Business context and reporting period
Intrusion Inc. develops and sells security, data-mining, identity-discovery, compliance and privacy software. This unaudited Form 10-Q covers the three and nine months ended September 30, 2012, compared with the same 2011 periods. The company identifies TraceCop as its principal revenue driver.
Financial results
| Metric (USD thousands, except percentages) | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Revenue | 1,855 | 1,792 | 5,202 | 3,902 |
| Gross profit / margin | 1,081 / 58.3% | 1,091 / 60.9% | 3,025 / 58.1% | 2,396 / 61.4% |
| Operating income (loss) | 80 | 145 | (7) | (714) |
| Net income (loss) | 48 | 121 | (92) | (755) |
| Net income (loss) attributable to common stockholders | 9 | 83 | (208) | (868) |
| Net interest expense | 32 | 24 | 85 | 41 |
For the nine months, product revenue increased $1.3 million, principally from TraceCop; customer support and maintenance revenue declined $20,000. TraceCop revenue was $1.8 million in Q3 2012 versus $1.7 million in Q3 2011. Product gross margin fell, which management attributed mainly to product mix and somewhat higher labor costs on TraceCop sales. Q3 research and development expense rose to $414,000 from $313,000; sales and marketing fell to $317,000 from $365,000, while general and administrative expense was broadly unchanged.
Cash, liquidity and debt
Cash and cash equivalents were $475,000 at September 30, 2012, versus $308,000 at December 31, 2011. The company reported a $1.6 million working-capital deficiency. Nine-month operating cash flow was positive $229,000, compared with negative $1.464 million in 2011; investing cash use was $21,000 and financing cash use was $41,000. Cash increased $167,000 over the period.
At quarter-end, current liabilities were $2.764 million, including $1.530 million owed to CEO G. Ward Paxton, $239,000 in accrued preferred dividends, and $43,000 under the bank line of credit. The officer loan bears interest at prime plus 1% (5% at quarter-end), with principal and accrued interest due March 31, 2013; accrued interest was $111,000. The SVB line was reduced to $625,000 in June 2012 from a prior $2.5 million facility; $43,000 was drawn and management reported $159,000 available. The CEO note allowed borrowings up to $2.2 million, with $670,000 still available. The SVB facility is secured by substantially all company assets, including intellectual property, and is guaranteed by the CEO.
Outlook, risks and unusual items
Management said it expected available cash, operating profits and borrowing capacity to fund operations and expected capital expenditures for the next 12 months, based on projected revenue and net-income growth. It cautioned that failure to generate positive operating cash flow or obtain acceptable financing could impair execution of its plan, liquidity, or continued operations. Additional financing could be unavailable, carry unfavorable terms, and/or materially dilute existing shareholders.
Revenue is concentrated: U.S. government sales represented 34.3% of Q3 revenue and 35.2% for the nine months. One commercial customer accounted for 64.0% of Q3 revenue; substantially all quarterly revenue came from TraceCop. Management cited government budget and cancellation risks, reliance on indirect sales channels, and potential demand, pricing and customer-concentration risks.
Preferred dividends continue to accrue whether or not legally payable. Accrued and unpaid dividends were $239,000; unpaid Series 2 and Series 3 dividends may lead to an 18% annual late-fee penalty, notice and a 45-day cure period, followed by a potential cash redemption right. The filing estimated a $2.0 million aggregate redemption price for those series as of October 31, 2012. It also described potential dilution from preferred-stock conversion or redemption and future financing. Routine legal matters were not expected to have a material effect, though no assurance was given. Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether revenue growth and positive operating cash flow can be sustained, given the working-capital deficit and nine-month net loss.
- Whether the company can repay the CEO loan by March 31, 2013 and maintain access to the smaller SVB facility and its covenants.
- The amount, timing and potential cash impact of preferred dividends, penalties and redemption rights, as well as resulting dilution.
- Whether the exceptionally high reliance on TraceCop and one commercial customer persists, and how government spending or order timing affects sales.
- Whether gross margins recover after the year-over-year decline and whether management’s 12-month liquidity assumptions are achieved.