We would like to welcome you to Intrusion Incorporated Third Quarter 2022 Earnings Conference Call and Webcast. Please note this conference is being recorded. An audio replay of the conference call will be available on the company's website within a few hours after this call. I would now like to turn the call over to Sam Cohen with Alpha Investor Relations.

Thank you and welcome. Joining me today are Tony Scott, Chief Executive Officer; and Kimberly Pinson, Chief Financial Officer. The call is being webcast and will be archived on the Investor Relations section of our website. Before I turn the call over to Tony, I'd like to remind everyone that statements made during this conference call relating to the company's expected future performance, future business prospects, future events or plans may include forward-looking statements as defined under the Private Securities Litigation Reform Act of 1995. Please refer to our SEC filings for more information on the specific risk factors that could cause our actual results to differ materially from the projections described in today's conference call. Any forward-looking statements that we make on this call are based upon information that we believe as of today and we undertake no obligation to update these statements as a result of new information or future events. In addition to U.S. GAAP reporting, we report certain financial measures that do not conform to generally accepted accounting principles. During the call, we may use non-GAAP measures if we believe it is useful to investors or if we believe it will help investors better understand our performance or business trends. With that, let me now turn the call over to Tony for a few opening remarks.

Thank you, Sam. Good afternoon and thank you all for joining us today. I'd like to follow our usual cadence and provide you with some updates on our strategic priorities that are positioning Intrusion for long-term growth. These priorities include expanding and strengthening our product offerings, realigning our sales and marketing resources, focusing on a channel-enabled sales model, strengthening our strategic partnerships, and improving our financial discipline. As we announced at the end of September, we've achieved the commercial release of our Shield Cloud and Endpoint products. The addition of the Cloud and Endpoint solutions improves the attractiveness of our advanced threat intelligence data set with products positioned to serve the growing hybrid and cloud world. Notably, as we released these new products, we identified some important patentable characteristics on our path to general availability. Now that we have patent coverage in place, these product additions strengthen our strategic vision for Intrusion as we continue to serve the growing demands of customers seeking advanced and highly effective cybersecurity solutions globally. So first, let me talk about our Shield Cloud product. Shield Cloud extends the effectiveness of the Intrusion global threat engine and serves as a protective gateway between a customer's virtual private cloud and the public Internet. It's an important addition to our product line. Next, let me talk about our INTRUSION Shield Endpoint solution. Shield Endpoint enables safe web browsing outside of the corporate enclave and data center allowing users to work remotely with confidence that authorized device connections are known, monitored, and protected. With this product, users can safely view content on sites that would otherwise be blocked through our Shield Renderer, which transparently redirects users to a safe cloud-based browsing environment. The indications of interest in the pipeline expansion as a result of our Shield Cloud and Endpoint products are highly encouraging. We received positive feedback from customers emphasizing the effectiveness of our solution and the overall value it brings to our dedicated users. Couple of data points to help you understand what I'm seeing. Our qualified leads have more than doubled, we've doubled our proof of concepts and proof of values, our quotes are 10x in terms of quotes that we have outstanding and all of those give me confidence in the future for these new products. Finally, we continue to invest in our Shield On-Prem appliance. Development of and enhancements to this product are continuing with new functionality and the ability to address increasingly higher network bandwidth over time. The demand remains strong for this hardware and we had several deals that didn't close in this quarter, but are in our qualified pipeline. So I continue to believe that the release of these new products will pave the way for INTRUSION Shield in all forms to become the largest source of revenue growth in the future. On the sales and marketing front, we've revamped our messaging around Shield with the launch of our new company website, new product branding, and a new company logo as part of this makeover effort. The revamping of the messaging around Shield and the launch of our new website will help us better communicate our unique value proposition and our competitive position in the marketplace. Last quarter we announced an agreement with Supermicro as our primary global supplier of hardware. I'm pleased to announce we've deepened our relationship with Supermicro by signing an agreement to also act as a reseller of Intrusion technology. This agreement will add Intrusion technology to the cybersecurity portfolio that Supermicro can sell