Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2022
OR
For the transition period from to
COMMISSION FILE NUMBER 001-39608
INTRUSION INC.
(Exact name of registrant as specified in its charter)
(Address of principal executive offices) (Zip Code)
Registrant’s telephone number, including
area code: (972)234-6400
Securities registered pursuant to Section 12(b)
of the Act:
Title of each class Trading Symbol Name of each exchange on which registered
Common Stock, par value $0.01 per share INTZ Nasdaq Capital Market
Securities registered pursuant to Section 12(g) of
the Act:
Common Stock, $0.01 par value
(Title of class)
Indicate by check mark if the registrant is a
well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes ☐ No ☒
Indicate by check mark if the registrant is not
required to file reports pursuant to Section 13 or 15(d) of the Exchange Act.
Yes ☐ No ☒
Indicate by check mark whether the registrant
(1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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 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.
Large accelerated filer ☐ Accelerated filer ☐
Non-accelerated filer ☒ Smaller reporting company ☒
Emerging growth company ☐
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
has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial
reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or
issued its audit report. Yes ☐ No ☒
If securities are registered pursuant to Section
12(b) of the Act, indicate by check mark whether the financial statements of the registrant included in the filing reflect the correction
of an error to previously issued financial statements. ☒
Indicate by check mark whether any of those
error corrections are restatements that required a recovery analysis of incentive-based compensation received by any of the registrant’s
executive officers during the relevant recovery period pursuant to §240.10D-1(b). ☐
Indicate by check mark whether the registrant
is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ☐ No ☒
State the aggregate market value of the voting
and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the
average bid and asked price of such common equity, as of June 30, 2022: $69,240,768.
As of March 24, 2023, 21,248,195shares of the issuer’s Common Stock were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant’s definitive
Proxy Statement filed in connection with the Registrant’s 2022 Annual Meeting of Stockholders are incorporated by reference into
Part III of this Annual Report on Form 10-K.
INTRUSION INC.
INDEX
PART I
Item 1. Business 1
Item 1A. Risk Factors 5
Item 2. Properties 12
Item 3. Legal Proceedings 12
PART II
Item 8. Financial Statements 23
Item 9A. Controls and Procedures 23
PART III
Item 10. Directors, Executive Officers, and Corporate Governance 25
Item 11. Executive Compensation 25
Item 14. Principal Accounting Fees and Services 25
PART IV
Item 15. Exhibits and Financial Statement Schedules 26
Signatures 29
i
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Annual Report on Form
10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities
Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), which statements involve
substantial risks and uncertainties. All statements other than statements of historical facts contained in this Annual Report on Form
10-K, including statements regarding our financial position; our ability to continue our business as a going concern; our business, sales,
and marketing strategies and plans; our ability to successfully market, sell, and deliver our INTRUSION Shield commercial
product and solutions to an expanding customer base; are forward-looking statements. In some cases, you can identify forward-looking statements
because they contain words such as "anticipate," "believe," "contemplate," "continue," "could,"
"estimate," "expect," "intend," "may," "plan," "potential," "predict,"
"project," "should," "target," "will," or "would" or the negative of these words or
other similar terms or expressions. Forward-looking statements contained in this Annual Report on Form 10-K include, but are not limited
to, such statements.
You should not rely on forward-looking
statements as predictions of future events. We have based the forward-looking statements contained in this Annual Report on Form 10-K
primarily on our current expectations and projections about future events and trends that we believe may affect our business, financial
condition, and operating results. The outcome of the events described in these forward-looking statements is subject to risks, uncertainties,
and other factors described in the section titled "Risk Factors" and elsewhere in this Annual Report on Form 10-K.
In addition, statements that
"we believe" and similar statements reflect our beliefs and opinions on the relevant subject. These statements are based on
information available to us as of the date of this Annual Report on Form 10-K. While we believe that such information provides a reasonable
basis for these statements, that information may be limited or incomplete. Our statements should not be read to indicate that we have
conducted an exhaustive inquiry into, or review of, all relevant information. These statements are inherently uncertain, and investors
are cautioned not to unduly rely on these statements.
The forward-looking statements
made in this Annual Report on Form 10-K relate only to events as of the date on which the statements are made. We undertake no obligation
to update any forward-looking statements made in this Annual Report on Form 10-K to reflect events or circumstances after the date of
this Annual Report on Form 10-K or to reflect new information or the occurrence of unanticipated events, except as required by law.
ii
PART I
Item 1. Business.
