VirTra: Competitive Advantages In Police Training Industry

Introduction

VirTra (NASDAQ:VTSI) operates in the competitive police training industry, offering a comprehensive range of products such as simulators, VR hardware and software, and specialized training solutions. The company’s strategic initiatives, including the Subscription Training Equipment Partnership (STEP) program and the Virtual Interactive Coursework Training Academy (VICTA), have significantly expanded its market reach and solidified its position as a leader in police training. Despite competing with companies like Inveris and Milo, VirTra’s unique nationally certified courses and advanced simulation technology set it apart. While risks such as adverse public opinion and the loss of key customers exist, VirTra’s strong competitive advantages, innovative products, and operational efficiency enhancements position it favorably for sustained growth and profitability, making it a compelling buy recommendation in the evolving police training industry.

Competitive Landscape

VirTra competes in the police training industry with its portfolio of products. It has one of the most extensive array of products that comprise simulators, real weapons for simulation, virtual reality (“VR”) hardware and software, return fire devices, and taser and spray training solutions. Furthermore, the company started to offer Subscription Training Equipment Partnership (“STEP”), which is allowing smaller police departments (measured by budget) to effectively train their cadets without making a large upfront payment, lowering the barriers to purchase and expanding the TAM, which it’s one of the principal VirTra’s objectives. Additionally, the Virtual Interactive Coursework Training Academy (VICTA) offers the only nationally certified course for police trainers, making VirTra’s training course a leader in the police training industry and a ‘must-have’ for trainers, in my opinion. Also, VirTra provides V-Author Software, which allows users to create specific training scenarios (using the school of the town, for instance) and test particular skills and objectives.

The principal competitors of VirTra are Axon, Inveris, Laser Shot, MILO, and Ti Training Corp. Laser Shot provides simulation training systems for law enforcement, military, and other agencies. Their products include interactive simulators for marksmanship training, judgmental use-of-force scenarios, and tactical training exercises. Still, its labor culture is bad (1.7 out of 5 on Glassdoor). Most of its products focus only on shooting sessions, so it doesn’t offer enough array of products to satisfy a whole police training, so I won’t worry too much about the Laser Shot’s capacity to threaten VirTra’s position.

Inveris is an important competitor, as it has a broader portfolio of products, including 300-degree and 180-degree simulators, VR hardware and software, and about 300 replicated weapons with its patented technology BlueFire. Furthermore, Inveris adapted VR hardware sooner than VirTra; thus, Inveris can keep VirTra’s rhythm in the technological race.

Axon specializes in tasers (no lethal weapons) and VR training, but its product portfolio is limited; furthermore, seeing a training session, the simulations have poor VR graphs. Nevertheless, the company received good reviews from customers and employees.

Milo specializes in de-escalation training, shooting, and 300-degree, 180-degree and 100-degree simulators. Also, Milo uses CO2 recoil technology (same for VirTra) and allows users to create training sessions, making Milo a close competitor with similar products. Like Milo, Ti Training Corp also focuses on simulation and has identical products, such as 300-degree and 180-degree simulators, and custom training. Still, Ti Training also offers Augmented Reality (“AR”) in combination with simulators; however, a disadvantage is the lack of recoil in its weapons.

Consequently, the closest competitors are Inveris and Milo, so the competition is limited. Inveris has an estimated revenue of $65 million per year (according to Growjo), and Faacs (owner of Milo) has an estimated revenue between $25-100 million per year (according to Glassdoor). Hence, these companies are larger than VirTra. Furthermore, most of its competitors have a significant product offering(heavy machine simulations, combat vehicle simulations, and Javelin simulations) in the military segment, so if VirTra wants to gain market share, it probably will have to equal the offering at least.

Even if there is competition, VirTra has some competitive advantages that set it apart. First, the company has the only nationally certified course for police training, which, in my opinion, creates a virtuous cycle: first, police trainers looking for the best education select VICTA, as they feel comfortable using VirTra products, they ask for their police departments to purchase VirTra products as long as possible, which in turn increase the demand for VICTA. Thus, the company is creating a high switching cost as police trainers, and police departments will find it more expensive to purchase competitors’ equipment and learn about them.

