Earnings Call Transcript - VTSI Q4 2020

Operator, Operator

Good afternoon. Welcome to VirTra's Fourth Quarter and Full-Year 2020 Earnings Conference Call. My name is John 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 Chief Accounting Officer, Marsha Fox. Following their remarks, we will open the call for questions from the VirTra's institutional analysts and investors. Before we begin the call, I would like to provide VirTra's safe harbor statement that includes cautions regarding forward-looking statements made during this call. During this presentation, management may discuss financial projections, information or expectations about the company's products 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.

Bob Ferris, Chairman and CEO

Thank you, John. Good afternoon, everyone, and thank you for joining us today for VirTra's fourth quarter and full-year 2020 earnings call. I'm also joined today by our new Chief Accounting Officer, Marcia Fox. When we held our 2019 earnings call one year ago, we had all just begun to experience dramatic shifts in our daily lives as COVID-19 spread across the United States and our federal government, states and local communities responded to the pandemic. Fear and uncertainty were rampant. And at that time, as markets declined, schools closed and businesses shutdown, the idea that VirTra could produce record financial results in 2020 would have been met with healthy skepticism, to say the least. Yet, we did. In fact, by many metrics, 2020 was the most successful financial year in our company's history, which you'd expect for a growing business during normal times. Despite pandemic headwinds and against the odds, our tenacious staff grew revenue for the 15th consecutive year. The $6.6 million in revenue we produced in the fourth quarter of 2020 ensured a strong finish, as we produced $19.1 million in revenue for the full-year 2020. We earned $1.5 million in net income, and our adjusted EBITDA increased 161% to $2.8 million in 2020. Even with the positive results in the fourth quarter, our backlog increased to $14.6 million as of December 31, 2020. It's natural to ask why VirTra flourished in a year that was incredibly challenging for so many. First, we serve a need that proved to be integral for law enforcement and military requirements. Our highly effective simulation products improve the training, which enhances the performance of law enforcement and military personnel. Second, we have great people who are unusually dedicated to our mission to save and improve lives through uniquely effective high-tech products. Lastly, regardless of being the largest police simulation company in the world, we very much operate like a nimble company with a flexible organizational structure, quickly adapting to changes in circumstances and unforeseen events. Despite the number of challenges posed over the past year—canceled trade shows, travel restrictions that impacted installations and international sales, calls to defund the police, and fears of budget constraints within our core customer group—VirTra not only persevered but thrived in 2020. With the lack of trade shows and conferences, which we traditionally rely on to generate leads and demo new products to current and prospective clients, our sales team adapted by switching to web-based tools, which were timely deployed by our marketing team. As COVID restrictions lift, our regional sales staff are performing in-person sales calls and demos whenever deemed safe for both parties. They've really done an excellent job throughout the year performing demos and converting them into sales. And in the fourth quarter alone, we generated $5.5 million in new bookings. However, the primary reason for the strong financial end of the year was that our team went above and beyond in converting a good portion of the $14.4 million backlog we had at the end of the third quarter into revenue. The combination of our salespeople continuing to pursue opportunities in their respective regions, coupled with our ability to effectively convert our backlog into recognized revenues, has led to the rare accomplishment of 15 years of consecutive top-line growth. At December 31, 2020, our backlog and our revenue both climbed, demonstrating that we not only ended the year on a high note but that there is strong momentum for 