Good afternoon. Welcome to VirTra’s Second Quarter 2020 Earnings Conference Call. My name is Jess, 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. Following their remarks, we will open the call for questions from VirTra’s institutional analysts and investors. Before we begin the call, I would like to provide VirTra’s Safe Harbor statement that includes cautions regarding forward-looking statements made during this call. During this presentation, management may discuss financial projections, information or expectations about the company’s products 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.

Thank you, operator, and good afternoon, everyone, and thank you for joining us today for VirTra’s second quarter 2020 earnings call. I am also joined today by Judy Henry, our CFO, who will join me in answering your questions after our prepared remarks. I would also like to remind you that shortly after the earnings call, we will have the Virtual Annual General Meeting, with another chance for questions and answers. But first, I am excited to report our progress. The second quarter of 2020 presented VirTra with an unusual operating environment to say the least. There was not one but two macro level events that impacted our company and our industry this quarter that are worth addressing today. The first is the continued impact of COVID-19, which started at the tail end of Q1 and continued to be a major influence during Q2. I’ll discuss those impacts at length in a moment. The second is a series of polarizing events ignited by the death of George Floyd in Minneapolis that have concentrated our country’s attention on the law enforcement community. More than at any other time in our history, there has been a very specific focus on how officers interact with those they are sworn to protect and how they decide, if and to what extent, force should be used in a situation. These are extremely complex questions that touch at the very nature of what police officers do. In our society, police officers exist to enforce the law and to protect the individual liberties of citizens from domestic threats. To do so, they are uniquely endowed with the authority to use force, should the need arise. As a knee-jerk reaction, some have suggested the defunding of police agencies. Fortunately, cooler heads have prevailed and many see the logic…

Thank you, Bob, and good afternoon, everyone. Our total revenue for the second quarter of 2020 was $2.8 million. This was a 9% decrease from the $3.1 million of revenue we recognized in quarter 2 of last year. For the 6 months ended June 30, 2020, our total revenue was $6.1 million, consistent with the $6.1 million we recorded in the first 6 months of last year. The decrease in revenues for the 3 months ending June 30 was the result of a reduction in the number of simulators and accessories delivered and installed compared to the same period in 2019, especially due to the COVID-19 travel restrictions. Our gross profit for the second quarter of 2020 increased 4% to $1.6 million or 57% of revenue from $1.5 million or 49.6% of revenue in the second quarter of 2019. The increase in gross profit was primarily due to reduced warranty costs. For the first 6 months of the year, our gross profit decreased 4% to $3.2 million or 51.9% of total revenue from $3.3 million or 54.3% of total revenue. The decrease in gross profit was primarily due to differences in our product mix and the quantity of systems, accessories and services sold. Our operating expense for the second quarter of 2020 was $2.4 million, consistent with $2.4 million we reported in Q2 of last year. For the first 6 months of 2020, our operating expense decreased 3% to $4.5 million from $4.7 million in the same period a year ago. The decrease in operating expense for the 3 months ending June 30, 2020, was due to reduced selling, general and administrative costs for travel, trade shows and professional service again a result of COVID-19 restrictions. Turning to our profitability measures, loss from operations for the second quarter of 2020…

Thanks, Judy. As we shift our attention to the rest of 2020, the strength of our landed sales and pipeline is encouraging. While the vast majority of the national discussions around law enforcement training and specifically, increased de-escalation training are very positive for VirTra and the nation, the very extreme idea of defunding the police has made headlines. As of today, we have not lost a sale due to defunding. As a reminder, many departments already have budgets allocated for the year, so it’s unlikely that we will see any major changes in the near-term. The real question is what will budgets look like towards the end of this year and into 2021? From what we have seen, departments are evaluating how they can most effectively allocate their funds as they’ve done in previous years. But bear in mind, these decisions are frequently being made in the spirit of allocating funding towards resources that make police more effective, not less, resources that help ensure officers and those who may have sworn to protect stay safe. For those reasons, there have been reports that some of the largest cities in the country have actually increased their budgets this year. It was recently reported that San Diego, Houston and Phoenix have all increased their police budgets. Whether or not that increase becomes the norm remains to be seen. We contend that money spent on VirTra’s certified simulation training for critical decision-making is money well spent. But ultimately, the 18,000 or so law enforcement agencies in the U.S. must decide for themselves. While most departments appear to still be in the evaluation phase, it is certainly possible that some cities may become more budget constrained. Should that occur, we are fortunate that we already have a viable alternative in place with STEP, VirTra’s…

Thank you. [Operator Instructions] Our first question will come from Jaeson Schmidt at Lake Street. Please proceed.

Hi, guys. Thanks for taking my questions. Bob, I know you talked about some of the civil unrest and how your products kind of fit into the trading mosaic, just curious if – with everything going on, if you have actually seen an increase in inbound interest coming your way?

