Intrusion Inc. (INTZ) Q4 2018 Earnings Report, Transcript and Summary

Good afternoon. My name is Sarah and I will be your conference operator today. At this time, I would like to welcome everyone to the Intrusion Inc Fourth Quarter 2018 Financial Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. I will now turn the conference over to Mr. Mike Paxton, Chief Financial Officer. Please go ahead, sir.

Okay, thank you, and welcome to this afternoon's conference call to review our fourth quarter 2018 financial results. On the call today are Ward Paxton, Chairman and Co-Founder, President, and CEO; and Joe Head, Senior Vice President and Co-Founder. Ward will give an update, I will discuss financial results and Joe will go over current projects. We will be glad to answer any questions after our prepared remarks. We distributed the earnings release at approximately 3:05 Central Time today. A replay of today's call will be available at approximately 6:30 PM tonight for a one-week period. The replay conference call number is 855-859-2056. The conference ID number is 1298823. In addition, a live and archived audio webcast is available at our website, intrusion.com. Please be reminded that during this call, including the question-and-answer session, we may make forward-looking statements with respect to financial results, business strategies, industry trends, and certain other matters. Forward-looking statements are based on management's current expectations and are subject to risk and uncertainties. We may be discussing our current outlook based on our own internal projections for the current quarter and fiscal year 2019. Actual, results may differ substantially from internal projections. We are not responsible to update any forward-looking statements. Many factors could cause our projections not to be achieved, including current economic and market conditions and other factors, which can be found in our most recent filings with the SEC, including our most recent Annual Report, on Form 10-K which was filed on March of 2018 and previous Form 10-Qs. Now, I'll turn the call over to CEO and President, Ward Paxton.

Thank you, Mike. Welcome to Intrusion’s fourth quarter 2018 conference call. It’s good to be with you today to discuss our outstanding fourth quarter and our outlook for the future. Our revenue and profit had – both had sequential growth again and we expect this trend to continue in the future. Our net income in the fourth quarter reached nearly $900,000, which was up 38% from the third quarter. Revenue in the fourth quarter was just under $3 million, which was up 10% from the third quarter. For the year 2018, net income reached $2.3 million compared to a net loss of $30,000 in 2017. Revenue in 2018 reached $10.3 million, up 50% from 2017. As the new projects come up to full speed, we expect that this will drive continued growth in revenue and profits. Now, Mike Paxton, our Chief Financial Officer, will review our fourth quarter financials that we released a little over an hour ago. Mike?

Okay, so Joe is going to be after me.

Yeah.

Okay. All right, well, this is kind of repetitive or kind of stole all my thunder there, but we’ll go over the fourth quarter and 2018 financial highlights. Revenue for the fourth quarter was $3 million compared to $2.1 million for the fourth quarter of 2017. For the year 2018, sales were $10.3 million compared to $6.9 million in 2017. Gross profit margin was at 63% in the fourth quarter compared to 58% fourth quarter of last year. For the year 2018, gross margin was 63% compared to 59% in 2018. Gross profit margin can be greatly affected by sales product mix of deliverables. Intrusion’s fourth quarter 2018 operating expenses were $1 million compared to $1 million for the comparable quarter in 2017 and $4 million for the year 2018 compared to $4.8 million in 2017. Operating expense variance was positive mainly as a result of a reduction of R&D expense for 2018 from shifting R&D labor into direct labor. Net income for the fourth quarter was $0.9 million compared to a net income of $0.2 million for the fourth quarter of 2017. Net income for the year 2018 was $2.3 million compared to $30,000 net loss in 2017. Okay, now we'll go back to Ward.

Thanks Mike. Now, Joe Head, my partner, Co-Founder of Intrusion and Senior Vice President, will discuss our outstanding sales results and our opportunities for this year and beyond. Joe.

