We would like to welcome you to Intrusion Incorporated Third Quarter 2022 Earnings Conference Call and Webcast. [Operator Instructions]. Please note this conference is being recorded. An audio replay of the conference call will be available on the company's website within a few hours after this call. I would now like to turn the call over to Sam Cohen with Alpha Investor Relations.

Thank you and welcome. Joining me today are Tony Scott, Chief Executive Officer; and Kimberly Pinson, Chief Financial Officer. The call is being webcast and will be archived on the Investor Relations section of our website. Before I turn the call over to Tony, I'd like to remind everyone that statements made during this conference call relating to the company's expected future performance, future business prospects, future events or plans may include forward-looking statements as defined under the Private Securities Litigation Reform Act of 1995. Please refer to our SEC filings for more information on the specific risk factors that could cause our actual results to differ materially from the projections described in today's conference call. Any forward-looking statements that we make on this call are based upon information that we believe as of today and we undertake no obligation to update these statements as a result of new information or future events. In addition to U.S. GAAP reporting, we report certain financial measures that do not conform to generally accepted accounting principles. During the call, we may use non-GAAP measures if we believe it is useful to investors or if we believe it will help investors better understand our performance or business trends. With that, let me now turn the call over to Tony for a few opening remarks.

Thank you, Sam. Good afternoon and thank you all for joining us today. I'd like to follow our usual cadence and provide you with some updates on our strategic priorities that are positioning Intrusion for long-term growth. These priorities include expanding and strengthening our product offerings, realigning our sales and marketing resources and focusing on channel enabled sales model as well as strengthening our strategic partnerships and improving our financial discipline. As we announced at the end of September, we've achieved the commercial release of our Shield Cloud and Endpoint products. The addition of the Cloud and Endpoint solutions improve the attractiveness of our advanced threat intelligence data set with products positioned to serve the growing hybrid and cloud world. Notably, as we released these new products, we identified some important patentable characteristics on our path to general availability. Now that we have patent coverage in place, these product additions strengthen our strategic vision for Intrusion as we continue to serve the growing demands of customers seeking advanced and highly effective cybersecurity solutions globally. So first, let me talk about our Shield Cloud product. Shield Cloud extends the effectiveness of the Intrusion global threat engine and serves as a protective gateway between a customer's virtual private cloud and the public Internet. It's an important addition to our product line. Next let me talk about our INTRUSION Shield Endpoint solution. Shield Endpoint enables safe web browsing outside of the corporate enclave and data center allowing users to work remotely with confidence that authorized device connections are known, monitored and protected. With this product, users can safely view content on sites that would otherwise be blocked through our Shield Renderer, which transparently redirects users to a safe cloud-based browsing environment. The indications of interest in the pipeline expansion as a result of…

Thanks, Tony. We are encouraged by the ongoing progress being made within our business as we continue to strengthen our balance sheet, bolster our financial flexibility and support our strategic growth initiatives to capture the growing customer demand for our sophisticated cybersecurity solutions. Revenues for the third quarter of 2022 were $2.2 million, an increase of $0.1 million or 6.5% sequentially and $0.4 million or 20.5% year-over-year. Third quarter revenues for our consulting business of $1.9 million increased 14.6% year-over-year and 7.9% sequentially due to an increased level of task orders during the quarter. This business has shown continued progress and we feel that we'll continue to see a consistent level of growth as the federal government works its way through the backlog of task orders for contracts that have already been awarded and eventually reaches a new budget for fiscal 2023. As you know, due to the CR, no new contracts can be awarded until either the CR ends or a new budget is approved. Third quarter results for our Shield On-Premise of $0.3 million was flat sequentially due to some minor churn we experienced in the business. During the quarter, we signed a number of new customers, which was offset by a nonrenewal of a contract. On a year-over-year basis, Shield third quarter revenues increased $0.1 million or 70.3%. We are still seeing strong demand for our Shield On-Prem solution with some opportunities that we did not close in Q3 expected to close in the fourth quarter. As Tony stated, we are pleased with the launch and progress of our 2 new Shield products and are encouraged by the prospects in the pipeline, particularly for the Endpoint solution that we expect to be a large contributor to revenues in the future. The gross profit margin was 54.6% for…

Thanks, Kim. To conclude, we're continuing to execute on our strategic initiatives through the launch of our new products and the partnerships that we've announced. We're pleased with our performance and are optimistic for what is yet to come. I believe that the actions that we are taking today set us up well to end the year on a good note and move into 2023 with strong momentum. I look forward to sharing the next steps in our journey with all of you and again thank our investors for your continued support as we execute on our strategy. This concludes our prepared remarks. And I'll now turn the call over to the operator for Q&A.