Second, compared to other VR technology, VirTra adds higher realism as the company programmed its scenarios using V3 – Volumetric Capture Studio, allowing it to use real people’s expressions and movements in the simulations. In contrast, other companies rely on pure program people, which is by far less realistic. For comparison, I invite you to see the simulation from Inveris and Axon and compare it to VirTra’s simulation. Furthermore, in a review (sponsored by VirTra) from Sean Curtis on Police1, we can read how Mr. Curtis found a more realistic simulation with VirTra-300 than with many of the other training simulators that he had proven before. Some worth-noting opinions were the wide assorts of realistic weapons and the realism of the simulation thanks to an exciting environment in all the 300-degree space (rather than just in the front). Another similar review (also sponsored by VirTra) comes from Todd Brophy, who studied different options of simulation training for the Washington State Criminal Justice Training Commission. Mr. Brophy stated that the two factors that led him to choose VirTra were comparability and realism; comparability comes from the wide array of realistic weapons and equipment that VirTra offers for its simulations, which is a crucial factor as the most realistic equipment the better the learning process. Realism comes from how the scenarios are similar to real-world situations and the capacity of VirTra (through V-Author Software) to allow users to set their scenarios using the local school, theater, supermarkets, etc. Finally, here’s another review from Atoka Mayor Barrin Akin, who said: “You take a top-notch company with a great product and a top-notch town like Atoka – you’ve got a great partnership.” Hence, based on his words, we can deduce that VirTra has a favorable position in the market, as the Mayor called it a “top-notch company.”

With these competitive advantages, it’s clear why VirTra can maintain 95% customer retention and increase its revenue quickly while achieving a high return on capital. Nevertheless, another constant factor among reviews is the high price, which is restrictive for many small police departments; thus, many customers would have to acquire other simulation training sets because of a lack of budget. However, VirTra launched the STEP program in 2019 to increase its TAM and grab market share from other competitors, as VirTra’s products do not require a significant upfront payment. The upfront payment is essential, as many police departments find it challenging to save money as they risk a cut in their budgets if they spend less in a year; hence, the price becomes an important issue.

Lastly, some police departments could share their simulation equipment to train other cadets from low-budget departments, which could somewhat limit VirTra’s TAM.

Trend Analysis and Industry

VirTra estimates a TAM of $650 million in its investor presentation. Still, this TAM only accounts for one-third of the largest police departments, as VirTra products cannot be afforded by many departments. Nevertheless, with the introduction of the STEP program, I think the other two-thirds of departments are reachable, elevating the TAM higher. VirTra TTM revenue is $36.574 million, so the company has a lot of room to keep growing at a double-digit rate without expanding in the military segment. Furthermore, an industry analysis by Precision Reports estimated the size of the whole industry at $12,349 million in 2021, with an expected growth of 4.52% until 2027; in this sense, GlobeNewswire estimated an annual growth rate of 6.53% until 2027, adding $4,885 million to the industry.

On the other hand, recent trends indicate a shift toward bolstering police budgets at both local and federal levels. Despite initial calls to defund the police following the 2020 protests, most U.S. cities augmented their budgets in 2021, continuing into 2022. President Biden’s proposed federal budget includes expansions in police funding, with over $32 billion allocated to new police spending, overshadowing allocations for alternative community violence intervention programs. In this sense, there seems to be positive momentum in the industry that could continue as people demand better training for police officers, who currently lack training in stressful situations, such as the VirTra’s scenarios.

Lastly, taking the words of the current VirTra’s CEO, John Givens, AI can bring a lot of innovation to the industry as the simulation can be enhanced by adding more dynamic scenarios and improving performance analysis and content creation. From my perspective, VirTra is well-positioned to take advantage of the AI revolution thanks to its cutting-edge technology, high customer retention, and a high commitment to developing the best products, which was demonstrated with its last release, VX-R with the V-3 Volumetric Capture Studio.

Management Team

VirTra is still led by its founder, Mr. Bob Ferris, the executive chairman. Under its leadership, VirTra achieved outstanding financial results before 2017, with annual ROE higher than 30%. Nevertheless, the company experienced severe troubles after 2017 (when it went public) as there were constant increases in the allowance for doubtful receivables, impairment of intangible assets, and unfavorable product mix; nonetheless, VirTra achieved higher margins in the last quarters. I think margins will trend higher and be more stable as the company’s recurring revenue increases as part of the total sales (management expects it to be around 30% of the product mix), thanks to the STEP program and the subscription to VR-X library of realistic scenarios, as these services carry low cost of sales compared to the products.

One factor that I think helped VirTra attain better results is the appointment of its current CEO in May 2022. John Givens has extensive experience in the simulation industry, founding BISim and leading it to success by scaling its operations internationally and selling it for $ 200 million, which doubles the current VirTra market share. Furthermore, in October 2023, Tony Cianflone joined the team to foster international and military sales, and keep increasing law enforcement market share by leveraging VirTra technology. The need for an outstanding sales force is crucial in the industry as law enforcement and military departments find valuable in-person demonstrations and allow VirTra to adapt to budget constraints and specific training needs, according to John Givens.

Nevertheless, the management team has low ‘skin in the game.’ John Givens and Bob Ferris own only 5.19% of the total shares outstanding; however, I’m not too worried about the low shares ownership because a significant portion of remuneration is stock awards, according to the last proxy statement. For instance, John Givens earned almost $415 thousand in stock awards while his salary was $188 thousand in 2022; furthermore, Bob Ferris earned $80 thousand in stock awards while his salary was $360 thousand. Thus, thanks to these stock awards, I believe there is an alignment between stockholders’ and managers’ interests.