to its customers globally. I'm delighted with this arrangement and know that the combination of Supermicro and Intrusion will offer excellent value to our joint customers. Finally, as we announced in October, we are partnering with vTech Solutions, an IT services firm based in Washington, D.C., that provides end-to-end managed solutions for its customers. We see a large opportunity to work with vTech due to its experience working with state and local governments. vTech currently operates in 40 U.S. states and 3 additional countries, which will help expand the reach of our Shield products as they see greater penetration into those markets. We have positive momentum resulting from these new partnerships, which expands our reach as we provide INTRUSION Shield protection to a greater number of customers. Our discussions have continued with other major technology partners on the strategic partnerships front, but we have nothing more to announce at this particular time. As I indicated last quarter, I was hoping to have something further to announce during the third quarter, but there's been a bit of a slowdown in these discussions mainly due to the macroeconomic environment that we're all currently experiencing. That said, no potential partner has left the discussion and we detect genuine enthusiasm for our IP and I remain optimistic that we will have something to announce on this front in due time and our strategic direction remains on course. Before wrapping up, let me also address our legacy consulting business. We were pleased to see this segment grow both sequentially and year-over-year. As you know, the federal government's fiscal year started on October 1 and there currently is a continuing resolution or CR as it's commonly known to temporarily extend the fiscal year 2022 spending levels. As can be typical in these situations, we expect that the appropriators and congressional leaders will reengage in negotiations to finalize federal spending for fiscal 2023 following the November midterm elections. As we navigate the terrain of conducting federal government business, we are continuing to make investments and are exploring additional opportunities within the space in support of our growth strategy. Our team continues to be active in our engagement with industry leaders and chief information officers through participation in a couple of select cybersecurity conferences. As many of you know, I have a background with the federal government, which ultimately led to Intrusion's participation in Cyberworld within the AUSA conference, the largest trade show for the U.S. military with over 60,000 attendees. I personally participated as a keynote speaker this year where I emphasized the technological capabilities of Shield in protecting critical information assets, which was well received by those in attendance. During the quarter, we also participated in GRR Con, an information technology, security, and hacking conference. This conference brings together a number of industry leaders to discuss pertinent changes to the cybersecurity industry and how CIOs are countering attacks. The participation at these two conferences allowed us to showcase our new and innovative products to a broader audience at significant industry events and we're continuing to evaluate additional ways to expand the awareness of our INTRUSION Shield offer. At a macro level, there are both positives and negatives. What I continue to hear and confirm is that while the forecast for technology and software spending are projected to be markedly lower, cybersecurity remains a top priority as we head into 2023. For example, in a recent Gartner study published in the Wall Street Journal, 66% of CIOs indicated that they plan to increase investment in cybersecurity. Long term, the demand backdrop for our solutions continues to grow, specifically in the market sub-segments we serve. Cyber criminals and ransomware attacks do not pause because of a slowing economy and we continue to operate in a segment that will continue to see increased spending irrespective of what's happening in the global market. While bad actors never cease, I'm excited about the ways in which our new and existing products can stand up to the most intelligent threats today and I remain steadfast in my belief that we are well on our way to sustainable Intrusion growth in this high-growth, exciting space. Before I turn the call over to Kim, I'd like to comment on our efforts to improve the company's financial discipline and stability as we continue to pursue our strategic initiatives. We further strengthened our balance sheet and overall financial flexibilities to meet our operational and strategic needs. In September, we completed a registered direct offering of approximately $6 million along our goal of $15 million to $20 million in the coming year. We remain confident that the capital markets remain open to us as we gain traction with our new Shield products. We plan to move forward with the same commitment to investing in our business in a responsible manner that's commensurate with our prospects for profitable growth. Overall, I'm proud of how our teams executed during the quarter. I'm happy with the positive trajectory in our new business wins paired with the strong sales pipeline as more companies look to leverage our advanced threat hunting capabilities. With that said, I'd now like to turn the call over to Kim for a detailed review of our third quarter financials. Kim?

