INTZ - Intrusion: Business Has Bottomed Share Price Should Recover (Rating Upgrade)

2023-08-24 08:09:15 ET

Summary

• Shares of Intrusion have plummeted in 2023, but the long-term thesis for the company remains intact.
• The company plans to raise $9.5 million in a capital raise, which will be used for operating needs and potentially for acquisitions.
• Despite disappointing second quarter results, INTZ has seen a change in the business environment and has a large contract in the pipeline, indicating potential future growth.

Shares of Intrusion (INTZ), a cyberattack prevention solutions company, have been absolutely demolished in 2023. Although the stock was already down significantly from its 52-week highs as we turned the calendar, investors (myself included) maintained hope that INTZ was on the brink of turning the corner. In fact, I wrote in March that the long-term thesis was still intact (and it still is). So, why are we now here five months later, with the stock down roughly 40% since then?

In this update article, I will argue not only that the long-term thesis for INTZ is still intact, but also that the business has bottomed out and turned an important corner. Now, obviously, I cannot predict how the share price reacts, so I am not calling for a "bottom" of the share price per se. There are reasons the share price has been under heavy pressure, as I will discuss. The question for investors to ask is if the risk/reward scenario now heavily favors INTZ outperforming over the coming months and years, which is my contention; and, therefore, if now is a good time to invest in INTZ or increase one's position.

Capital Raise

Let's just get the ugly out of the way first. Everyone should have known that INTZ would be raising money this year following management's commentary on the 4Q22 conference call . On that call, CEO Tony Scott said he expected to raise $15-20M in FY2023 just to fund INTZ's operating needs.

The good news since then is that the company's cash needs have been lessened due to cost cuts and business progress, and so the dreaded raise will "only" be for roughly $9.5M instead of the $15-20M earlier projected. The bad news, of course, is that the share price is much lower than if the company had executed the capital raise earlier in the year.

One other aspect of the raise that might slightly mitigate the short-term damage is that CEO Scott mentioned on the 2Q23 conference call that some of the money from the raise could be used for an acquisition(s). Presumably, INTZ has its eyes on an accretive acquisition (one that is cash flow neutral to cash flow positive), hence the commentary. It would seem unfathomable that INTZ would acquire a company with cash flow needs.

Immaterial Gains in the Second Quarter

Again, getting the bad news out of the way early: INTZ's 2Q23 numbers were unimpressive. While the sequential revenue growth of 12% sounds good on paper, it means little in terms of actual dollars given that INTZ started from such a low base.

I can imagine INTZ's 2Q print disappointed investors since CEO Tony Scott ended the 1Q23 call by noting he expected a different (i.e. much more positive) call for 2Q. While the 2Q call was, in fact, more positive-more on that later-the 2Q results fell flat. The overall consensus seems to be that investors want to see CEO Scott and INTZ actually put up the numbers and not just talk about future prospects. Since the 2Q call focused on the future and fell short on any material revenue increases in the quarter, the stock responded extremely negatively following that call.

The question for investors now is whether INTZ is a good buy at these roughly $0.70/share stock price levels. At this point, based on the share price action, it seems the market is essentially leaving the company for dead. Certainly, as an investor in INTZ, I am not pleased with the lack of material revenue through 2Q23 nor with the current share price. But has this punishment now led to an attractive risk/reward level? Even after factoring in the upcoming dilution, is INTZ materially underpriced? I believe so, for the reasons I will now outline, as I turn to the positives happening at the company.

Change In The Environment

CEO Scott noted on prior calls this year that INTZ was seeing some hesitancy on deals closing due to concerns of a recession or possible budget cuts. However, on the 2Q23 call, Scott pointed out that INTZ has seen these concerns start to dissipate.

As you've heard me describe on previous calls, we sensed a pretty significant and growing level of interest in our Shield offerings early in the year, which, by the way, continues. But we were not seeing that interest translate into signed contracts. Many potential customers told us that they were highly interested in our solutions, but were cautiously watching their budgets and holding back…in anticipation of potential business downturns and the threat of unplanned budget cuts."