Financial Performance

VirTra margins have skyrocketed in the last quarters, improving significantly from 2021 to 2022. However, in the earnings call, the management stated they expect the margins to be close to 1Q23 margins in the long term; thus, higher margins achieved in 3Q23 may not be sustainable in the long term. We must recall that the company struggled after going public as it had to recognize several impairments and allowances for doubtful accounts. At the same time, it had an adverse product mix for many years. Thus, something had to change to achieve better results, and the management described the initiatives in the 2Q23 and 3Q23 earnings calls. VirTra undertook several key initiatives to enhance both operational efficiency and customer experience. They addressed their backlog and bolstered customer service through an ERP system overhaul, leading to faster installations and improved performance tracking.

Additionally, they strengthened their supply chain, minimizing delays and enhancing overall operational performance alongside refined inventory management. Restructuring their sales force with regional managers, revising incentive plans, and employing dedicated support specialists have also yielded positive results. Furthermore, the centralization of their facilities under one roof has unlocked immediate operational and cost efficiencies. Finally, establishing a dedicated training center within their headquarters aims to showcase their products and strengthen customer relationships, ultimately driving greater product adoption.

I think these initiatives have brought higher efficiency and will boost future revenue in law enforcement and military segments. Moreover, these benefits will likely remain in the long term, so alongside the higher recurring revenue (25% according to the last earnings call), they will bring higher and stable margins compared to the previous three years.

Finally, it’s insightful to see which were the returns when the company had double-digit operating margins before going public:

Unlike the last three years, when ROE has been high single-digit and low double-digit (even negative in 2019), the ROE before going public was higher than 30% when margins were in the low double-digit and high single-digit; now the company is reporting operating margins higher than 15%, and I think these results are likely to continue; thus, it’s plausible to expect that returns will skyrocket.

Risks

Competition

VirTra has clear competitive advantages; however, the competition is there, and trying to improve its products and adopt new technologies to equal the quality of VirTra’s products. Furthermore, the race for AI adoption could bring new competitors or make other competitors outpace VirTra. Finally, the adventure in the military segment is going better than expected by the management; however, VirTra faces many more competitors, such as Northrop Grumman (NOC), Lockheed Martin (LMT), Meggit, etc.

Adverse Public Opinion

As it happened in 2020 when the public asked for a reduction in the police budget, it could happen in the future. This could severely affect the VirTra revenue as the law enforcement departments are susceptible to prices, and a decrease in their budget could delay the acquisition of new simulators.

The Loss of Key Customers

Even though the firm is diversifying its customer base, some customers still represent a significant portion of the revenue, as can be deducted from the last earnings call. Nonetheless, in my opinion, the high retention rate and a higher portion of recurring revenue will diminish the importance of this risk in the future.

Valuation

For my DCF model, I will assume a revenue growth rate of 22%, which is very optimistic. Nevertheless, the company is expanding its sales team and production capacity to meet its law enforcement and military growth objectives. Furthermore, the STEP program, the V-3 Volumetric, and the VX-R are expanding VirTra’s TAM, which, according to its investor presentation, is $650 million. Moreover, even assuming a 22% revenue growth rate, VirTra won’t account for more than 16% of its current TAM by 2028. Finally, we should note that the simulation training market is expected to keep growing during this period, so the TAM will increase even without the abovementioned initiatives.

On the other hand, I’ll be more conservative about margins; in my DCF model, the gross margin will begin at 62% and increase by 50 bps per year. The same growth rate will apply to the operating margin, which will start at 19.3%, significantly lower than the operating margin achieved in 1Q23 of 35%. Finally, as revenue ramps up, I expect the CAPEX as a percentage of revenue will decrease to 3%, the tax rate will be 21%, and the discount rate will be 14.5%.

Given these premises, the net present value of VirTra shares is $13.95; thus, I consider the shares to be undervalued at their current price of $9.69, giving a wide margin of safety (>30%). Consequently, at the current prices, the company is a ‘Buy’ with significant protection against downside risk.

Conclusion

VirTra’s position in the competitive police training industry is fortified by its diverse product portfolio, including simulators, VR hardware and software, and specialized training solutions. The company’s strategic initiatives, such as the Subscription Training Equipment Partnership (“STEP”) program and the Virtual Interactive Coursework Training Academy (VICTA), have significantly expanded its market reach and solidified its leadership in police training. Despite competition from industry players like Inveris and Milo, VirTra’s unique nationally certified courses and advanced simulation technology set it apart. While risks such as adverse public opinion and losing key customers persist, VirTra’s competitive advantages, innovative products, and operational efficiency enhancements position it favorably for sustained growth and profitability. With a strong emphasis on customer retention, recurring revenue streams, and operational excellence, VirTra presents a compelling investment opportunity in the evolving police training sector.