Our Corporate Information
We were organized in Texas
in September 1983 and reincorporated in Delaware in October 1995. Our principal executive offices are located at 101 East Park Boulevard,
Suite 1200, Plano, Texas 75074, and our telephone number is (972) 234-6400. Our website URL is www.intrusion.com. We post the following
filings in the “Investors” section of our website as soon as reasonably practicable after they are electronically filed with
or furnished to the Securities and Exchange Commission: our Annual Reports on Form 10-K; our Quarterly Reports on Form 10-Q; our current
reports on Form 8-K; and any amendments to those reports or statements filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange
Act. All such filings on our website are available free of charge. Additionally, filings are available on the Securities and Exchange
Commission’s website (www.sec.gov). In this report, references to the “Company,” “we”, “us,”
“our”, “Intrusion” or “Intrusion Inc.” refer to Intrusion Inc. and its subsidiaries. TraceCop
and Savant are registered trademarks of the Company. We have also applied for trademark protection for INTRUSION Shield.
Our Business
Intrusion, Inc. is a cybersecurity
company based in Plano, Texas. The company offers its customers access to its exclusive threat intelligence database containing the historical
data, known associations, and reputational behavior of over 8.5 billion Internet Protocol (“IP”) addresses. After years of
gathering global internet intelligence and working exclusively with government entities, the company released its first commercial product
in 2021.
Our Solutions
INTRUSION ShieldTM
INTRUSION Shield,
our newest cybersecurity solution is a Zero Trust reputation-based Security-as-a-Service (“SaaS”) solution that inspects and
kills dangerous network (in and outbound) connections. What makes our approach unique is that INTRUSION Shield evaluates
every packet and analyzes the IP addresses (source and destination), as well as domain information and the ports utilized and, when combined
with other threat intelligence data reports, blocks malicious connections. Many breaches today are caused by Zero-Day and malware free
compromises that may not trigger alarms in a traditional firewall or endpoint solution. INTRUSION Shield’s
capabilities are designed to continuously evolve as the threats and landscape change over time. Unlike traditional industry approaches
that rely heavily on signatures, complex rules, and human factors mitigation, which malicious actors and nation states have learned to
bypass, INTRUSION Shield’s proprietary architecture isolates and neutralizes malicious traffic and network
flows that existing solutions are ill equipped to handle.
In September 2022, we expanded
the INTRUSION Shield product line to include the Shield Cloud and Shield End-Point solutions. The initial INTRUSION Shield
offering released in early 2021, the Shield On-Premise solution, utilizes hardware and is placed behind a firewall in a data center. Shield
Cloud extends the effectiveness of the Shield On-Premise solution to Infrastructure as a Service (IaaS), Platform as a Service (PaaS),
SaaS and serverless resources in the public cloud. This product serves as a protective gateway to the cloud, providing both Zero Trust
access to, and protecting outbound connections from, virtual hosts and serverless functions within the cloud. Shield Endpoint helps protect
the network outside of the corporate enclave and data center to include protection for remote workers, mobile, and cloud devices. This
product brings the network protection of the Shield On-Premise to these remote user devices establishing a Zero Trust network, both for
intra-organization connectivity and external internet connectivity.
INTRUSION TraceCop®
INTRUSION TraceCop
is a big data tool with extensive IP intelligence canvassing the entire internet. It contains what we believe to be the largest existing
repository of reputation information on known good and known bad active IP addresses (both IPv4 and IPv6). TraceCop contains
an inventory of network selectors and enrichments useful to support forensic investigations. The data contains a history
of IPv4 and IPv6 block allocations and transfers, historical mappings of IP addresses to Autonomous Systems (ASNs) as observed through
BGP, and approximately one billion historically registered domain names and registration context. TraceCop contains tens
of billions of historic DNS resolutions of Fully Qualified Domain Names (FQDNs or hostnames) on each of these domains. Together, the resulting
data shows relationships, hosting, and attribution for internet resources. TraceCopalso contains web server
surveys of content, such as natural language and topic of the content on hundreds of millions of websites and servers and OS fingerprints
of services showing applications running on a given IP address. TraceCop also contains a history of threat and reputation
for each hostname and IP address over time. All these features combine to create a very effective network forensics and cybersecurity
analysis tool.
