INTRUSION INC - Quarter Report: 2019 March (Form 10-Q)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

INTRUSION INC.

(Exact name of registrant as specified in its charter)

1101 East Arapaho Road, Suite 200, Richardson, Texas 75081

(Address of principal executive offices)

(Zip Code)

(972) 234-6400

(Registrant’s telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

* * * * * * * * * *

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

           Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☐

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act): Yes ☐ No ☒

Securities registered pursuant to Section 12(b) of the Act:

The number of shares outstanding of the Registrant’s Common Stock, $0.01 par value, on May 1, 2019 was 13,515,236.

INTRUSION INC.

INDEX

PART I – FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

INTRUSION INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except par value amounts)

See accompanying notes.

INTRUSION INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)

See accompanying notes.

INTRUSION INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (DEFICIT)

(In thousands)

See accompanying notes.

INTRUSION INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)

See accompanying notes.

INTRUSION INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Item 2.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward Looking Statements

This Quarterly Report on Form 10-Q, including, without limitation, the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Such forward-looking statements are generally accompanied by words such as “estimate,” “expect,” “believe,” “should,” “would,” “could,” “anticipate,” “may” or other words that convey uncertainty of future events or outcomes. These statements relate to future events or to our future financial performance, and involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance, or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these forward-looking statements. Factors that may cause actual results to differ materially from current expectations, which we describe in more detail elsewhere in this Quarterly Report on Form 10-Q, as well as in our 2018 Annual Report on Form 10-K, filed March 28, 2019, in Item 1A “Risk Factors” include, but are not limited to:

If one or more of these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may vary significantly from what we projected. These forward-looking statements and other statements made elsewhere in this report are made in reliance on the Private Securities Litigation Reform Act of 1995. Any forward-looking statement you read in this Quarterly Report on Form 10-Q or our Annual Report on Form 10-K reflects our current views with respect to future events and is subject to these and other risks, uncertainties and assumptions relating to our operations, results of operations, growth strategy and liquidity. We assume no obligation to publicly update or revise these forward-looking statements for any reason, or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future. The section below entitled “Factors That May Affect Future Results of Operations” sets forth and incorporates by reference certain factors that could cause actual future results of the Company to differ materially from these statements.

Results of Operations

The following table sets forth, for the periods indicated, certain financial data as a percentage of net revenues. The period-to-period comparison of financial results is not necessarily indicative of future results.

Net Revenues. Product revenues increased for the quarter ended March 31, 2019 to $3.2 million, compared to $2.3 million for the quarter ended March 31, 2018. TraceCop revenues increased to $3.1 million for the quarter ended March 31, 2019, compared to $2.2 million for the quarter ended March 31, 2018. Savant revenues remained constant at $0.1 million for the quarter ended March 31, 2019 and 2018. Substantially all of our revenue for the quarters ended March 31, 2019 and 2018 were derived from TraceCop/Savant sales.

Concentration of Revenues. Revenues from sales to various U.S. government entities totaled $2.8 million, or 86.4% of revenues, for the quarter ended March 31, 2019, compared to $1.8 million, or 79.6% of revenues, for the same period in 2018. Although we expect our concentration of revenues to vary among customers in future periods depending upon the timing of certain sales, we anticipate that sales to government customers will continue to account for a significant portion of our revenues in future periods. Sales to the government present risks in addition to those involved in sales to commercial customers which could adversely affect our revenues, including, without limitation, potential disruption to appropriation and spending patterns and the government’s reservation of the right to cancel contracts and purchase orders for its convenience. Although we do not anticipate that any of our revenues with government customers will be renegotiated, a large number of cancelled or renegotiated government orders could have a material adverse effect on our financial results. Currently, we are not aware of any proposed cancellation or renegotiation of any of our existing arrangements with government entities and, historically, government entities have not cancelled or renegotiated orders which had a material adverse effect on our business. There was one individual commercial customer in the first quarter of 2019 attributable for 11.1% of total revenue compared to 19.0% of total revenue to one individual commercial customer for the same period in 2018.

