INTRUSION INC. — Q3 2018 Form 10-Q
Business context and reporting period. Intrusion develops and sells cybersecurity and entity-identification products, including TraceCop and Savant. This unaudited report covers the three and nine months ended September 30, 2018; comparisons are with the same 2017 periods. Financial amounts below are in U.S. dollars.
Key financial results
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $2.665 million | $1.678 million | $7.296 million | $4.780 million |
| Gross profit / margin | $1.698 million / 63.7% | $0.942 million / 56.1% | $4.552 million / 62.4% | $2.829 million / 59.2% |
| Operating income (loss) | $660,000 | ($311,000) | $1.581 million | ($992,000) |
| Net income (loss) | $617,000 | $568,000 | $1.437 million | ($221,000) |
| Net income (loss) attributable to common stockholders | $582,000 | $533,000 | $1.333 million | ($325,000) |
| Basic earnings (loss) per share | $0.04 | $0.04 | $0.10 | ($0.03) |
Cash flow and liquidity. For the nine months, operating activities provided $1.792 million, investing activities used $173,000, and financing activities used $990,000. Cash increased from $224,000 at December 31, 2017 to $853,000 at September 30, 2018. The company reported a $416,000 working-capital deficit at quarter-end (rounded in MD&A to a $0.4 million deficiency).
Debt and other obligations. The company owed its CEO $1.815 million under a revolving note bearing interest at 6.25% at quarter-end, with principal and accrued interest due March 31, 2020. Accrued interest was $450,000. The company reported $1.9 million of remaining borrowing capacity under the $3.7 million facility. Current liabilities included $557,000 of accrued preferred dividends; preferred dividends continue to accrue.
Material changes and operating trends
- Revenue rose about 59% in Q3 and 53% for the nine-month period versus 2017, primarily from higher TraceCop sales. Q3 TraceCop revenue was $2.7 million; Savant revenue was $29,000, unchanged from the prior-year quarter.
- Gross margin improved, which management attributed mainly to product mix. Research and development expense declined substantially, mainly because lower payroll costs were allocated to cost of sales. Sales and marketing expense increased modestly.
- Q3 2018 operating income of $660,000 contrasts with the prior-year operating loss. Prior-year results included $928,000 of other income, primarily from the sale of unused IP addresses ($872,000) and an investment ($56,000); this nonrecurring income supported Q3 2017 net income.
- U.S. government entities accounted for 84.5% of Q3 revenue and 84.2% of nine-month revenue. One commercial customer represented 14.5% of Q3 revenue. TraceCop and government-related sales therefore remain significant concentrations.
Outlook, risks, and contingencies
There is no specific quantified revenue or earnings guidance. Management expected sales and marketing costs to increase through year-end with revenue, while research and development and general and administrative costs were expected to remain relatively constant, subject to revenue-related changes. Management believed cash, anticipated profits, and CEO-note availability would fund operations and expected capital expenditures for the next 12 months; this assessment depends on projected revenue and earnings growth.
- Liquidity remains a key risk: the company relies on positive operating cash flow and financing from its CEO, and warns that unavailable or unfavorable financing could impair its ability to fund operations or continue business. Additional equity financing could dilute shareholders.
- Preferred dividends continue to accrue even if payment is restricted. If Series 2 and Series 3 dividend defaults are not cured after notice, holders may have redemption rights; the filing estimates a $2.4 million aggregate cash redemption amount for those series as of November 1, 2018. The company also disclosed an 18% annual late-fee provision on unpaid dividends for those series, subject to waivers described in the filing.
- Other disclosed risks include dependence on U.S. government customers and indirect sales channels, reliance on TraceCop, customer concentration, possible government contract cancellations, preferred-stock conversion or redemption dilution, and influence held by management and large shareholders.
- The company reported routine legal proceedings that it did not expect to materially affect its financial position, results, or cash flows, while noting future claims could have a material impact. Management concluded disclosure controls were effective as of September 30, 2018 and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether TraceCop growth and improved margins can be sustained, and whether Savant contributes meaningfully to revenue.
- Customer and channel concentration, especially the high share of revenue from government entities and the material Q3 commercial customer.
- Cash generation, the working-capital deficit, and continued access to the CEO note or other financing.
- Preferred dividend arrears, any redemption triggers or penalties, and the resulting potential cash demands or dilution.
- The extent to which reported profitability reflects recurring operations rather than prior-period unusual income; 2017 included the IP-address and investment sale gains.