Earnings Call Transcript - INTZ Q3 2021

Operator, Operator

Good afternoon and welcome to Intrusion’s Third Quarter 2021 Financial Results Conference Call. As a reminder, today’s conference call is being recorded for replay purposes. I would now like to turn the call over to Joel Achramowicz of Shelton Group Investor Relations. Joel, please go ahead.

Joel Achramowicz, Managing Director, Investor Relations

Good afternoon and welcome to Intrusion’s third quarter 2021 earnings conference call. I am Joel Achramowicz, Managing Director of Shelton Group, Intrusion’s Investor Relations Firm. Joining me today are Intrusion’s Co-Founder and CTO, Joe Head; CFO, Franklin Byrd; and CMO, Gary Davis. Also on today’s call is Intrusion’s Chairman of the Board, Tony LeVecchio, who will be available for questions after management’s prepared remarks. Before we begin, I want to remind you that today’s conference call may contain forward-looking statements regarding future events, including, but not limited to, expectations for Intrusion’s future business, financial performance and goals, customer-industry adoption of Shield technology, successfully bringing to market Intrusion’s design pipeline, executing on its business plan, anticipated capital needs as well as the engagement of investment professionals to assist the company. These and all forward-looking statements are based on estimates, judgments, current trends and market conditions and involve risks and uncertainties that may cause actual results to differ materially from those contained in the forward-looking statements. We encourage you to review the company’s SEC filings, including the 2020 Form 10-K filed with the SEC on March 9, 2021, and other SEC filings made from time-to-time in which we may discuss risk factors associated with investing in Intrusion. All forward-looking statements are made as of the date of this call, Thursday, November 11, 2021, and except as required by law, we do not intend to update this information. This conference call will be available for audio replay for at least 90 days in the Investor Relations section of Intrusion’s website at www.intrusion.com. With that, it’s my pleasure to turn the call over to Franklin. Franklin, please go ahead.

Franklin Byrd, CFO

Thanks, Joel, and thank you to everyone who has joined us on our call today. As mentioned in our last quarterly call, we expected our third quarter would be a period of transition, due primarily to the effects of aggressive hiring in the first half of the year that aligned with our projected operating model. As such, early in the third quarter, we announced a reduction in force along with additional cost reduction initiatives, a new shelf registration, and an ATM at-the-market stock sales program, which has been effective in raising capital. Additionally, in the third quarter, we experienced a partial delay in some of our consulting revenues tied to the number of changes at the company. I’m happy to say that for the most part, these transition items have concluded, and Q4 will show clear benefits from the changes that were made. Now I’d like to review the company’s third quarter results. Third quarter 2021 revenue was $1.8 million compared to $2.0 million in the second quarter and $1.6 million in the third quarter of last year. Similar to past quarters, the majority of the third quarter revenue derived from our consulting business, which was slightly lower from the prior quarter due to certain contract delays associated with the recent changes at the company. Revenues from Shield increased sequentially and represented approximately 13% of total revenue as compared to 7% last quarter. Gross margin in the third quarter was 62% as compared to 63% last quarter and 59% in the third quarter of 2020. Third quarter operating expenses were $7.2 million compared to $6.9 million last quarter and $2.3 million in the same quarter a year ago. The $300,000 increase in operating expenses from the prior quarter was primarily due to headcount payroll prior to the reduction in force, higher legal expenses associated with previously announced matters, fall season tradeshow expenses, all of which were offset by a non-cash credit in stock compensation and subsequent lower expenses for the partial quarter, both as a result of the recent reduction in force. We expect next quarter’s operating expenses to more materially reflect our cost reduction actions, as we continue to focus on optimizing cash. The net loss for the third quarter of 2021 was $6.1 million, or a loss of $0.34 per share, compared to a net loss of $5.8 million, or a loss of $0.28 per share in the prior quarter, and a net loss of $1.4 million or a loss of $0.10 per share in the third quarter of 2020. Turning to the balance sheet as of September 30, 2021, the company had cash and cash equivalents of $7.2 million compared to $9.3 million at the end of the second quarter. During the third quarter, we raised $4.8 million in net proceeds from the issuance of new stock through our ATM facility that we put in place in August. As mentioned last quarter, this facility enables the company to periodically raise cash by issuing equity at market prices. Our intention is to use this facility in a measured way that minimizes dilution to our shareholders while providing capital as required. In addition to this facility, both the board and the company continue to evaluate all potential options that are consistent with our goals of accelerating Intrusion’s growth, achieving improved operating results, as well as maximizing shareholder value. Regarding the company’s financial outlook for the fourth quarter, we are maintaining our policy of not providing quarterly financial guidance until such a time that we have greater visibility into our revenue ramp. With that, I’d like to turn the call over to Joe Head for a more detailed update on our business and our sales initiatives. Joe?