Gross Profit. Gross profit was $1.9 million or 59.8% of net revenues for the quarter ended March 31, 2019, compared to $1.4 million or 62.4% of net revenues for the quarter ended March 31, 2018. Gross profit on product revenues for the quarter ended March 31, 2019, remained at 59.8% compared to 62.4% for the quarter ended March 31, 2018, mainly due to TraceCop/Savant product mix. Gross profit as a percentage of net revenues is impacted by several factors, including shifts in product mix, changes in channels of distribution, revenue volume, pricing strategies, and fluctuations in revenues of integrated third-party products.

Sales and Marketing. Sales and marketing expenses remained constant at $0.4 million for the quarter ended March 31, 2019 and 2018. Sales and marketing expenses may vary in the future. We believe that these costs may increase through the end of 2019 if we achieve anticipated increases in revenue.

Research and Development. Research and development expenses decreased to $0.2 million for the quarter ended March 31, 2019, compared to $0.3 million for the quarter ended March 31, 2018. The decrease in research and development expense was due to labor expense shifted to direct labor costs on existing projects. Research and development costs are expensed in the period in which they are incurred. Research and development expenses may vary in the future; however, we believe that these costs will remain relatively constant through the end of 2019, although expenses may be increased if we achieve anticipated increases in revenue.

General and Administrative. General and administrative expenses remained constant at $0.3 million for the quarters ended March 31, 2019 and 2018. It is expected that general and administrative expenses will remain relatively constant throughout the remainder of 2019, although expenses may be increased if we achieve anticipated increases in revenue.

Interest. Net interest expense decreased to $35 thousand for the quarter ended March 31, 2019 compared to $53 thousand interest expense for the same period in 2018, due to the Company paying down $1.0 million of debt during the quarter ended March 31, 2019. Net interest expense may vary in the future based on our level of borrowing, which will be affected by our cash flow, operating income (loss) and capital expenditures.

Liquidity and Capital Resources

Our principal source of liquidity at March 31, 2019, was approximately $1.0 million of cash and cash equivalents. At March 31, 2019, we had working capital of $0.6 million compared to a $0.3 million deficiency at March 31, 2018.

Net cash provided by operations for the three months ended March 31, 2019 was $787 thousand due primarily to a net income of $947 thousand and the following sources of cash and non-cash items: a $475 thousand decrease in accounts receivable, a $246 thousand decrease in operating lease right-of-use assets, $39 thousand in depreciation expense, $6 thousand in penalties and waived penalties on dividends, and $4 thousand in stock-based compensation. This was partially offset by a $529 thousand decrease in deferred revenue, a $307 thousand decrease in accounts payable and accrued expenses, and a $94 thousand increase in prepaid expenses and other assets. Net cash used in operations for the three months ended March 31, 2018, was $206 thousand due the following uses of cash: $330 thousand decrease in deferred revenue, a $282 thousand increase in accounts receivable, and a $92 thousand increase in prepaid expenses and other assets. This was partially offset by a net income of $346 thousand and the following sources of cash and non-cash items: a $87 thousand increase in accounts payable and accrued expenses, $15 thousand decrease in Inventories, $5 thousand in stock-based compensation, $33 thousand in depreciation expense, and $12 thousand in penalties and waived penalties on dividends. Future fluctuations in inventory balances, accounts receivable and accounts payable will be dependent upon several factors, including, but not limited to, quarterly sales volumes and timing of invoicing, and the accuracy of our forecasts of product demand and component requirements.

Net cash used by investing activities for the nine months ended March 31, 2019, was $96 thousand for net purchases of property and equipment, compared to net cash used in investing activities for the three months ended March 31, 2018, was $37 thousand for net purchases of property and equipment.

Net cash used by financing activities in 2019 was $1.4 million with payments to the CEO Note of $1.0 million, payments for preferred stock dividends of $597 thousand, and payment on principal of finance right-of-use leases of $15 thousand. This was directly offset by the following provisions of cash: proceeds from exercise of stock options of $220 thousand. Net cash provided by financing activities for the three months ended March 31, 2018, was $152 thousand resulting from proceeds of $100 thousand from an officer’s loan and $70 thousand on the exercise of stock options. This was offset by a provision of cash for $18 thousand payment on the principal of finance right-of-use leases.