Thanks, Tony. We are encouraged by the ongoing progress being made within our business as we continue to strengthen our balance sheet, bolster our financial flexibility, and support our strategic growth initiatives to capture the growing customer demand for our sophisticated cybersecurity solutions. Revenues for the third quarter of 2022 were $2.2 million, an increase of $0.1 million or 6.5% sequentially and $0.4 million or 20.5% year-over-year. Third quarter revenues for our consulting business of $1.9 million increased 14.6% year-over-year and 7.9% sequentially due to an increased level of task orders during the quarter. This business has shown continued progress, and we feel that we'll continue to see a consistent level of growth as the federal government works its way through the backlog of task orders for contracts that have already been awarded and eventually reaches a new budget for fiscal 2023. As you know, due to the CR, no new contracts can be awarded until either the CR ends or a new budget is approved. Third quarter results for our Shield On-Premise of $0.3 million were flat sequentially due to some minor churn we experienced in the business. During the quarter, we signed a number of new customers, which was offset by a nonrenewal of a contract. On a year-over-year basis, Shield third quarter revenues increased $0.1 million or 70.3%. We are still seeing strong demand for our Shield On-Prem solution with some opportunities that we did not close in Q3 expected to close in the fourth quarter. As Tony stated, we are pleased with the launch and progress of our two new Shield products and are encouraged by the prospects in the pipeline, particularly for the Endpoint solution that we expect to be a large contributor to revenues in the future. The gross profit margin was 54.6% for the third quarter of 2022, which is significantly below the gross margin that has been reported in prior periods. During the quarter, we identified amounts recorded in operating expense that should be included in cost of sales. We included this expense in cost of sales in Q3 and made a reclassification from operating expense to cost of sales in all prior periods for comparability. This reclassification resulted in a reduced gross margin of approximately 12% and 14% for each of the 3-month periods ended September 30, 2022, and 2021. When comparing our current quarter gross margin to the same period in 2021 after reclassification, our gross margin increased 6.2%. We anticipate our gross margin will continue to increase as Shield revenues make up a greater percentage of our sales. We are continuing to control our cost structure while also making prudent investments in our long-term profitable growth. Third quarter operating expenses of $5 million were down $2 million or 28% year-over-year. Looking closer at our operating expenses. Sales and marketing expenses of $1.7 million were down $1.8 million or 52% year-over-year as a result of the actions taken over the past year to realign our sales organization and implement cost savings measures. Research and development totaled $1.5 million, a decrease of $0.4 million from the prior year period. As you may recall, we began capitalizing internally developed software costs in the second quarter of this year. When adjusted for amounts capitalized, the R&D expense would be $2 million, an increase of $0.1 million or 5% year-over-year. General and administrative expenses of $1.9 million were up $0.3 million or 16% year-over-year mainly due to legal costs that are nonrecurring in nature. During the quarter, we finalized the calculation of our employee tax credit related to 2020 and 2021 and we recognized $2 million in other income net of expenses. Net loss for the third quarter was $2.9 million or $0.15 per share compared to a net loss of $6.1 million or $0.34 per share for the third quarter of 2021. Our losses have improved significantly compared to the same period of the prior year, which reflects our responsible fiscal management as we grow revenues and manage our costs. Turning to the balance sheet. As of September 30, 2022, we had cash and cash equivalents of $6.9 million, up from $4.1 million on December 31, 2021. On September 12, we entered into a securities purchase agreement to issue and sell shares in a registered direct offering of common stock and warrants totaling $5.9 million. We closed on 959,057 shares and warrants or $4 million in the September quarter. The additional financing allows us to prudently invest in our growing suite of INTRUSION Shield products and address our capital allocation priorities while driving sustainable shareholder value. With that financial overview, I'd like to turn the call back over to Tony for a few closing comments.

Thanks, Kim. To conclude, we're continuing to execute on our strategic initiatives through the launch of our new products and the partnerships that we've announced. We're pleased with our performance and are optimistic for what is yet to come. I believe that the actions that we are taking today set us up well to end the year on a good note and move into 2023 with strong momentum. I look forward to sharing the next steps in our journey with all of you and again thank our investors for your continued support as we execute on our strategy. This concludes our prepared remarks. And I'll now turn the call over to the operator for Q&A.

Our first question will come from Zach Cummins with B. Riley Securities.

Just starting off, I mean with Shield revenue I think essentially flat quarter-over-quarter. It sounds like you had a nonrenewal with a customer. Can you talk about some of the dynamics that went on there and why that customer decided to not continue forward with your On-Premise product?

