Description

***Situation overview
Intellicheck was written up on VIC about a year ago as a steal at <9x forward revenues with revenue growth that was going to reaccelerate due to salesforce hires, continued land-and-expand progress, and reacceleration of retail transaction counts to pre-pandemic levels.

Despite some operating hiccups in the last year, the company does appear to have the pieces in place to reaccelerate growth but the good news this time around is that the stock is so cheap that even if growth declines, the investment is unlikely to be a disaster.  Furthermore, these operating hiccups didn’t actually merit the 75% price decline that the company has since experienced.  However, the market has decided that these are significant issues so it is worthwhile to go through them.

Aside from the operational issues, the market is missing (or ignoring) the fact that IDN has been investing in a transformation from a U.S.-focused ID validation company to a global provider of digital identity services - the company will retain all of its existing business and continue to find online identity verification use cases to expand into - and so we are left with a 90% gross margin service provider (i) who in many cases delivers a measurable ROI to its customers, (ii) whose product is used every single time a customer needs to validate a consumer’s identity, (iii) with the ability to increase its revenue by several multiples leading to a 40% return in two years in a conservative case and a multibagger return over a few more years.


***Company and industry overview
IDN is “an industry-leading identity company delivering on-demand digital and physical identity validation” for “KYC, fraud, and age verification needs.  Intellicheck validates both digital and physical identities for financial services, fintech companies, [Buy Now Pay Later] providers, e-commerce, and retail commerce businesses, law enforcement and government agencies.”  The company was first incorporated in 1994, employs 49 people, and is based in Melville, NY though it has benefitted in attracting talent by adopting a flexible remote work policy since the pandemic.

The company’s base-level offering, named IDN-Portal, is a software interface that can be set up in under an hour and allows customers to (i) scan and validate a physical ID using a mobile phone and (ii) use the same mobile phone to take a picture of the ID holder in order to match the photo on the physical ID to the physical appearance of the holder of the ID.  These validations can be performed either by the IDN customer (i.e. a bank teller or retail associate) or by person being validated (i.e. an individual consumer of banking or retail services performing the validation scans on their own phone at home).

IDN also offers (i) IDN-Portal+, which provides the IDN-Portal services as well as analytical data, the ability for customers to white-label the service, and the ability to use a retail scanner for ID validation, and (ii) IDN-Direct, which provides API access to IDN-Portal and IDN-Portal+ functionality so that it can be integrated with customers’ own apps and systems.

IDN’s customers use these products to (i) prevent fraud losses by verifying consumer identity for credit card account openings, card-not-present transactions (in-person or online), non-receipted returns, in-person banking transactions, and customer service call center interactions (ii) manage risk by verifying age or identity of persons wishing to enter age-restricted businesses or access-controlled facilities, and (iii) verify identity in law enforcement situations.  There are a number of other significant use cases on the horizon (KYC and cannabis to name two, and the company says it is continuing to find more, while its customers also find additional use cases) but these applications are what currently drive the business.

The company boasts that its product is by far the most accurate among competitors, offering a 99.9%+ detection rate of fraudulent IDs vs. 65-75-ish% among other solutions.  The company attributes this difference to the fact that its technology relies on a deep knowledge of barcode formats used by government ID issuers that IDN has built up over the last 25+ years.  By contrast, competing products often use visual templating solutions, which can be fooled by today’s high quality consumer imaging and printing products.  Secondly, with the ability to use mobile devices or existing point-of-sale scanners, time and cost to implementation is much lower than solutions that rely on proprietary scanners that can cost $1,600 each (consider this cost in the context of a retailer with a few thousand locations and multiple registers at each location).  In one instance the company noted that it was able to displace a visual-template-based competitor at a large retail customer on day 30 of what was supposed to be a 90-day trial.  As a result of the excellent accuracy, hassle, and cost characteristics of IDN’s product, the company has been able to build up a customer base that includes seven of the top 15 financial institutions, over 3,800 bank branches, over 30,000 retail locations, and over 65 law enforcement agencies.  Customer concentration is high, with Q122’s top three customers representing 53% of revenues and 2021’s top ten customers representing 79% of revenues.  While it is likely that IDN’s strategy will result in more diversification over time, I don’t think the company would be disappointed to maintain this high level of concentration if these large customers keep expanding their use cases and spend.