2021. While we've had to adjust some of our tactics given the state of the world, our fundamental strategy remains unchanged: innovate and launch solutions that serve the current and future needs of our core customer base, build our reputation as an industry leader in marksmanship skills and use of force training, and then capitalize on that reputation to expand our foothold within the law enforcement and military markets. During 2020, we excelled in each of these areas. We enhanced our V-VICTA training curriculum with content for autism awareness training. We expanded our deployment of our new driving simulators through an IDIQ contract from the Department of State for the Republic of Mexico. As a result, we now have a total of 77 simulators deployed in 10 different states within Mexico, just to name one contract. We received follow-on orders from Customs and Border Protection, a longstanding VirTra client, and we received a major follow-on order from the Federal Law Enforcement Training Center or FLETC in September of last year. Through our relationship with FLETC, there's now the potential for thousands of additional federal officers to be exposed to VirTra's industry-leading products each year as we help modernize their programs with the latest technology, certified use of force training, and interactive content that contains the highest quality branching scenarios on the market. In the military market specifically, we secured a $1.9 million contract to support the Air Force Research Laboratory ADMIRE program, which is intended to develop technology that improves our military warfighters' decision-making and marksmanship skills. While our 2020 results are very encouraging, we did face headwinds last year, particularly in foreign markets. Selling internationally in 2020 was an enormous challenge due to extensive travel restrictions, but our ability to continue to grow despite these headwinds demonstrates the robustness of our core customer base and the growing scale of our business. As the world changed around us, VirTra experienced its own internal changes as well this past year. Our business has grown along with the opportunities in front of us. We've increased our personnel to ensure we have the right people in place to meet the growing demand we see in our pipeline. In fact, for the first time in our company's history, we have reached 100 employees. As part of the growth process, we decided to invest in our infrastructure and prepare to transition to a new ERP or enterprise resource planning system. Not so long ago, our company was about one-fifth the size it is today, and we could get by with various systems that weren't fully integrated with each other, sometimes doing manual work to bridge the gap. However, as we've grown in staff and revenues, it became clear that we needed to better handle our current business and prepare for future growth, so we moved to a robust ERP that went live in early 2021. Such transitions are logistically challenging in the short-term but necessary for sustained long-term returns. Also, it was a difficult time for us in October of 2020 with the passing of Mitch Saltz, a longtime board member. His vacancy on our board was filled by John Givens’ appointment, whose expertise and connections in the military market have already proven to be beneficial to VirTra. The military, as I'll discuss in a moment, remains one of the largest potential growth drivers for VirTra. And by having John on our team, we're that much better positioned to capitalize on those opportunities. As you may recall, our former CFO, Judy Henry, retired in November of 2020. Her vacancy was filled by our new Chief Accounting Officer, Marsha Fox. Marsha originally joined us in an interim capacity, but I'm pleased to report that she'll be staying on full-time. She brings over 20 years of experience in financial operations, business transformation strategies, and all phases of the accounting process and controls to our team. She's held multiple senior leadership positions in various industries, including our own. She has been doing an excellent job since taking the reins from Judy, and we're very happy to have her on board. So with that introduction, I'm going to turn the call over to Marsha to provide an overview of the financial results for the fourth quarter and full-year 2020. Marsha?