[Operator Instructions]. Our first question will come from the line of Zach Cummins with B. Riley Securities.

Just starting off, I mean with Shield revenue I think essentially flat quarter-over-quarter. It sounds like you had a nonrenewal with a customer. Can you talk about some of the dynamics that went on there and why that customer decided to not continue forward with your On-Premise product?

Yes. This is Tony. So the circumstance there was a deal that was signed before I actually got there. The customer had turned on Shield and it was an educational institution. On the first day of school when all the students logged in, our box crashed and they got kind of jittery and basically refused to turn it back on again. Again all of this happened well before I got to Intrusion. So it was one of those things that when I got there, we spent the first couple of months on the hardware stabilizing our software and making sure things like that wouldn't happen again. And we just couldn't resurrect that 1 customer out of the trashbin, if you will. So I felt real bad about it, but I do understand in that particular case why a customer would feel burned and would not want to renew. So that's the circumstance. I wish it were otherwise, but it is what it is.

Understood. That's helpful. And Kim, I think you mentioned around kind of the lower gross margin that we saw in this quarter. I mean, any way you can give us a sense of what sort of costs are being moved into that cost of revenue line versus what was classified as operating expenses before?

Yes, I can. In reviewing the cost of sales and it was primarily as we were getting ready for the planning phase of the remainder of this year and 2023, I noticed some contractor expense. It's really some direct labor expense associated with a consultant contract that previously had been included in operating expense and should have been fully recorded in cost of sales. That is a long-term contract. The billing on that contract was consistent. So we went back and did a correction of an immaterial error and restated the cost of sales for all periods presented. And it did not have an impact on our operating income, gross margin or earnings per share. It was clearly a reclassification.

Understood. That's helpful. And Tony, final question for me is really around the launch of your new Cloud and Endpoint solutions. Just to make sure I was getting all the metrics right. Would you mind repeating kind of some of the pipeline metrics that you shared during the conference call script? And I'm assuming all of the existing channel partners you have are likely ready to go right now to sell these new solutions?

Yes. So we've been working for the last several months getting our partners and resellers and so on ready for this launch, getting our collateral material together and all the things that you would expect at that particular time. And so the metrics I was talking about has to do with our proof of values, proof of concepts and things like that. So let me re-share those. So one of the things that we track in our sales force instance is qualified leads. So these are leads that we know there's a budget, we understand what the demand is, there's been at least an initial conversation and a desire to learn more about our product and so on. It's not just somebody clicking on the website or some sort of casual interest. It's a real sales opportunity for us. And we have a funnel process that we go through to eventually determine that it's a qualified lead that bears our putting time into and also our channel partners putting time into. In most cases, they've already put some considerable time into it. So those have doubled. We've also doubled the proof of concept and proof of value. So once we get through the initial sales pipeline, then we actually get our hardware or software as the case may be installed at the customer site and we begin a defined period of time where the customer experiences what our product can do in order to make a determination whether they ultimately want to buy it or not. So those have doubled. And then probably the other measure that I think is important and we talked about on the call is quotes outstanding. So these are cases where in dialog with the customer, we have a specific request to provide a quote and our goal is to turn those quotes into actual sales. So those are all leading indicators of trajectory in terms of where the company is going and I'm pleased to see those numbers kind of show up in Q3.

Understood. That was extremely helpful. Well, congrats on the continued progress here in Q3 and then best of luck with the rest of the year.

Your next question will come from the line of Scott Buck with H.C. Wainright.

My first question, I may have missed it, Tony, at the front end of the call, but what part of the quarter did you guys go live with Endpoint and Cloud?

Yes. It was near the end of the quarter. What happened there is, we were ready to go, and we realized there was some additional patent coverage that we really wanted to have and needed to have before we went GA with these products. So we had a slight delay of a couple of weeks while we got that patent coverage in place. The good news is it allowed us to do some additional feature development that probably wouldn't have gotten done otherwise. So I'd call it a good delay for 2 reasons, but it was a little bit later in the quarter than I had originally been hoping for, but we did get it out at the end of the quarter, hope for them.

