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Virtra Systems Is In A Very Enviable Position

|About: VirTra, Inc. (VTSI), Includes: AAXN, AOBC, ATRO, CUB, DGLY, LMT, MEGGY, VTSI

Summary

The escalating global push to have smarter law enforcement and military personnel provides a major growth opportunity for Virtra Systems.

Virtra Systems products are far superior to its competitors products, and intellectual property protects Virtra from significant amounts of competition.

Virtra is a great acquisition target. Even with no acquisition, shares are due for a major revaluation.

Virtra has a very solid balance sheet and a simple shareholder structure.

Numerous potential catalysts in the near-term could propel Virtra's shares to trade closer to their intrinsic value.

About VirTra Systems

According to its website, "VirTra began in 1993 as one of the first virtual reality companies in the world. The company's primary focus is the sale and support of the world's finest small arms training simulators.

The world can be a very dangerous place. Both military and law enforcement officers are expected to make the correct decision, with excellent marksmanship, in split-second life-and-death situations. The better and more realistic the training, the greater the chance the trainee will succeed when lives hang in the balance and threats are real! Customers throughout the world buy our simulators for realistic training so that trainees have better chances to succeed in their missions and survive lethal encounters.

VirTra (VTSI) has created the world's most realistic military firearms training as well as judgmental use-of-force training simulators. With best-in-class customer service and unparalleled technology, like 300-degree real-world scenarios, tetherless recoil kits, and the patented Threat-Fire™ safe return fire system, it is no surprise that the finest military and law enforcement agencies in the US and throughout the world have hand-selected VirTra's simulators after trying out all other options."

I have found a couple different videos that better display VirTra's technology. Here and here you can find videos giving overviews of VirTra's V-Range and related systems, which could save police and military institutions millions from the need to no longer purchase bulletts.

Here is an older video showing how the use of force simulators work and here is a newer video showing VirTra in action. Here is another video of U.S. marshalls training in a Virtra simulator and a story of how their VirTra simulator training helped them in a use of force situation that directly helped to save lives.

Macro Environment

No matter what a given person's beliefs are in relation to gun control, I would hope that everyone can agree on one thing. This is that gun regulation, police brutality/excessive use of force, and active shooter situations are all very hot issues currently. Recent events in the United States have certainly brought these issues to the forefront of our nations attention.

Please understand that I am in no way voicing any pro or anti-gun regulation rhetoric in this article. Seeking Alpha is not the proper arena for this. I am just mentioning events that are happening in the world, and observing things that are happening in response to these events.

Literally ten minutes before I sat down to write this article, I saw that there was an active shooter situation in Ottawa, Canada today.

The recent shooting of Michael Brown by a police officer in Missouri has brought into question police training methods... again. The "recent shooting" link describes how training methods are being readdressed. I don't need to go into any detail on this situation for anyone to understand the public outrage that this, or any of the other similar events over the past few years has caused.

The list of these events goes on and on. Rather than listing every individual incident, I think it would be more appropriate to give some examples of how these incidents have affected certain types of related businesses.

Recent Related Company Corporate News

Phoenix based TASER International Inc. (TASR), has seen a major surge in orders of its products recently. It has seen surges in its police officer worn cameras, and also in its less-than-lethal taser guns. These orders have been coming in from all over the world. The biggest surge however, has been Taser's stock price. Its valuation is pretty ridiculous if you ask me. We will come back to this point shortly.

A different company, Digital Ally (NASDAQ:DGLY), saw its stock price rise more than 500% from mid-summer through September. Digital Ally makes camera's to monitor police actions similar to Taser. These cameras are worn on the potential officers body to monitor all of her/his actions in the line of duty.

Information about the above two companies recent developments can be found here. I encourage people to follow some recent press releases made by these companies to really understand just how much this sector heating up because of recent incidents of violence/excessive use of force.

Another good link describing the new push for better police training can be found here.

Recently, gun companies have been scrambling to deal with regulatory uncertainty. Italian gunmaker, Beretta, has partnered with Virtra in the past to develop weapons suitable for Virtra's simulators. Virtra also has its simulators set up for Taser's products, Smith & Wesson's (SWHC) products, and many more. A one year old product list for Virtra can be found here. This can give you an idea of all of the different types of weapons that Virtra has custom tailored its simulators to be compatible with.

Support Of VirTra's Product Superiority

I strongly encourage anyone interested in this investment to read the links in this paragraph.

Sonoma County outlined a comparison of VirTra to the available alternatives and this can be found here. Pages 5-9 in the previous link outline how VirTra simply has a superior product offering and no one else can really compete with VirTra.

Here you will find an approval from the City of Omaha to buy some virtra equipment. The important page in this link is the page titled, "Sole Source Justification". It explains why VirTra's products were chosen instead of the competing products.

Here is a link about a criminal justice program at a college purchasing a VirTra simulator.

Could A Deep Pocketed Defense Company Make A Rival Product?

In my opinion, this isn't really a big risk for 1 reason... Intellectual Property. For a company to be able to recreate VirTra's technology is a problem in itself, and would be difficult and take a long time even if a company had very deep pockets. The main thing stopping a rival simulator is the threat fire system that is patented by VirTra.