While IDN claims to have no “real” competition (i.e. it is the only solution working off its 25+ year history of analyzing ID barcodes for each U.S. state), there are a number other identity validation companies.  Two of the most visible of these are Jumio and Socure, who boast clients as large as HSBC, United Airlines, Capital One and SoFi (i.e. “real” and large customers, implying that these are certainly “good enough” alternative solutions for the largest prospects).  Jumio has raised just over $200mm of private capital, while Socure has raised nearly $650mm, which in both cases explains how they can afford to be quite visible.  However, as anyone who has made an investment based on the target’s marketing presence can tell you, what matters is what’s happening in the street.  Jumio has been around since 2010 and Socure has been around since 2012, so neither of these companies is a new threat.  Even so, most of the seven top financial institution customers that I mentioned above were all signed by IDN in the ~four years since Bryan Lewis was appointed CEO (i.e. during a period when these large competitors were well off and running).  I feel the need to emphasize that this is a ~$40mm market cap company that is winning business with the largest echelon of customers, meaning not only that its product is actually commercially viable, but viable enough that it can get over the its larger competitors telling prospective customers that IDN is too small to be a real company.  My takeaway is that while there are many situations where having the best product isn’t necessary to winning business, in the case of ID validation for fraud prevention, it gives IDN a big leg up because every single missed fake ID has a real, measurable financial cost to the customer.

One further point around competition relates to the TAM.  The company has in a number of past earnings calls referred to research by Javelin Strategy & Research.  Javelin estimates that for 2021, identity fraud losses totaled $52 billion and affected 42 million U.S. consumers vs $16.8 billion in 2017 (yes, $16.8 billion to 52 billion in four years).  While this of course doesn’t mean the TAM is $50 billion (what percentage would you pay a provider in order to prevent fraud losses? 5%? 10%? 30%? 50%?) there is no doubt that the TAM is large and growing quickly.  It’s not a large ask for IDN to grow its TTM normalized (meaning exclusive of $3mm total of nonrecurring equipment sales in Q221 and Q321) revenue of $13.9mm by several multiples, even if the competition keeps improving.

IDN collects revenue from its customers in a number of different ways but the vast majority is from licensing fees that customers pay to use IDN’s platform either on a fixed-fee or per-transaction basis (referred to collectively by the company as “SAAS revenue”).  This SAAS revenue has typically represented 90-95% of revenue over the last several quarters (excepting two quarters that included significant equipment sales, which I’ll discuss below), and has generated gross margins of 90-93%.  Equipment sales have run about 3-5% of sales (down from 5-10% in prior years) and generate a gross margin of about 18%.  Providing equipment isn’t business that IDN is looking for, but rather a service that the company is willing to undertake for customers if necessary, provided it earns a margin.  The remainder of the company’s revenue categories (other subscription and support, non-recurring services, extended warranties on equipment, other) make up 1-3% of sales.


***How we got here
Prior to the arrival of current CEO Bryan Lewis, IDN was focused largely on the government/military/law enforcement and bar/restaurant industries, with use cases focused around identity/age verification to dictate access control to bars and secure facilities.  Without belaboring the point, there were a number of problems with the strategy and its execution.  The issues with the operation clearly showed in its results:  Revenue peaked in 2011 at ~$12.5mm and fell to ~$3.6mm by 2017.  Operating income was negative every single year for this time period (it still is actually but I’ll explain below why that’s not a concern), and cash flow was negative almost every single year, supported by occasional equity raises.  And all this while generating 60+% gross margins!

While this is not a jockey stock, Bryan Lewis’ arrival to the company as President and CEO in February 2018 is key to the story.  Prior to joining IDN, Lewis served as COO of Third Bridge Group (provider of research and deal information to public and private investors) from 2013 to 2017 during which period the company grew from 100 to 600 employees.  Lewis’ resume also includes Head of Sales and Relationship Management at BondDesk Group LLC (sold to TradeWeb) and senior sales positions at Reuters, Barra, and Bloomberg.  IDN admittedly was starting to look into providing a SAAS solution to retail and financial institutions customers prior to Lewis’ arrival, however it appears that Lewis put this effort into overdrive and was very forceful about shutting down pieces of the business that weren’t delivering.