Yes. This is Tony. So the circumstance there was a deal that was signed before I actually got there. The customer had turned on Shield and it was an educational institution. On the first day of school, when all the students logged in, our box crashed, and they got kind of jittery and basically refused to turn it back on again. Again, all of this happened well before I got to Intrusion. So it was one of those things that when I got there, we spent the first couple of months on the hardware stabilizing our software and making sure things like that wouldn't happen again. And we just couldn't resurrect that one customer out of the trash bin, if you will. So I felt real bad about it, but I do understand in that particular case why a customer would feel burned and would not want to renew. So that's the circumstance. I wish it were otherwise, but it is what it is.

Understood. That's helpful. And Kim, I think you mentioned around the kind of lower gross margin that we saw in this quarter. I mean, any way you can give us a sense of what sort of costs are being moved into that cost of revenue line versus what was classified as operating expenses before?

Yes, I can. In reviewing the cost of sales, it was primarily as we were getting ready for the planning phase of the remainder of this year and 2023, I noticed some contractor expense. It's really some direct labor expense associated with a consultant contract that previously had been included in operating expense and should have been fully recorded in cost of sales. That is a long-term contract. The billing on that contract was consistent. So we went back and did a correction of an immaterial error and restated the cost of sales for all periods presented. And it did not have an impact on our operating income, gross margin, or earnings per share. It was clearly a reclassification.

Understood. That's helpful. And Tony, final question for me is really around the launch of your new Cloud and Endpoint solutions. Just to make sure I was getting all the metrics right. Would you mind repeating kind of some of the pipeline metrics that you shared during the conference call script? And I'm assuming all of the existing channel partners you have are likely ready to go right now to sell these new solutions?

Yes. So we've been working for the last several months getting our partners and resellers and so on ready for this launch, getting our collateral material together and all the things that you would expect at that particular time. And so the metrics I was talking about has to do with our proof of values, proof of concepts, and things like that. So let me re-share those. So one of the things that we track in our sales force instance is qualified leads. So these are leads that we know there's a budget, we understand what the demand is, there's been at least an initial conversation and a desire to learn more about our product and so on. It's not just somebody clicking on the website or some sort of casual interest. It's a real sales opportunity for us. And we have a funnel process that we go through to eventually determine that it's a qualified lead that bears our putting time into and also our channel partners putting time into. In most cases, they've already put some considerable time into it. So those have doubled. We've also doubled the proof of concept and proof of value. So once we get through the initial sales pipeline, then we actually get our hardware or software as the case may be installed at the customer site and we begin a defined period of time where the customer experiences what our product can do in order to make a determination whether they ultimately want to buy it or not. So those have doubled. And then probably the other measure that I think is important and we talked about on the call is quotes outstanding. So these are cases where in dialogue with the customer, we have a specific request to provide a quote and our goal is to turn those quotes into actual sales. So those are all leading indicators of trajectory in terms of where the company is going and I'm pleased to see those numbers kind of show up in Q3.

Understood. That was extremely helpful. Well, congrats on the continued progress here in Q3 and then best of luck with the rest of the year.

Your next question will come from the line of Scott Buck with H.C. Wainright.

My first question, I may have missed it, Tony, at the front end of the call, but what part of the quarter did you guys go live with Endpoint and Cloud?

Yes. It was near the end of the quarter. What happened there is, we were ready to go, and we realized there was some additional patent coverage that we really wanted to have and needed to have before we went GA with these products. So we had a slight delay of a couple of weeks while we got that patent coverage in place. The good news is it allowed us to do some additional feature development that probably wouldn't have gotten done otherwise. So I'd call it a good delay for two reasons, but it was a little bit later in the quarter than I had originally been hoping for, but we did get it out at the end of the quarter, hope for them.

Was there any revenue contribution from these two products during the quarter?

No, because neither were GA at the end of the very end of the quarter, so.

Okay. Perfect. My next question on the vTech partnership and really just your channel partnerships in general. Can you remind us what the economics look like there? I assume maybe a little bit lower revenue, but higher gross margin versus what would occur under our direct sales relationship?

Right. So we have agreements in place with all of our resellers. And most of them are commission kind of basis or a discount basis, but they sell our products, they bill the customer, we bill them is kind of the nature of the relationship. In most cases, they'll provide first-line support. They'll have technical teams that help with the install, answer any Tier 1, helpdesk kind of calls and so on. So it's a good alternative in my view to building up a large team internally that would be needed if we were going to do all of that directly ourselves.

Sure. And how many channel partners do you guys have in place currently? And what's the pipeline look like for adding additional capacity?