Scott continued (emphases mine):

Mid to late Q2, we began to sense a moderation of this cautious approach, and we were able to finally close on opportunities that have been in the pipeline for more than two quarters . Continuing into Q3, we've been informed that we won on several relatively long-standing quotes and RFP responses , which date back to Q4 2022 and Q1 of 2023. We've now finalized some of these and others are in the last stages of the formal contract process, which when complete will lead to increased Shield revenue in Q3 and beyond ."

Still, Scott was hesitant to provide any concrete guidance because "we do not have complete clarity in terms of the delivery schedules and operational timing of at least one large contract, and there are others that have closed or will close shortly that are planned to start small in Q3 and then are expected to grow in Q4 and beyond."

Based upon conversations with people familiar with INTZ, I believe Q3 should show material improvement from Q2, not just in terms of percentage increases, but in terms of absolute dollar amounts. In other words, Q3 results should show that INTZ's business has bottomed out and will see materially better days ahead.

One Large Contract

During the 2Q call, CEO Scott mentioned "we do not have complete clarity in terms of the delivery schedules and operational timing of at least one large contract." During the Q&A I asked Scott more about this specific contract. As it turns out, this specific contract is one that INTZ won through a competitive bidding process, and because they won through that process, they would be a sole source provider. For reasons not totally understood by me (and it sounds like even Scott has been perplexed by the whole situation), the actual finalization of the contract has taken over half a year now. So why the optimism it will actually close?

During my research I learned that this contract, as well as several others that Scott characterized as being in the final stages, are actually being reviewed now by the legal teams of the prospective customers. This is an important point because, generally, legal is the last step before a customer actually signs a contract. Now, granted, it may take some time for legal to review, and some slight changes might need to be made; but, generally speaking, a customer only gets to this stage if they are extremely serious, and rarely does a contract like this fall through completely because of the legal team's review.

In terms of the impact of this "large contract," I get the impression that the deal could be worth up to $2M annually for INTZ. Keep in mind this would be annual recurring revenue at roughly 80% gross margins-a very nice contribution to INTZ's bottom line.

Future Sales

Up to this point, INTZ has been simply trying to keep its head above the water, so to speak. However, following the upcoming capital raise, the company will have some more flexibility. Based upon my research, I believe one important way INTZ could use the additional cash is to hire a Chief Sales Officer. I believe such a decision would be wise. If nothing else, INTZ has proven that a good product does not sell itself! Bringing in someone experienced in enterprise sales could be a huge boon for the company in finalizing deals.

In addition, as I have argued in my previous articles, Tony Scott, up to this point, has been laying the foundation for the possibility of future success. To that end, INTZ has inked deals with the likes of Netgate, NetFoundry, and SEI Investments Company ( SEIC ). Despite that foundational progress, we have seen no material contract wins yet from these relationships, but I believe that will soon change.

Netgate

Scott highlighted the progess with Netgate on the 2Q call. "We are also nearing completion of our integration of Shield technology into the pfSense firewall from Netgate. And we will shortly introduce a cloud dashboard, which will allow customers to consolidate reporting across multiple Shield and pfSense instances." I asked Scott more about this relationship in the Q&A, and he explained that multiple prospective customers are looking for a more full-service solution than INTZ could previously offer. Namely, they were looking for a firewall in addition to Shield's capabilities.

Not only can INTZ now offer this more robust solution to new potential customers, but Netgate has a large base of current pfSense customers who will be offered an upgrade to the firewall to now include Shield. I believe this partnership with Netgate could lead to material revenue for INTZ, possibly as early as 4Q23, but almost certainly in FY2024 and beyond.

