PSA ADAPT State of Industry Panelists: RMR Is a Lifeline in Ravaged Economy
The virtual session featured PSA CEO Bill Bozeman and President Ric McCullough, joined by NSCA’s Chuck Wilson and Bill Polk of EGIS Capital Partners.
ADAPT 2020, a managerial conference for PSA owner and member company employees, is being hosted virtually Oct. 6-8 following cancellation of the in-person event, which was originally scheduled to be held in Hilton Head Island, S.C.
On opening day, a State of the Industry general session featured PSA CEO Bill Bozeman and President Ric McCullough, who were joined by NSCA Executive Director Chuck Wilson and Bill Polk, a managing partner at EGIS Capital Partners. The panelists participated individually from remote locations, but they all shared the same virtual background: a waterfront image with Hilton Head’s iconic red-and-white-striped Harbour Town Lighthouse prominently positioned behind them.
Serving as moderator, McCullough drove a wide-ranging conversation that covered topics relevant to stakeholders that ply the security and A/V integration channels. The discussion included impacts to businesses caused by the coronavirus pandemic, related trends and challenges, an overview of sector performance, and more. But possibly the most compelling subject matter centered on the role that RMR-producing managed services are having on the sustainability of integration companies.
First Dread, Then ‘Really Good News’
At the onset of economic collapse when state economies began shuttering in mid-March, Bozeman said he was at first deeply concerned by the heap of vulnerabilities threatening the integration channel. Several months into the pandemic, however, his sentiments have improved greatly.
“PSA is a great barometer of what is going on in our space. We are doing better than anticipated,” he said. “Our organization is solid, but this really isn’t about our organization. This is about our equity partners — our integrators and our vendors.”
Most of PSA’s approximately 200 member companies have payrolls with 25 to 100 employees, and annual revenues ranging from $15 million to $25 million. As an organization, the cooperative is “meeting our numbers” with smaller and middle-sized integrators doing better than projected, “which is really, really good news,” Bozeman said.
Maintaining profitably has been achieved by those security integrators that have adapted to the wickedly shifting and constricting market niches in which they normally play. For those companies that are “faring quite well,” diversification has been essential, Bozeman said.
“We preach an intelligent level of diversification where you don’t put all your eggs in one basket. But when you have as many integrators as we do, you always have a few outliers,” he continued. “If your main vertical — if 80% of your business is coming from retail, gaming, etc. — then you have issues and you have problems.”
Wilson then commented on how larger A/V and security integration companies within the overall low-voltage community have performed during the pandemic.
Wilson said he has recently conferred with leading manufacturers to gauge the percentage of sales volume that has increased or declined. The feedback he received was that larger integrators are the ones experiencing the greater decline.
“I think it ties into probably the PPP funding for those companies over 500 employees,” he said. “They weren’t eligible for that, so they took the most immediate and sharp decline in their workforce.”
Specific to NSCA members, Wilson said he was initially most worried for medium-sized integrators and would they be nimble enough to pivot and adapt to offering new technologies that were suddenly in demand. Much to his surprise, many have been able to make payroll and power through the economic malaise.
“We’re going to predict that by year-end we’ll see about a 20% decline in overall revenue from our members if you lump them altogether. And then a 20% hit on the productivity or utilization, meaning that if they bid 100 hours on a job it would turn out at 120,” Wilson explained. “So there’s a double whammy of inefficiencies — like not being able to have the project meetings — because of all the different things going on with personal protection safety, as well as a decline of 20% in overall revenue.”
Industry Sector Performance
Polk provided a rundown of the security industry’s various subsectors, based on EGIS Capital’s own observations and by virtue of conversations he has had with investment bankers and other investors. Here is an abbreviated summary of his insights concerning assorted technologies, market niches and company types:
Access control — These technologies are becoming increasingly critical where systems are securing the enterprise in order to help manage employee wellness and distancing requirements.
Cloud-based systems — Systems that can be operated remotely are experiencing revenue upticks and customer adoption. Conversely, legacy systems that require onsite physical access are experiencing headwinds.
Cybersecurity — There has been a massive shift to Cloud deployments due to the work-from-home trend, along with the increased number and form of network attacks. There are very substantial private equity and venture capital bets being made across the range of cyber solutions: ransomware, destruction service, malware insider threats, as well as deep and dark web activity.
Residential — The sector has a number of very large, highly leveraged installation companies that have borrowed too much money. These firms are experiencing some financial difficulties unrelated to the pandemic, but also compounded by it.
