Description

Description:

RMDX sells monitoring devices to track sex offenders and other parolees.  Currently, it is a “story stock” with a significant amount of upside potential.  Based on my calculations, it is trading at approximately 10x fully taxed run rate ’07 (exit) numbers and 6x fully taxed run rate ’08 (exit) numbers, yet it has $60M of NOLs and will not pay taxes at all for the next few years.  My estimates could prove to be conservative.  The company is in discussions at the state level for contracts in CA, IL, MI and TX – any one of these contracts would dwarf my numbers.  We believe that there is potential for a multi-bag return on the stock.  There is no sell side coverage on the name – we believe that Merriman Curran Ford is doing work and will launch coverage in the near future.   Sam Zell has helped to finance the company.

 

RMDX makes GPS monitoring devices for two markets:

o        Medical market – monitoring senior citizens that live alone

o        Law enforcement market – monitor sex offenders and other parolees (drunk drivers, pre-trial “at risk” offenders, domestic violence offenders etc).

 

Secular Tailwinds:

The crux of the RMDX story lies within the law enforcement market and the company’s TrackerPAL product.   Most VIC readers are probably aware that there is a strong secular trend towards better monitoring of sex offenders.  Currently, Orin Hatch is sponsoring the Adam Walsh Child Protection and Safety Act of 2006.  The bill would require sex offenders to wear GPS devices for life.  Furthermore, over the past 14 months, 40 out of 50 states have either passed laws that require all sex offenders to be monitored 24/7 by a GPS device OR have bills that will imminently pass.  As an example, we will point VIC readers to Prop 83, which just passed in CA on the November ballot. http://www.smartvoter.org/2006/11/07/ca/state/prop/83/

Prop 83 requires every sex offender to wear a GPS device and restricts their ability to live near schools.  This is a serious issue that local, state and federal legislators are acting upon.  In addition to the obvious benefits of being able to track a sex offender, it is also a significantly cheaper proposition versus incarcerating someone.  The current cost of keeping someone in jail is approximately $70 - $100 per day.  The cost of monitoring someone with a GPS device is approximately $8 per day.   

 

The Market:

The National Alert Registry nationwide database lists approximately 500,000 sex offenders.  In addition, it is estimated that there are a few hundred thousand unregistered offenders.   The market is not limited to just these criminals.  There are municipalities that are using the devices to track DUI and drug offenders, individuals who are considered a pre-trial “flight risk” and domestic violence offenders (restraining orders).  While we do not have statistics on how many individuals fall into these categories, it is safe to say that it is many multiples of the sex offender market.   Assuming 700k sex offenders and 2M “other” offenders, the potential market is approximately $8B (over time).   In the near term, the sex offender market represents a $2B opportunity (700k offenders x $8 per day monitoring fee x 365 days). 

 

The market is in a nascent stage and is ready for rapid growth.  Although many states have passed laws requiring 24/7 electronic monitoring, the reality is that has yet to be a significant amount of dollars released by the state governments.  For the most part, the state governments have passed the responsibility of execution to various state agencies (corrections agencies, parole agencies etc).  Many county and local municipalities have taken the bull by the horns and have been ordering devices on their own.  We expect smaller orders from these municipalities to be the majority of market demand for the next six to twelve months.   From there, we should see states begin ordering devices on a statewide level.  These orders will move the market across the chasm from early adopters to mainstream acceptance. 

 

The Device:

The TrackerPAL device is an ankle bracelet with embedded CPU, cell phone and GPS.  It is attached to an offender with fiber optic and braided cable wire and it is 100% tamper proof.  It is waterproof up to ten meters and comes with two rechargeable batteries (24 hour battery life).  The offender’s motivation for always keeping the device on is the alternative option – going back to jail.  Offenders that are wearing the device do not get a second chance – its either “on” or “back in jail.” 

 

Current contracts, backlog and “big” opportunities:

RMDX has contracts with approximately 125 different municipalities / agencies including the city of Oakland, Orange County FL, Mecklenberg NC, Cumberland County PA and the Bail Bond Association of Florida.  RMDX’s largest contract is with the State of South Carolina.  The total size of the contract at this point is unclear although they are shipping units on a weekly basis.  Across all contracts, the company has 20k units that have been ordered and another 15k on what we call hard backlog.  Based on our conversations with management, we believe that there are another 10k units in soft backlog.  As South Carolina grows, the total backlog number will grow as well. 

 

RMDX is also working on several large deals, several of which would be company changing:

• California – RMDX is in conversations with the state for a statewide contract.  This would be a company changing event and would dwarf any of my estimates.   CA passed Prop 83 in the November ballot which said that every sex offender in the state has to wear a GPS device and their ability to live near schools will be limited.  This creates statewide funding for the project.
• Discussions at the state level in TX, IL and MI – co will likely announce smaller deals with municipalities in these states as they continue to make a push at the state level.
• Mexico – We expect an announcement by year end for an order in the range of 10k units.  This might be a diff’t model (sales of actual unit and a very small monitoring fee  vs. purely monitoring fee) as Mexico has their own monitoring center. 

 

Business Model / Financials:

RMDX has an extremely profitable business model with inherent leverage.  We compare it to the razor / razor blade model.  The company makes money by charging a daily monitoring fee of $8 / device / day (initial contracts were in the $6.50 range, current contract signings are in the $8.75 range).   Current margins on the device are approximately $2.58 / device / day.  Costs of $5.42 (per day) consist of:

• $1.48 communication services
• $0.06 location services
• $1.00 commission (distributor commission for selling / installation)
• $0.11 maintenance
• $0.23 cost of monitoring center
• $1.04 cost of device amortized over a year (device currently costs $550 to manufacture, company has contracted to manufacture device for $380 starting in six months)
• $1.50 royalty fee paid to early shareholders***

 

*** We believe that RMDX is in the process of renegotiating the royalty fee and issuing additional shares to these shareholders.  This will improve margins from $2.58 to $4.12, or from 32% to 52%. 