Thanks Ward. For some time now, Ward and I’ve been reporting that we were optimistic about our prospects. So as you just heard in 2018, we booked $900,000 in Q1, $2 million in Q2, $6.3 million in Q3, and $5.2 million in Q4. So our base level of business has moved up a step based on several large – new large projects. The driver for this new business is entirely based on our customers being pleased with our performance over many projects over the past years. One of our customers noted that our record of delivering on hard challenges made them want to stretch us with some larger projects, so we can add staff and be capable to engage on even larger projects. There are other many large contractors, but they don't always over perform and in fact they often underwhelmed on their work. And our customers want some options beyond their current stable of integrators and the solutions providers. In the third quarter, we booked 6.3 million of which 5.5 million was a single order from a new – for a new project. And then in Q4, we booked an additional $5.2 million which was mostly renewals. I'm glad to report that the one customer we were eyeing as a possible loss as another loss of customer in future ongoing business has issued a renewal covering the next five years. And so we expect this long-term customer continue for quite a while. The first 10 months renewal is included in the November bookings at $100,000 a month. We also booked a new Savant customer in Q4 in addition to a renewal of another Savant customer. Both of these are small. In total there's 350k. But as I've mentioned with the base business now, I feel profitable level. We’ve been able to shift a little bit of our intention to other business areas with growth potential. Large majority of these orders are for 12 months of business at a time. So the big uptake and uptick in new orders in Q3 and Q4 won't be up for renewal until Q3 and Q4 of 2019. So as usual, our new orders for the first half of 2019 is expected to be down quite a bit from these year end highs and bookings with the increased revenue we’ll ensure our profitability for 2019 as we continue the deliveries for these new orders. We were working to book new business to start working on a number of areas in the coming months. As a company, we have a number of datasets in our TraceCop family, which we use all the time and our analytic efforts to meet customer needs, but this represents part of the pipeline a fuel for new projects as well. In TraceCop, we have one dataset. We licensed for $1.2 million a year, and it represents a case where our customer's analysts make use of the data directly. And my pipeline is one new customer, who is a prospect for another $1.2 million a year TraceCop subscription. Like all prospects, this one might not turn into a new order, but this one is relatively – is a relatively new opportunity from a new customer, whom I've been working with for a little over a year. We find that developing new large datasets takes a few years to grow from initial efforts into world-class. During that time, we use the newer developmental datasets internally and weekly reports that customer – and weekly reports that answer customer questions and security challenges. But after a while, these new datasets grow and represent new subscription fees that we can sell on their own. In the $5.5 million order, I just mentioned, we have $600,000 license for analytic research using one of our newer data sets that we've been building for approximately seven years. If a customer wants to license this feed for regular use, the dataset will license for about 1.8 million a year per customer. At Intrusion, we collate some rather large datasets, of which this is one of the largest yet. We have been adding about $1 billion records a day into this dataset for seven years and have over 2 trillion rows added to this one dataset to-date. This one represents one of the largest commercial IP security databases in the world and this allows Intrusion to address a wide variety of concerns and challenges. Some of our datasets aimed to understand, who is infected by what, but other datasets are used to understand the context of observed communications at one of our customers. For example, what is it mean when our customer observes communications from inside their network to one of the 1.5 billion live hosts on the internet this month. To be complete, these 1.5 billion host names are parked on just 899 million servers, so there is more host names than that our servers, so some have a shared arrangement. So some of our databases specialized and what it means when you talk to a certain server. If that server serves up malware for a Nation State Actor, the simple visit likely means you have a compromised computer. If a server has almost no content, and you have computers talking to it all the time, it’s like a command and control node for a compromise that you have. So this fact shades light on what the advisory is up to on your network. So for every communication we see at a customer, we set out to answer many questions like why would you visit this server, what languages it in, where is it, who owns it, what content or topic is this data and is our customers' traffic showing signs of something risky by communicating with it, et cetera, so one of our latest new datasets for TraceCop is a survey of the Internet for topic. We know who owns every server and where it's located, but it's also nice to know what language or topic the sites visitors go there for. When we see a customer's machine going to a site that’s in a language they don't speak or read and it’s not – that’s not unexpected and you might click on an add that takes you to the Chinese or Russian language site. But that's not unusual unless you keep going back day after day after day. If so it's probably a site uses a relay for an exploited stealing your data, since the user doesn't speak that language. We have collections showing what the language and the topic for about 150 million websites, but we see about 250 million sites active this month. So one of our new efforts is to scrape every home page of every website in the world to discover new ones and record their language, and topics, et cetera. Security can be concerned with who wants to make a bomb, who sells drugs, or who wants to be a terrorist, but these are not usually that interesting or likely to be the case. Bad guys take over small sites and use them as relays for malicious command and control of compromised computers. So that have observed the security chief will dismiss the communications if there’s just some employee surfing a website. But one of Intrusion specialties is to discover compromise within the sea of normal. There's about 250 million www websites and there's about 1.5 billion total host on the internet, not counting users, that's just servers. So pinpointing [indiscernible] through otherwise innocent servers they have compromised it’s important to know. Sorry, we don't usually go down to this level of detail in our conference calls, but this is kind of where we live day-to-day. Security in the world is in a horrible state because people treat the problem superficially and look for a magic bullet. It takes huge data to discover and discern between normal and abnormal communications. In that specialty is one of the areas where we live and make some nice discoveries. Back to the main topic, discussing the nature of our new, larger orders there are a lot of companies who talked enough big data solutions, but their big datasets really aren't that big. Intrusion has some of the largest data sets around, as well as the track record of knowing how to apply that big data to a customer's security challenges. We're now starting to apply our knowledge in how to build, use and deploy our big data expertise at a higher level with the customers. Instead of just being a boutique firm with a more narrow focus, we're now working on solving larger customer challenge with custom engineering of systems which expand on our internal in house successes. As I mentioned earlier, many times the company has a desire to take this step and expanding their base, but for whatever reason can't or don't see that desire bear fruit. In our case a good customer pressed us to take these steps to stretch this, so that we could solve bigger challenges for them that's the $5.5 million order. So we're going to expand and we’re going to do that real successfully. By my count I'm working nine new prospects currently and expect that pipeline to grow by a few in the next few months. But count alone doesn't tell the story because of the mix of large and extra large prospects compared to small and medium ones. I'm not ignoring customers with small or medium size money presently, we’re working hard to ensure that our extra large opportunities, which I'm defining as 2.4 to 6 million a year get more attention, both the renewal of the current ones and also the pursuit of new opportunities that are larger than our historical order size. I'm also making presentations and writing whitepapers on a larger class, which I'll call giant. These won't happen in the next few months, but are worth spending some cycles on for the future. We'll make sure to keep our current customers happy as we always do intending to add new and even larger opportunities to our pipeline for next year. Ward?

