected in our second quarter results. However, while sourcing many of our parts has been accomplished, we are still sourcing some parts for the remainder of 2022, some at higher costs. Therefore, to meet the demand, we will be instituting a second round of price increases in September, specifically on our casino and gaming products. I truly dislike these price increases, and our customers know we have rarely raised our prices, but the cost of parts to meet the elevated level of production requires another round of price increases. We expect the second increase to be fully in effect starting in September, with our fourth-quarter results reflecting the new pricing structure. We are also thrilled that the team we put together was so successful and able to resolve the parts issues with our casino printers. The results in Q3 and Q4 should reflect their hard work. In point-of-sale automation, we continue to be dealing with similar dynamics, with every printer we make being shipped out as soon as they are ready. Our team has been able to ramp production effectively, and we will be achieving near-record numbers of printers shipped and revenue in the second half of 2022. Our products are filling gaps that competitors have been unable to address, thus picking up market share. Our special project with McDonald's continues, and we expect the back half of the year to see a significant pickup in the number of point-of-sale printers sold as we can effectively ramp production and deliver additional units. Now let's talk about the FST market. We saw solid results in FST underpinned by a return to a more normalized label sales cadence, which pushed our recurring revenue back over $2 million to $2.2 million. We also saw robust demand for new hardware, which combined resulted in total FST sales of $3.4 million, a significant jump sequentially and a solid increase year-over-year. In the second quarter, we added 814 new paid terminals for a total of 10,941 currently in the market. While this number was slightly below our expectations for the quarter, we are optimistic about the back half of the year as our sales team, now led by our new sales executives who have deep experience with selling enterprise software products, is fully built out, and I could not be happier with the progress they are making. While we did reduce expenses in various parts of TransAct this year, as I've previously stated, we added more salespeople to our FST team. Our overall cost structure will be lower, and I'm pleased to say we now have a full complement of salespeople across all the different verticals in the FST markets we serve. Our pipeline is as robust as ever, and we are seeing great traction with several new brands testing our BOHA! products. Some of the most recognizable brands in the world are currently being counted among our pipeline, which, as a reminder, is fully vetted and does not include anyone merely kicking the tires. We still have more selling to do, but our pipeline has really grown since doing the NRA Supermarket and C-store trade shows. Many of these potential customers are nationwide chains with units in the hundreds, if not thousands. However, timing can be uncertain as well as initial order sizes and rollout strategy. With this in mind, it's probably best to take down the guidance of how many new BOHA! Terminals and workstations we will add this year. Though our sales pipeline is more robust than at the start of the year, there is a chance that we can meet our original guidance, but due to the difficult first quarter of 2022, it is prudent that we speak about a lower number. Therefore, we have decided to adjust the number of new placements to 4,500 to 5,500 for 2022. However, we are maintaining our ARPU guidance for the year at $8 million to $10 million. I also briefly wanted to mention that in July, we put out a press release announcing our first-ever BOHA! enterprise license sale. This software win is a 5-year, 300-terminal and software license deal and represents a crucial step in the lifecycle of BOHA!, and represents the type of deal we will be actively pursuing in the future as we continue our evolution into a SaaS-based software solution provider. We sold the software enterprise license with the customer agreeing to buy the license for 300 locations, all upfront. This gives us confidence in our SaaS potential revenue going forward. Lastly, I wanted to discuss our ARPU, or average revenue per unit for the quarter, which came in at $861 versus $638 sequentially. The rebound in label sales helped bring ARPU to a more normalized rate. And as a reminder, our target continues to be an ARPU of between $1,000 and $1,200. For the remainder of the year, we expect ARPU to maintain its current levels. However, please remember, we are selling BOHA! Terminals to replace our old AccuDate 9700s that were sold without any recurring revenue. These units are included in our ARPU calculation. In closing, I want to recap what I believe are the most important takeaways from the quarter. One, we are seeing tremendous success in navigating the exceedingly difficult supply chain issues. With the second quarter of 2022 being good, we expect to deliver many more printers in the remaining two quarters of 2022, and we still expect to sell about every single unit we can produce. Two, our FST sales team is now fully built out, and we are seeing a lot of momentum build in our pipeline. Three, our cost-reduction plan is seeing excellent early results and was fully implemented in the third quarter. In the fourth quarter, we will see the full effect. Additionally, the price increase is flowing through and helped to offset the increase in supply chain costs we have experienced. Four, altogether, we now expect to be moving towards adjusted EBITDA breakeven by the end of 2022. I want to thank the entire team at TransAct for their tireless effort. This was quite an effort. You never gave up; the results have been outstanding, and I want to thank you. And I want to thank our shareholders for the support and for your time here today. Now I will pass the call over to Steve for a more detailed review with the numbers.