INTRUSION Savant®
INTRUSION Savant
is a network monitoring solution that leverages the rich data available in TraceCop to identify suspicious traffic in real-time.
Savant uses several original patents to uniquely characterize and record all network flows. Savant is a network
reconnaissance and attack analysis tool used by forensic analysts in the DoD, Federal Government, and corporations with in-house threat
research teams. For example, Savant users can create various automated rules to inspect packets matching (or not) certain
criteria such as creating a rule to ensure the Source MAC address field in the Ethernet header and Source IP address from the IP header
are always the same, failing which could indicate MAC or IP Spoofing in progress. Similarly, threat investigators can create rules using
regular expressions to analyze multiple fields in the packet headers.
Our Intellectual Property and Licenses
Our success and our ability
to compete are primarily dependent upon our proprietary technology. We principally rely on a combination of contractual rights, trade
secrets and copyright laws to establish and protect our proprietary rights in our solutions. In addition, we have received two patents,
and we have applied for patents for our INTRUSION Shield family of solutions. We have also entered into non-disclosure agreements
with our suppliers, resellers, and certain customers to limit access to and disclosure of our proprietary information. There can be no
assurance that the steps taken by us to protect our intellectual property will be adequate to prevent misappropriation of our technology
or that our competitors will not independently develop technologies that are substantially equivalent or superior to our technology, although
it would be extremely difficult to replicate the proprietary and comprehensive internet databases we have developed over the past 26 years.
We have entered into software
and solution license agreements with various suppliers. These license agreements provide us with additional software and hardware components
that add value to our cybersecurity solutions. These license agreements do not provide proprietary rights that are unique or exclusive
to us and are generally available to other parties on the same or similar terms and conditions, subject to payment of applicable license
fees and royalties. We do not consider any of the solution license, software, or supplier agreements to be material to our business, instead,
they are complementary to our business and offerings.
Our Competition
The market for network and
data protection security solutions is intensely competitive and subject to frequent introductions of new technologies, and potentially
improved price and performance characteristics. Industry suppliers compete in areas such as conformity to existing and emerging industry
standards, interoperability with networking and other cybersecurity solutions, management and security capabilities, performance, price,
ease of use, scalability, reliability, flexibility, features and technical support. Our principal competitors in the data mining and advanced
persistent threat market include Niksun, NetScout, and Darktrace.
There are numerous companies
competing in various segments of the data security market. At this time, we have little or no competitors for TraceCop;
however, we believe competitors could emerge in the future. These competitors currently perform only a portion of the functions that
we can perform with TraceCop. We have been continuously collecting the TraceCop data for more than twenty
years, and we believe that none of our current or future competitors will have the ability to provide and reference this historical data.
In our newest market segment, data mining and advanced persistent threat detection, we compete directly and indirectly with companies
and open-source technologies in the firewall, intrusion detection and prevention, anti-virus, network analysis, endpoint protection, and
insider threat prevention areas of cybersecurity technology.
We believe the INTRUSION
Shield product line is novel and unique in our industry because of our proprietary threat-enriched big data. We believe that
our INTRUSION Shield family of solutions complement our customer’s existing cybersecurity processes and third-party
solutions. If the INTRUSION Shield receives widespread acceptance in the market, we anticipate that other businesses will
seek to compete with INTRUSION Shield; however, we believe our existing, mature, and proprietary database which is integral
to the operation of INTRUSION Shield will be difficult, if not impossible, for other companies in our industry to replicate
and will be a significant barrier to entry of competitors in the near- and long-term future of cyber security solutions.
Our Customers: Government
Sales
Sales to U.S. government
customers accounted for 65.8% of our revenues for the year ended December 31, 2022, compared to 71.4% of our revenue in 2021. We expect
to continue to derive a substantial portion of our revenues from sales to governmental entities in the future as we continue to market
our products and data mining products to the government, and we intend to market INTRUSION Shield not only to our long-standing
governmental customer base but to expand our efforts to include more traditionally administrative and civilian governmental entities.
Sales to government clients present risks in addition to those involved in sales to commercial customers that could adversely affect our
revenues, including potential disruption due to irregularities in or interruptions to appropriation and spending patterns, delays in approving
a federal budget and the government’s reservation of the right to cancel contracts and purchase orders for its convenience.