Joe Head, Co-Founder and CTO

Thank you, Franklin. Let’s start with an update on our legacy and consulting business. Our base government business declined slightly this quarter due to some contract renewal delays, which are now behind us. Despite quarter-to-quarter fluctuations in this business, it’s been a very solid base of business for us, consisting of long-standing customers that are expected to continue renewing for years to come. Last quarter, we reported that we expected a few new programs to start in the second half of the year. We expect that these new programs, along with increased spending rates on others, will contribute to a gradual upward trend on top of our historical run rate. Now shifting to our Shield business, over the past several quarters, we’ve made substantial progress on Shield. Most recently, we included a number of enhancements based on customer and market feedback, which includes the following: 1. A new executive dashboard, which shows what security issues Shield has presented; we display four quadrants on the dashboard. Quadrant one is how many times Shield has blocked malicious traffic today and yesterday. Quadrant two is which machines are sending how much data to each foreign country. You can now drill down to see details of each individual instance of communication. Quadrant three counts events that made it past your firewall that Shield caught, and quadrant four shows you which machines on your network have transmitted traffic that Shield blocked, in other words, machines that you should consider cleaning up. 2. Enhanced daily reporting. We now offer a three-day look back on live use of traffic where previously it was an hour, along with a variety of custom drill downs and data export options to give threat analysts much more visibility into all kinds of traffic; the good, the bad, and the suspicious. 3. We’ve made major engine improvements that greatly refine our DNS protections and increase our speeds, even as we have added more protection methods. We also have made some key product discoveries as we worked with customers in Q3. This further shows how Shield delivers value. For instance, bad actors scan infrastructure and launch attacks on devices that are not protected by the firewall. In this case, Shield blocks those incoming scans and connection attempts simply based on the source IP's reputation, showcasing its value as part of a defense-in-depth security architecture. Another example is around credential theft, which bad actors use to gain access to internal systems. They don’t typically try this from their homes or businesses; instead, they use virtual private hosts and other relay types to protect their identity while logging in and stealing data. In one case, Shield blocked 23 out of 25 login attempts made by bad actors, which allowed the customer to isolate the stolen credentials and deactivate them. Our lessons learned are that Shield has unique strengths in blocking inside-out connections, but also delivers surprisingly good resistance against outside attacks, due to its bi-directional zero trust approach based on reputation. We will continue to make refinements to Shield to meet our customers’ needs. Lastly, we established an advisory board of cybersecurity experts and executives who will collectively help us further refine and optimize our business. They’re already opening doors for us and assisting us with new opportunities. Our advisory board includes Vice Admiral T.J. White, Greg Akers, and Eric Jackson as our inaugural members. Greg Akers was the Senior Vice President and CTO of Advanced Security Research and Government, as well as chief technology officer within the security interest organization at Cisco. A major focus of his group was to expand security awareness and launch product resiliency initiatives throughout Cisco’s development organization. Eric Jackson, retired FBI Special Agent in Charge of the Dallas field office, had a career in law enforcement spanning almost 22 years, which included experiences fighting terrorism, fraud, and cybercrime. He currently serves as the chief security officer and risk mitigation executive for TBK Bank, SSB with locations in Dallas, Iowa, Kansas, Colorado, Illinois, and New Mexico. Vice Admiral T.J. White, US Navy retired, is a 30-year plus national security practitioner strategist and cyber operations expert. He has commanded at all levels within the Navy and joint service. These prominent individuals joined our advisory board because they recognize that Shield delivers value like no other cybersecurity solution in the market. They’re motivated to help us get the word out to the market and connect us to potential new customers and partners. I can’t tell you how excited we are about these initial appointments; their professional counsel and cybersecurity expertise will be a great value to us. Our plan is to add additional members to this important group in the future. Now Gary will update you on sales and marketing.

Gary Davis, CMO

Thank you, Joe. Notable achievements in Q3 include the addition of five new customers. We also met with great success at JSX in Orlando this September. We onboarded new partners for our quest to extend our reach across Brazil, and Liquid PC serves as a conduit to the top tier distributor CW. We continue to make progress on thought leadership with media coverage across TV, radio, and online outlets. As part of our recent efforts, we recognize the need to improve our sales production while also implementing incentive programs that drive improved performance. As part of this process, we’re actively hiring a new sales team with a strong deal-closing mindset and cybersecurity experience. Our hope is that we will have the new sales team on board and closing deals by early in Q1. As part of this reassessment, we’ve also stepped up our work with our partners, collaborating closely with them to better understand how we can help them succeed selling Shield. In summary, we have a strong pipeline of opportunities and have already closed four new deals since the start of the fourth quarter. Back to you, Joe.

