Intrusion Inc. — Q3 2016 Form 10-Q
Business and period: The company develops and sells network-security and entity-identification products, principally TraceCop and Savant. This unaudited filing covers the three and nine months ended September 30, 2016; comparisons are with the corresponding 2015 periods unless noted. Results are not necessarily indicative of full-year performance.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $1.595m | $1.552m | $4.693m | $5.336m |
| Gross profit / margin | $0.985m / 61.8% | $0.982m / 63.3% | $3.016m / 64.3% | $3.352m / 62.8% |
| Operating loss | $(0.244)m | $(0.405)m | $(1.109)m | $(0.667)m |
| Net loss | $(0.280)m | $(0.432)m | $(1.211)m | $(0.746)m |
| Net loss attributable to common stockholders | $(0.315)m | $(0.467)m | $(1.315)m | $(0.850)m |
| Basic and diluted loss per share | $(0.02) | $(0.04) | $(0.10) | $(0.07) |
Quarterly revenue increased 2.8%, while nine-month revenue declined 12.1%. TraceCop quarterly sales rose to $1.6m from $1.3m; Savant sales fell to $22,000 from $0.2m. The nine-month revenue decline was attributed primarily to lower Savant sales. Customer support and maintenance revenue was zero in 2016 because all existing contracts expired at year-end 2015.
Quarterly gross margin decreased, which management attributed to product mix and somewhat higher labor costs for TraceCop. Nine-month gross margin improved despite lower revenue. Quarterly operating and net losses narrowed, but nine-month operating and net losses widened. Nine-month R&D expense increased to $1.908m from $1.641m; sales and marketing and general and administrative costs declined slightly.
Cash, liquidity and debt
- Cash and cash equivalents were $210,000 at September 30, 2016, versus $102,000 at December 31, 2015. Current assets were $891,000 and current liabilities were $1.907m, a working-capital deficit of approximately $1.0m.
- Operating cash flow was negative $606,000 for the first nine months, versus positive $282,000 in 2015. Investing cash outflow was $41,000. Financing provided $755,000, primarily from $805,000 of CEO-note borrowings, partly offset by capital-lease principal payments.
- The unsecured revolving note from CEO G. Ward Paxton was renewed September 30, 2016, with a maximum principal balance of $2.7m through March 2018 and interest at SVB prime plus 1% (5% at quarter-end). Outstanding principal was $2.335m; accrued interest was $151,000. Management reported $635,000 of excess funding available under the note; verify this against the stated commitment and outstanding balance.
- The SVB credit line was not renewed; the company said it replaced that facility with increased capacity under the CEO note. Capital-lease obligations totaled $193,000, including $142,000 current. Accrued and unpaid preferred dividends were $267,000.
Outlook, risks and other notable matters
- Management said it expected available cash and borrowing capacity, together with projected revenue and net-income growth, to fund operations and expected capital expenditures for the next 12 months. This is conditional: failure to produce positive cash flow or obtain acceptable financing could impair the business plan, liquidity, or ability to continue operations. The filing provides no specific revenue or earnings guidance.
- U.S. government entities and resellers accounted for 78.4% of Q3 revenue, up from 55.4%; government customers represented 70.0% of nine-month revenue. Indirect channels generated 79.8% of Q3 revenue. Customer concentration, government spending and contract cancellation, and dependence on resellers are material risks. Management reported no known proposed government contract cancellations or renegotiations.
- Preferred dividends continue to accrue. Series 2 and Series 3 preferred holders may have redemption rights following an uncured dividend default; the filing estimated a $2.2m cash redemption obligation if those shares were redeemed as of November 1, 2016. Unpaid dividends may also incur an 18% annual late penalty on those series, subject to stated waivers for certain holders.
- The filing highlights potential dilution from preferred conversions/redemptions, options, and future financing. It estimates that Series 2 and Series 3 redemption under specified assumptions could require approximately 3.472m common shares, about 27.2% of the then-outstanding shares. Preferred-stock and option conversions could also materially increase shares outstanding.
- Routine legal matters were not expected by management to have a material adverse effect, though no assurance was given. Disclosure controls were concluded effective as of September 30, 2016; management reported no material change in internal control over financial reporting during the quarter.
Key facts for investors to verify
- Whether the reported $635,000 of CEO-note availability is consistent with the $2.7m commitment and $2.335m principal outstanding, and the terms and continued availability of this related-party funding.
- Cash runway and the assumptions behind management’s 12-month liquidity expectation, given negative operating cash flow, the working-capital deficit, and accrued preferred dividends.
- Recent sales trends and customer concentration, particularly the sharp decline in Savant sales and dependence on government customers and indirect channels.
- Preferred-stock dividend arrears, any redemption or penalty triggers, and the resulting potential cash obligation or common-share dilution.
- Whether revenue growth and improved cash generation materialize sufficiently to support sustainable profitability.