Virtra's Financial Progress Has Been Impressive

in millions 2009 2010 2011 2012 2013
Revenue $4.35 $6.42 $7.86 $8.83 $9.82
Gross Profit $2.79 $3.97 $4.07 $5.55 $6.46

Solid improvement was displayed over this time period. Virtra moved into its current Tempe headquarters in 2011, and the bottom line improvement has been pretty impressive since then.

in millions 2011 2012 2013
EBITDA ($0.374) $0.460 $1.911
GAAP Net Income ($0.693) $0.113 $1.581
Free Cash Flow ($0.394) $0.068 $1.843

Not to downplay VirTra's financial improvement over the past 3 years, but I believe that recent announcements will have a very significant impact on VirTra's results over the coming quarters and the improvements that will be shown in the future will make these past achievements look pretty unimportant. Why I believe this is as follows...

Recent Press Releases

On September 22 of this year, VirTra announced a $6 million dollar order for its simulators from the U.S. Department of Homeland Security. According to the terms of the contract award which can be found in the above link, it is deliverable over the next 6 months.

On October 15 of this year, VirTra announced that they had a record number of orders for the third quarter, nearly $11 million. This is big news.

They only did $9.8 million in revenue for the entire year last year and they just booked $11 million in sales orders in one quarter (although not all of them will be recognized at once). I believe the highest order total in a quarter previous to this was just shy of $5 million.

These press releases can be found here.

Virtra's ability to decrease SGA expenses from 2012 through 2013 leads me to believe that these new orders can essentially have the ability to add huge incremental amounts to the bottom line. I would think that about 40% of all order volume above a $10 million dollar annual revenue run rate would drop straight to the bottom line.

The stock has essentially moved from $0.07 to $0.13 in light of these announcements, but I think that when the quarterly results are released in the near future, the market will realize how big these orders really are in regard to increasing VirTra's free cash flow and income and the stock should see much more love.

What Is It Worth?

Taser currently trades at 38 X its free cash flow and its EV/EBITDA is 23. This would value VirTra at $0.44 or $0.29 based on its current EBITDA and free cash flow. If we applied these multiples to VirTra's future EBITDA/free cash flow that will be added from these new orders, its valuation could get pretty crazy. However, I think we should wait and see the sales before we get too crazy with the valuation.

From another viewpoint, Taser trades at 45 X its EPS over the trailing twelve months. Applying this to VirTra would give us a current valuation of $0.46. VirTra's revenues grew 34% in the mrq compared to around 16% revenue growth at Taser.

Digital Ally isn't profitable. VirTra & Digital Ally are about the same size revenue wise, but VirTra makes money and Digital Ally doesn't. I realize they make different products, but they are both playing off of the same use-of-force and judgment training trend, and this is the reason for my mention. DGLY has burned through a bunch of cash over the trailing twelve months and it trades at a premium to VirTra for some reason I can not understand. It trades at an EV/Revenue of 2.8. VirTra should be valued much higher than DGLY in my opinion since it actually makes money. Despite this, VirTra trades at a discount to DGLY.

Comparable Companies

Cubic Corporation (CUB) - Cubic does three things: 1. sells transportation systems to the government, 2. provides mission support services to the government, and 3. provides defense systems to the government. Use-of-force training simulators are a large part of this business.

Taser International - Makes many different types of electrical less than lethal weapons. Also makes many other types of law enforcement equipment that promotes smarter and more monitored law enforcement.

Digital Ally - Makes digital video imaging and storage products for use in law enforcement. Although not comparable on an operational standpoint to VirTra, it is comparable based on the major trend that is being capitalized on for smarter military and law enforcement.

Astronics Corp (NASDAQ:ATRO) - Aerospace and Defense contractor. It is big into the test, training, and simulation business. In March of this year, it purchased the test and services division of EADS.

Meggitt PLC (OTCPK:MEGGY) - Makes components and sub-systems for aerospace, defense, energy, midical, industrial, test, and automotive markets in the United Kingdom and internationally. It has a large virtual training simulator segment that competes with VirTra.

There are other more direct competitors and comparable companies, but they are mostly private companies.

  EV/EBITDA P/E (fwd) Growth (yoy)
Taser 23 36 16%
Astronics 12 18 N/A*
Cubic 13 16 1%
Meggitt 11 13 -11%
Digital Ally No Ebitda 15 -31%

*Astronics quarterly year over year growth comparisons would improperly skew data because of major acquisitions/changes in debt/shares outstanding during the period

I think VirTra is worth between $0.25 and $0.30. I think that this is more than conservative based on the above chart and a comparison to virtra's past growth and future growth that will come from the recent order surge. I will be revaluing the company whenever it releases its next quarterly report here in a week or so.

Shareholder Structure

VirTra only has 1 class of shares currently outstanding. The only 10% or greater holder is the CEO, Bob Ferris. He owns roughly 10 or 11% of the company. There are 158 million shares out and this number has been pretty constant. This is almost a requirement of mine when the company is this small (management needs to be a big stockholder).