Okay. Thank you, Joe. It was pretty exciting to follow big things that you're working on. We’ll talk about them some more latter. The fourth quarter was a continuation in the outstanding growth in sales and profits that we have had for the past five quarters. Additionally, the significant level of orders in the past two quarters, allow us to start 2019 on solid footing. We expect this sound growth to continue into 2019. Our orders continued to be bumpy. Consequently, we expect total quarterly orders to be up and down as we go forward. And as Joe mentioned just a moment ago the orders this past year were 900,000 in the first quarter, two million in the second quarter, 6.3 million in the third quarter and 5.2 million in the fourth quarter. And so you can see that even though the efforts were making in everything are pretty substantially the same our results are significantly varied. This has also been the trend in the past with the bigger orders coming in the last two quarters. We're currently adding people, both sales and engineering. Additional engineers are required to attain the current expected revenue levels. Also additional salespeople are desired to further drive our orders growth. Our engineering team is developing new products and services at a rapid rate. And we are using these results to support our existing customers and to fuel our drive for new customers. Our sales team have been performing quite well and will be expanded for increased growth in the near future. I look forward to another good year and opportunity to communicate the results with you. Thank you. Mike?

Yes operator at this time could you remind the participants how to queue up for questions?

Certainly. [Operator Instructions] Our first question comes from Howard Brous. Your line is open.

Thank you. A Ward, Joe, Mike, first congratulations on all the work and how it's paid off. So congratulations on the fourth quarter.

Thank you.

Thanks.

You're very welcome. The bulk of your orders are they sole-source contracts as recently?

Yes.

I think all of them.

They are all sole source, okay. Just on some outstanding items that we've talked about in the past, IR firm where do you stand on that now Ward?

What’s that?

IR firm.

Working on it, making good progress, expect to be able to communicate some to you soon.

Could you define soon sometime in this quarter?

Yes.

Okay. In addition to you plan on uplifting the stock....

Well, right now that requires some performance results that we don't have. As soon as we meet the requirements, yes.

Okay, fine. Can we talk about Savant and the potential that you have in Savant? Joe when you mentioned the giant class was that TraceCop or is that Savant that you're talking about?

It's sum of both. They sort of go together.

Right.

And I didn't really define my term giant, so I'm thinking the 10 million to 12 million a year kind of size thing. And I certainly don't have one on the string yet, but I've got a couple of proposals that I'm in the process of creating to do some things in that area. And those will be basically a combination of Savant, TraceCop for larger networks.

This is something that we could look forward to say third, fourth quarter this year.

Yes, that'd be my pitch for a couple of those. I'm actually talking to two states and a couple of DoD entities about doing things like that. And I think there those things take forever to get through the budgeting and contract cycle. But that's if you don't pitch it, you don't get it.

That’s true. You've had a good jump in margins this past quarter from 60 to 63. Is this something that we could expect on a going-forward basis for the year, not quarter-by-quarter, just for the year?

Our margins vary around a lot of things there.

Yes.

That you see this last couple of quarters has been a result of improved overall margin between the different projects. We have fewer projects that generate a lower margin than we've had in the past. In terms of going up further, I don't expect it to go up further.

No, but if I looked at this year as an entity and I know things are lumpy in terms of margins and I get that, but could I look at it 63% for the year?

