Brekford Corp. (BFDI): Positioned for Perfection

Quick Facts: $9 million market cap, $17.6 million 2014 revenue, 18 million share float, 65% owned by insiders...and damn near profitable

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Disclosure: Long BFDI, opened position on 7/24/2015, cost basis of $0.22

It's not everyday that you begin researching a company and immediately say to yourself, "wow, this just makes sense". Well, for me, Brekford (BFDI) provided the "aha" moment I always look for that triggers me to dig in and do some serious due diligence on a company. Fortunately, the time I spent on Brekford led me to the conclusion that I needed to put some money to work in this one as the market has it seriously mispriced with many potential catalysts around the corner.

What does Brekford do?

Brekford is a security technology company that serves the public safety sector. The public safety sector includes police and law enforcement divisions within municipalities, the U.S. Military, as well as other federal entities. Its business divisions include automated speed and red light camera enforcement ticketing systems, parking citation collections technology, and equipment for public safety vehicle uplifting. But perhaps where the true opportunity lies for Brekford going forward is in the police body camera business, an area that they are focusing major efforts on in the midst of all the police turmoil that you hear about whenever you turn on the news these days. 

Below is a video from the company back in 2012 that will give you a decent overview of the company story and vision. The police body camera business is not included in this video, but it is a good overview of the company nonetheless.

Brekford's Sector

The security technology sector is, in my opinion, in the infancy stage of developing into what could be a giant for decades to come. Politicians and citizens can debate all day long whether or not foreign policy and foreign wars are acceptable, but one thing that is never questioned is whether police brutality, or violence bestowed upon police, is acceptable. The clear answer to that is no, and there is no argument with the fact that we all, every last one of us, want our law enforcement personnel to be able to perform their jobs as safely and effectively as possible.

On another extreme, we have the seen the outrage within the past 12 months of police violence upon citizens that was unnecessary, and as a result of this there has been significant Federal funding at the local level encouraging police body cameras. 

Simply stated, I believe we are ahead of a huge underlying theme that has yet to surface, and I believe that Brekford is positioned well to take advantage of the opportunity before it.

Financials and Looking Ahead

2014 was a transformational year for Brekford. Total revenues were $17.6 million compared to $13.6 million for 2013, which represents a 30% increase. Net loss was around $1.5 million. The primary reason for the net loss is because of business development expenses for Automated Traffic Safety Equipment ("ATSE") to meet US demand and to expand Internationally into Mexico. On March 17, 2015, the company entered into a $715,000 note and warrant purchase agreement with an "Accredited Investor", the proceeds of which to be used to directly fund the company's international expansion into Mexico....more on this later. 

Q1 2015 was very positive as well, with the following highlights:                                              

  • Revenues increased 10% year over year, reaching $5.15 million. 
  • Gross profit increased 57% year over year, reaching $926,000.
  • Gross margins up to 18% from 12% from same period in 2014.
  • Operating expenses were down 11% from same period in 2014.
  • Net loss of $127,000 for the period, compared to a loss of $572,000 for same period in 2014...that is a 78% improvement. 

Losses decreasing, expenses down, revenues up (and recurring revs increasing...more below) = profitability soon.

Brekford's Opportunities

While the numbers improved across the board in Q1 2015, here is why Q4 2014 and Q1 2015 have set the stage for tremendous success for the company through 2015 and beyond:

  • Body camera demand has increased substantially and Brekford is uniquely positioned to capitalize on this opportunity since its competitors are really just the technology manufacturers. Brekford is truly a partner to its customers; not only can they sell the body cameras but they can also provide customized total program solutions for law enforcement agencies (think software, storage, evidence management, administrative oversight, etc). This provides a competitive advantage over competitors who can only sell law enforcement companies a specific, single technology/product.
  • The first international ATSE program was launched in Saltillo, Mexico in April 2015...revenue generated from this business will be new recurring revenue for the company and should start being reported on Q2 earnings report in mid-August. This initial rollout will include up to 150 speed cameras, 60 red light cameras, cell phone usage cameras, parking citation technology, and automated license plate readers for the enforcement of unpaid fines. 
  • In the areas where cameras have been installed in Saltillo, auto accidents have decreased 40%, validating the effectiveness of the technology. 
  • Brekford is picking up traction in the USA as well as they were selected during Q1 2015 to provide a red light photo enforcement system for Rochelle, New York. This program is anticipated to be launched in Q3 2015. 
  • Most importantly, the CEO believes the company is positioned to return to profitability in 2015. And with the improvement in Q1 2015 numbers, I believe him. 