Yes, thank you for the question. We have seen an increase. It is a longer sales cycle than a very short-term sales blip. So even if there is a general focus on better training for decision-making and use of force or even if agencies realize that one bad decision can result in rioting and has potentially long-term negative impact and is worth effort to avoid, even if that’s true, we are not obviously an impulse buy and the sales increase, if it does occur, can occur over a period of time. So yes, we have seen an increase in inquiries. We hope that, that will result in an increase in sales. And we have also seen now a little bit of an increase in sales overall for second quarter 2020 as compared to a year ago. So there are some metrics that are indicating that we have a bit of an increase in sales that could be temporary. Our focus is to make that a long-term trend of increased sales.

Okay, that’s helpful. And I know you have the STEP program, but have you seen any pushback from customers on pricing just given the macro?

I would say, given the macro there is – in many agencies, there is likely a focus on getting the best training. I do think there is a bit of danger for departments that buy training simulators for life and death decision-making. There is so much on the line right now that going and getting in a cheap simulator, a kind of check-the-box simulator that does the bare minimums and there is no comparison done, there is no kind of kick the tires, there is no SME, subject matter expert, being involved in selecting the product and making sure that there’s actionable training value, I do think that there’s a lot more risk for that and an inversion of that. So, I do believe that the market does reward effective products and even if the effective product might cost a little more money and of course, there are exceptions to the rule. There are those that might be looking for the least amount of money to spend to say that they have simulation training, whether it’s effective or not. But I think that the macro level, if anything, has pushed a lot of agencies who might have inclined in that direction and may have pushed them away from that attitude.

Okay, perfect. Thanks a lot guys.

Thank you.

We will move next to Richard Baldry at ROTH Capital. Please proceed.

Thanks. I am sort of curious if restrictions are easing, what would be the bottleneck to sort of clearing or pulling down that backlog sort of rapidly? Is it really gated by your own resources because the backlog has grown so much or is it more on the customer side? Again, assuming that we don’t re-close up everything sort of curious what that is?

Yes. So, great question. It’s a combination. There is a potential that some clients, even if states start to reopen and move through their phases, there is a chance that some of our customers will have their own internal policy and might delay allowing for installation or travel. There is a – obviously, we don’t have an infinite number of installers. So there is a physical limitation on our installation capacity. Our operations team does a great job of scheduling that, and we have been hiring some to try to make sure we have adequate staff to avoid a bottleneck in that area. So obviously, if there is a tremendous number of customers who want delivery all at the same time, then there does naturally occur a bottleneck. we have, though, in the past, been able to work with clients, and we do have a lot of staff that are cross-trained. So sometimes, we are able to use a staff member who used to do installations, but hasn’t for a while, but they still have all the skills to do so, and possibly, they would help out, assuming that they are okay with travel. We definitely want safety as a priority for our installation teams. But yes, there is a potential that there could be a bit of bottleneck. We don’t think that would be a horrible situation. We think that it would just mean that possibly some revenue would move off to one quarter further than it would have otherwise been. But we – our operations team has been anticipating this and has been watching the phase transitions around the nation. And so we have been staffing to a level to allow us to unwind the backlog as quickly as possible, but also not to overstaff. VirTra has had a very proud tradition that we have not had mass layoffs. So we try to be very careful with when we add staff, we are looking at that staff to not be a let-go on a moment’s notice. And we have been very fortunate to be able to plan around that. Sometimes that means we – staff works a little harder. We have had staff have to work through the weekends and work longer hours. But the upside has been that we have not had a large layoff at VirTra in many, many years now. So – but yes, we do think there is a potential for some bottleneck depending on the – if everything starts to reopen at the same time and we have clients who are eager to have the equipment at the same time. But we do have quite a bit of infrastructure in place to accommodate quite a bit of installs and if there is service trips needed.

And should we look at Q2’s OpEx as sort of a good near-term level given sort of the balance between uncertainties out there and – but the ability to sort of offset some of the spending with the PPP loan? And then maybe another way to think about spending above – more above the line, though, assuming some of the backlog started to clear out and the revenues popped a bit, how much of the COGS side is more fixed versus variable, so we can get an idea about sort of modeling what an upside quarter would look like as you clear some of that backlog?

Well, of course, Richard, we are going to see a very similar fixed cost. And I believe a vast majority of the variable will remain in the same level. We do see some uptick in – pretty heavy uptick, actually, in our trade show sales and marketing events in Q3, but then that will, of course, be dependent on opening and reopening of the various sites. Some of them are moving them to virtual. Some of them are coming up with other opportunities and ways to continue with them. So a little bit of unknown in that position. But I would anticipate there to be mostly upside in the OpEx in terms of staying pretty consistent overall.

Okay. And then we made our own assumptions that possibly municipal budgets could be a little bit tight, given the revenue side of the table. If there was a big sort of shift into more of a STEP model, can you talk about the availability to sort of finance that because you would be talking about having to take on the value of a lot of the hardware installations and then amortize over time. So your ability or flexibility to address that if it actually emerged?