With Lewis in place at IDN and the company steered directly toward the $50 billion problem of identity fraud, progress has been brisk.  Revenue has grown from $3.6mm in 2017 to $13.9mm over the trailing twelve months while operating loss has narrowed from ~$6mm in 2017.  IDN just restated some earnings due to an error in how they were accounting for stock comp.  I’ll discuss the restatement further below but for the purpose of this discussion, the pre-restatement operating loss of ~$0.3mm in 2020(!) and $4.2mm in 2021 are the relevant figures to compare against.  Gross margins are now trending above 90% (in fairness to Lewis’ predecessors, they’d reached ~85% by 2017).  Driving this progress has been the significant sales wins referred to above.  When Lewis arrived, the company only had business with one large financial institution and was working on a second (vs the seven it has now, and keep in mind that these are huge, slow-moving institutions), and these relationships were not particularly strong or well structured.  Under Lewis, the company has signed new clients, expanded relationships with existing clients, “fixed” agreements where pricing has been too low, started a marketing department, and undertaken an always-ongoing effort to improve the effectiveness of the salesforce.

During this time period, the stock price rose from the $2-$3 range prior to Lewis’ arrival to a $5-$8+ range from mid-2019 through late 2021 (ignoring a massive spike in late 2020 and early 2021 that briefly brought the price over $15/share, as well as an unsurprising crash and recovery in the first half of 2020).  Following the company’s Q321 results, and in sympathy with software names broadly (and the market as a whole, to a degree), IDN’s stock price started cratering, dropping first to $5 from $8-9 within a few weeks, and then to $2-3 over the next few months.  While market softness was certainly a factor in the price drop, there have also been a few hiccups in the numbers that are likely giving some investors pause.

The first “hiccup” likely didn’t fool investors who were looking closely.  IDN sold about $1.5mm (~30% of revenue) of equipment to clients in each of Q221 and Q321.  This caused consolidated gross margin to drop below 70% for these two quarters and caused Q421 consolidated revenue to decline sequentially by ~20%, masking the fact that non-equipment (i.e. “core” revenue) actually grew ~12% sequentially.  While most investors likely looked past these headline revenue and gross margin figures, I bring it up because in microcap land this isn’t a given, and when investors look back at the company’s recent history, this episode might suggest to some that the company has a history of operating issues.  In terms of more “real” operating hiccups, Q321 SAAS revenue was flat to Q221.  This isn’t something that we would expect from a company that is successfully executing a “land and expand” strategy with high retention rates and a huge TAM.  This flat revenue growth illustrates that, at least for the time being, a significant portion of IDN’s revenue relies on “per-scan” fees, so when overall scans decline (be it new credit card applications, card-not-present transactions, or non-receipted returns), IDN’s revenue will be affected.  Within a few weeks of the Q321 earnings report, IDN’s stock price had fallen by over 40%.

IDN stated on the Q321 call that the quarter was a mix of department stores and apparel sellers being down 7-10%, while electronics, appliance, and banking customers were up nearly the same amount.  The company also stated that the customers that were down in Q3 were up over 15% in September, suggesting that the quarter was just an odd blip.  A quick look at the Census Bureau’s quarterly data shows that Q321 was flat to slightly down for both total commerce and ecommerce on both a seasonally adjusted and unadjusted basis, implying that Q3’s weak numbers weren’t an IDN-specific issue.  Sequential SAAS revenue growth of ~12% and year-over-year growth of ~23% in Q421 further supports management’s “odd blip” theory.  The market briefly responded positively to the Q421 results, but the stock price then resumed its march downward, suggesting that the good-but-not-mind blowing Q4 results were not enough to reverse the impact of Q3.

On May 9 of this year, the company announced the appointment of Jeffrey Ishmael as CFO, stating that departing CFO Jeff White was pursuing a role at another company outside the identity space (the company has not had much commentary on this swap other than to say how incredibly excited they are to have Ishmael onboard - I agree that Ishmael seems very strong.  He was the seventh employee and “founding CFO” at cyber security company Cylance, which was acquired for $1.4 billion).  Then three days later IDN announced that it was postponing its Q122 earnings results “to allow additional time for the Company and the Company’s external auditors to complete the accounting analysis pertaining to the Company’s equity compensation program.”  While the stock dropped briefly below $1.40 / share, it quickly returned to the $1.70-$2.10 range, where it seems to be pinned for the moment.  Concurrent with the announcement of delayed earnings, IDN preannounced revenue implying year-over-year growth of ~18%, again seeming to fall into the zone of “not so bad the stock dropped more, but not interesting enough to raise the stock price”.  On June 13, 2022, IDN reported Q122 earnings, including a few million dollars of non-cash restatements pertaining to charges and liabilities related to the equity compensation program.  While from a quantitative perspective I don’t think it’s unreasonable that the market snoozed through these earnings, there was plenty of very positive news around client wins and the business pipeline.  Finally, on June 17, 2022, IDN filed an 8-k detailing the resignation of director Amelia Ruzzo (appointed January 16, 2019) who believed that the restatement (prepared by EisnerAmper) “was prepared without input or consideration to the governance structure that is in place for Intellicheck.”  The company again had surprisingly little to say about this other than to say that both the board and the company’s lawyers had unsuccessfully attempted to follow up with this director to discuss her concerns.  There is no denying that this is strange, however given (i) EisnerAmper’s involvement, (ii) the fact that the restatement was caused by some arcane calculation and tax issues around stock comp and (iii) IDN will now be outsourcing these equity compensation matters to a specialist firm, I’m chalking this issue up to just being strange.

I’ve tried in the last few paragraphs to catch everyone up on what might be going through investors’ mind as they currently value IDN at 1.9x trailing normalized revenue despite its mission-critical, ROI-proven product, huge TAM, lack of true competition, and recent sales wins.  However I think it is reasonable to summarize as follows: Q321 earnings threw the “IDN is a rapid growth company” thesis into question.  Looking over the last several quarters, there are several negative data points that an investor might find off-putting, especially in a small company.  At the same time, sequential SAAS revenue growth in the teens and year-over-year growth in the 20s has been enough to show that the story isn’t completely broken, but not enough to entice investors to get on board at valuations that acknowledge any kind of strong outlook for the company (see discussion below on expense leverage and the incredible implied cheapness relative to mid-term net income).  While I don’t fault microcap investors for demanding “show-me” performance and refusing to get taken for a ride by yet another story company, I believe the qualitative data in IDN’s case points overwhelmingly to a very high probability of massive revenue growth from here, and therefore implies that IDN stock is extremely undervalued.


***Where are we now
So given this bad quarter, followed by some operating distractions, a few mediocre quarters, and some head-scratching corporate behavior, we are left with a ~$40mm market cap company with 90%+ gross margins, where 20% revenue growth is mediocre, that is trading at only 1.9x trailing normalized revenue.  While I’ll admit that I have seen software companies that did “make it” trade lower than these levels, there is no doubt in my mind that this valuation incorporates extreme skepticism that the company will even double its revenue.  What concerns can we dispel, or at least mitigate?

Starting high level, I think it’s worth dealing with the external existential-seeming issues first.  I’m going to skip a highly detailed discussion of whether the $50 billion of identity fraud is actually relevant to IDN.  While I’ll happily be told in the comments that I’m an idiot, I keep trying to come up with some manner of identity fraud that’s in this $50 billion (fraudulent credit account openings, fraudulent online purchases, fraudulent merchandise returns) that wouldn’t be prevented by an accurate validation of a physical government identification accompanied by a photo of the user that validates that they are indeed the person on the ID, and I’m coming up short.  This $50 billion opportunity is relevant to IDN unless there is some uneconomic choice that customers want to make (for example allowing a certain amount of fraud in order to streamline a checkout process), but I don’t see that taking a significant chunk out of this opportunity.

The first existential risk that merits discussion is “what if barcodes stop being used in driver licenses?”  I think this is very unlikely, at least in the next decade.  The process to get fifty states on-board with a significant change is long and arduous.  It’s worth noting that the federal act that led to REAL ID was passed by Congress in 2005 and it took DHS another three years to actually come up with the standards for licenses that federal agencies could accept.  I got my first REAL ID in 2018.  They are still not necessary for air travel until the middle of next year (i.e. more than 18 years after the passage of the federal act) and as of last year 99 million Americans still didn’t have one.  Further, the transition to REAL ID involved minimal changes in technology – only requiring the inclusion of data that for the most part was already in, security features (i.e. holograms etc., which were also generally included in licenses), and a machine-readable section (i.e. barcode which, again, was already generally present on IDs).  It seems that the most likely successor to a barcode would be an EMV chip, as is used in credit cards these days.  However, in contrast to the 18-year REAL ID project, adding EMV technology to driver licenses would require a huge investment (out of state budgets, no less) in equipment used to create IDs and equipment used to verify IDs.  As with credit cards, the EMV technology would be useless in any remote/online/“ID not present” scenario.  Finally, while EMV technology was developed because it provided a significant reduction in fraud relative to magnetic strip credit cards, IDN currently provides a product with 99.9% accuracy, which can be set up for a customer in less than an hour, using equipment like mobile devices that frequently already exist on-site, and which costs less than a dollar per scan (much less for high-volume customers).  Taking this argument one more step, I’m not sure that it makes sense to think of IDN as “the barcode company,” but rather as “the company that is by far most closely in bed with state DMVs and AAMVA (American Association of Motor Vehicle Administrators).”  The importance of this distinction is that if another technology does come along that supplants barcodes in physical IDs, I expect IDN to be well-positioned to help these agencies implement it and ultimately remain a significant player in its validation.

Perhaps the replacement of the physical ID with a “digital wallet” is another existential risk that merits mentioning.  I’m not smart enough to know exactly what such a digital wallet would look like and how it would work.  I do know that Europe is currently discussing this at an “idea” level.  For some context, Europe started discussing EMV credit cards in the mid-1980s and was using them in the 1990s.  EMV credit cards were soft-mandated by banks in the U.S. in 2015.  On the flipside, admittedly a software-only solution could be implemented much more quickly and wouldn’t likely require a significant investment in hardware infrastructure.  All in all, I expect physical driver licenses to remain an important method of identity validation for the foreseeable future.  Even if we could transact everywhere with an artifact of some sort in our phones that represents our identity, businesses will still need a solution to validate that the artifact is legitimate (i.e. retailers generally still need to purchase software from someone), and it doesn’t seem unreasonable that IDN will have a leg up in being that partner.

Beyond the questions about a disappearance in the need for IDN’s product, are the questions of whether IDN’s tech is really is as good as they say, whether this matters, and whether it can be copied or displaced.  Starting with the second question, it matters.  By the time an IDN customer is identifying a fake ID, there is little doubt that the holder of the ID, who has already gone through significant effort and risk to get this far, will use it to commit fraud if possible.  This means that each fake ID that IDN catches has a real dollar value (the company cites an average figure of $2,700 per fraud incident), and each fraud that IDN catches that a competitor misses has a real dollar value.  Regarding the first question, Competitors Jumio, Mitek, and Acuant don’t make an accuracy figure easily available on their websites.  Competitor Socure advertises “up to 95% reduction in third-party and synthetic identity fraud.”  Only IDN puts right on the front page of their website that it “leads the industry with 99.9% accuracy.  For what it’s worth, the company has stated that competitors can run at around 65% accuracy (a gigantic difference).

For the third question, as mentioned above, the disparity in accuracy is because competitors use template-based image recognition to match the scanned ID to a database (can be fooled with a high-quality fake that matches visually what it’s “supposed to” look like) while Intellicheck reads the barcode data on the ID and verifies that it conforms to the proper format given the issuing agency.  So…why don’t these competitors smarten up and copy this barcode technology to improve their accuracy rate?  The short answer (other than “patents” (cue eyeroll)) is that every state and agency has its own specific barcode format and they all change from time to time.  In theory a competitor could wrangle holders of IDs from each state and agency to hand over their license so that the barcode could be analyzed, but this isn’t a great solution because once any state’s format changes, accuracy statistics will drop and customers will start calling and asking why they’re generating so many false negatives.  A competitor could hypothetically try to examine a license that’s issued every single day from every state and agency, but that doesn’t seem like a great solution.  By contrast, IDN has developed a close relationship with the AAMVA and DMVs (and law enforcement agencies) over the last 20+ years as the partner for the AAMVA’s Driver License/Identification (DL/ID) Card Verification Program (formerly the Courtesy Verification Program).  The AAMVA recommends that DMVs use this program before issuing a change in their format, when diligencing contractors, and as part of periodic testing as unintentional changes to license format and content sometimes occur.  Agencies submit sample IDs, which Intellicheck then checks for compliance with AAMVA document standards, and recommends corrective measures where needed.  IDN thus reviews changes to document formats before the format changes are even released.  An obvious question is “why doesn’t someone else just go into the AAMVA with a ton of money and/or innovation and replace IDN?”.  The answer to this has two parts:  First, this is a fairly simple, discrete task i.e. there aren’t a lot of additional features that these agencies are looking for - IDN knows these formats inside and out and can both verify and provide consultation.  There’s not much that’s additional and relevant that a competitor can bring to the table to encourage an agency to switch.  Secondly, and most importantly, these agencies consider this data to be sensitive and not something they want shared broadly (and they don’t have a commercial incentive/imperative).  IDN has continuously earned their trust over the last 20+ years.  It’s hard to imagine that a hotshot Silicon Valley firm waving around a significant funding base and a vision for building a “global platform for everything” would be well received, especially given the current state of trust around personal data.

The two companies most likely to impede IDN in this way are Jumio and Socure.  However they’re more focused (as the venture capitalists likely demand) on selling a broad platform of which an identity validation solution is only one of several services.  Therefore, their focus is less on the situations (e.g. preventing identity fraud) where accuracy of identity validation is by far the most important factor.  The company says that they don’t run into Jumio and Socure very often in competitive situations.  Competitor Acuant was acquired in 2019 by GB Group plc (GBP 1 bn mkt cap) so they also have some funding behind them as well, however Acuant has been around since 1999 and has not proven to be a particularly strong competitor in direct product comparisons.  The instance mentioned above, where IDN displaced a competitor at a large financial firm after only 30 days of what was supposed to be a 90-day pilot program, was a displacement of Acuant.

One further aspect of IDN’s product that gives it a leg up on competitors is its ease of implementation and use.  The abovementioned displacement of Acuant at a large financial firm is a good example of this.  This was a call center use case, and IDN was able to set the customer up so that service reps could text a link to the consumer that would bring the consumer to an ID verification page on their phone, at which point they could take a picture of their ID and a picture of themselves.  The customer service rep meanwhile would interface with IDN’s system via a web interface on their own computer.  While login/passwords would need to be set up for each customer service rep, this is almost a completely frictionless implementation.  By comparison, Acuant’s implementations can involve a scanner that sells for $1,600 per seat, and Jumio and Socure can involve time-consuming enterprise-software-level implementations.  This difference allows IDN to not only promise a speedy implementation, but also give clients a quick, risk-free way to test out the product and actually start realizing/caring about how much more accurate it is than the competitors (and then multiply that accuracy difference by $2,700 average fraud size).  It is worth mentioning that IDN does offer an API product, and most if not all of its largest customers opt to integrate API usage into their internal software flows.

Outside of the existential / competitive risks, there is the question of this being a small company that has had some stumbles.  As we all likely know, microcap companies don’t necessarily need a great reason to fail.  Sometimes the numbers just don’t come in, leading either to an actual failure or to a many-year stay in zombie territory.  I want to acknowledge that some of IDN’s optics appear troubling.  Namely, transaction scans dropped with the pandemic meaning that after quarterly sequential SAAS revenue growth of ~30%, ~40%, and ~63% in Q219, Q319, and Q419, respectively, Q120 and Q220 showed sequential changes of negative 12% and negative 25% (though peak non-holiday SAAS revenue of $2.2mm in Q120 was exceeded just two quarters later in Q320).  During Q220, the company issued equity equal to about 10% of outstanding shares as a safeguard against further economic dislocation.  It was clear at this point to investors that the company’s growth and cash flow characteristics weren’t sufficient to make IDN immune to external shocks.  As discussed above, Q321 results showed that some of the pandemic’s more extended economic impacts, such as a lull in credit card openings and card-not-present transactions, were continuing impact IDN’s revenue.  This was followed by the abrupt CFO change, delay in quarterly results, (arguably not-terrible) restatement due to the error that was discovered relating to stock comp, and the sudden board member departure.

Any one of the above items would be an eyebrow-raiser, and to have them all be present in a microcap story company that needs to actually improve operations and doesn’t have significant cash flow to fall back on, certainly merits careful consideration.  I would argue, however, that (i) at this valuation, these risks are more than priced in, (ii) the company has already demonstrated the leverage in its operating model, given that operating loss and cash burn narrowed significantly in 2020 despite all that happened, and cash flow turned marginally positive in 2021, and (iii) this management team appears to be competent, highly focused on the goal, with incentives aligned.  Regarding this latter point, in 2022 alone, CEO Bryan Lewis has made five open market purchases of stock totaling just under $50,000 and new CFO Jeff Ishmael has made 30 purchases totaling nearly $105,000.

This is far from a risk-free situation, but at this price, with the positive datapoints around the TAM, competitive dynamics, opportunities to expand into other sectors, and competency and alignment of the people in charge, it’s a buy.  To cap off the “story”, I’ll go through “why now?” (i.e. how do we know this isn’t actually stuck in zombieland already?).  There are a few developments that I expect in the coming quarters.  First, Jeff Ishmael is an incredible addition to the team and is only getting started.  The company has stated that it has been meaningfully hampered in its efforts to expand by a simple lack of actionable data: where are we making money? What deals are we good at closing? What types of leads generally are leading to revenue? What kinds of customers end up being the best match for us?  These are all “strategic CFO”-types of queries, that will be directly in Ishmael’s wheelhouse and which should help the salesforce accelerate revenue growth.  Secondly, the marketing team that Bryan Lewis built out is just starting to bear fruit in terms of funneling valuable leads to the salesforce.  Thirdly, IDN states that its customers are already expressing interest in expanding their relationship to include international document verification.  Fourth, IDN’s rollout of its next generation platform has just begun and is off to a good start.  This platform will allow the company to provide additional services to customers on a passthrough basis as well making implementations even easier and providing a better interface for customers that are using IDN for multiple different use cases.  While by itself this is far less important than the quality and accuracy of the core product, this platform may get additional prospective customers over the hump by allowing IDN to provide incremental functionality that certain customers would prefer in a single bundle.  Finally, Bryan Lewis, a guy who lives and breathes sales, is continuing to put effort into improving the salesforce.  A few underperforming reps have left the company and he has stated that improvements in the hiring process have resulted in a few new experienced reps joining who have hit the ground running and are generating the kinds of leads and meetings needed to sign meaningful deals.

I haven’t found a deeply buried secret on this name.  Overall the market is just too heavily in “show-me” mode due to the string of difficulties that the company has seen since 2020.  My “variant view” is that the underlying product and sales dynamics, helped along by focused and competent management, are way too positive for the distribution of potential outcomes to imply that $13.9mm is anywhere near the right normalized revenue number or that 1.9x is anywhere near the right multiple, even at a time when the economic outlook is shaky and software names have lost some of their luster.


***Valuation
Starting with the downside case, this is a small company with a high level of customer concentration.  If my thesis about the revenue trajectory is completely wrong and the company actually starts losing revenue, there could of course be a significant capital impairment.  For example, if we assume that IDN’s top three customers, who total 53% of revenue, are equal in size, that means that losing one would cause a revenue decline of ~18%.  Assuming as well that none of the company’s growth initiatives pan out, the company will have $11.5mm of normalized revenue, which I could see trading at a pessimistic 1.0x revenue, leading to an EV of $11.5mm, plus $11.1mm in net cash and $1.8mm (very rough estimate) in NOL value.  This leads to a share price of $1.31 or a ~38% decline from the last close.  A 38% loss is nothing to sneeze at, but (i) I think this is a conservative downside case for any scenario where the product doesn’t prove to be completely broken and (ii) there’s some potential downside protection provided by a competitor coming in and purchasing IDN at a distressed valuation.  If they pay 1.2x normalized revenue, downside is ~33%.  I don’t pretend to be an expert in revenue multiples but I think that these multiples are conservative, implying that downside is likely less than I’ve laid out here.  In exchange for the upside scenarios where things generally go right, however, I’m willing to wear the risk of even a 40% potential loss in this name.