Well, that's our driving – that's our plan.

Okay. Just two more quick items and I’ll get back in queue. The $5.5 million and all the other renewals you have, this $3 million really turns out to be $4 million a quarter on an ongoing basis. Is that a correct statement for revenue?

I don't think if there's a number there it gives you the correct look on an ongoing basis, because a lot of different factors besides the thing of getting a new project fully in gear. You have always – some of the projects we have smaller orders but then we have repeats regular. And those we frequently have gaps in terms of delivering. So we’ll always have some gaps. And if the gaps get the excessive then that of course reduces the overall revenue level. That…

No, I'm just looking, not necessarily on a quarter-by-quarter basis, but if I took 2019 as a whole without any incremental new orders, would $40 million be a reasonable number based on what I think you have overall, again, notwithstanding the lumpiness of the business?

Where are you getting the $40 million?

Where is the $40 million you're talking about?

Well, the $5.5 million annualized is one and a quarter, a quarter plus base business that turned out to be two six plus one and a quarter, close to four million.

Four million on top of that.

Okay.

Just again, that's overall annual number, not necessarily each quarter. Does that sound reasonable?

Well I think it’s in the realm of being reasonable.

Okay.

But it still depends on – it still depends on future orders too significantly.

Okay, fair enough. I'll get back in the queue. Thank you.

Thanks Howard.

[Operator Instructions] Your next question comes from the line of Walter Schenker. Your line is open.

Hi Ward, Joe, Mike.

Hi, Walter.

Hi, Walter.

Hi, Walter.

Said to a lot of people, and we are – hopefully we're all smiling. So I think my first investment in the company was 2003 when I bought the preferred. It's good to see a profit on that investment, congratulations. Could you just update us Ward or Joe on what – where we're at adding personnel, obviously you're operating at a meaningfully higher level and what issues if any you are having in both expanding the people to work on the contracts at a higher level. And Joe mentioned expanding the sales team.

Well certainly we're working on expanding both. As Joe mentioned, he has hired a new senior level executive sales guy that’s going to join us sometime this quarter we think. Added a few engineering types do inhibit to both [indiscernible] and production of existing contracts. As a result of the way we always do of reassigning our R&D guys to development, I mean to production, they move from being an expanse to cost of sales and that gives us the flexibility on the short-term of being able to produce more and then backfill with the new people to give us an ability to resume our very important R&D efforts and still meet our requirements there. We’re still, a small number of personnel to go to be at the level – the current running level we want for the production but not much, we were almost there and then the additional people we hire will give us the ability to resume and increase our R&D efforts. So it's all coming along pretty good.

We've been able to hire some really good ones.

Great.

Good, because you read stories about the difficulty in getting skilled people in the cyber area, your people are more based on computer skills and don't have to have prior cyber security experience.

Well, it depends if you have all cuts.

Yes. So we're mostly hiring people with cyber background. So we've picked up three good ones in the last 30 days and we've got, I think three more to grab, but we've got some good candidates for that. So we're not having nightmares in finding them but – and we're also being picky, because we want the very best folks.

You specifically mentioned a couple of smaller Savant renewals and Savant could play a large role in its ability to identify information flow.

Yes.

Is these renewals are people going all the way back a number of years to the – when you first started signing some people up under the marketing effort, who had been with you number of years?

Yes. We've got one that's renewal like that, but then we had one in December, I reported that was brand new, so I can't remember I broke down on the call, but I think the two together was like 350, the new one was 200k, that's a customer we haven't had before. And there's some upside potential there for growing and it's a bigger organization that we're doing some small things for them.

Is there still the opportunity at some point to find a partner, whatever the right term is to take that technology more broadly outside of your traditional government DoD base, which was thought a few years ago?

Yes, I mean both the ones that I mentioned that are the renewal and the new one are both, just commercial, corporations that are not even close to the DoD space. So I think the opportunity is there and we'll be communicating more, I'd rather get a few orders under our belt with live customers and then we will decide kind of where and how to scale it.

Okay. But that still has the potential as again thinking of what we were discussing a few years ago, if with the right partner to be much bigger than given the whole commercial world then the DoD work at some point?

Correct, correct. And then, the thing, the thing – the reason I mentioned all those words about our big data sets is, when you go out to the commercial world, if you don't have those big data sets, you don't know what you're looking at. So we've got a an incredible asset when we decide it's time to take it commercial and you'll always have a few early adapters that I believe that it's getting closer to time for going out in the commercial space. That's why I wanted to do more profitable and then we can afford to go back out and look for those other opportunities.