Joe Head, Co-Founder and CTO

Thanks, Gary. We’re glad to report traction in sales as we’ve made necessary changes to the sales organization and connected with new potential customers at trade shows. Our marketing activities and advisory board connections have provided us great feedback on the new release of Shield based on first impressions. We expect this latest version will accelerate adoption by new customers. With that, we’ll open the call to your questions. Operator?

Operator, Operator

Your first question comes from the line of Zach Cummins with B. Riley Securities. Your line is open.

Zach Cummins, Analyst

Hey, good afternoon, Franklin, Joe, and Gary, thanks for taking my questions. And Franklin, just starting off, in terms of the OpEx run rate, I know a lot of the changes you made to really optimize that occurred in this quarter. But what sort of runway rates are you assuming for Q4 of this year for OpEx?

Franklin Byrd, CFO

I appreciate that, Zach, and I think what I tried to convey last quarter is still true. We expect Q4 to be closer to our Q1 run rate, with a couple of exceptions. So it will be a little bit higher than Q1, but we do have a bit more non-cash stock compensation now with the ramp-up of employees, and we are experiencing some heavy legal costs right now too. I’m trying not to give the exact number, but it’ll be a little bit higher than Q1, but closer in line to Q1.

Zach Cummins, Analyst

And Joe, can you talk about some of the traction that you’re seeing with Shield now? I mean, nice to see it ramp up to 13% of total revenue during the quarter and secure five more customers. I mean, can you give us a sense of the industry that those customers are in and what areas Shield is really standing out and driving a lot of interest?

Joe Head, Co-Founder and CTO

We reported four new customers and had some subsequent demos that have gone pretty well since then. The numbers are so small that it’s hard to zero in on an industry. We’ve got clients in banking, education, DOD, and manufacturing as well.

Zach Cummins, Analyst

Got it. Sorry, I didn’t mean to cut you off there. Sorry about that.

Joe Head, Co-Founder and CTO

That’s right. You first, and then I’ll continue. I won’t forget my thought.

Zach Cummins, Analyst

Okay, perfect. Yes. I’ll let you finish talking about Shield. I mean, maybe I’ll just pile one more on in there that both you and Gary can address in terms of changes to the sales force. I mean, why was this kind of considered to be a necessary change to really revamp that entire team and refine the process there?

Gary Davis, CMO

I’ll take that one. Joe?

Joe Head, Co-Founder and CTO

Yes, sure, Gary.

Gary Davis, CMO

For me, it was a very straightforward thing we had to do. It’s easy to assess the effectiveness of your sales team, and when they are closing deals and making quota, then it’s time to rethink their participation at the company. We’re also looking for a different mindset going forward. We’re really looking hard for salespeople who have a strong closing mentality; they love to hunt and they must go out and close deals. I think we’re looking for a different DNA in the people we’re interviewing to bring them into the company.

Zach Cummins, Analyst

And just a final question for me would be around the legacy consulting business. It sounds like you also made some changes there. Can you talk about maybe some of the changes that you’re making, but it sounds like you have at least some solid momentum there that should drive at least historical rates, or maybe slightly above that, as we think about it going forward?

Franklin Byrd, CFO

Yes, this is Franklin. I’ll start and I’ll turn it over to Joe, who knows a lot more about it. I’m measuring it and he’s driving it sometimes. But no, you’re right. We had a little dip in our quarter here. We kind of took a pause on some of the activity there based on just some change of activity, but we do see momentum. We’ve already had new orders in Q4 and we do see it returning to some of the historical levels. We’ve taken a snapshot of what we think it’ll be next year and we’re excited to see it moving up. Joe?

Joe Head, Co-Founder and CTO

I would further add to your comment about that we’ve made changes in the legacy area. I would say that probably isn’t true. None of the staffing changes were made. As I said in my comments, we had a little blip in the quarter due to slow renewals, and that is behind us now. We expect to see a slight tick up from the historical run rates that have been reasonably flat for a long time. We have one new program that has already started, and we’re expecting another one that’s been in the queue for a while. Unfortunately, it’s at the whim of a CR or real budget. We expect this will go forward if there’s a CR. That’s an open question. We think the answer is yes.

Zach Cummins, Analyst

No, go ahead and finish your thought.

Joe Head, Co-Founder and CTO

I’d say there’s a tick up, and the gap we had will end up being made up over some period of time. It’s a pause that is going to be made up.

Zach Cummins, Analyst

Understood. Well, thanks again, guys, for taking my questions. Best of luck as you go forward from here.

Operator, Operator

Your next question comes from Ross Taylor with ARS Investment Corporation. Your line is open.

Ross Taylor, Analyst

Thank you, gentlemen. I’m trying to get a handle on whether the moves you’ve made with the sales force are basically a complete reset of what you had been doing or if roughly 10 months into the process, we are gaining and should be gaining more meaningful traction with the major customers and potential new business that we’ve been looking for earlier this year.