Additional catalysts include:

  • Awarded a $1.4 million contract from the Maryland Police Department to supply in-car evidence cameras and back office video management services. Revenue recognition should hit the books this quarter and be reported on the Q2 report in August.
  • Aggressive international expansion beyond Mexico; increased sales efforts internationally.

Recurring Revenue: A Potential Major Growth Driver

The company's Automated Traffic Safety Enforcement ("ATSE") business, which consists of speed and red light enforcement technologies, currently provides about 20% of the company's recurring revenues. The recurring revenue is generated through each automatic ticket issued as Brekford gets a piece of the fine paid by the driver. What's exciting is the expansion of his business across the USA and Mexico, and as Mexico full implements the 200+ speed and red light enforcement cameras it wouldn't surprise me to see this business division supersede that of the vehicle services side as recurring revenues to greatly increase, kicking up  significant revenues and cash flow to the company. If the ATSE side of the business picks up significantly more traction in the USA, which their is a major push by local governments as it is a revenue generator for a municipality, the recurring revenues could quickly become a major contributor to the company's overall revenue mix. And when this happens I believe the market will really take note. 

Management/Ownership: As can be seen by the chart below, the CEO and President own a significant percentage of the company.  Mr. Brechin and Mr. Rutherford own around 64% of the total company. Directors and Executives own a total of roughly 65% of the company. This is the kind of conviction I like to see by a management team, particularly by long-tenured members of the Executive Team, Brechin and Rutherford.

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Valuation

Let's take a look at a few competitors to try to analyze the potential fair value of Brekford. I like valuing companies based on a company's Price/Sales ratio as compared to its peers. The reason I like this method is because a company's sales is a "real" number, as opposed to using a Price/Earnings ratio where "earnings" can often times be manipulated. 

The closest publicly traded competitor that may help us value Brekford is a company called Digital Alley (DGLY). DGLY trades at roughly 4 times it's Price/Sales Ratio. And get this, the company lost around $900,000 this past quarter! If Brekford, a company on the verge of profitability, were to trade at 4 times its Price/Sales Ratio, it would be trading in the ballpark of $2.50/share, or roughly 11 times the current share price! While a much more mature company that should trade at a higher multiple given its size and industry strength, Taser (TASR) trades at a Price/Sales ratio of about 7.5.

Note: DGLY does claim that it will be debt-free at the end of the current quarter, but I do not buy it. They had a huge offering and the share structure is pretty ugly. Abundance of options and warrants. They claim they will be debt-free only if the options are exercised, but given the sharp pullback in the company's shares I think it's a longshot!

Let's be super conservative here and price Brekford at a mere 1x sales, the stock should be trading at around $.50, which means the upside is 100%. A still conservative 2x sales would mean BFDI should trade at $1.00, which means the upside is 300% from current levels.

With the company on the verge of what I would consider explosive sales growth....well, I think you get it. That P/S ratio should, at a minimum, surpass that of DGLY's. 

Risks

  • There has been some criticism of Brekford's (and Xerox's) cameras issuing "erroneous" tickets in order to generate revenues. These issues appear to be from systems used in late 2013 and early 2014, so hopefully the problem has been remedied. However, with technology there is always risks of error, and errors within this industry can lead to cancellations of contracts. I will follow up with the company to learn more about any recent issues that may be of concern.
  • In May of 2014 the company completed a $715,000 note and warrant purchase agreement (see image below) with the primary use of proceeds to fund equipment purchases for international expansions. While sometimes notes can create issues down the road, I do not believe this will present any overhangs, particularly if the company executes as I expect it will.

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Conclusion

Brekford falls firmly within my requirements for an investment; solid insider ownership, business model is fairly easy to understand, shareholder friendly management, an overall good share structure, and profitability right around the corner.

Brekford is literally positioned for perfection. If Management can execute on the opportunities in front of them, which I believe they can, then the return potential over both the near-term and long-term is unlike many risk/reward profiles currently in the US markets. Brekford's quarterly report, which I expect on the week of August 10th, should be the catalyst needed to begin some upward momentum. A realistic return expectation is 2-3x return over the next 6 months, with 10x return potential over the next 12-24 months. 

Disclosure: Long BFDI, opened position on 7/24/2015, cost basis of $0.22