So we do have quite a bit of flexibility in that area. Obviously, we have cash reserves, and that’s – but in a situation like you described, where there were – there was a considerable increase in STEP, a couple of things to keep in mind. One is that we require a 12-month commitment for STEPs. So you can imagine that we have worked a lot of the numbers internally, and we are comfortable with the 12-month commitment. That might well correspond to sort of our internal capital expense to get that equipment out if we – as far as just materials. That’s not obviously including amortizing software and content and a lot of other costs that have gone into developing the product in the first place. The second thing is we have had groups with tremendous resources approach us and say, if you ever need funding for your STEP program, we would like to be near the top of your list to compete for that business. So we do have plenty of depth on being able to go and if financing was needed, to go and obtain it at attractive rates. So we feel that even if STEP became wildly successful in a short period of time that the financial side wouldn’t be the issue, we might bottleneck on production, if there was a tremendous increase in a short period of time. And we have – in the past, when we have had a tremendous increase in production, we have absorbed that very well based on tenacity for success and being a bit clever on how we integrate our products together. So – but yes, we do feel like there should not be an issue where a STEP becomes so successful that there becomes a financial bind of any kind.

Thanks. And last for me would be – and I don’t know if this is sort of off topic. But I am sort of curious, how long it takes to turn what I would describe it like custom content? So if someone wanted something very specific, like to address a near-term issue, like looting, rioting, that maybe wasn’t in your training simulators. How quickly can you react to something like that with a quality product that you would be proud to put your name on? Thanks.

Yes. No problem. I love that question because it allows me a chance to explain a little more one of our most innovative products. So our quickest method for creating scenarios is actually a method that also is photorealistic, meaning that there is some folks that try to take a shortcut in some of this technology, and they try to use CGI, computer-generated images. So it’s just computer-generated humans, which don’t emote properly. They don’t quite look and feel real and people often has described them as kind of a zombie or a soulless human. And they are – they can’t get over the fact of how the human does not look normal. V-Author is interesting in that it attempts to solve the problem of how do you get the highest level of training, the most realistic people, natural-looking people, photorealistic people at high-definition the level of the human eye, how do you get that and how do you do it incredibly fast and incredibly affordable? Normally, you don’t get all of those. Normally, if you do very high quality, it costs a lot of money, it takes a lot of time. But it’s interesting, V-Author, by being very clever in how it puts together the scenario using green screen technology, using high-definition video, using a library that’s now built up, we are able to very quickly produce high-quality content using that capability of green screen. So – and we have the ability to use panoramics that are as simple as using smartphones. Use a smartphone, get a panoramic background and then we can drop in training assets, and those can be done in a matter of hours. There is more time involved in adding the logic behind them so that they respond properly, right? If they – if some…

Alright. Thanks, and congrats on the backlog build. It’s pretty impressive and given the conditions out there. Thanks a lot.

Thank you very much for your questions.

We will go next to Allen Klee at National Securities Corp.

Good afternoon. The gross margins that you had in this quarter were higher than we expected. And in your earnings release, you said the factor behind this was lower warranty costs. Could you talk about why you think that is? And if there’s any reason why that might be sustainable?

Yes. Thanks, Allen, for the question. So I believe last year, we had some substantial international installations in countries that had higher costs. And so that is the reason we had lower margins a year ago. And this year, we did not have the headwinds of that situation. So that’s really what happened. I would, though, recommend that when it comes to gross margins, looking at it at an annual level is a better way to go. We will have some quarterly – quarter fluctuations. So we do tend, overall, to be around 60% gross margins in our – if you look back through our quarters in history. But we do need things working right to achieve that. And there are chances that, based on other factors, we could go after a large contract with lower margins, for example, or COVID could restrict our sales such that our cost of goods sold overhead takes a bigger bite of our overall cost. So – I mean of our overall gross margin. And so we end up having a quarter somewhat based on COVID. Or like the situation where last year, we had extra cost with an international order. And so – and this year, we didn’t have those costs. So – but yes, overall, we try to stay around a 60% gross margin on – over more of an annual level.

Thank you. My last question is, if you could remind us of the major buckets of the money that police budgets have and to what extent there might be any additional federal money being allocated, if at all.

Sure. Yes, there’s – so the buckets for police are often capital expense or operation expense and then they also have the ability to go get grants. There’s a few other buckets, like we have had some groups that have purchased our simulator using a charity that is dedicated to advancing police issues. And so they actually had money donated, and they used that money to buy our simulator. But federal grants and other grants are sometimes used. There’s also a forfeiture money. Simulation equipment is one of the few items that is allowed to be purchased using asset forfeiture. So if – when the police apprehend a criminal, they are able to track down the assets, and then those can be used for simulation equipment so those are some of the various buckets that are available. There’s probably more than that. But just off the top of my head, those are some that we have seen used to buy simulation equipment in the past.

Okay. Thank you so much.

Thank you.

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

Thank you. We appreciate you all taking the time to join us today. I hope you are able to sense the excitement and optimism I have. I firmly believe the best days for VirTra are ahead of us and enabled by our extraordinary staff, customers, shareholders, vendors, thank you all. As a reminder, our 2020 Annual Meeting of Stockholders, which is being held virtually, is about to begin at 2:30 p.m. local time, which is 5:30 p.m. Eastern Time. For those of you able to join, we look forward to continuing the conversation with you shortly. And for everyone else, we look forward to updating you on our next call. In the meantime, be safe, take care and God bless.

Thank you for joining us today for VirTra’s second quarter 2020 conference call. You may now disconnect.