Stocks Investment

A New CEO Sets Up Wrap Technologies For Strong Growth

New York (July 30th) – A recent Seeking Alpha article by White Diamond Research took to task Wrap Technologies, Inc. (WRTC) and suggested a short case for investors. The article made some reasonable points. But we’re of the view that the short case made in that piece is likely overstated and missed a potential growth story in non-targeted markets, as well as the prospect the company might be acquired. Both of those issues should be addressed.

Background

WRTC is a single-product company that produces the “BolaWarp”, a hand-held, non-lethal, Batman-like device, about the size of a pocket calculator, that expels two Kevlar strings that wrap around and disable individuals without inflicting any serious harm on them. Croatoan Capital did a nice summary of the technical specifications in January of 2019.

The company went public in 2017 at around $4 per share. It topped out at $14 earlier this month it closed at $11.49 today, with a total capitalization of $375,840,000. That’s extraordinary given that, as of March 31, and including unaudited 2020Q1 financials, total product sales have only been about $1,350,000. It is effective in some instances to constrain individuals without lethal force or other serious injury, as shown below.LEO Press ReleaseSource: Press release from Bernalillo County Sheriff’s Office.

Our Investment Thesis

We first submitted this article earlier this week with the headline,

“Wrap Technologies’ BolaWrap Is Not A Bust, But Management Might Be” – saying that we agree with much of what Diamond Research wrote earlier this month.

We identified WRTC as

a troubled company with over $8,000,000 in accumulated losses and, in our view, a board and management that is ill suited to making the company a success.

Well, from our keyboard to the WRTC board’s ears. To our surprise, when we listened to the WRTC earnings call late this afternoon, we found that the company – which is barely out of its startup stage – had named a new CEO, Marc Thomas, with a very impressive military, management, and legal background. Nevertheless, the stock carries considerable investment risk at its current valuation.

We’re of the view that WRTC went public prematurely, before its market was adequately developed. It would have been better served being owned and managed by a private equity fund with some tech / defense / engineering expertise before being put out to operate on its own as a separate publicly held company.

We wrote originally that the

WRTC board is top-heavy with members with law enforcement ties and experience and not enough members with government relations, tech, engineering, marketing, and management expertise.

To our surprise this afternoon, Marc Thomas, the new CEO, fills many of the holes on that punch list.

A former special adviser to the Vice President at the White House, with a civil engineering degree from Stanford, a Masters in industrial engineering from Columbia, an MBA from Columbia, and a law degree from University of Texas, a military background in the 5th Special Forces Group, and a Six Sigma Black Belt, we expect very good things from Mr. Thomas. We were not so hopeful just 48 hours ago. In our draft submitted Tuesday, which was based on 2020Q1 numbers, we wrote:

[L]ast quarter’s earnings show an exorbitant amount spent on SG&A – 31.5% of sales versus just 9% for the prior year quarter, a 22 percentage-point-increase! – so it does not appear that management is minding its burn rate, a critical consideration in any startup. That’s worrying, as virtually all cash is from securities offerings. Operations are using – not generating – cash. It has also, in our view, made the company overly myopic that its only customers are law enforcement agencies. We think otherwise.

We’re also concerned with the nature of the balance sheet, particularly inventory management. If we annualized first quarter sales, WRTC is carrying nearly a whole year of inventory (inventory to annualized sales is nearly 85%!) when JIT inventory would suffice. Unless BolaWarp is flying off the shelves, or big sales are announced Thursday when earnings are reported, that’s far too much, particularly for a company actively committed to R&D. It leads to big inventory impairments when the company innovates a new device (e.g., a BolaWarp with a laser range finder).

It’s also clear that the company is spending far too much on selling expenses. Consider, for example, that I was already familiar with the company after seeing an earned media piece on it and through a client when BolaWrap was launched. After seeing Diamond Capital’s short case in passing, I thought it was incorrect and sought out more information from Seeking Alpha and other sources. Since that search a couple of days ago, though, my social media accounts have been bombarded with ads for BolaWrap, as though it were a retail product that could be sold to anyone, like toothpaste or carving knives. I have no ties to law enforcement or security, so bombarding someone like me is a case of inept social media targeting.

Why We’re Bullish for Risk Capital

The cost of using lethal force to contain suspects or offenders runs into the millions and tens of millions of dollars in civil lawsuits and in civil unrest, and that’s not to mention the political costs thereof to incumbents. Even non-lethal force, such as with the Taser, or wrestling and punching, can result in civil lawsuits and deaths for both suspects and cops.

Moreover, city councils are moving to abandon, prohibit, or criminalize means by which police have traditionally restrained suspects, including headlocks (which can be, and often are, mistaken for chokeholds), the seatbelt maneuver, and restraining a suspect to handcuff them by putting a knee in their back (so-called “diaphragm bills”). In the wake of Eric Garner’s death in 2014, where Mr. Garner’s struggling words, “I can’t breathe!” became a rallying cry for police reform, NPR’s reporter on police matters, Martin Kaste, commented:

…cops are desperate for options. They’re facing an increasing number of people who are mentally ill or agitated, perhaps on drugs. And in those situations, a police officer much prefers to have some other options besides the pepper spray, the Taser or gun.