Steve DeMartino, President and CFO

Thanks, Bart, and thanks, everyone, for joining us. Before I start, I want to mention that all of our results for the prior periods that we will be discussing today are on an as-adjusted basis, taking into account the retrospective application of the change in accounting method we made on April 1. I'll talk more about the accounting method change a bit later. Now let's turn to our second quarter '22 results in more detail. Total net sales for the second quarter were $12.6 million, up 35% from $9.3 million in the second quarter of '21. Sales from our Food Service Technology market, or FST, were up 12% to $3.4 million compared to the second quarter of '21. FST hardware sales increased by 24% to $1.3 million from $1 million a year ago. We added 814 paid terminals during the quarter and finished with a total of 10,941 in the market. Our recurring FST sales, which includes software and service subscriptions, as well as consumable label sales, were $2.2 million, which was up 5% from $2.1 million in the prior year period and up 39% sequentially. This improvement was due to a more normalized cadence of label sales as well as additional software deployments in the quarter. Our ARPU for the second quarter of '22 was $861, up from $638 in the first quarter of '22. The recovery of ARPU was due directly to the return of higher FST recurring revenue, which, as I just mentioned, had experienced a more normalized run rate during the quarter. Our casino and gaming sales were $6.5 million, up 88% from the second quarter of '21. We're seeing a very strong resurgence of international demand as those gambling floors continue to come back online, with total sales up over 150% for the quarter. Domestic sales also saw robust demand, with revenue up over 60% there as well. As Bart mentioned, we're continuing to see demand outstrip supply, although we saw our manufacturing throughput improve greatly this quarter, which allowed us to deliver more printers than in the first quarter. Additionally, in the 2022 second quarter, we experienced a full effect from our first price increase, which generated a higher total revenue number and allowed us to absorb the cost increases we've incurred. Our engineering and operations teams did a phenomenal job of finding alternative parts sourcing, and in some cases, designing around parts entirely. As we experienced some improvement in supply chain conditions, we're expecting to make a higher number of printer deliveries in the back half of the year. As a reminder, we experienced a second wave of product cost increases, and our second price increase will not go into effect until early September. So we expect somewhat lower gross margins in the third quarter and improvement in the fourth quarter when the second price increase takes full effect. POS automation sales were down 7% from the prior year period to $1.2 million. While we could have shipped many more printers based on the backlog of orders for both the special project with McDonald's and their regular business, unfortunately, supply chain issues limited our sales in the quarter. We expect production and therefore sales in this market to increase significantly in the second half of the year. Moving now to TransAct Services Group, or TSG, sales. Overall, TSG sales were up 6% to $1.5 million. This increase was largely due to an increase in domestic spare parts and accessories to legacy lottery and POS customers. Moving down the income statement, our second quarter gross margin was 43% as compared to 36.8% in the prior year period. Gross margin was positively impacted by higher sales, especially in the casino and gaming market, as well as the implementation of our first across-the-board price hike, which went into effect at the end of the first quarter '22. Our operating expenses for the second quarter increased $2.3 million or 38% to $8.4 million when compared to the second quarter of '21. Breaking this down, our engineering and R&D expenses increased 20% to $2.2 million largely due to investment spending in R&D for BOHA!, including the hiring of additional software developers for continued BOHA! development projects as well as higher costs related to design changes for alternative electronic components for existing hardware. Our selling and marketing expenses increased 86% to $3.3 million, mostly due to additional investment spending related to BOHA!, including marketing studies, enhanced marketing programs, and additional support staff around our BOHA! offering. Additionally, we saw higher trade show and travel expenses as these return to pre-COVID levels. Lastly, our G&A expenses increased 17% to $2.9 million. This increase was due to increased salaries across the board in response to wage inflation, higher professional fees, and depreciation and other expenses related to the implementation of the company's new ERP system in April 2022. These increases were partially offset by a reduction in incentive compensation expense. We incurred an operating loss of $3 million or 23.4% of net sales from the second quarter of '22, which compares to an operating loss of $2.6 million or 28.4% of net sales in the second quarter of '21. On the bottom line, we recorded a net loss of $2.4 million or $0.24 per diluted share in the second quarter of '22 compared to a net loss of $2 million or $0.23 in the year-ago period. Adjusted EBITDA for the second quarter of '22 was negative $2.5 million, which compares to negative $2.1 million in the year-ago period. Another thing I'd like to mention is that we successfully amended our credit facility with Siena Lending Group in July. The amendment extended the term of our existing $10 million credit facility, which is subject to a borrowing base, for an additional 2 years through March of '25. It also requires us to maintain a minimum outstanding borrowing of $2.25 million during the term. As Bart mentioned, we completed the implementation of our cost-cutting measures during the third quarter and expect to see the beginning effect of these expense reductions in the third quarter and the full effect in the fourth quarter results. We expect this cost-reduction plan, combined with higher sales, to result in lower cash burn as we expect to move towards adjusted EBITDA breakeven as we approach 2023. As a result of this, combined with our now extended Siena credit facility, we expect to have enough liquidity for at least the next 12 months. Lastly, I wanted to discuss the reason for the delay with our earnings call and the filing of our Form 10-Q. As mentioned in our press release and on previous earnings calls, on April 1, 2022, we implemented our new ERP system, which was necessary as we move towards a business model with a greater focus on software sales. One change we made as we adopted the new ERP system was to change the accounting method we use to measure the value of inventory from standard cost to average cost. We made this change because the average cost method reflects a better measurement estimate of inventory cost as we now procure fully built finished printers rather than manufacturing them. Average cost also aligns better with our go-forward business model and simplifies our business. Unfortunately, as we closed this quarter, we were delayed by the work required to retroactively apply the accounting change for all periods for which financial information is presented in our 10-Q. We are now through this process and expect to file our 10-Q within the permitted 5-day extension period. And with that, I'd like to turn the call back over to Bart for any closing remarks.