 

According to the CFO, the current SGA costs are approximately $500k / month, or $6M per year.  This run rate can support up to 40k units.  At 80k units, the SGA will be approximately $10M.  To be conservative, we have assumed that SGA will be $15M at 45k units (my estimate of total units in the field by year end 2007).    Additionally, I have assumed an 80% utilization rate on the devices, the company uses 90% for internal modeling purposes.

 

Assumptions	2006	2007	2008
# Units	20,000	50,000	80,000
Price / day	$8.00	$8.00	$7.50
Utilization (2)	80%	80%	80%
Cost of Device (4)	$550	$465	$380
Monitoring Costs:
Communications Srvc	$1.48	$1.48	$1.48
Location	$0.06	$0.06	$0.06
Commission	$1.00	$1.00	$1.00
Maintenance	$0.11	$0.11	$0.11
Monitoring center	$0.23	$0.23	$0.23
Royalty	$1.50	$0.00	$0.00
Total Monitoring / day	$4.38	$2.88	$2.88
Depreciation (% sales)	0.5%	0.5%	0.5%
Tax Rate (3)	36%	36%	36%
	RUN RATE BY YEAR END
	2006	2007	2008
Sales	$46,720,000	$116,800,000	$175,200,000
COGS	$11,000,000	$13,950,000	$11,400,000
Gross Profit	$35,720,000	$102,850,000	$163,800,000
Gross Margin	76.5%	88.1%	93.5%
Operating Expenses
Monitoring	$31,974,000	$52,560,000	$84,096,000
SGA (1)	$6,000,000	$15,000,000	$24,000,000
Total Opex	$37,974,000	$67,560,000	$108,096,000
EBITDA	-$2,254,000	$35,290,000	$55,704,000
EBITDA margin	-4.8%	30.2%	31.8%
Depreciation	$233,600	$584,000	$876,000
EBIT	-$2,487,600	$34,706,000	$54,828,000
Taxes	-$895,536	$12,494,160	$19,738,080
Net Income	-$1,592,064	$22,211,840	$35,089,920
EPS	-$0.01	$0.16	$0.25
Shares	131,540,000	140,000,000	140,000,000
Share Price	$1.60	$1.60	$1.60
Market Cap	$210,464,000	$224,000,000	$224,000,000
P/E	-132.2	10.1	6.4
(1) CFO said $500k / month can scale to 40k units, $1M / month to 80k units
(2) CFO thinks no more than 30 down days implying 90% utilization, using 80% to be conservative
(3) Co has $60M in NOL's, my numbers are fully taxed
(4) Current cost of device = $550, co has contracted Canadian firm for manufacturning at $380 starting 5/07.  Cost of device is ammortized over one year

 

 

Valuation:

Based on 50k units in the field by the end of 2007, RMDX is trading at approximately 10x fully taxed ’07 exit numbers.  Based on 80k units in the field by the end of 2008, RMDX is trading at approximately 6x fully taxed ’08 exit numbers.  In reality, the company has $60M in NOLs that will be used to offset taxes for the next several years.  We believe that this is an extremely cheap stock that has the potential to be a multi-bagger return over the next one to two years. 

 

Share Count:

One negative to the story is the frequent issuance of stock.  It’s a young, growing company so I give them a partial pass but it is something that needs to be watched closely in the future.  The company has explored the ability to used debt to fund future growth and has received preliminary interest from several parties to do so.  Independently, we have spoken to several debt shops that are interested in doing a deal if one is available.  The current share count is approximately 131.5M shares.  I have used 140M in my calculations.

 

77,178 common

+ 6,530 Series A (17.7k shares convertible to 6M)

+ 512 Series B (58k shares convertible to 440k)

+ 16,071  Series C (5.4M shares convertible to 16.1M)

+ 21,250 options / warrants

+ 3M common (11/13 financing)

+7M warrants (11/13 financing….$2 cash strike)

= 131.54M shares

 

 

Key Risks:

• Better mousetrap is built.
• Pricing – early deals struck at $6.50, current deals struck at $8.75, blended rate = $8.  RMDX expects pricing to accelerate over time.  I assume flat pricing in ’07 and down pricing in ’08.
• Company has been a serial equity issuer – its share count has become bloated thru the issuance of common, preferred, options and warrants
• Future financings – RMDX will need to do another financing in the future.   Current financings will take them to 15k units in the field (co spends money up front to buy units then collects $8 / day once deployed).  According to the CFO the co should be able to finance this with debt (although I suspect it will be somewhat expensive).  The good news is that another financing would imply future growth. 
• Current competition from two private companies and one microcap makes industry news flow somewhat difficult to track.   

 

Catalysts:

• Announcement of one or more state contracts in CA, TX, IL and / or MI.
• Announcement of Mexico contract.
• Renegotiation of a royalty agreement that will improve margins on devices from 32% to 52%.
• Initiation of sell side coverage.
• Strong secular trends / increased awareness.

Catalyst

Catalysts:
• Announcement of one or more state contracts in CA, TX, IL and / or MI.
• Announcement of Mexico contract.
• Renegotiation of a royalty agreement that will improve margins on devices from 32% to 52%.
• Initiation of sell side coverage.
• Strong secular trends / increased awareness.