Was there any revenue contribution from these 2 products during the quarter?

No, because neither were GA at the end of the very end of the quarter, so.

Okay. Perfect. My next question on the vTech partnership and really just your channel partnerships in general. Can you remind us what the economics look like there? I assume maybe a little bit lower revenue, but higher gross margin versus what would occur under our direct sales relationship?

Right. So we have agreements in place with all of our resellers. And most of them are commission kind of basis or a discount basis, but they sell our products, they build the customer, we build them is kind of the nature of the relationship. In most cases, they'll provide first-line support. They'll have technical teams that help with the install, answer any Tier 1, helped us kind of calls and so on. So it's a good alternative in my view to building up a large team internally that would be needed if we were going to do all of that directly ourselves.

Sure. And how many channel partners do you guys have in place currently? And what's the pipeline look like for adding additional capacity?

I don't know the exact number off the top of my head. I can get back to you with that. But we're focused on around 8 to 10 at this particular point or, I'll say, more active than the others and it's probably double that in total that I'd say are active partners, but we're really focused on the top 8 or so that are really delivering leads and really engaging in direct customers. And that's apart from the managed service providers and managed security service providers that are their own sort of activity.

Right. Okay. And they're all educated up on the product, so there's not a 6-month lag in terms of when they could actually start selling?

Yes, they are. We'll obviously continue to develop additional material. And one of the things that happens when you get a product into the marketplace is you try to anticipate ahead of time with all of the questions and all of the frequently asked concerns or whatever it might be. But there's no substitute for getting out in the marketplace and getting feedback and hearing what the real customers have to say. So, there will be a period here where that feedback will be critically important as we try to do a better job.

Sure. All right. Just one more for me. You guys did a nice job bringing down OpEx over the course of the last year. What's the expectation going forward in terms of -- are there some additional areas that you can, I don't know, be more disciplined around if the environment gets a little bit worse? Or do you need to really start to add here to support the growth in the top line?

Well, I'll let Kim comment, but our main goal is to improve sales. We think now we have the opportunity with the 2 new products in a pretty complete offering to really spur sales. And then our objective is to grow internal resources at a slower rate than sales. So I think Kim mentioned improved margins in her conversation. But our goal for the next 2 quarters, in particular, and I think forever, will be grow sales and then grow cost at a slower rate.

And then just to add on to what Tony said. I think the go-to-market structure that we have achieved will allow us to grow our expenses in relation and have to make those significant investments as we grow our clients. So we do plan on responsible fiscal management and really not getting ahead of ourselves in terms of expense spend, and we'll continue to spend responsibly, we'll continue to invest in new features and functionality and new products, but we will moderate that with our product adoption as in at the rate at which our top line growth. And on that same basis, to a lower expenses, we will continue to invest in sales and marketing, but due to the go-to-market structure, it will be at a lesser extent than what otherwise we would have seen once the new products launched.

Okay. Great. I appreciate the time guys.

Your next question comes from the line of Ed Woo with Ascendiant Capital.

Congratulations on the product releases. My question is, you mentioned about the weakening macro environment, challenges of IT budget, at the same time, cybersecurity remains a priority. Do you anticipate longer sales cycles and/or maybe pricing pressures going forward?

Yes. I think that's a natural sort of result given the macroeconomic climate we're in. But there's a couple of other things I would mention here, too. I hear a couple of themes from CIOs and CCIOs when we talk to them. One of them is that they're [indiscernible], having 52 vendors in the cybersecurity space, and they're sort of looking for better coverage from a fewer number of vendors than what they have today. So it tells me that there's likely to be some industry consolidation or things like that as the pressure comes to -- from the customer base. But I also hear and I think this helps Intrusion, they're looking at solutions that are focused on the coming threats and the threats that are -- that seem to be growing today versus yesterday's problems. And I think our forward facing cybersecurity solutions play well in that dynamic, so. And as we all know, cybersecurity attacks are still successful. There was news this week of yet another one. So a big company getting attacked. So I think those show that we're not winning the war yet against some of these adversaries.

Well, I wish you guys good luck.

Your next question comes from the line of Aaron Warwick with Breakout Investors.

I'm sorry, I had a problem, technical difficulty getting on the call. And I got on at the very end of when you were talking about strategic partnerships and some delays. Could you cover that again for me real quickly?