Marsha Fox, Chief Accounting Officer

Thank you, Bob, and good afternoon, everyone. It's a pleasure to be speaking to you today for the first time as a member of the VirTra team. Our total revenue for the fourth quarter of 2020 was $6.6 million. This was an 11% increase from the $5.9 million of revenue we recognized in Q4 of last year. For the full-year ended December 31, 2020, our total revenue was $19.1 million. This was a 2% increase from the $18.7 million we reported in 2019. The increase in revenues in both periods was the result of an increase in sales and subscriptions of simulators, accessories, curriculum, training, and recurring extended warranty revenue in 2020. Our gross profit for the fourth quarter of 2020 increased 80% to $4.8 million or 72.5% of revenue from $2.6 million or 44.8% of revenue in the fourth quarter of 2019. For the full-year, our gross profit increased 23% to $11.9 million or 62.3% of total revenue from $9.7 million or 51.9% of total revenue. In both periods, the increase in gross profit was primarily due to differences in the quantity and type of simulator systems, type of accessories, and variety of services sold, combined with a decrease in the cost of sales. Our operating expense for the fourth quarter of 2020 was $3.4 million, a 50% increase from the $2.3 million we reported in Q4 of last year. For the full-year 2020, our operating expense increased 13% to $10.7 million from $9.5 million in the same period a year ago. The increase in operating expense for the three months ended December 31, 2020, was due to a $434,000 impairment in the investment in The Eatertainment Corp or Modern Round, which was recorded as an operating expense, as well as a $307,000 allowance for bad debt on accounts and notes receivable. The full-year results included an $840,000 impairment in the investment of That's Eatertainment, recorded as an operating expense, as well as a $346,000 allowance for bad debt on accounts and notes receivable. Turning now to our profitability measures. Income from operations for the fourth quarter of 2020 was $1.3 million, a 276% increase from income from operations of $356,000 in Q4 of last year. For the full-year 2020, income from operations was $1.2 million, a 367% increase from the income from operations of $262,000 we reported in 2019. Our net income for the fourth quarter of 2020 totaled $1.6 million or $0.21 per diluted share. This compares to the net loss of $66,000 or $0.10 per diluted share in Q4 of last year. For the full-year ended December 31, 2020, our net income totaled $1.5 million or $0.19 per diluted share compared to a net loss of $75,000 or $0.10 per diluted share in 2019. Our adjusted EBITDA, a non-GAAP financial measure, increased 119% to $2.2 million in the fourth quarter of 2020 from $729,000 in Q4 last year. For the full-year 2020, our adjusted EBITDA increased 161% to $2.8 million from $1.1 million in 2019. Turning to our bookings and backlog, we define bookings as the total of newly signed contracts and purchase orders received in a time period. For the three months ended December 31, 2020, we received bookings totaling $5.5 million. We define backlog as the accumulation of bookings from signed contracts and purchase orders that are not started or are incomplete performance objectives and cannot be recognized as revenue until delivered in a future period. Backlog also includes extended warranty agreements and step agreements that are deferred revenue, recognized on a straight-line basis over the life of each respective agreement. As of December 31, 2020, our backlog was $14.6 million, which is up 52% from the $9.6 million we recorded a year ago, and up from the $14.4 million at September 30, 2020. And finally to our balance sheet. At December 31, 2020, we had approximately $6.8 million in cash and cash equivalents, which was up from the $3.3 million in cash, cash equivalents and certificates of deposit at December 31, 2019. Accounts receivable and unbilled revenue combined to total approximately $6.8 million at year-end, compared to $5.9 million at December 31, 2019. From a working capital standpoint, we ended the full-year 2020 with $10.3 million in working capital, compared to $7.2 million in working capital at December 31, 2019. For additional details of our financial results, please reference our form 10-K, which was filed earlier today. That concludes my prepared remarks. I'll now turn it back to Bob.

Bob Ferris, Chairman and CEO

Thanks, Marsha. As Marsha mentioned, we had a substantial write-off in our investments in Modern Round, whereby we licensed some of our technology in exchange for part of their revenue. As you can imagine, the pandemic had a negative impact on both the entertainment and restaurant industries, which means it uniquely impacted the business strategy of Modern Round last year. Please know that we remain a large shareholder, and Modern Round staff are working incredibly hard to succeed, so that they can enjoy the potential upside post-pandemic. But as an audited public company, we must be prudent and err on the side of caution. We chose to take a one-time write-off of our ownership in Modern Round. Had it not been for the write-off, 2020 would have been the most profitable year in VirTra's history, and from a cash flow perspective, it still was. If we can generate these results in such a difficult operating environment, we have even higher hopes as the world begins to open back up. Our core competencies are desperately needed, and we understand where they are needed most: effective certified training, working alongside experts to have training that can improve skills in the real world—that's the key of everything we do, whether it's supplying point-of-need training for the military market or simulators for law enforcement. On our last call, we discussed how the ADMIRE contract demonstrates the military's appetite for our solutions, as well as our ability to customize our products' functionality to seamlessly integrate with the military's training programs. Companies partner with us because we have a key piece to the puzzle that they lack: we can leverage our industry expertise and IP portfolio to partner with a larger player who has already built a relationship with key decision-makers. That sales strategy, by supplying a critical missing piece to help a large player perform better on a contract, is one that we believe will continue to be an effective way for VirTra to expand further into the military market. We've already seen evidence of it in 2021. Due to the sensitive nature of some of our current work, we're constrained in what we can disclose at this time, but we hope to provide more details on the strategy and our progress later in the year. So, please stay tuned. Two things remain clear: the world needs quality training for those whom we endow with the incredible responsibility of using force, if and when necessary; and the world will buy simulators to help train those who serve. Our performance this past year demonstrates that as long as that need for quality training exists, and as long as we're able to execute on our strategy, VirTra will continue to perform well. Our increased backlog plus last year's revenues indicates that we are growing at a healthy pace. Our balance sheet has only gotten stronger as we continue to carry no debt other than our PPP loan, and our cash position continues to increase. With the tailwinds in both the law enforcement and military markets that we're currently experiencing, that's exactly what we plan to do in 2021 and beyond. 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, Operator