At March 31, 2019, the Company did not have any material commitments for capital expenditures.

During the three months ended March 31, 2019, the Company funded its operations through the use of cash and cash equivalents.

As of March 31, 2019, we had cash and cash equivalents of approximately $951,000, down from approximately $1,652,000 as of December 31, 2018. We generated net income of $947,000 for the quarter ended March 31, 2019 compared to a net income of $346,000 for the quarter ended March 31, 2018. As of March 31, 2019, in addition to cash and cash equivalents of $951,000, we had $1.9 million of funding available from a promissory note to borrow up to $2.7 million from G. Ward Paxton, the Company’s Chief Executive Officer. We are obligated to make payments of accrued dividends on all our outstanding shares of preferred stock that will reduce our available cash resources. Based on projections of growth in revenue and net income in the coming quarters, and the borrowings available previously mentioned, we believe that we will have sufficient cash resources to finance our operations and expected capital expenditures for the next twelve months. We expect to fund our operations through anticipated Company profits and borrowings from the Company’s CEO, and possibly additional investments of private equity and debt, which, if we are able to obtain, will have the effect of diluting our existing common stockholders, perhaps significantly. Any equity or debt financings, if available at all, may be on terms which are not favorable to us and, in the case of equity financings, may result in dilution to our stockholders. If our operations do not generate positive cash flow in the upcoming year, or if we are not able to obtain additional debt or equity financing on terms and conditions acceptable to us, if at all, we may be unable to implement our business plan, fund our liquidity needs or even continue our operations.

We may explore the possible acquisitions of businesses, products and technologies that are complementary to our existing business. We are continuing to identify and prioritize additional security technologies, which we may wish to develop, either internally or through the licensing, or acquisition of products from third parties. While we may engage from time to time in discussions with respect to potential acquisitions, there can be no assurances that any such acquisitions will be made or that we will be able to successfully integrate any acquired business. In order to finance such acquisitions and working capital it may be necessary for us to raise additional funds through public or private financings. Any equity or debt financings, if available at all, may be on terms, which are not favorable to us and, in the case of equity financings, may result in dilution to our stockholders.

We maintain “disclosure controls and procedures,” as defined in Rule 13a-15(e) under the Exchange Act, that are designed to ensure that information required to be disclosed by us in reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable assurance of achieving the desired control objectives, and we necessarily are required to apply our judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures.

Our management, including our principal executive officer and principal financial officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of March 31, 2019, and concluded that the disclosure controls and procedures were effective.

Our management, with the participation of our principal executive officer and principal financial officer, evaluated our “internal control over financial reporting” (as defined in Rule 13a-15(f) under the Exchange Act) as of December 31, 2018, and concluded that there have not been any changes in our internal control over financial reporting that occurred during the quarter ended March 31, 2019, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II – OTHER INFORMATION

We are subject from time to time to various legal proceedings and claims that arise during the ordinary course of our business. We do not believe that the outcome of those "routine" legal matters should have a material adverse effect on our consolidated financial position, operating results or cash flows; however, we can provide no assurances that legal claims that may arise will not have such a material impact in the future.

Factors That May Affect Future Results of Operations

We are providing the following information regarding changes that have occurred to previously disclosed risk factors from our Annual Report on Form 10-K for the year ended December 31, 2018. In addition to the other information set forth below and elsewhere in this report, you should consider the factors discussed under the heading “Risk Factors” in our Form 10-K for the year ended December 31, 2018 filed on March 28, 2019. The risks described in our Annual Report on Form 10-K and our Quarterly Reports on Form 10-Q are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

We may not have sufficient cash to operate our business and may not be able to maintain future liquidity requirements. Additional debt and equity offerings to fund future operations may not be available and, if available, may significantly dilute the value of our currently outstanding common stock.