Sure. Well, I think the bottom line of this is, I've hoped to announce a major strategic partnership by the end of the third quarter. And in my comments, I said I think the macroeconomic conditions are creating an environment where those conversations have slowed down a little bit. Just to add a little color. One of the partners we were talking to had a staff reduction of almost 50% in the team that was talking with us. So I think it means that in major tech companies, and you're seeing this in the market broadly, most of them are not having a great time right now, and that puts a lot of pressure on internal teams and I think also limits the kinds of relationships that they're willing to engage them. So I'm seeing that firsthand. That said, nobody has said, go away, we don't want to talk to you anymore and our conversations will continue. So we will announce something in due time when it's when it's done. I'm still pursuing those with vigor. And I'm still hopeful that we'll be able to get one done. The timing is just a little more uncertain and I would say I felt it was going to be 3 or 4 months ago.

Okay. Well, it was good on the positive note, I guess, it's good to hear about the deepening of the relationship with Super Micro. Could you talk about that a little bit more? I mean, I just -- specifically, I guess, from the perspective, I know they do a lot of white box offerings. I know they have an international presence. And what does that -- what has kind of opened up with you guys, I guess, in terms of opportunities?

Super Micro builds a lot of platforms. And there's a platform for lot of open source solutions. They've got great penetration in the small and medium market. And increasingly, as there's cost pressure on IT budgets and so on, they're going to be a great alternative to some of the higher priced solutions that are there in the market. And so our ability to partner with them and be a part of the portfolio they can offer their customers, I think is good for us, and I think good for them as well. And they wanted to broaden their offerings, and I think we're a very good partner for them in that respect.

Good. Final one for me, I guess, would just be as it relates to more on the government side, have you guys been looking into being added to the GSA schedule or being added to things like Department of Homeland Security in terms of the offerings that they're able to accept?

Yes. And we'll go on initially as a sub to other offerings, not directly, but we are working on also being on directly as well. But the most immediate occurrence will be as a sub to other offerings.

And is that on like for both the departments or just the GSA or what's --?

GSA, and DoD are our 3 primary targets. Excellent.

Our final question will come from the line of Ross Taylor with ARS Investment Partners.

Congratulations on getting the cash burn down. Tony, real quick, just to pick up on an answer you gave to Aaron. You said you'd be a sub to other offerings. That sounds very much like you already know who those other offerings are, and you're in the process of getting approval or getting put into those offerings? Is that a correct way to read that?

That is correct, yes.

So what needs to be done to cross that bridge? It sounds like that could be a fairly -- that could either be a forever or it could be a very quick short bridge to cross. Where -- how long do you think it takes before you get to --?

Yes, the normal process would be a proposal goes in and the prime time director lists, the subs that they want to use or could participate in that particular contract. And once it's awarded, then the prime becomes responsible for the relationship. So as we mentioned, there's a CR right now, so we're not expecting any new contracts until after the CRs get ended and normal funding occurs. But as in every year, where there's been CRs, there ends up building a lot of demand behind the dam, if you will. And as soon as the CR ends, then contracts start to flow. So we hope to be on a number of those new contracts when the dam finally gets released.

So I read that as you're saying that those -- since they're in that process and are being held up by the CR, which I guess we've had 15 at the mid last '20 budget years.

Yes, correct.

You already have the prime that has put the contracts in and you've already basically worked with the prime, the prime is intending to include you in that. Is that a correct way to think about that?

Yes, we have some, and we're working on a whole heck of a bunch more. So, is the way I would characterize that. We're in a handful today, and I want to be in multiple handfuls within the next year.

Okay. Do we know -- have you announced those primes that you're working with? Are they already customers? Or are they people who at this point in time, we do not know are going to be working with you?

We've not made any announcements in that regard at this point now.

Okay. So you basically -- and what they're going for is specific contracts. So these -- when they get -- when we get out of the CR and these get approved, this could be a fairly significant revenue ramp and quite honestly, proof point, although I think it's becoming less of a concern for many investors as to whether or not the shield works, it will be a massive proof point as you get these contracts out. So it sounds like you've already won those primes over on the value shield. Would that be correct?

I'd say that's true. I think the one caveat I would say is that in most of these cases, there's competitive bidding going on. So if our prime, the one we selected doesn't win the contract, and neither do we. And so we'll see over time how many of these end up being winning contracts versus ones that are not winning. And that's always a lot challenging aspect. But our goal is to have more of that than we've historically had, and I think we're well positioned to do that.