Mr. Garner, who was arrested for the minor infraction of selling loose cigarettes (so-called “loosies”), was a physically massive individual, reportedly 6’2″ and 395 lbs., with assorted serious co-morbidities. He refused to be arrested, as seen in this video. He died when a comparatively small NYPD officer tried to effect a “seatbelt maneuver” that was interpreted by the NYPD to have morphed into a chokehold, the latter of which is banned by the NYPD patrol guide. Had the NYPD had a BolaWrap available, it’s possible Mr. Garner could have been quietly handcuffed and arrested without serious incident.

A New Paradigm in Law Enforcement and Security Services

It’s clear that the political and social environment that now exists after the death of George Floyd requires law enforcement agencies to expedite the “other options” of which Mr. Kaste spoke. But unlike White Diamond Research, we’re of the view that the BolaWrap device likely has a far larger total addressable market (TAM) than law enforcement alone. We believe that market, globally, is considerable.

For example, we think retailers, office park and tower security workers, building doormen, bar keepers, hotel staff, church ushers, and other gatekeepers will be hard pressed to enforce mask wearing and will require “other options” to manage people who refuse to comply and who might become disorderly and sometimes violent.

We also see a market among mental health and in-patient substance abuse clinics, homeless shelters, schools, airport and TSA security workers. In these and other venues, those charged with maintaining the safety of both those acting out and those around them must be able to restrain individuals who offer or threaten violent resistance.

Finally, we see a market among those social workers and community activists. The political leadership of major cities are now calling on such individuals to address things like the homeless, mentally ill, disorderly conduct, public intoxication, and other quality-of-life matters where metropolitan political leaders demand a new paradigm of law enforcement in which armed police are less involved.

The “only choice” in each of these instances cannot be hand-to-hand intervention by workers who are ill equipped and untrained to address them and who do so only at risk of grievous bodily harm to themselves and the person acting out.

It’s enormously clear that in this new environment, there will be need to “bootstrap” non-lethal but effective and relatively harmless personnel restraints like BolaWrap.

That need is being recognized at the highest levels of government. Just earlier this month, in a meeting at the East Room of the White House, President Trump agreed with Georgia State Representative Vernon Jones, a Democrat from the suburbs of Atlanta, who said, “more money is needed to buy less lethal enforcement types of tools like the Bola — what they call the ‘BolaWrap,’” to which the president replied, “Right.”

BolaWrap is not usable in all situations, such as when a resisting individual holds out his arms. But it can restrain some suspects who are fleeing or approaching (perhaps excluding an Usain Bolt sprinter) when their ankles and shins are targeted, and it is among the less lethal enforcement tools to which Rep. Jones and the president referred.

The Future of BolaWrap

The company’s market valuation assumes a spectacular level of growth vis-à-vis its inception to date sales. Sales and income for 2020Q2, announced today at $823,000, are irrelevant to the company’s valuation. Note, however, that WRTC announced at the end of June that it had an order from the police in Indonesia for 21,600 additional BolaWrap cartridges, the device that expels the Kevlar wires from the BolaWrap device. At the reported U.S. retail price of $30, it would bump up aggregate sales in USD terms by $648,000 before any ancillary charges. That sale was unlikely to have been reported in the 2020Q2 results because it was unlikely it was fulfilled in 2020Q2, reported as it was in the last week of the first quarter.

WRTC’s ability to execute on such a large order – if only for the cartridges that dispense the Kevlar cords – will be watched carefully to determine the company’s ability to execute. If successfully fulfilled, the Indonesia order would also give greater credence to WRTC’s ability to execute.

A Wider Marketplace

WRTC’s management has, so far, seen the scope of BolaWrap’s only users as “police”. In our view, the we thought management – before the change announced Thursday – lacked sufficient vision to see the wider market we see.

We believe the market of prospective users to be wider, as discussed above. We think that there is a new paradigm of law enforcement and security, along with the realization by leading public officials that “other options” are required. Before this afternoon’s announcement, we thought very few scenarios would make WRTC a target for acquisition. We thought that perhaps the prospective acquirer would be an established defense or security technology company that could supplement the company’s R&D budget and expertise to make it more effective. Or perhaps a private equity firm – or, more likely, a consortium of such firms whose management could catapult the company into the larger marketplace we see.

That view remains, but we believe Mr. Thomas’ management will, over a course of a couple of years, produce a higher selling price. We were also happy to hear on the call today that management is looking to evolve beyond a single product. We would like to see BolaWrap technology evolve into a smaller, “pocket-sized” version of the NetGun, which – in its more compact form – is about the same size as a large flashlight. But with $35 million on the balance sheet, it seems innovation from the BolaWrap will evolve.

Conclusion

This is a “jump ball” investment.

Investors could do very well or could lose 100% of their investment, so tread carefully and only invest with risk capital. This is not an investment for your children’s college fund or your retirement. It could be in a year or two.

For more cautious and longer-term investors, we suggest legging in using dollar-cost averaging when the price comes in below $10 and there is evidence of sales other than in small police agencies.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The views expressed, including the outcome of future events, are the opinions of the firm and its management only as of today, July 30, 2020, and will not be revised for events after this document was submitted to Seeking Alpha editors for publication. Statements herein do not represent, and should not be considered to be, investment advice. You should not use this article for that purpose. This article includes forward looking statements as to future events that may or may not develop as the writer opines. Before making any investment decision you should consult your own investment, business, legal, tax, and financial advisers. We associate with principals of Technometrica on survey work in some elements of our business.

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