Commercial — Commercial-centric alarm companies are doing well, where service offerings are expanding beyond traditional services to remote video, remote access and IoT-based monitoring.
Manufacturers — Overall, revenues for product companies are down. Video hardware has increased demand where cameras, especially cameras and analytics for monitoring employee health. Federal government’s efforts to limit Chinese sales in the U.S. are helping Western hemisphere businesses.
Alarms — Alarm system sales are doing reasonably well, with RMR streams remaining steady. In general, new installations are down but offset slightly by concerns over civil unrest, which is prompting both commercial and residential customers to invest in systems.
Systems integration — Specifically those integrators servicing essential customers like the U.S. government have seen only modest revenue drops. Those servicing nonessential enterprises, such as retail, hospitality and travel, saw big declines. Systems integrators with an RMR-based model have performed much better by comparison than more traditional-minded companies.
A Shining Light: Managed Services
For several years now Bozeman has evangelized about the need for security integrators to gradually augment their core business models with a managed services program that creates steady streams of recurring revenue. This allows integrators to stabilize their cash flow and be more predictable, and therefore be more desirable to banks and other potential investors.
Those companies with an RMR business model in place prior to the pandemic have unequivocally fared better than those security providers that haven’t, PSA’s performance indicators show.
“From the PSA companies that we’ve talked to during the pandemic it is proven over and over again that [managed services] is what has allowed some of these companies to survive,” McCullough noted. “Without that safety net of the RMR, that steady income, I’m not sure where some of them would actually be at today.”
Bozeman commented that while all PSA integrators may understand managed services are here to stay, a significant number of them are yet to make the pivot to recurring revenue program.
“Twenty percent of them are already neck deep [in managed services]; 40% are active,” Bozeman said. “That leaves a pretty large percentage of 60% who haven’t yet put forth what we think is the needed effort to prepare themselves for the future related to manage services, which we think is going be a huge part of their revenue run rate.”
Polk would have the integration channel keenly understand an overriding caveat about recurring revenue: Not all RMR is created equal. Broadly, the higher the percentage of total revenue, the better. North of 50% to 60% will help grab investor’s attention. But the quality of the managed services revenue is as heavily scrutinized as the quantity of it by bankers and investors, Polk explained.
“What is the organic growth rate of the RMR? What’s the future RMR revenue visibility? By that I mean the quality of the backlog and the term of the RMR contracts,” he continued. “Is it a one-year contract or a three-year contract? That will give greater views of the pro forma revenue streams.”
There’s much more scrutiny involved, such as the quality of pipeline. Are you upselling customers and acquiring new customers or not? What are the margins, and especially the gross margins? A 35% gross margin — regardless of whether or not there is RMR associated with it — is not going to excite many investors, Polk said.
The rate of attrition and customer creation costs are other key factors. In terms of the sales cycle, how long does it take to land that recurring revenue and does the RMR conversion lead to sales quickly?
“If we add up margins, attrition rate and creation costs, those three things determine the long-term value of a customer,” Polk said. “And, obviously, the greater the long-term value, the greater the value of that RMR.”
While the integration channel has copious capital available to it, in both debt and equity forms, Polk invoked a quote from Warren Buffet to illustrate investor caution in the current economy: “You never know who’s swimming naked until the tide goes out.”
The current environment has especially highlighted what works and what doesn’t, Polk said.
“The greatest opportunities are the rapidly expanding number of Cloud-based, RMR-based offerings that integrators can sell across access control, video, smart buildings, smart homes and smart cities,” he said. “Certainly all things cyber, too. There is access control in the Cloud. There’s video in the Cloud. There’s environmental monitoring in the Cloud, but also in cyber there’s firewall monitoring.”
The answer to longevity, Wilson said, is to sell solutions that help end customers run their businesses better. Focus on the factors that drive technology investment that help end users improve their workflows, processes and outcomes.
“The biggest opportunities for us as integrators is to always try to figure out how to add relevance and add value to everything that you’re doing for your clients when it comes to helping solve their problems,” he said.
The biggest threat to integrators in Wilson’s purview is living job to job, project to project, selling only hardware. Legacy integrators, Wilson said, face a huge threat of eventually becoming extinct, diminishing in size over time due mainly due to margin erosion.
“That isn’t where we want to go,” he continued. “We have the backstop, the safety net of that recurring revenue to prop us up going forward.”
To learn more about PSA ADAPT 2020, go here.
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