Joe Head, Co-Founder and CTO

It’s a reset. The thing to note is that, even with those departures, we’re still making meaningful progress on the sales front. It feels like we’re getting a better pipeline, more commitments, more proofs of concepts, and more engagement than we had before. We’ve also changed the incentive plan to focus on digital. Previously, salespeople didn’t see incentives until they hit the quarter. We changed that to allow them to earn commissions based on everything they bring in upfront. That was an important distinction as well. Earlier in the year, we set out to sign 100 partners before the end of the year, and it became apparent that it was more a quantity thing than a quality thing. We aim to lean into those partners that are really committed to working with us instead of just getting a logo on the website and not hearing from them again.

Ross Taylor, Analyst

How long do you think it will take to get this new sales force in place with meaningful traction? I think that everyone had high expectations that haven’t been met, and now you’re looking at this going, are we six months away from something? Do you think the sales force can start to show us something in the next three to four months? What kind of time horizon are we looking at?

Joe Head, Co-Founder and CTO

I feel strongly that we’ll see some meaningful traction from the new sales team starting in Q1. They are stepping into a pipeline that we've been building and nurturing all along. It’s just a matter of making regular distributions while ensuring we have the right business development and sales focus on the right partners to make them successful. I genuinely believe these new hires will find success starting in Q1 for sure.

Ross Taylor, Analyst

You’ve received favorable feedback from third-party reviewers, yet that hasn’t translated into new business. What do you find when people don’t buy? What are they telling you as to why they’re not purchasing?

Joe Head, Co-Founder and CTO

The biggest challenge we see is that Shield is a very different cybersecurity product. A lot of what we’re having to do is educate potential customers on a different way to approach their problems. The good news is there’s been a lot of discussion around the notion of zero trust, which we’ve mentioned in our media outreach. We believe there's a significant intersection between the category of zero trust network access and Shield's outcomes. We also foresee opportunities in the IDPS displacement area because companies are looking to replace products like McAfee and Cisco. We’re seeing a lot of potential there for business.

Franklin Byrd, CFO

When you look at changing the sales force, I don’t want to overlook that we had other people working on partner relationships and deals in progress, and they weren’t being closed. The lead guys are now me, Gary, and others who have been here all along. Gary and I have upped our interaction with the major partners that we expect to perform well. This effect is part of why we’ve moved from zero to a larger number of customers since then.

Ross Taylor, Analyst

Do you see things like the issue with the federal government and the continuing resolution being a roadblock to getting wins with the DoD or a client where you have a lot of experience?

Joe Head, Co-Founder and CTO

Yes, we do. We just got one order from the DoD, so that’s positive.

Ross Taylor, Analyst

You got a field order from the DoD?

Joe Head, Co-Founder and CTO

Correct.

Ross Taylor, Analyst

That’s significant, because I would think the DoD doesn’t mess around with these types of decisions. This should be something that you would consider a major proof of concept approach.

Joe Head, Co-Founder and CTO

Yes, it’s a big deal. If you ask around, if you look at T.J. White, Akers, and the others, they all have connections that we are not as familiar with. We expect good things in our former space as well.

Ross Taylor, Analyst

Thank you for the insights. It looks like you’re starting to gain some traction that will demonstrate your product's viability and garner interest from serious parties. That would be a major positive.

Operator, Operator

There are no further questions at this time. I’d now like to turn the call back over to Mr. Joe Head.

Joe Head, Co-Founder and CTO

Thanks, operator. Before closing out the call, I want to quickly highlight that we are participating in a virtual road show with Alliance Global Partners this coming Monday. We’ll also be attending Benchmark's Discovery conference on December 2. Feel free to reach out to your respective sales reps at these firms or contact the Shelton Group if you’re interested in meeting with us. Now our chairman, Anthony LeVecchio, has a few comments he would like to make.

Anthony LeVecchio, Chairman of the Board

Thanks, Joe. One final update: I’m very pleased to announce that we’ve appointed a new president and CEO, Tony Scott, who will start on Monday, November 15. A press release will be issued within the next 30 minutes announcing his appointment and providing substantial details on his background. Tony brings to Intrusion many years of cybersecurity experience, including serving as the Federal CIO for the U.S. government, CIO for multi-billion dollar corporations such as VMware, Microsoft, and the Walt Disney Company, as well as having served as a cybersecurity private consultant. As I mentioned, you can read more about his background and qualifications in the release that will be sent out in the next 30 minutes. Both the board and management team are very pleased to have Tony Scott join the company, and we’re excited about the future of Intrusion under his leadership. We thank you again for your support and interest in Intrusion. We look forward to speaking with you during our fourth quarter call, and introducing you in the coming weeks and months to Tony Scott, our new CEO.

Operator, Operator

Thank you, and you may now disconnect the call unless there’s another question after that comment. There are no further questions at this time. Ladies and gentlemen, this concludes today’s conference call. You may now disconnect.