We make our sales under purchase
orders and contracts. Our customers, including government customers, may cancel their orders or contracts with little or no prior notice
and without penalty. Although we transact business with various government entities, we believe that the cancellation of any order in
itself could have a material adverse effect on our financial results. Because we derive and expect to continue to derive a substantial
portion of our revenue from sales to government entities, a large number of cancelled or renegotiated government orders or contracts could
have a material adverse effect on our financial results.
Third-Party Products
We currently utilize commercially
available computers and servers from various vendors which we integrate with our software products for implementation into our customer
networks. We do not consider any of these third party relationships to be material to the Company’s business or results of operations.
Customer Services
Our solution sales may include
installation, operation of our technology and threat data interpretation and reporting.
Sales, Marketing and Customers
Field Sales Force.
Our sales organization focuses on major account sales, channel partners including distributors, value added resellers (VARs) and integrators;
promotes our solutions to current and potential customers; and monitors evolving customer requirements. The field sales and technical
support force provides training and technical support to our resellers and end users and assists our customers in designing cyber secure
data networking solutions. We currently conduct sales and marketing efforts from our principal office in Plano, Texas.
Resellers.
Resellers such as domestic and international system integrators and VARs sell our solutions as stand-alone solutions to end users and
integrate our solutions with products sold by other vendors into network security systems that are sold to end users. Our field sales
force and technical support organization provide support to these resellers. Our agreements with resellers are non-exclusive, and our
resellers generally sell other products and solutions that may compete with our solutions. Resellers may place higher priority on products
or solutions of other suppliers who are larger and have more name recognition, and there can be no assurance that resellers will continue
to sell and support our solutions.
Foreign Sales.
Export sales did not account for any revenue in 2022 and 2021.
Marketing.
We have implemented several methods to market our solutions, including participation in trade shows and seminars, distribution of sales
literature and solution specifications and ongoing communication with our resellers and installed base of end-user customers.
Customers.
Our end-user customers include United States (“U.S”) federal government, state and local government entities, large and diversified
conglomerates, and manufacturing entities. Sales to certain customers and groups of customers can be impacted by seasonal capital expenditure
approval cycles, and sales to customers within certain geographic regions can be subject to seasonal fluctuations in demand.
In 2022, 65.8% of our revenue
was derived from a variety of U.S. government entities through direct sales and indirectly through system integrators and resellers. These
sales are attributable to seven U.S. Government customers through direct and indirect channels; three U.S government customers individually
exceeded 10% of total revenue in 2022. A reduction in our sales to U.S. government entities could have a material adverse effect on our
business and operating results if not replaced.
Backlog. We
believe that only a small portion of our order backlog is non-cancelable, and that the dollar amount associated with the non-cancelable
portion is immaterial. Commercial orders are generally fulfilled within two days to two weeks following receipt of an order. Certain orders
may be scheduled over several months, generally not exceeding one year.
Customer Support, Service
and Warranty. We service, repair, and provide technical support for our solutions. Our field sales and technical support force
works closely with resellers and end-user customers on-site and by telephone to assist with pre- and post- sales support services such
as network security design, system installation and technical consulting. By working closely with our customers, our employees increase
their understanding of end-user requirements and are then able to provide specific input in our solution development process.
We warrant all our solutions
against defects in materials and workmanship for periods ranging from 90 days to 36 months. Before and after expiration of the solution
warranty period, we offer both on-site and factory-based support, parts replacement, and repair services. Extended warranty services are
separately invoiced on a time and materials basis or under an annual maintenance contract.
Employees
As of December 31, 2022,
we employed a total of sixty-seven persons, four of which are part time. None of our employees are represented by a labor organization,
and we are not a party to any collective bargaining agreement. Competition in the recruiting of personnel in the networking and data security
industry is intense. We believe that our future success will depend in part on our continued ability to hire, motivate and retain qualified
management, sales, marketing, and technical personnel.
Our Code of Conduct
The Company’s directors
and employees are required to abide by the Company’s Code of Business Conduct and Ethics, which the Company adopted on September
14, 2020 (the “Code”) to ensure that the Company’s business is conducted in a consistently legal and ethical manner
and to avoid instances of insider trading. The Code cover areas of professional conduct that include conflicts of interest, fair dealing
and the strict adherence to all laws and regulations applicable to the conduct of the Company’s business.