Bart Shuldman, CEO

Thanks, Steve. Great job as always. I just want to say that we had a fantastic quarter, and I am incredibly proud of the team for successfully launching our new ERP system, getting all the parts together, returning to full production, and significantly ramping up. Operator, I would like to take some questions now, please.

Operator, Operator

Our first question comes from the line of George Sutton with Craig Hallum.

George Sutton, Analyst

Bart, nice job. So I wondered if you could just walk through the delta, the 2000 placement delta, from what you expected prior and what you're suggesting now. And could we break them down into what those might have come relative to sales changes you made or 7-Eleven cadence or supply chain? If you could just kind of break those down, I think that would be helpful.

Bart Shuldman, CEO

Yes, thank you, George. We had no supply chain issues with our FST business, which is why we don't emphasize that aspect. We have adequate inventory, so there were no supply chain concerns. The low figures from the first quarter were an anomaly, making it challenging to achieve our expected projections for the year. However, I can say the current pipeline at TransAct is robust. After the pandemic, we initially focused on the convenience store, truck stop, and food service management markets, which were the only ones open to us then. As we moved into 2021 and 2022, we recognized that the restaurant market was becoming accessible. We hired our new Head of Sales, who has enterprise experience, and spent the last six months building our sales team. We now have full representation across our diverse segments, including quick serve, fine dining, casual, and convenience stores. It will just take some time for the team to ramp up. Additionally, we have several new projects where we expected to deploy all terminals, but due to rollout schedules, some will start smaller than planned. For instance, one project will begin with 100 units instead of the anticipated 600. My primary focus right now is on securing new accounts. For another deal with a potential of 500 units, they opted to start with 50, so we agreed to that to initiate the order. It’s a matter of gradually increasing the scale. I had a review with our sales manager about potential opportunities, and I believe we could reach that previously anticipated number this year, but it's wise to adjust our expectations due to the challenging start we had and the limited rollout plans for this year.

