INTRUSION INC. — Q2 2016 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2016. Financial amounts below are in thousands of dollars unless noted. Intrusion develops and sells cybersecurity and entity-identification products, including TraceCop and Savant.
Financial performance and position
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Revenue | $1,587 | $2,069 | $3,098 | $3,784 |
| Gross profit | $1,059 | $1,287 | $2,031 | $2,370 |
| Gross margin | 66.7% | 62.2% | 65.6% | 62.6% |
| Operating income (loss) | $(352) | $22 | $(865) | $(262) |
| Net income (loss) | $(387) | $(4) | $(931) | $(314) |
| Net loss attributable to common stockholders | $(422) | $(39) | $(1,000) | $(383) |
- Revenue and profitability: Q2 revenue fell 23% year over year; first-half revenue declined 18%. Product revenue was the source of nearly all revenue. Savant sales fell to $32 from $800 in Q2 2015, while TraceCop sales rose to $1,600 from $1,300. All existing maintenance contracts had expired by the end of 2015.
- Expenses and margins: Gross margin increased, which management attributed mainly to product mix. R&D expense rose to $670 for Q2 and $1,400 for the first half; sales and marketing was $419 and $847, respectively. Net interest expense increased to $35 for Q2 and $66 for the first half, primarily due to higher borrowings from the CEO.
- Cash flow: First-half operating cash use was $34, versus cash provided of $82 in the prior-year period. Investing cash use was $27. Financing provided $525, primarily from CEO loans. Cash increased to $566 at June 30 from $102 at December 31, 2015.
- Liquidity and obligations: Current assets were $1,234 and current liabilities $2,268, a working-capital deficit of approximately $1,034. The balance sheet reported $2,055 due under the CEO loan and $237 of current and noncurrent capital-lease obligations. CEO-loan accrued interest was $125. Accrued and unpaid preferred dividends were $231; stockholders’ deficit was $2,758.
Material changes and management commentary
- Q2 sales mix shifted toward government customers: U.S. government sales represented 66.2% of revenue, up from 41.9% a year earlier. Three government customers accounted for approximately 54.4% of Q2 revenue. One commercial customer accounted for 30.3%.
- Management said it expects sales to government customers to remain significant. It cited potential government spending interruptions and contract cancellations as risks, while stating it was not aware of proposed cancellations or renegotiations.
- Management expected sales and marketing expense to increase through the remainder of 2016, with increases in revenue; R&D and general and administrative expenses were expected to remain relatively constant, subject to revenue-related increases.
- No quantified revenue or earnings guidance was provided. Management projected sufficient cash for operations and expected capital expenditures over the next 12 months, based on revenue and net-income growth projections and available CEO borrowing. It warned that failure to generate positive cash flow or obtain acceptable financing could jeopardize operations.
Risks, contingencies, and unusual items
- The CEO’s unsecured revolving note permits borrowing up to $2,200 through March 2018 at a floating rate of SVB prime plus 1% (5% at June 30, 2016). The company reported only $145 of remaining availability at quarter-end. It chose not to renew its SVB credit line, citing increasing fees.
- Preferred dividends continue to accrue. If Series 2 and Series 3 dividend defaults are not cured after notice, holders may have redemption rights; the filing estimated an aggregate cash redemption price of $2,200 as of August 1, 2016. Preferred-stock obligations and potential financing could materially dilute common holders.
- The company reported substantial potential dilution: conversion of outstanding preferred stock would increase common shares by approximately 8.4%; exercising certain outstanding options could increase shares by approximately 18%. A specified preferred-stock redemption scenario could approximately double shares outstanding.
- Routine legal matters were not believed likely to have a material adverse effect, though the company gave no assurance about future claims. Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether revenue—particularly Savant sales—and operating cash flow recover, given the sharp year-over-year revenue decline and larger losses.
- Availability, continued terms, and related-party dependence of CEO financing, as well as the company’s ability to meet near-term liquidity needs.
- Preferred-dividend arrears, possible redemption triggers and cash requirements, and the resulting dilution scenarios.
- Exposure to concentrated government and individual-customer sales, and the status of maintenance-contract renewals.
- The filing’s liquidity comparison is not fully consistent: management describes a $1.0 million working-capital deficit versus $1.4 million at June 30, 2015, while the balance sheet shows a deficit of about $1.0 million at June 30, 2016 and about $787,000 at December 31, 2015.