On March 16, 2022, our board
of directors, upon recommendation of our Nominating and Corporate Governance Committee, approved the following sentences to be added under
the “Conflicts of Interest” section of the Company’s Code: “Any and all actual, perceived, or possible Conflicts
of Interest involving either the Chief Executive Officer or the Chief Financial Officer shall be submitted in writing by a Company Agent
to the Company’s Board Chair. The Chair will then be charged with addressing the Conflict of Interest, or with presenting the matter
to the full Board for consideration, in accordance with the Company’s policies including those regarding ‘related party transactions,’
with the ultimate goal of avoiding even the ‘hint of impropriety’ in the Company’s business dealings.”
The full text of the amended
Code is published on the Company’s website under the investor relations tab at www.intrusion.com. The Company intends to disclose
future amendments to, or waivers from, certain provisions of the Codes of Ethics on the Company’s website within four business days
following the date of such amendment or waiver. Upon the written request of any stockholder, the Company will furnish, without charge,
a copy of the Code. This request should be directed to the Company’s Secretary at 101 East Park Blvd., Suite 1200, Plano, TX 75074.
Item 1A. Risk Factors
The following are the significant
factors that could materially adversely affect our business, financial condition, or operating results, as well as adversely affect the
value of an investment in our common stock. The risks described below are not the only risks facing our Company. 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 operating results.
Risks Related to Our Financial Position and
Liquidity
The Company’s ability to
implement its current business plan is dependent on our ability to raise additional funds through additional public or private financings,
which raises the possibility that the Company may not be able to continue as a going concern.
As of December 31, 2022,
we had cash and cash equivalents of $3.0 million and negative working capital of $7.8 million. Our primary source of cash for funding
operations and growth in 2022 has come from net proceeds received from the issuance of notes payable, net proceeds received from our registered
direct offering and from our at-the-market program in an aggregate amount of approximately $15.6 million. To finance our operations and
to continue as a going concern, we believe it will be necessary for us to raise additional funds through public or private financings,
including the utilization of our at-the-market program. We can provide no assurances that we will be able to raise additional funds through
any future equity or debt financings, and the terms of those financings, if available at all, may be on terms, which are not favorable
to us and, in the case of equity financings, will result in dilution to our stockholders.
We are subject to certain contractual and regulatory limitations on our ability to consummate future financings.
Pursuant to that certain
securities purchase agreement we entered into in March 2022 with to Streeterville Capital, LLC and related issuance of two promissory
notes, we agreed to be subject to certain restrictions on our ability to issue securities during the term of the notes issued under the
agreement. Specifically, we agreed to obtain Streeterville Capital’s consent prior to issuing any debt securities or certain equity
securities where the pricing of such equity securities is tied to the public trading price of our common stock. Furthermore, we also must
offer Streeterville with the right to purchase up to 10% of future equity and debt securities offerings, subject to certain exceptions
and limitations, in each case during the term of any note issued to Streeterville.
Furthermore, unless our public
float exceeds $75 million, we will be subject to the restrictions set forth in General Instruction I.B.6 to Form S-3 that limit our ability
to conduct primary offerings under a Form S-3 registration statement. Under such limitations, we may not sell, during any 12-month period,
securities on Form S-3 having an aggregate market value of more than one-third of our public float. As of March 24, 2023, our public
float calculated in accordance with General Instruction I.B.6 of Form S-3 was $28.7 million. These restrictions may delay or prevent
us from entering into funding arrangements or being able to access the capital markets, including under our at-the-market program, on
favorable terms or at all.
We may be unable to generate sufficient
cash to service our indebtedness.
Our ability to make scheduled
payments on or to refinance our indebtedness and financial commitments to the noteholder under the convertible notes issued under our
March 2022 securities purchase agreement depends on our financial condition and operating performance, which are subject to prevailing
economic and competitive conditions including financial, business, and other factors beyond our control. The notes mature on September
10, 2023, and December 29, 2023. We may be unable to generate sufficient cash flow to permit us to pay the principal, premium, if any,
and interest on that indebtedness which would have a material adverse effect on our financial condition and results of operations.
The terms of our March 2022 securities purchase
agreement contain significant obligations and limitations that could restrict our right to enter into transactions that would otherwise
be favorable to our stockholders.
Our debt agreements contain
a number of significant covenants, including the obligations to not issue debt securities or certain equity securities where the pricing
of such equity securities is tied to the public trading price of the Common Stock, in each case, without the noteholder’s prior
consent, and offer the noteholder the right to purchase up to 10% of future equity and debt securities offerings, subject to certain exceptions
and limitations. These obligations and limitations may limit our ability to enter into certain, corporate, financing, operational or capital
raising transactions.