Thank you. Ladies and gentlemen, the floor is now open for questions. [Operator Instructions] And your first question is coming from Jaeson Schmidt from Lake Street. Jaeson, your line is live.

Jaeson Schmidt, Analyst

Hey, guys. Thanks for taking my questions. Early strong finish to 2020. Bob, not looking for specific guidance on Q1, but could you just talk about if the order momentum you saw at the last year continued here in the first three months of 2021?

Bob Ferris, Chairman and CEO

Hello, Jason. Thanks for the question. We are seeing continued strength on the sales order front. But it can, of course, come in spurts. So, we are happy with the deal flow in the sales pipeline. Yes.

Jaeson Schmidt, Analyst

Okay, that's helpful. And just curious if you're seeing any concerns or pushback from customers on potential budgetary pressures?

Bob Ferris, Chairman and CEO

That obviously is very much a client-specific situation. But I know your question pertains more to an industry move. We're not seeing a major industry move right now either to expanded budgets or constrained budgets. So, I think our issue is more just in the mechanics of how we close a sale and how we work with a client, and making sure that they know that they have a subscription option available to them, and navigating with them any grant programs that might apply or helping them in any way we can. There's a lot more for us to work on how we can improve that side of the business than we're really encountering people saying, 'Listen, I simply can't. My budget was unexpectedly removed, and I can't buy your product.' We're not seeing that. Of course, those conversations can and do occur not just for our company, but for any company in this market. But I think we have a lot of room to work on improving our processes, ensuring that when people do have a budget, we can convert them to a sale, whether that be a purchase or a subscription.

Jaeson Schmidt, Analyst

Okay. And last one from me, and I'll jump back into the queue. A pretty significant step up in gross margin sequentially. How should we think about gross margin going forward? Is this sort of 70%-plus type figure sustainable?

Bob Ferris, Chairman and CEO

Over the years, our comment on gross margin has really focused on historical long-term trends. One of the most reliable things to look at is that we've had margins push up and down some over the years. But if you look historically, we're usually around 60% gross margin and we try to stay in that range. However, situations may cause that to vary somewhat. But I think investors are well-advised to look at the overall historical margins for VirTra.

Jaeson Schmidt, Analyst

Okay. Thanks a lot, guys.

Operator, Operator

[Operator Instructions] And your next question is coming from Richard Baldry from ROTH Cap. Richard, your line is live.

Richard Baldry, Analyst

Thanks. Can you talk about the implementation environment as it's beginning to ease up as some states seem to be opening up a bit? What do you expect that to play into the backlog as 2021 unfolds?

Bob Ferris, Chairman and CEO

Yes, thank you for the question. We are seeing a bit more easing in COVID-19 restrictions. That does directly help us in being able to recognize revenue when there is an easing of restrictions, although we still maintain vigilance on the health of our staff. So even if a client wants us to deliver, if we feel it's unsafe, we will hold back. But in general, our staff is eager to install and very dedicated to having our equipment placed in the right hands. So, we do see an easier time recognizing revenue in 2021, with a major assumption that COVID-19 restrictions ease up on a consistent trajectory. In other words, not a major snapback to heavy restrictions like what we saw in 2020. So there is definitely a correlation between fewer travel restrictions and our staff being able to install equipment and recognize revenue, as you would likely suspect.