I don't know the exact number off the top of my head. I can get back to you with that. But we're focused on around 8 to 10 at this particular point or, I'll say, more active than the others and it's probably double that in total that I'd say are active partners, but we're really focused on the top 8 or so that are really delivering leads and really engaging in direct customers. And that's apart from the managed service providers and managed security service providers that are their own sort of activity.

Right. Okay. And they're all educated up on the product, so there's not a 6-month lag in terms of when they could actually start selling?

Yes, they are. We'll obviously continue to develop additional material. And one of the things that happens when you get a product into the marketplace is you try to anticipate ahead of time with all of the questions and all of the frequently asked concerns or whatever it might be. But there's no substitute for getting out in the marketplace and getting feedback and hearing what the real customers have to say. So, there will be a period here where that feedback will be critically important as we try to do a better job.

Sure. Just one more question from me. You all did a great job reducing operating expenses over the past year. What are the expectations moving forward? Are there any additional areas where you can be more disciplined if the market conditions worsen, or will you need to increase spending to support top-line growth?

Well, I'll let Kim comment, but our main goal is to improve sales. We think now we have the opportunity with the two new products in a pretty complete offering to really spur sales. And then our objective is to grow internal resources at a slower rate than sales. So I think Kim mentioned improved margins in her conversation. But our goal for the next two quarters, in particular, and I think forever, will be grow sales and then grow cost at a slower rate.

And then just to add on to what Tony said. I think the go-to-market structure that we have achieved will allow us to grow our expenses in relation and have to make those significant investments as we grow our clients. So we do plan on responsible fiscal management and really not getting ahead of ourselves in terms of expense spend, and we'll continue to spend responsibly, we'll continue to invest in new features and functionality and new products, but we will moderate that with our product adoption as in at the rate at which our top line growth. And on that same basis, to lower expenses, we will continue to invest in sales and marketing, but due to the go-to-market structure, it will be at a lesser extent than what otherwise we would have seen once the new products launched.

Okay. Great. I appreciate the time guys.

Your next question comes from the line of Ed Woo with Ascendiant Capital.

Congratulations on the product releases. My question is, you mentioned about the weakening macro environment, challenges of IT budget, at the same time, cybersecurity remains a priority. Do you anticipate longer sales cycles and/or maybe pricing pressures going forward?

Yes. I think that's a natural sort of result given the macroeconomic climate we're in. But there's a couple of other things I would mention here, too. I hear a couple of themes from CIOs and CCIOs when we talk to them. One of them is that they're overwhelmed by having 52 vendors in the cybersecurity space, and they're sort of looking for better coverage from a fewer number of vendors than what they have today. So it tells me that there's likely to be some industry consolidation or things like that as the pressure comes from the customer base. But I also hear and I think this helps Intrusion, they're looking at solutions that are focused on the coming threats and the threats that are growing today versus yesterday's problems. And I think our forward-facing cybersecurity solutions play well in that dynamic. And as we all know, cybersecurity attacks are still successful. There was news this week of yet another one, a big company getting attacked. So I think those show that we're not winning the war yet against some of these adversaries.

Well, I wish you guys good luck.

Your next question comes from the line of Aaron Warwick with Breakout Investors.

I'm sorry, I had a problem, technical difficulty getting on the call. And I got on at the very end of when you were talking about strategic partnerships and some delays. Could you cover that again for me real quickly?

Sure. Well, I think the bottom line of this is, I've hoped to announce a major strategic partnership by the end of the third quarter. And in my comments, I said I think the macroeconomic conditions are creating an environment where those conversations have slowed down a little bit. Just to add a little color, one of the partners we were talking to had a staff reduction of almost 50% in the team that was talking with us. So I think it means that in major tech companies, and you're seeing this in the market broadly, most of them are not having a great time right now, and that puts a lot of pressure on internal teams and I think also limits the kinds of relationships that they're willing to engage in. So I'm seeing that firsthand. That said, nobody has said, go away, we don't want to talk to you anymore and our conversations will continue. So we will announce something in due time when it's done. I'm still pursuing those with vigor. And I'm still hopeful that we'll be able to get one done. The timing is just a little more uncertain and I would say I felt it was going to be 3 or 4 months ago.