George Sutton, Analyst

Got you. Regarding the supply chain, there was a suggestion about possibly reengineering products. Can you provide some insight on what you accomplished by bringing these different teams together to work more efficiently?

Bart Shuldman, CEO

Oh, yes. First, I'd like to thank our chip supplier who worked hand-in-hand with us. If you look at one of our products, I won't tell you where it goes, but we started with one design. They were able to get us like processors that were not the same as our original chip and got us enough to get through most of this year. We had to redesign the product for that chip, which means we changed the firmware. If you look at how the printer works, we connect to another system. That is pretty much done. It's what's below that, that we have to do. We got a new chip. We have to program it to turn on the motors, turn on the sensors, move the paper, print on the paper. Every time you have a different chip, that machine code language changes. So with this one product, we completed that redesign, knowing we're only going to have enough chips for this year. Our chip manufacturer told us, and we've agreed, to go to a certain line family of chips that they can produce in large quantities. By the end of the year, we will have redesigned a second time for the next-generation chip. So this was a war room situation where operations, engineering, and purchasing worked hand-in-hand. We had a motor driver that we ran out of and went into the marketplace and found it. We had a capacitor that we couldn't find, so we had to go with a different capacitor, which changed the way we look at black mark sensors. That's the way we look at the sensor that turns on and off and looks at the black mark, which tells us when to print or when to stop printing. So we had to open up the band of focal length that we could use the sensor to see the black mark. We had to get another capacitor, we had to take another capacitor out. This was ongoing. The good news is our chip manufacturer has asked us, and we've agreed, to go to their latest design. We are in the process. Every piece of hardware at TransAct will transition to that family of chips, including gaming, casino, food service, and POS. We're designing an overall firmware base that will run the chip. Depending on the type of printer or hardware, we'll just add an extra piece of code to cater to that specific product. This process should all be completed by the end of the year. The chips we've already ordered have increased our inventory. That’s all the piece parts, all the chips, and all the electronics that we bought. That's why we feel very comfortable about the ramp-up in production and how it's going to continue. We're going to ship a significant number of printers in the third and fourth quarter, and we've got those products already at our contract manufacturer.

George Sutton, Analyst

That's great detail and very helpful. So lastly, you talked about May, June, July in terms of everything getting stronger with July, the strongest of the three. Can you just give us a sense of that dynamic?

Bart Shuldman, CEO

Sure. We'll likely ship three times the amount of printers in the third quarter compared to the second quarter. Most of the printers for that product went out in June. We shipped no product in April, and very little in May as we ramped up production. Once we got through all the redesigns, which took us months to complete, we called it ramped up in May and went into production in June. In one aspect, we will triple production in the third quarter for that one product.

Operator, Operator

Our next question comes from the line of Jeff Martin with ROTH Capital Partners.

Jeff Martin, Analyst

I wanted to get an update on 7-Eleven. I know they placed a larger-than-usual order for Q2. Did all that ship as expected? And how does your visibility for the balance of the year with 7-Eleven look at this point?

Bart Shuldman, CEO

Visibility is good, Jeff. Some of it did go, I think, in the third quarter. Label sales continue to come in. Actually, they're going to be one of our first customers to renew. Their 3-year agreement ends in the fall, and we expect to renew with them. I know a lot of people ask us about the customer retention rate, with 7-Eleven being our largest. We should expect to sign another 3-year agreement with them. They are fine. We are trying to figure out the Speedway deal and see if they're going to roll out the Fresh Food program at Speedway. I can say that I have talked to our sales manager on that account, and we are hearing that the Fresh Food program has been a real winner for them. It wouldn't surprise them if they expand the program.