There aren't any related party transactions clouding things up.

Balance Sheet

This is definitely one of my favorite aspects of this investment. They have about 1 million in cash and they are debt free.

Acquisition Target

VirTra presents a great acquisition opportunity to a lot of firms for a number of reasons. The main reason being that VirTra has a fantastic product offering with high profit margins. Other companies can't duplicate VirTra's product offering or technology, and even if a competitor could make a comparable product it couldn't do so without violating VirTra's intellectual property rights.

Who are some potential suitors? In my opinion, there are many potential suitors in the defense industry. Let's take Taser for example.

Taser has partnered with VirTra to make simulators compatible with Taser's less-than-lethal weapons which can be seen here. Also, its probably important to point out that the two companies are headquartered 20 minutes apart. If VirTra's results turn out how I think over the next year or so based on its recent order success, it could be doing $22 million in revenue and about $6 + million in EBITDA. For Taser to keep its current sky high valuation, they are going to have to make some moves to maintain growth. Why not buy the company down the road they are already familiar with that operates in the exact same industry? It isn't too far fetched of an idea.

Another great example of a suitor would be Lockheed Martin (NYSE:LMT). One might wonder why a $55 billion company like LMT would buy a company as small as VirTra, but in reality, LMT makes tiny acquisitions all of the time. For example, it just purchased an astrotech unit for $61 million. Lockheed is very familiar with VirTra. Lockheed placed its first order with VirTra in 2009. In 2012, Lockheed actually entered into a partnership with VirTra so that VirTra can use Lockheed's distribution network and Lockheed essentially gets royalty payments for VirTra units it sells through its network (2nd part is assumption). Now, if Lockheed wanted to make its own simulators they definitely have the money to do so. Lockheed can't however recreate the patented threat-fire system that VirTra has developed. If Lockheed didn't see the value in VirTra's systems, they wouldn't have done this deal. Lockheed must have really seen value in VirTra's offering or they wouldn't have partnered with them in my opinion... They have $3 Billion in cash! They had no reason to enter this partnership unless they saw big down the road applications for this patented technology. I seriously doubt the motivation behind this partnership was to receive some miniscule royalty payments and to simply feel good about themselves for helping out a small struggling defense company. This partnership screams future potential acquisition to me but this is just speculation. I would like to point out that a different possible motivation for the partnership could be because Lockheed gets preferential bidding status when bidding on certain types of government contracts when they subcontract to smaller or minority owned firms like VirTra. Even if this is the case, the partnership is a very good sign for the value that VirTras products offer.

I think that there are a number of potential suitors, these are just two that make a lot of sense to me.

Catalysts

1. VirTra simply continuing to ride the trend towards smarter law enforcement decision making and reduced military/police budgets forcing agencies to switch to the best bullet free simulators

2. Release of next quarter. I typically wouldn't consider this a catalyst, but I really do not think that investors have grasped how much bottom line impact these recent orders could have.

3. The company is currently a pinksheets current filer. They file quarterly reports and audited annual reports. They stated after announcing last years full year results that, "The Company does not plan to register with the Securities and Exchange Commission at this time. However, the Board of Directors is monitoring the situation regularly and is prepared to proceed with registration, if and when the Board deems it is in the best interests of all the shareholders." I would argue that the time to register is rapidly approaching and this would serve as a major catalyst.

Risks/Things That Bother Me A Bit

1. The company is not currently an SEC filer which means that they have reduced reporting requirements. That being said, they file annual audited financials which is a requirement for me to invest in a public company (and should be a requirement for all investors).

2. The sales cycles in this business can range from 6 months to 3 years or more. What does this mean? Quarter over quarter comparisons are nearly impossible and this frustrates many investors... It has lumpy growth and this makes forecasting harder than it already is.

3. They have the ability to issue preferred stock with crazy voting rights, but this wouldn't ever become an issue unless a hostile takeover was attempted. Many companies have this ability but it never really amounts to anything happening... I don't consider this an actual risk I just want to point it out.

4. Despite the superior product offering (based on customer comments) and 2 patents, there is the obvious risk of deep pocketed companies making more innovative or somehow superior products eventually.

5. Very cyclical industry that is tied to government spending, although it does aim to capture business from displaying cost saving with certain of its products.

6. I don't invest in technology very much because it is hard to value something that changes so fast... I am breaking my own investing preference by this measure with VirTra.

7. The company is very small, and some unimaginable blow to the business in some form or another could be tough to deal with because they simply wouldn't have the capital to obtain an optimal solution for shareholders.

Summary

VirTra is trading at 11 X 2013 free cash flow net of cash, and probably trading at around 4 x forward free cash flow based on the recent trend in order activity. There is a possibility that I am overestimating (or under) VirTra's future earnings due to the recent order surge. Even if I am, the stock is still much too cheap in my opinion. This should have a high growth valuation and it is valued like a company on the decline. It has a clean balance sheet and any other risks are not risks that particularly bother me as an investor.

Disclosure: The author is long VTSI.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.