Richard Baldry, Analyst

And can you talk from a broad perspective, about any changes in your opportunity pipeline from the unfortunately increasing rates of murders in major cities or the discussion around the use of force, which could argue in a good way to drive more training for the forces that are deployed? From a high-level, do you see any changes overall that might impact 2021 productivity?

Bob Ferris, Chairman and CEO

Well, first, let me say that I'm really happy with the pipeline that we have right now. It's tremendous. I will caution you that it's hard for me to really discern why that pipeline is strong. Is it because more groups are worried about having high-quality training due to the headlines? It's difficult to determine the exact cause. However, it is logical that with more pressure from the public to want certain outcomes in police encounters and scrutiny of any use-of-force encounters, they would want high-end training to avoid negative consequences and potential loss of life. That would all make sense—but we do know that our pipeline is strong, and there are many opportunities forming in 2021. We've got our work cut out for us during those opportunities for VirTra shareholders.

Richard Baldry, Analyst

Last one for me. You talked in the past about increasing your digital marketing to adjust to the environment and doing more virtual sales. Can you talk about how well you think your end customers have also adjusted to doing things more virtually versus in person? Since this has lasted longer than many expected, are some of those actions becoming more consistent? Or do you feel like some people are just waiting to get back to normal in-person interactions and that maybe the second half of 2021 could be better if that develops? Thanks.

Bob Ferris, Chairman and CEO

Sure, great question. I think that—and this is very much a personal opinion of Bob Ferris—but I think trade shows have really been impacted. Virtual trade shows are not anywhere near as effective as actual physical trade shows. Buyers who want to attend physical trade shows and check out VirTra's simulators, and compare them with competing simulators face-to-face, they are in entirely different leagues in many cases. So, that scenario is very hard to replicate in a digital format. We were very fortunate to have had our marketing team launching an entirely new digital sales process prior to COVID. So, there was a lot of luck involved in that. I wish I could say I was preparing for a potential pandemic, but we were not. We just happened to be focused on visual communication and enhancing our online presence. Our customers have responded well. I think in many areas of their lives, they were required to transition to a digital environment, and they adapted well. The only area where I see a negative impact is with trade shows; the effectiveness of trade shows has been significantly weakened during COVID-19 and will remain that way as long as virtual events attempt to replace in-person experiences. In my opinion, it just doesn't work as effectively unless it's a physical event.

Richard Baldry, Analyst

Maybe one last one too. If you look at the revenue plus growth in backlog, the overall growth could feel closer to a 20% level if you had been able to shift out of that backlog. Do you feel like that's a sustainable growth forward? There are obviously some growth inhibitors in 2020 even. Or were there some one-time events in there that we have to set aside?

Bob Ferris, Chairman and CEO

Yes. That's a really good question at the heart of much of what we're discussing today. It's interesting that you don't see many major press releases in 2020 where VirTra had in the past where we might announce a $4.6 million sale or another sizable transaction. It gives a sense that in 2020, VirTra was simply executing the basics well—essentially just doing the blocking and tackling to grow the business. This suggests a potential for steady growth. However, as we mature in the market, it will be increasingly important to look at how we expand beyond just law enforcement. We still believe there's tremendous room for growth in law enforcement. Many individuals are not being trained at the level they should be, and that number is enormous in the United States alone, let alone in other countries. The police market that we have not tapped is still massive, and there are certainly other opportunities, such as the military market and beyond, that we have not fully explored. If we were extensively engaged in police and military, it would be challenging to expect double-digit growth year-over-year. Fortunately, that's not the case. Thank you very much, I appreciate that.

Operator, Operator

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

Bob Ferris, Chairman and CEO

Thank you, John. We really appreciate everyone taking the time today to join us. I want you to know that our staff of 100 talented professionals are hard at work building the world's most effective simulation training products, so that those who serve their country can accomplish their mission and make it home safely. We are at our best when we perform at higher standards for both our customers and our shareholders. I firmly believe the best days for VirTra are ahead of us. Be safe, take care, and God bless.

Operator, Operator

Thank you for joining us today for VirTra's fourth quarter and full-year 2020 conference call. You may now disconnect.