Last question, given the not totally unique but relatively unique capability of that data set actually the capability, breadth of information in that data set, what does that data set be very valuable as part of the tools they use for much larger companies, wide cyber companies?

Possibly look at the world like we do…

As you know, we've had the discussion many times including at annual meetings that given the unique datasets, the history of the data sets and some of your capabilities, I still believe that some point in the future Intrusion as a little company, you should be part of a much bigger company who could take that and really lever it over a much broader customer base. Everyone says amen. Right?

Yes, I mean that's – it logically follows that, what's valuable to us as an early implementer. It will be valuable to the broad market and you have somebody at the bigger outfits.

So anyhow congratulations and thank you.

Thank you, Walter.

Your next question comes from the line of David Baker. Your line is open.

Hi gentlemen. Congratulations on good operating results.

Thank you, Baker. Thank you.

Thank you.

My first question is expounding on the previous gentleman on the call, the database data set for the commercial space, I guess I don't really understand what's the timing for pursuing additional commercial markets with this history and capability of the dataset, what are – are you waiting for something vis-à-vis your current operating performance. Were you waiting for more development? What were you waiting for and are you still waiting for it? I'm just trying to understand possible rollout of an additional product.

Well, we, we went out early with a couple of big commercial partners to take it to market and they got some initial orders but it just sort of fizzled. A part of that was they built a good practice and brought it in-house and didn't use a partner. Is it time now? Yes, I think so. The impediment to taking it out earlier which is as we were losing money, it was important to shore up orders and make money again. So I went out from DoD world to shore up our orders to make sure we are profitable and good, stabilize everything and now it's time to expand it out and be looking at the broader opportunities. We haven't talked about on the call that there is a tradeoff between do you go to pure commercial or do you go to the DoD state government world and I think we’re to the point where we're going to see some successes in both. So this will market won’t see the biggest opportunity first.

Okay. And so you see this contributing in 2019?

I think we'll see it go from sort of a lifeless state to where it starts seeing some meaningful orders in 2019. But like I said before, I Just started so we’ve got a couple of community orders and I'm pitching a couple of large ones. So I think it's early to tell, but I'm sure we working at and expect the results to be good.

Great, that's very helpful. I was late on the call, so if I'm asking a question that's already been repeated, I apologize in advance. What about NASDAQ listing now that you're profitable and your stock price is above $3, what about the NASDAQ listing?

As soon as we meet the requirements, we'll look at that. Right now we don't meet all the requirements. We're aware and focused on the requirements.

Okay. Okay. Okay, lastly your margins, you expect them to stay flat? Obviously it had been increasing what do you expect from 2019?

We expect them to stay relatively flat.

Okay, great. No more questions, thank you gentlemen.

Thank you.

Thank you.

And your next question comes from Howard Brous, your line is open.

Hi, just to put a bow on a quick couple of things. Joe, you talked about nine new prospects size, $2.4 million to $6 million is that TraceCop or is it TraceCop and Savant?

Most are TraceCop and then they weren't all in that size at a couple of smalls and a couple of large as I didn't do the count honestly hard before the call. I think it's probably two mediums – two smaller mediums and all, but two of those were in the large and two are in the extra large category.

Extra large have been $5 million, 6 million?

Yes. Yes, that’s right $2.4 million to $6 million.

Right. In addition, you also discussed those giant classes two stage $10 million to $12 million.

Yes.

Is that sometime towards the end of the year you'll get a good sense of it?

Yes. I'm actually writing up a proposal for one of those this week, but I think it's realistic for October shift if we can move that forward. But it's – there's no glimmer in the eye yet, it's just a developmental thing, but they said that's a good idea, tell us about it.

Alright, that's fair enough.

But the point there is just how do you fill the pipeline? We can't focus on things that were old large, I think we need to keep moving larger and the indications there is, there is some of those available and addressable. So I'm going to work on.

Fair comment to say that every million dollars of incremental revenue translates to about $0.05, $0.06 bottom line, is that a fair comment? But if you talk about 60%, 65% gross margins?

Yes.

I don't need to take my shoes and socks off for that I just wanted to confirm that, that's generally in line with your thinking. Correct?

Yes, really yes.

Okay. I appreciate it. Again, Ward, Joe, Mike, congratulations on a great quarter and looking forward to next conference call. Thank you again

Bye Brous.

Thanks Howard.

And I'm currently showing no other questions at this time.

All right, operator, we'll wrap up the conference call now. Thank you for participating in today's call. If you didn't receive a copy of the press release or if you have further questions, you can contact me at 972-301-3658 or email mpaxton@intrusion.com. Thanks a lot.

Bye.

That does conclude our conference call today. Thank you for your participation. You may now disconnect.