If we fail to comply with the restrictions
and covenants in our March 2022 securities purchase agreement, there could be an event of default under the convertible notes issued thereunder,
which could result in an acceleration of payments due under those notes and other consequences.
Failure to meet the restrictions,
obligations, and limitations under the March 2022 securities purchase agreement may result in an event of default in accordance with the
terms of the convertible notes issued thereunder. An event of default would, among other things, provide the noteholder with the right
to increase the outstanding balance by 15% for certain major events of default and 5% for others. Additionally, upon an event of default,
the noteholder may consider the convertible note immediately due and payable. Furthermore, upon an event of default, the interest rate
may also be increased to the lesser of 18% per annum or the maximum rate permitted under applicable law.
The redemption feature under our convertible
notes is dependent upon the market value of our common stock, which could result in significant dilution to our existing stockholders.
The noteholder has the right
to redeem up to $0.5 million of the outstanding balance of each note per month. In January 2023, we amended the note agreements whereby
the noteholder agreed to waive their redemption rights through March 31, 2023, in exchange for a fee equal to 3.75% of the outstanding
principal balance. We have the option to make such payments in either (a) cash, (b) by paying the redemption amount in the form of shares
of common stock with the number of redemption shares being equal to the portion of the applicable redemption amount divided by the redemption
conversion price or (c) a combination of cash and shares of common stock. Since the redemption conversion price will be equal 85% multiplied
by the average of the two lowest daily volume weighted average prices per share of the common stock during the 15 trading days immediately
preceding the date that the noteholder delivers notice electing to redeem a portion of the note, the number of shares to be issued by
us in satisfaction of this redemption will vary, perhaps considerably. A reduction in our trading value could cause us to issue a greater
number of shares under a redemption notice and therefore increase the dilutive effect to other stockholders.
We must increase revenue levels
in order to finance our current operations and to implement our business strategies.
For the year ended December
31, 2022, we had a net loss of $16.2 million and had an accumulated deficit of approximately $96.3 million as of December 31, 2022. We
need to increase current revenue levels from the sales of our solutions if we are to regain profitability, and our new INTRUSION Shield
suite of products may take time to achieve market penetration which could negatively impact future revenues and results of operations.
If we are unable to increase revenue levels, losses could continue for the near term and possibly longer, and we may not regain profitability
or be able to implement our business plan, fund our liquidity needs, or continue our operations.
Business and Operational Risks
Most of our current revenues are generated
from one family of solutions with a limited number of customers, and the decrease of revenue from sales of this family of solutions could
materially harm our business and prospects.
Approximately 80.9% of our
existing revenues result from sales of TraceCop a cybersecurity solution. TraceCop revenues were $6.1 million
for the year ended December 31, 2022, compared to $6.3 million for the year ended December 31, 2021. We can offer no assurances that
our new INTRUSION Shield solution will reduce our dependence on this single solution and in the absence of a shift in solution
mix, we may continue to face risks in the event that sales of this key solution to these limited customers were to decrease.
We may not be successful in our
efforts to broaden the marketing and sale of the INTRUSION Shield.
We believe that we must expand
our sales and marketing efforts for INTRUSION Shield to achieve marketplace acceptance and to generate revenue for the Company.
However, these efforts depend, in large part, on the success of our channel partners as they market and sell INTRUSION Shield,
which may not be successful. If we are unsuccessful in our efforts to leverage channel and strategic partners, we may not be able to generate
sufficient revenue from INTRUSION Shield to improve the Company’s financial position, results of operations, and cash
flow position.
The current geo-political climate
may add uncertainty in the dealings of our customers and could cause them to delay indefinitely certain cyber-security initiatives or
to determine not to introduce or implement any new or innovative cyber-solution products into their information networks.
Continuing events in Eastern
Europe and Russia have introduced a significant level of uncertainty in the dealings of our current and potential customers that could
cause them to be hesitant to implement new cyber-security initiatives regardless of the efficacy of our INTRUSION Shield
product. Further, these entities may also determine not to deploy their cash reserves in the face of such uncertainty. These uncertainties
could depress the interest or the ability of companies and governmental entities to test, evaluate, and deploy our INTRUSION Shield
in their network environments.