Jeff Martin, Analyst

Okay. That's great to hear. I wondered if you could give us a little bit of insight into the average size deals within the pipeline. You've mentioned a couple of times that it's as big or bigger than it's ever been to date. Are you seeing larger potential deals on average? Are you seeing some megadeals in that pipeline? Just some relative perspective would be really helpful.

Bart Shuldman, CEO

Yes. Today just happens to be my every other week review in detail of the projects. We've got everyone on Salesforce now. I mean, truthfully, Jeff, the deals range from 1 to 20,000 and everything in between.

Jeff Martin, Analyst

Can you provide an update on the progression of the pipeline? I understand that the sales cycle tends to be lengthy, and with the recent addition of several sales resources at the restaurant trade show, many leads have been generated. How is the pipeline looking? Are there any near-term opportunities that could lead to a significant increase in BOHA! Terminal installations this year? It would be helpful to get some insight on how to model for next year.

Bart Shuldman, CEO

Yes. I think that's what Steve wants to know from me. We've got some good-sized opportunities. Some are in the 600, 2,500, or 4,000 range, progressing through trials and all that. I think 2023 has a great chance of being a lot bigger than any year we've ever done. The opportunity list I looked at for the third and fourth quarters this year is much larger than the numbers I shared with you. But I want to be conservative in my approach and allow the sales team time to do their work and close those orders. I have to be honest with you, Jeff. I've never been this excited because we've got a whole team of people on our staff now that come from Oracle, and other big companies that are very impressive in their approach to sales. In fact, we had a conference call today about an opportunity, and they asked me to write a letter on their behalf to someone I know at a restaurant company. They guided me through their logic, and I was totally impressed with how they're navigating through customer relationships. It’s a critical time for us. It's very easy to forget what 2020 and 2021 were like when all our customers in the restaurant market were closed and uninterested in talking to us. But they are open again. We've got a full sales team out there representing you, representing us in that market to grow BOHA! I’m looking forward to our next call. I appreciate the support we've been given by shareholders throughout what was a really challenging time. Now I see much better prospects ahead for the company and for our shareholders.

Jeff Martin, Analyst

Great. And then the last question is you ticked down the BOHA! Terminals number for the year. You maintained the recurring revenue component. What bridges the delta there? Is it higher-than-anticipated label sales relative to your last forecast?

Bart Shuldman, CEO

That’s a great question, Jeff. It’s exactly right that some of the new accounts have a higher volume of labels and software. When we look at the enterprise deal, that was all software. That’s predictable, right? We know exactly what we're going to be building every month. We do have one customer that’s at a higher rate of labels than some of the others. We can put into Salesforce exactly how many cases of labels they will use and try to calculate what that recurring revenue is going to be from there. We look at the cadence to confirm that. We now have a report that goes back to the beginning of 2021, allowing us to analyze the purchasing cadence from our larger customers and understand fluctuations. But we've also added a lot more customers, meaning each new customer adds more recurring revenue. So we feel confident maintaining our ARPU guidance at $8 million to $10 million.

Operator, Operator

At this time, we have reached the end of the question-and-answer session. And I will now turn the call back over to Bart for any closing remarks.

Bart Shuldman, CEO

It’s a significant achievement we made in the second quarter, and I cannot express enough how pleased I am with the TransAct team. They put in the effort and got us to this point. I truly appreciate the support we've received from our shareholders during this period. None of us wished for a pandemic, nor did we have a hand in creating one. We introduced our BOHA! Technology in 2019 to an enthusiastic reception, but the pandemic set us back in 2020 and 2021, extending into early 2022. However, we are now on a path of growth again. Our production has ramped up, and we've navigated through significant supply chain challenges. Our sales team is fully equipped to represent us and to expand BOHA! I am optimistic about the future for the company and for our shareholders. Thank you for your time and your support.

Operator, Operator

Thank you, everyone. This does conclude today's conference. You may disconnect your lines at this time. Thank you for your participation. Have a great rest of the day.