As of March 31, 2019, we had cash and cash equivalents of approximately $951,000, down from approximately $1,652,000 as of December 31, 2018. We generated net income of $947,000 for the quarter ended March 31, 2019 compared to a net income of $346,000 for the quarter ended March 31, 2018. As of March 31, 2019, in addition to cash and cash equivalents of $951,000, we had $1.9 million of funding available from a promissory note to borrow up to $2.7 million from G. Ward Paxton, the Company’s Chief Executive Officer. We are obligated to make payments of accrued dividends on all our outstanding shares of preferred stock that will reduce our available cash resources. Based on projections of growth in revenue and net income in the coming quarters, and the borrowings available previously mentioned, we believe that we will have sufficient cash resources to finance our operations and expected capital expenditures for the next twelve months. We expect to fund our operations through anticipated Company profits and borrowings from the Company’s CEO, and possibly additional investments of private equity and debt, which, if we are able to obtain, will have the effect of diluting our existing common stockholders, perhaps significantly. Any equity or debt financings, if available at all, may be on terms which are not favorable to us and, in the case of equity financings, may result in dilution to our stockholders. If our operations do not continue to generate positive cash flow in the upcoming year, or if we are not able to obtain additional debt or equity financing on terms and conditions acceptable to us, if at all, we may be unable to implement our business plan, fund our liquidity needs or even continue our operations.

We had a net income of $947 thousand for the quarter ended March 31, 2019, and we have an accumulated deficit of $58.3 million as of March 31, 2019. To continue current financial performance, we must sustain or increase revenue levels.

For the quarter ended March 31, 2019, we generated a net income of $947 thousand and had an accumulated deficit of approximately $58.3 million as of March 31, 2019, compared to a net income of $346 thousand for the quarter ended March 31, 2018 and an accumulated deficit of approximately $61.2 million at March 31, 2018. We need to maintain current revenue levels from the sales of our products if we are to continue profitability. If we are unable to achieve these revenue levels, losses could happen for the near term and possibly longer, and we may not maintain profitability or generate positive cash flow from operations in the future.

A large percentage of our revenues are received from U.S. government entities/resellers, and the loss of any one of these customers could reduce our revenues and materially harm our business and prospects.

A large percentage of our revenues result from sales to U.S. government entities/resellers. If we were to lose one or more of these key relationships, our revenues could decline and our business and prospects may be materially harmed. We expect that even if we are successful in developing relationships with non-governmental customers, our revenues will continue to be concentrated among government entities. For the quarter ended March 31, 2019, sales to U.S. government entities/resellers collectively accounted for 86.4% of our revenues, compared to 79.6% for the comparable period in 2018. The loss of any of these key relationships may send a negative message to other U.S. government entities or non-governmental customers concerning our product offering. We cannot assure you that U.S. government entities will be customers of ours in future periods or that we will be able to diversify our customer portfolio to adequately mitigate the risk of loss of any of these customers.

Almost all of our revenues are from one product line with a limited number of customers, and the decrease of revenue from sales of this product line could materially harm our business and prospects.

Almost all of our revenues result from sales of one security product line. TraceCop revenues were $3.1 million for the quarter ended March 31, 2019, compared to $2.2 million for the first quarter 2018. Savant revenues remained constant at $0.1 million for the quarters ended March 31, 2019 and 2018. There was one individual commercial customer in the first quarter of 2019 attributable for 11.1% of total revenue compared to one individual customer at 19.0% for the same period in 2018. If sales of this key product line and individual customer were to decrease, our revenues could decline and our business and prospects may be materially harmed.

We are highly dependent on sales made through indirect channels, the loss of which would materially adversely affect our operations.

We derived 86.4% of revenue in the first quarter of 2019 through indirect channels of mainly government resellers, compared to 79.6% of our revenues in the quarter ended March 31, 2018. We must continue to expand our sales through these indirect channels in order to increase our revenues. We cannot assure you that our products will gain market acceptance in these indirect sales channels or that sales through these indirect sales channels will increase our revenues. Further, many of our competitors are also trying to sell their products through these indirect sales channels, which could result in lower prices and reduced profit margins for sales of our products.

You will experience substantial dilution upon the conversion or redemption of the shares of preferred stock that we issued in our private placements or in the event we raise additional funds through the issuance of new shares of our common stock or securities convertible or exercisable into shares of common stock.