SEIC and Others

INTZ's relationship with SEIC is more recent than that with Netgate, but according to Scott, it is "leading to new opportunities to showcase our technology and generate new business." Scott also mentioned a new partner on the Q2 call, First Advisory Health Services. First Advisory "has been including INTZ in their RFP (request for proposal) responses and consulting proposals, one of which we recently won with multiple others in the queue for a decision." He then added he believes "that partnerships with leading cybersecurity organizations like First Advisory Health Services will provide great growth opportunities for Intrusion."

Between hiring an executive to focus on sales and beginning to ramp sales from the partnerships Scott has already established, I believe INTZ's Shield product has a bright future. I expect we will start to see the fruits of that in the 3Q23 report and beyond, with FY2024 set up to be the year INTZ really shows its ability to monetize the Shield product.

Risks

The glaring risk right now for INTZ is the dreaded capital raise. At its current market cap of roughly $15M, INTZ would be nearly doubling its share count. I expect that INTZ will have some good news to announce ahead of the capital raise based upon CEO Scott's bullish commentary on the 2Q call. If the share price responds well, then obviously the dilution is smaller. However, investors should be prepared (financially and emotionally!) for this raise to happen at current prices.

A second risk is that the upcoming capital raise will not be the last. There is certainly no guarantee that $9M will be enough for INTZ to get to cash flow neutral. I think absent an accretive acquisition that would require some more cash, INTZ should be able to reach cash flow neutral before using the $9M; however, that assumes the company does start closing these deals in its pipeline over the next couple of quarters. If that does not happen, they may very well need to raise additional funds.

The final risk I want to mention is that the SEC investigation into INTZ has not formally closed. In fact, based upon my research, I believe this investigation has been a bigger headwind to closing deals than the company has let on publicly. So, its closure would be welcome not only from the perspective of reducing risk that INTZ will be fined, but also because INTZ being cleared of any wrongdoing could help their sales process-or at least not hinder it! I believe the likely outcome of the SEC investigation is that INTZ will be cleared of any wrongdoing.

Valuation

My valuation has not changed from my previous article except for the fact that I have pushed back the revenue numbers by two quarters. In short, although INTZ has not yet given out any concrete numbers, I believe they have won multiple contracts worth several hundred thousand dollars per year up to, perhaps, $1M per year. Moreover, I believe that by the end of 2024, the company could be on a revenue run rate of $15M annually or more. Note that the current market cap is around $15M and the company should have 75-80% gross margins (if not higher) at those levels.

Keep in mind also that if INTZ attains that level of sales, they will be SaaS-based revenue and almost certainly still growing. They will also no longer be a going concern. If that happens-and obviously this is by no means certain-then it seems highly unlikely the stock will be trading anywhere near 1x sales. And even if INTZ ends up diluting at current stock prices, the stock should then be trading for well over 1.5x sales, which would roughly represent a breakeven point from the current share price plus the capital raise.

Finally, as I noted, it is extremely unlikely that INTZ would reach a $15M annual recurring revenue run rate and be stuck at those levels. Their deals with Netgate, NetFoundry, SEIC, First Advisory, and others, provides a much deeper pipeline than that $15M run rate. Consequently, I still believe INTZ can see a $5-6/share price within the next 18 months (i.e. by EOY24). That would be a 7-bagger from here. And while that may seem absurd with the stock trading in the $0.70/share range right now, it was not that long ago that the stock was in the $5-6/share range, not to mention the $20/share range in 2021. All that to say that if INTZ is actually successful, there is plenty of upside from here.

Conclusion

While INTZ shares have been hammered in 2023, the business has actually progressed significantly, most especially in 3Q23 based on the CEO's commentary from the 2Q23 conference call. Moreover, the company has multiple other contracts on the verge of closing as they go through the final legal process. Once they raise the necessary funds, INTZ should be able to hire a dedicated and seasoned salesperson. They might also make an accretive acquisition. While the stock price is at lows, the business has actually turned the corner, making the risk/reward scenario for INTZ shares arguably better than ever.

For further details see: