Intrusion Inc Q1 FY2020 Earnings Call

Thank you all for joining us today for the Intrusion Inc. First Quarter 2020 Financial Conference Call. I will now turn the call over to Mr. Michael Paxton, Interim Chief Executive Officer. Please proceed.

Thank you, and welcome to this afternoon's conference call to review our first quarter 2020 financial results. Also participating on the call today is Joe Head, Senior Vice President and Co-Founder of the company. I'll go over the financial results. Joe will give a business update and review current projects. We'll be glad to answer any questions after our prepared remarks. We distributed the earnings release at approximately 3:05 Central today. A replay of today's call will be available at approximately 6:30 p.m. tonight for a 1-week period. The replay conference call number is (855) 859-2056, conference ID number 7278964. In addition, a live and archived audio webcast of the call is available at our website, intrusion.com. Please be reminded that during this call, including the question-and-answer session, we may make forward-looking statements, which reflect management's expectations regarding future events and operating performance and speak only as of the date hereof. Forward-looking statements involve a number of risks and uncertainties. Such statements include, without limitation, statements regarding expectations of future revenue, product orders from new and existing customers, and profitability, and are qualified by the inherent difficulties in forecasting future sales caused by current economic conditions and spending patterns of appropriations to U.S. government departments. Forward-looking statements also include the effects of sales and implementation cycles for our products on our quarterly results and difficulties in accurately estimating market growth, the unpredictability of government and corporate spending on information security products and, of course, the effects of the coronavirus pandemic. These statements are made under the safe harbor provisions of the Private Security Litigation Reform Act of 1995 and involve risks and uncertainties, which could cause actual results to differ materially from those in forward-looking statements. The factors that could cause actual results to differ materially from expectations are detailed in the company's most recent reports on Form 10-K and Form 10-Q, particularly under the heading Risk Factors. Now let's move on to the financial results. First quarter 2020 financial highlights from the press release. We had a net loss of $465,000 in the first quarter of 2020 compared to a net income of $947,000 for the first quarter 2019 and a net income of $296,000 for the fourth quarter of 2019. Revenue for the first quarter was $1.8 million compared to $3.2 million for the first quarter of 2019 and $2.6 million for the fourth quarter of 2019. Gross profit margin was 58% in the first quarter of 2020 compared to 60% in the first quarter of 2019 and 61% in the fourth quarter of 2019. The first quarter 2020 operating expenses were $1.5 million compared to $0.9 million for the first quarter of 2019 and $1.3 million for the fourth quarter of 2019. Thank you. And now I will turn the call over to Senior Vice President, Joe Head. Joe?

Thanks, Mike. In the last quarter's call on February 24, we were still in a pre-shutdown mindset, with the government open but directing unallocated funds toward the wall. Our thoughts and prayers are with our group of shareholders in New York. Our government clients are in a varied state. Many are still remote, some are on partial schedules, and others have returned to work. The common issue is that procurement departments are not functioning normally. The positive news is that we have had very few renewals during this time, and those that have renewed seem to be doing so with minimal impact despite having partial staff working. As you know, I brought on a salesperson to promote Savant, STA, in the DoD space, who joined us in late Q3 last year and has proven to be an excellent hire. He has strong cybersecurity skills and a solid understanding of networking security. He’s been active on the ground for a while and has built relationships with several new DoD customers that we hadn't worked with before. I'm pleased to share that through his efforts, we have forged connections with 6 new customers: 3 are in the process of establishing a new contract with us, while the other 3 are still waiting for the government to resume their operations. I’ll go into more detail about the 3 in procurement shortly, but the 2 that are still in the early stages represent between $2 million and $3 million in potential revenue. One of these is quite significant. Our sales team has remained proactive during the pandemic and has been engaging with potential customers weekly. In fact, it has been easier than usual since many people are at home and looking for things to occupy their thoughts. I've maintained communication with the customer who had a $2.4 million contract with us last year every two weeks during the shutdown. They remain hopeful about moving forward with this project and believe they have secured funding, but their procurement department is still not operational. Depending on their delays in starting up, I expect the $2.4 million contract to resume billing in early to mid-Q3. Additionally, we are processing 3 orders from 3 of the new clients. We anticipate these will be placed this quarter: one for $375,000, one for $100,000, and one for $412,000, all representing new business from new customers. As I mentioned last quarter, one of our Savant, STA customers has referred us to 2 other companies in their industry that experienced breaches while our clients remained secure. We view this as a valuable opportunity, although we currently lack the workforce to engage the broader commercial market, even though we have a few strong customers there. Moreover, over the past quarter, we have been considering the best methods to expand our marketing and sales. To that end, I have been in discussions with potential partners who can introduce us to others. I won't repeat everything I said last time. So, we are still working on entering that space. As you may recall, I mentioned that we aim to achieve three main objectives: make it more difficult for adversaries to penetrate your network, make it harder for them to operate undetected within your network. Currently, our TraceCop, Savant, and STA products mainly address 2 of these objectives—operating undetected. Last year, we were involved in developing a novel approach to make it more challenging for adversaries to penetrate as well. This has proven to be the most challenging area due to numerous unaddressed threats and realities, which I did not delve into during the last call. This new initiative aims to make initial penetration more difficult and restrict the spread of threats within a network by fundamentally changing the approach. It's true that all antivirus and security products claim to do this, but the persistent number of breaches and the substantial payments made to ransomware criminals indicate that the current defenses for enclaves, networks, desktops, and hosts are ineffective. This new set of solutions will be innovative and significantly decrease the number of adversaries and tactics that can persist in a compromised environment. During the shutdown, our team has been focused on creating new offerings, primarily for the commercial sector. I intended to explore the details today, but we realized that recent changes in patent law necessitate some provisional filings before we can disclose product information outside of a nondisclosure agreement or beta. Since investor calls cannot operate under an NDA, we are scheduling a follow-up call for next Friday, May 22, at 3:15 Central, 4:15 Eastern. As you know, our balance between commercial and government business has shifted toward too much reliance on government funding cycles over recent years. We look forward to informing you about how we've utilized this pause to innovate new products, leverage our core competencies, and reshape the company to seize this opportunity. We anticipate renewals from current customers will automatically renew, even with limited staffing, and we expect a wave of renewals in Q3. There are 3 new orders in procurement, along with the usual renewals, and we've engaged with a partner to bid on a few opportunities during this hiatus. We've submitted 3 proposals since January. In the near future, we expect the government to resume normal operations, which should facilitate procurement schedules for our pipeline of new DoD opportunities generated by our new salesperson. This concerns the 3 opportunities that were not initiated in securing funds or procurement documents before the shutdown. We have ample capacity to maintain our existing customers' satisfaction and have new projects lined up for new funding as they begin to return to work. We look forward to providing a more comprehensive overview of our new plans for the commercial sector on May 22 at 3:15 Central time. Mike?

Yes. Thank you, Joe, for the business update. Thank you all for your attendance today and your continued support of Intrusion. A special thanks to our dedicated employees, our band of remote warriors. We appreciate you guys, and we look forward to getting everybody back in the office. We have a tremendous team here at Intrusion. I'd like to go ahead and end the prepared remarks and go to questions. Operator, please remind the participants how to queue up for questions.

Your first question comes from the line of Howard Brous.

I would like to clarify a few points that were brought up during last quarter's conference call, starting with a question that Ross Taylor posed. He inquired whether you have hired an investment banker. He mentioned that if the answer is yes, that's acceptable, and if it's no, we understand. No comment suggested that you had indeed hired one. Based on your response, it seems we share the same perspective. It appears that the best interpretation is that you've engaged an investment bank to enhance shareholder value. Is that an accurate statement? Let me clarify that.

We'll fill in more of the details on what we see the outlook. So we'll talk more about that in the future. It may not take the exact shape of what you're expecting on the answer, but I think you'll like it. So we'll talk more about that next Friday.

We're planning to provide the business update next Friday. However, it might be delayed by a few days since that date is right before Memorial weekend. We will post any updates regarding the timing of the business update on our website.

I appreciate that. Let me go to a couple of things. And my understanding on a historical basis, money in procurement, basically the contract happens. We had talked a quarter or so ago about any dollars in procurement. What is in procurement today, if you can comment, please?

Sure. The contracts currently in procurement, which we know are funded, include amounts of $375,000, $100,000, and $412,000. There's also a renewal for $1.2 million a year that will extend for more than a year, and that’s the extent of what is actually in procurement with committed funds. I anticipate the other $2.4 million contract hasn’t moved to procurement yet because they are still searching for a procurement person. So, in total, there are those four contracts, amounting to $2.4 million plus the other figures, bringing it to about $3 million.

Right. Can I jump in? That's for this year, basically.

Yes. For this, we believe we can achieve it this quarter. However, I anticipate that the $2.4 million will likely be recognized in the next quarter.

Fair enough. One of the things I'd like to address is what the total addressable market is for TraceCop.

We're trying to understand this from a commercial perspective. We believe there is a larger opportunity if we tap into the interest in understanding connections and communications, and we will provide more details in the next call. Addressing the total addressable market and our approach to it is crucial because we view it as an underutilized asset. This resource has significant relevance in the commercial sector, and we also believe there are additional opportunities in the government sector.

So at the same time, can we address Savant and STA also in terms of the TAM?

Yes, we will be communicating more frequently about the total addressable markets and how we plan to address those various markets.

How would you evaluate this quarter as we move into the next quarter? When we discussed the fourth quarter, we expected the first quarter to be fairly similar, with just a minor fluctuation. It turned out that way. I'm not seeking a specific dollar amount for guidance, but can we establish a better momentum with Q2 and some contracts to look forward to a stronger second quarter compared to the first quarter?

It's not there yet. I mean we're trying to get some of these orders placed where it can be better, but right now, it's on par with the first quarter. Yes, we'll see where we're going to get to.

Yes, we'll see an increase. To clarify my figures, the three orders in procurement total $887,000, and we also have an additional order of $2.4 million in procurement. Furthermore, there is another $2.4 million, but the first $2.4 million I mentioned is actually for a two-year period, so it represents the usual $100,000 amount. Altogether, this results in a net increase of approximately $200,000 to $220,000 per quarter in billings when we include the new customers. So we shift from a negative outlook to a more positive one, particularly when the $2.4 million is renewed or as we bring in additional new business—though it's uncertain when exactly they will proceed and finalize their decisions.

One thing I didn't mention earlier that I think is important to note is that due to the prolonged government shutdown, there is no funding available for labor using the unspent budget for the year and purchasing data work. Many of our new sales initiatives have been focused on different government cyber teams acquiring licenses for our data, which they can purchase with funds that will expire on September 30 if they aren't utilized. While it's too early to be optimistic since we've been facing a challenging year, I believe there might be a good opportunity for spending during the summer before those funds disappear. Therefore, I am fairly confident that the third quarter will be strong. The second quarter is more about whether it will be sufficient to mitigate some losses experienced in Q2. Mike, you would know the government landscape better than I do.

Yes, it's really a question of whether these customers will have their services restored and how quickly we can initiate certain processes. We still haven't seen much progress, so there are many uncertainties at this moment.

Yes. But I always see them weekly, and they are not even going to the office. It's kind of...

All these guys aren't even back in the office yet.

Well, supposedly, the government will open up. Just in putting a bow on with the last quarter's conference call, you talked about 4 orders representing $6 million to $8 million of potential orders that were not pie in the sky. You mentioned the first 2 were proceeding with contracts on their first few items. Was that delayed because of the government shutdown? Are those 2 orders or 4 orders, excuse me, still expected to be signed and go into procurement?

Yes. Everything I talked about before is still there. And I guess, to be truthful, the 6 I talk about is actually 7, and the seventh one has been idle. They're shut down and not even going to work. So I was expecting that originally for a June order of a couple of million. And so that's where the delta is. I've got about $2 million to $3 million in that next batch of 3. And then that other one was about $2 million as well. So yes, sorry, I left one out of my list, I apologize.

Your next question comes from the line of Ross Taylor.

Could you address a couple of things? First, you mentioned in the last call about a Pentagon project where you were selected and worked with a lead cyber thought expert in the Pentagon to develop something that seems quite unique. Can you provide an update on where that project stands now? Has it progressed into implementation, or what is the current status?

That might be the subject of next Friday's call, but yes, that's the ticket. So that's what I've been working a lot on lately.

Yes. Let me just provide an update regarding the business and also share the results from the shareholders' meeting, which is scheduled for next Friday.

We will provide a good update on that, and in fact, everything is going quite well.

Okay. You have your new marketing guy, and you've mentioned the introductions and leads he has. Looking at his potential book of business right now, what kind of dollar amount is associated with the opportunities he's exploring and connections he's making at this point?

He has spoken to about 50 potential clients and narrowed it down to around 6 that are currently in procurement. Additionally, he is engaged with another 3 sizable organizations that conduct various cyber investigations. His efforts have been fruitful; just yesterday, we had a call with a company that has a skilled team in the field interested in utilizing Savant. Prior to his discussion with them, they were unaware of our offerings. While they were familiar with our company and TraceCop, they did not know about this aspect. At this moment, he's working hard to gain traction in a challenging environment, particularly since government engagement is limited. I believe that once government opportunities reopen, we could see an increase of about $15 million to $20 million in business over the next year. We will discuss this further in our next call, but he is performing well. I also anticipate growth in the commercial sector, reflecting the growing frustration with Chinese intellectual property theft, which may drive both commercial and Department of Defense contractors to take action.

So it definitely makes a great deal of sense that, I mean, it's time we actually start to protect it like it has value. So basically, this new guy alone...

Right. But it doesn't really change.

This new guy alone can double your revenue base this year.

I believe that's true. We will definitely be doing more, as we have been discussing partnerships. It’s important to consider how to engage more people than we can hire through effective partnerships, and this will be a way for you to assess our progress over the coming year.

Okay. So kind of in summary, you're going to give us feedback on next possible, hopefully, next Friday, about where we stand with the Pentagon and other initiatives. You'll also address probably the commercial opportunities at that point in time.

Correct.

This new salesman alone has the potential to double your revenue base within the next 12 months. He is making introductions for you, and I believe that as you start to establish connections, it will attract more attention from commercial partners who will value your offerings this time around.

Correct. Correct.

Yes. I think you're all pleased with what you hear there. So we'll give you a lot more detail and clarity on there. So...

I wanted to ask one more question because when we last spoke, the stock was trading at $5.75, and it seemed like you had initiatives that made it undervalued at that time. Now, it's trading significantly lower. Has anything changed since our last quarterly call that would make this company worth less than you previously believed?

No. I wouldn't think so.

No, not at all. In fact, I'm more excited than I have been in years. So...

I have to tell you, so am I.

Yes. Honestly, that was the case. When you're preparing notes for a call after a challenging financial quarter due to the shutdown, it's hard to feel optimistic because it seems inappropriate. But the truth is, I'm...

Plus, there's still a lot of unknowns with this going back to work thing. But we feel good about the future.

Very fired up about our products and prospects and where we are in the market. And to me, the biggest thing is how do you make sure that you don't fail to capitalize on your opportunity this round.

I recently spoke with someone who had a conversation with a senior cyber or defense expert from Homeland Security. When asked about the current situation, the expert expressed hope that bad actors would acknowledge the troubled state of the world and act fairly. However, we all know that if this was indeed said, it reflects a naive view of reality, as these bad actors seem to be increasing their activities. From what I'm hearing, once the government resumes operations, which is just a matter of time, the opportunities in front of you may be significantly greater than they were a few weeks ago.

Yes. Absolutely.

Sure, thanks. Yes.

Yes, it's really exciting. I know the market can be a bit complex for many investors, but it looks like you are positioning yourselves well. Whether you find someone to acquire you or partner with you and provide the capital to leverage the technology, it seems we are in a very promising place moving forward. So, thank you all.

I'm pleased with how everything has come together. The pause we've taken has been very beneficial for moving forward. You'll notice the impact of this in our next discussion.

And don't be afraid to be upbeat when you actually are upbeat.

Yes, agreed, agreed.

Lessons of life last for a while. But yes, I am really excited about what we've developed. I have actually been writing patents for the last week and I am currently drafting 14.

14.

Yes.

Wow. This sounds like you’ve really, during this quarter, I know people might view it as a disappointing quarter, but the reality is, one is, I was hinting at some of that. You currently have no bid contracts with the government, correct?

Correct.

So there was no one in the world who has the capability of doing what you're doing.

Correct.

Yes. Everything we have...

You have spent the last few months developing things that require new patents.

Correct. Well, we may be adding to our development...

We are currently drafting those items, and some may not be patentable. I am working on 14 and I'm unsure how many we will ultimately have. I am just in the drafting phase, and then we need to conduct research. My goal is to have provisional applications filed before our discussion next Friday so I can share updates on them.

And these are things that have been in the works...

For a while.

Since before last quarter, yes.

Been pondering it for a while, but there's nothing like no distractions to let you get a lot done in that. It's a good way to look at it.

Yes, I understand that. However, it seems that you all have been significantly enhancing the fundamental value of this business. As one of your major investors, I find it very encouraging to hear this at this time. Many people misunderstand that...

Yes. Our engineers have been working from home. We're at a point now where businesses are reopening, and most people don’t know anyone who has had the virus. We’re close to being significantly more productive together than we are remotely, just in terms of workflow. Instead of waiting two hours for an email, you can simply walk down the hall and get what you need. Entering a new phase is always exciting because things happen quickly, and progress is made rapidly, which has been great. We’ve also noticed that our potential audience in the government cyber sector has also experienced a slowdown since travel is restricted. We’ve had some productive discussions with them about utilizing better tools, which ours certainly are, but people often don’t have the time to learn new things when they are occupied with existing ones. I believe this will turn out positively for us, especially if we had more users engaging with our tools.

I think, as I mentioned, it's clear that many perceive you solely as a quarterly earnings story, which is a significant misunderstanding of your business. You appear to be on the brink of seizing the long-standing opportunity within the company. That genuinely excites me.

Yes. I appreciate it as well.

Your next question comes from the line of Drew, whose last name was not able to be gathered.

My last name is Carter. I'm inquiring about the cash flow statement. I couldn't find it in the 8-K. Were you cash flow positive or negative compared to last year?

The cash flow statement will be included in the 10-Q, which will be filed later today or tomorrow morning. I believe it was about even, but I can't remember the exact number.

Okay. And going forward, I'm just wondering the cash amount was over $3 million. And it was about the same as last quarter. Do you anticipate you'll have to eat into those cash reserves going forward? Or will you generally be cash flow positive?

Well, it's possible we'll eat into it a little bit. I think we feel pretty fortunate that we had a pretty profitable year last year. And along with that, which will also be in the 10-Q is the fact that we were successful in getting some funding from the PPP program. Where is that amount? Hold on. We got $629,000 from that. So that helps out.

Your next question comes from the line of Walter Schenker.

I feel bad, not that I can control over it, that I won't be the only person showing up at the annual meeting this year.

Yes. We're going to have an interesting meeting from our corporate headquarters, and we're going to make it accessible, but it will be different. You'd be in the lobby on a call with us, so it might not be very enjoyable.

I have questions, but they may be addressed next week. I want to share a couple of thoughts since significant effort is being put into this. It would be very beneficial for everyone involved if something like a presentation or at least some kind of slides could be included. As you tackle issues such as total addressable market or end markets, as well as your initiatives with the Department of Defense and new products, it would be helpful to have visual aids that explain or define your goals and current status. I understand there may be security concerns regarding your website, but it would be useful if some of the technical information could be available in written form, especially if you're going to delve deeper into technology and information. So, consider this a request.

Yes, we'll look into that.

We will make you happy on that front.

Good. Secondly, since we're not directly going to talk about our quarter, you're anticipating this is going to be roughly an hour call? I don't know how big your presentation is. I'm just trying to get a sense of what you're looking for.

It's going to be about an hour.

Yes, we'll open it up for questions as well. It will likely depend on the question-and-answer session.

Yes, it might take a bit longer. We'll include that in the...

No, I don't anticipate more than an hour.

Okay, could be an hour.

Since our shareholders' meeting is so different this year, I wanted to do a call after our meeting to let you know the results, and then we'll give a little further business update at that time.

Okay. I recommend that we include some visuals along with our presentations. I’ve been mentioning this for more than 15 years, so there are many aspects to consider. There are new opportunities that you will discuss, including new areas and collaboration with the Department of Defense, as well as your commercialization goals. It's better to provide more details than fewer, both for everyone's benefit and so we can revisit any concerns later since you provided information without holding back. I'm looking forward to receiving more details. We all recognize that there's a lot happening, and I would like to hear more about it, but I won’t take up anyone’s time now because I’ll hear it next week.

Your next question comes from Howard Brous.

In the last conference call, you mentioned the shift from government DoD to commercial markets, highlighting a significant increase in addressable market and potential sales. Will this transition be the focus of your discussion next week?

Yes.

Well, there yes, I mean, one amongst others.

But that combination, it's always a combination here, and we're going to continue all of our government business, but we're hoping to get this other area going too.

I'm showing no other questions.

Okay. Operator, we will wrap up the call. Thank you for participating in today's call. If you did not receive a copy of the press release or if you have further questions, you can call me at (972) 301-3658, e-mail mpaxton@intrusion.com. Talk to you all later.

Thanks, guys.

This concludes today's conference call. Thank you for your participation. You may now disconnect.