For a slightly less bearish case, let’s say that things stay as they are for a few years and revenue growth doesn’t accelerate.  We still have 18.4% annual growth!  In year three of this model we’ve reached $23.1mm of normalized revenue which, relative to our $30.3mm current EV, implies a way-too-cheap 1.3x multiple.  If investors, having now been shown that the growth opportunity was as real as it seemed, value IDN at 2.5x revenue, the stock price in year three is $3.43 or 62% above its current level (note this analysis does take into account the $6.6mm of cash burned during the three-year period).  Further, with gross margins remaining flat and opex growing by 5% per year, the company becomes cash flow positive in year three and still has over 40% of its current cash pile remaining.  Carry this model forward another two years and IDN is generating a 19% operating margin (management has stated that they’re not interested in running continuous negative margins in order to run a landgrab sales operation).  I can understand objections that the pandemic has distorted quarterly revenue figures and 18.4% may not represent a stabilized growth figure.  I’ll offer that management has stated multiple times that the company should be growing significantly faster than it currently is.  I’ll also mention that IDN’s normalized revenue was essentially back to its pre-pandemic level by Q420, implying that Q421 and Q122 year-over-year normalized revenue growth figures of 26.8% and 18.4% may be as stabilized as they need to be.

I acknowledge that nobody is taking on the risk inherent in this company to make 60% over three years.  However remember that this is the “growth initiatives don’t accelerate growth” case.  What other cases should we look at?  It's not worth anyone’s time for me to lay out a detailed base or upside case.  If growth remains where it is, we make 40% in two years and 60% in three years and more beyond that.  If growth increases to 35% or more, we get a cash flow machine and a significant rerating and make a lot more.  I’m in this stock for what I believe will be multibagger returns, even assuming reasonable valuation multiples, over the next several years.


***Key risks
---The biggest risk to me is that the company doesn’t deliver on its revenue growth aspirations (the product and competitive dynamics lead me to believe that IDN is unlikely to experience a churn event of a significant customer, which would otherwise likely be the most significant risk to the company).  I have been in situations before where companies would announce all kinds of constant good news on the “deals signed” front, but it would never translate to the revenue that investors were expecting.  To some degree, this stock seems so cheap that I’m wondering if there’s a major disconnect that I’m missing about future revenue generation.  That said, it appears cheap enough that revenue disappointments would lead to at worst a sale to a larger competitor, who would now be able to boast that it has the most accurate ID validation product in existence.  One partial mitigant to this risk is the fact that Bryan Lewis is a rabid salesman.  This is sometimes a good quality in a CEO and sometimes not.  In IDN’s case I think it’s exactly what the company needs (provided Lewis can actually manage a budget, which it appears he has already done an admirable job of since his arrival).

---An economic downturn that severely reduces demand for ID validation (less shopping, less use of credit) would hurt IDN’s financial strength.  Given that the company is generally cash flow breakeven at this time and that financing might not be available in such an environment, this could end up being an existential issue for the company.  As much as I’m bullish about the outlook, this isn’t a company that I would say is a Fort Knox relative to the economy falling apart.

---The “poor optics” events (earnings restatement, CFO departure, board member departure) could actually be indicative of a deeper issue at the company whose severity I’m missing.  I think management’s stock purchases are a potential mitigator here.

---Management comp more than doubled in 2021 from “reasonable for a very small company” to “everyone makes a million.”  This is way high for where the company gotten to so far.  The company has stated that they’ve hired an outside consultant to maintain a comp program that is inline with the industry and that comp will only be high if aggressive targets are achieved, but this is still less attractive than previously from an investor point of view.  Management stock purchase are again a partial mitigant here.

---The company’s expansion into international could turn out to be a bust.  While this wouldn’t crush existing revenue, it would significantly cap upside.  IDN has greatly benefitted from its deep and trusting agency relationships in the U.S.  They don’t have this leg up internationally.

---Although I’ve addressed the existential risks around demand for the product above, I’ll mention it here just to say that while in theory, the elimination of physical identification is a risk, I think that even if it happens, IDN will earn a lot of money long beforehand.

---Lastly, the company could be acquired early by a competitor at a significant premium to today’s price.  This of course wouldn’t be a losing situation, but it would put a cap on what I believe is significant upside beyond the $4/share mark.

Catalyst

---Revenue rolling in from the many deal signings and expansions and price increases that the company has announced over the last couple of quarters

---CFO Jeff Ishmael getting up to speed and providing information and analysis that increases sales productivity

---Continued improvement of the salesforce including hiring of additional experienced sales reps

---Impact of new marketing function begins to flow all the way through to revenue generation

---Platform rollout is completed and generates additional passthrough revenue opportunities

---Operating income, net income, and cash flow over next few quarters and years increase significantly as revenue increase results in leverage over expense base