On May 3, 2019, we had 13,515,236 shares of common stock outstanding. Upon conversion of all outstanding shares of preferred stock, we would have 14,582,678 shares of common stock outstanding, approximately a 7.9% increase in the number of shares of our common stock outstanding.

In addition, management may issue additional shares of common stock or securities exercisable or convertible into shares of common stock in order to finance our continuing operations. Any future issuances of such securities would have additional dilutive effects on the existing holders of our Common Stock.

Further, the occurrence of certain events could entitle holders of our Series 2 Preferred Stock and Series 3 Preferred Stock to require us to redeem their shares for a certain number of shares of our common stock. Assuming (i) we have paid all liquidated damages and other amounts to the holders, (ii) paid all outstanding dividends, (iii) a volume weighted average price of $4.28, which was the ten-day volume weighted average closing price of our common stock on May 3, 2019, and (iv) our 13,515,236 shares of common stock outstanding on May 3, 2019, upon exercise of their redemption right by the holders of the Series 3 Preferred Stock and the Series 2 Preferred Stock, we would be obligated to issue approximately 103,000 shares of our common stock. This would represent an increase of approximately 0.8% in the number of shares of our common stock as of May 3, 2019.

The conversion of preferred stock we issued in the private placements may cause the price of our common stock to decline.

The holders of the shares of our 5% Preferred Stock may freely convert their shares of preferred stock and sell the underlying shares of common stock pursuant to Rule 144 of the Securities and Exchange Commission. As of May 1, 2019, 800,000 shares of our 5% Preferred Stock had converted into 1,272,263 shares of common stock and 200,000 shares of our 5% preferred stock, convertible into 318,065 shares of common stock, remain outstanding.

The holders of the shares of Series 2 5% Preferred Stock may freely convert their shares of preferred stock and sell the underlying shares of common stock pursuant to Rule 144 of the Securities and Exchange Commission. As of May 1, 2019, 605,200 shares of Series 2 Preferred Stock had converted into 605,200 shares of common stock and 460,000 shares of Series 2 5% preferred stock remain outstanding.

The holders of the shares of Series 3 5% Preferred Stock may freely convert their shares of Series 3 Preferred Stock and sell the underlying shares of common stock pursuant to Rule 144 of the Securities and Exchange Commission. As of May 1, 2019, 275,230 shares of Series 3 Preferred Stock had converted into 275,230 shares of common stock and 289,377 shares of Series 3 5% preferred stock remain outstanding.

For the four weeks ended on May 3, 2019, the average daily trading volume of our common stock on the OTCQB was 8,200 shares. Consequently, if holders of preferred stock elect to convert their remaining shares and sell a material amount of their underlying shares of common stock on the open market, the increase in selling activity could cause a decline in the market price of our common stock. Furthermore, these sales, or the potential for these sales, could encourage short sales, causing additional downward pressure on the market price of our common stock.

You will experience substantial dilution upon the exercise of stock options currently outstanding.

On May 3, 2019, we had 13,515,236 shares of common stock outstanding. Upon the exercising of current options exercisable at or below the exercise price of $2.73, we would have approximately 14,500,000 shares of common stock outstanding, a 7.3% increase in the number of shares of our common stock outstanding.

Our management and larger stockholders exercise significant control over our company and have the ability to approve or take actions that may be adverse to your interests.

As of May 3, 2019, our executive officers, directors and preferred stockholders beneficially own approximately 36% of our voting power. In addition, other related parties control approximately 27% of voting power. As a result, these stockholders will be able to exercise significant control over all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions, which could delay or prevent someone from acquiring or merging with us. These stockholders may use their influence to approve or take actions that may be adverse to the interests of holders of our Common Stock. Further, we contemplate the possible issuance of shares of our Common Stock or of securities exercisable or convertible into shares of our Common Stock in the future to our Chief Executive Officer and Chief Financial Officer. Any such issuance will increase the percentage of stock our Chief Executive Officer, Chief Financial Officer and our management group beneficially holds.

The following Exhibits are filed with this report form 10-Q:

S I G N A T U R E S

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

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