It’s great to hear about the strengthening relationship with Super Micro. Can you elaborate on that? Specifically, I'm curious about their white box offerings and international presence. What opportunities have arisen for you as a result of this partnership?

Super Micro builds a lot of platforms. And there's a platform for a lot of open source solutions. They've got great penetration in the small and medium market. And increasingly, as there's cost pressure on IT budgets and so on, they're going to be a great alternative to some of the higher-priced solutions that are there in the market. And so our ability to partner with them and be a part of the portfolio they can offer their customers, I think is good for us, and I think good for them as well. And they wanted to broaden their offerings, and I think we're a very good partner for them in that respect.

Good. Final one for me, I guess, would just be as it relates to more on the government side, have you guys been looking into being added to the GSA schedule or being added to things like the Department of Homeland Security in terms of the offerings that they're able to accept?

Yes. And we'll go on initially as a sub to other offerings, not directly, but we are working on also being on directly as well. But the most immediate occurrence will be as a sub to other offerings.

Is that for both departments or just the GSA?

GSA and DoD are our three primary targets. Excellent.

Our final question will come from the line of Ross Taylor with ARS Investment Partners.

Congratulations on getting the cash burn down. Tony, real quick, just to pick up on an answer you gave to Aaron. You said you'd be a sub to other offerings. That sounds very much like you already know who those other offerings are, and you're in the process of getting approval or getting put into those offerings? Is that a correct way to read that?

That is correct, yes.

So what needs to be done to cross that bridge? It seems that it could either take a long time or be a very quick process. How long do you think it will take before you reach that point?

Yes, the normal process would be a proposal goes in and the prime time director lists, the subs that they want to use or could participate in that particular contract. And once it's awarded, then the prime becomes responsible for the relationship. So as we mentioned, there's a CR right now, so we're not expecting any new contracts until after the CRs get ended and normal funding occurs. But as in every year, where there's been CRs, there ends up building a lot of demand behind the dam, if you will. And as soon as the CR ends, then contracts start to flow. So we hope to be on a number of those new contracts when the dam finally gets released.

So I understand that those are currently being delayed due to the continuing resolution, which we've experienced 15 times since the middle of the last budget year.

Yes, correct.

You already have the prime that has put the contracts in and you've already basically worked with the prime, the prime is intending to include you in that. Is that a correct way to think about that?

That is correct, yes.

Okay. So what kind of work do those firms do to validate your product?

We have selected companies in different areas. One offers products suitable for integration, while the other provides services that we can also integrate. Currently, we are not engaging with multiple options for each; instead, we chose a top product company and a leading services company based on the gaps in their offerings. I should mention that if the pace remains slow, I may consider expanding our discussions to include more companies than we are currently engaging with.

If you truly have a unique product, it makes sense to create some competition for it. If people start to recognize its value, there should be a significant push towards it. I just want to mention that I could discuss this in more detail at 6:00. I believe people might be a bit fatigued with my speaking, but they likely enjoy hearing from you.

Yes. My only comment, Ross, would be, I chose one because of the impact on resources. These conversations take people, engineers, blah blah, and I didn't want to dilute our resources broadly. I chose a more focused approach, and we'll see what happens as time marches on here, but that was a deliberate choice initially.

The individuals who are partnering with you on these potential government deals have dedicated resources and made the decision to include you in their offerings. They are putting their reputations on the line alongside yours. Many years ago, I had significant success with a company called Albany International, which created a new method for producing fan blades for jet engines. When Boeing announced they would use the engine, many thought it was a foolish move, but there are indeed innovative technologies from companies that seemed unlikely to be successful.

That's right. That's exactly right.

Congratulations, it sounds like there's a lot more happening here than what has been shared. It's really exciting, and I sense there are some opportunities that haven't been revealed yet. Thank you very much, and I'll talk to you later.

And with that, I'll turn the conference back over to management for any closing remarks.

Well, again, I would just like to say thank you to our investors and analysts and all those who are paying attention to us. For me, it's coming up on my one-year anniversary of joining the company, and I'm quite proud of the team. I'm quite proud of the work that we've been able to do this year. And I'm even more excited about what the next year will bring. So I appreciate your going on the journey with us. Stay tuned, we'll have, I think, more exciting news for you in the coming weeks and months. So thank you very much.

Ladies and gentlemen, that will conclude today's call. Thank you all for joining. You may now disconnect.