Talk about the competitive landscape for people doing what you do. How -- in the past, it was said this is a fairly unique thing. Does it still remain -- is there anyone else who is offering a product like what you're offering? Are the people bidding for these contracts using a different -- a totally different approach to provide -- you've said before that basically Shield is almost prime [indiscernible] a 0-day defense Cloud defense that's very unique. Is that the case? So other people are offering what you would consider an inferior defense?

Well, I think it's a question of 2 things. One is there is nobody else like us that we can find that has this sort of reputation-based approach and the really large database that we have. There's nobody that comes close, we think we're at least 10x bigger than the next closest guys. So we think that offers a real strong advantage. There are others who claim that their solutions are effective because they use things and these are all great buzzwords in the industry today, machine learning, AI, behavior-based analytics, the list kind of goes on and on and on. We still think our solution is more effective than those kinds of approaches. And the fact that we don't rely on strictly on signatures or fingerprints or some known set of behavior that we've seen before is, I think, unique in the marketplace. Time will tell. Right now, we're still a little known company. And our biggest effort is to speak with a louder voice and get more exposure so that people can learn what we do and try us out and provide additional references and things like that. But we keep looking around to try to see if there's anybody doing what we do. And while there are some companies that are starting to gather the kind of data that we have, they can't get the 30-year history that we already have. It's just not -- it's not possible. So we still think there's unique value there and one that gives us a leg up.

Put a different way, by the time they have a 30-year history, you'll have a 60-year. One of the ways that an investor like me, judges companies like you, where it's hard to truly understand the nature of the dynamics of the product is by finding who you ally with. We were early into Zscaler because of the relationship they have with Microsoft. Well, when we know the names of your primes, we know the names of your strategic partners, will we be impressed by them?

Well, impressed, I hope so, but you'll know the names for sure.

So that will be significant players in the space.

That's our goal, yes.

Okay. And what kind of work do those guys do -- those firms do to proof out your product?

Well, there -- we picked ones in -- each in different spaces. So some have -- one has products that we would integrate with. One has services that we would integrate with as an example. So we're -- at the moment, we were not talking to multiple versions of each of those. We picked a leading product company and a leading services company and thought that was our best shot after looking at gaps that they have in their offerings. I will say that if things stay slow, I will probably broaden our conversation to more companies than we're currently talking to.

It would seem that if you do have this truly unique product, it would make a great deal of sense to effectively kind of create -- you're going to play with one player in each space, it would make sense to actually create a little bit of a race or a hustle for it because if people start to recognize that, this is what it appears to be, there should be a landslide pushing towards it. I just want to say I think that I could talk at greater length at 6:00. I think people are certainly tired of having me speak. They probably aren't tired of hearing you.

Yes. My only comment, Ross, would be, I chose one because of the impact on resources. These conversations take people, engineers, blah blah, and I didn't want to dilute our resources broadly. I chose a more focused approach, and we'll see what happens as time marches on here, but that was a deliberate choice initially.

But by the same measure, the people who are partnering you with these potential deals with the government have also committed resources and decided after putting those resources that they want to include you in their package. So they're willing to bet their reputations on yours. Actually, quite a lot of years ago, I made a lot of money on a company called Albany International, which developed a new way to make fan blades for jet engine when Boeing said that they were going to use the [indiscernible] engine, people thought that was crazy, but they actually -- there are leading-edge technologies, the companies who never think could happen.

That's right. That's exactly right.

Well, congratulations, I heard there's a lot more going on here than you're letting on. It's pretty exciting, I think, just picking up some of the stuff that some of the following -- going through some of these doors aren't open. So thank you very much. I'll talk to you later.

And with that, I'll turn the conference back over to management for any closing remarks.

Well, again, I would just like to say thank you to our investors and analysts and all those who are paying attention to us. For me, it's coming up on 1-year anniversary of joining the company, and I'm quite proud of the team. I'm quite proud of the work that we've been able to do this year. And I'm even more excited about what the next year will bring. So I appreciate your going on the journey with us. Stay tuned, we'll have, I think, more exciting news for you in the coming weeks and months. So thank you very much.

Ladies and gentlemen, that will conclude today's call. Thank you all for joining. You may now disconnect.