A large percentage of our current revenues are received
from U.S. government entities, and the loss of these customers or our failure to widen the scope of our customer base to include general
commercial enterprises could negatively affect our revenues.
A substantial percentage of our current revenues
result from sales to U.S. government entities. If we were to lose one or more of these customers, our revenues could decline, and our
business and prospects may be materially harmed. Further, sales to the government present risks in addition to those involved in sales
to commercial customers, including potential disruption due to appropriation and spending patterns, delays in approving a federal budget
and the government’s right to cancel contracts and purchase orders for its convenience. While we expect that developing relationships
with non-governmental customers will mitigate or eliminate this dependence on, and risk from, serving governmental entities, we can offer
no assurances that we will be able to sufficiently diversify our customer portfolio in a time and manner to adequately mitigate this risk.
We are highly dependent on sales of our
current solutions through indirect channels, the loss of which would materially adversely affect our operations.
For the years ended December
31, 2022, and 2021, we derived 31.5% and 37.5% of our revenues from sales through indirect sales channels, such as distributors, value-added
resellers, system integrators, original equipment manufacturers and managed service providers. We must expand sales of our current solutions
as well as any new solutions through these indirect channels in order to increase our revenues. We cannot assure you that our current
solutions or future solutions 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 product and solutions through these
indirect sales channels, which could result in lower prices and reduced profit margins for the sales of our solutions.
Our business depends on the continued
service of our key management and technical personnel.
Our success depends upon the continued contributions
of our key management, sales, marketing, research and development and operational personnel, including Anthony Scott, our President, and
Chief Executive Officer; T. Joe Head, our Chief Technology Officer; Kimberly Pinson, our Chief Financial Officer; and other key technical
personnel. The loss of the services of one or more of our key employees in the future could have a material adverse effect on our operating
results. We also believe our future success will depend upon our ability to attract and retain additional highly skilled management, technical,
marketing, research and development, and operational personnel with experience in managing large and rapidly changing companies, as well
as training, motivating and supervising employees. The market for hiring and retaining certain technical personnel, including software
engineers, has become more competitive and intense in recent years. Failure to attract and retain a sufficient number of qualified technical
personnel, including software engineers, or retain our key personnel could have a material adverse effect on our operating results.
We could experience damage to our reputation in the cybersecurity
industry in the event that our INTRUSION Shield solution fails to meet our customers’ needs or to achieve market acceptance.
Our reputation in the industry may be harmed if
we experience delivery delays, or if our customers do not perceive the benefits of purchasing and using INTRUSION Shield
as part of their comprehensive cybersecurity solution, our position as a leader in this technology space may be damaged and could affect
the willingness of our customers, as well as potential customers, to purchase our other solutions that function separately from INTRUSION
Shield. Any reputational damage could result in a decrease in orders for all our solutions, the loss of current customers,
and a decrease in our overall revenues which could in turn have a material adverse effect on our results of operations.
If we fail to respond to rapid technological
changes in the network security industry, we may lose customers, or our solutions may become obsolete.
The network security industry
is characterized by frequent product and service introductions, rapidly changing technology, and continued evolution of new industry standards.
We have and must continue to introduce upgrades to our current solutions rapidly in response to changing circumstances and customer needs
such as the creation and introduction of new computer viruses or other novel external attacks on computer networks. Further, our new INTRUSION
Shield solution represents our efforts to continue to provide state-of-the art first-in-time innovation for our customer’s
cybersecurity solutions. As a result, our success depends upon our ability to develop and introduce timely upgrades, enhancements, and
new solutions to meet evolving customer requirements and industry standards. The development of technologically advanced network security
products and solutions is a complex and uncertain process requiring high levels of innovation, rapid response, and accurate anticipation
of technological and market trends. We cannot assure you that we will be able to identify, develop, manufacture, market or support new
or enhanced solutions successfully in a timely manner. Further, we or our competitors may introduce new solutions or enhancements that
shorten the life cycle of our existing solutions or cause our existing solutions to become obsolete.
We must expend time and resources addressing
potential cybersecurity risk, and any breach of our information security safeguards could have a material adverse effect on the Company.
The threat of cyber-attacks
requires additional time and money to be expended in efforts to prevent any breaches of our information security protocols. However, we
can provide no assurances that we can prevent all such attempts from being successful, which could result in expenses to address and remediate
such breaches as well as potentially losing the confidence of our customers who depend upon our services to prevent and mitigate such
attacks on their respective business. Should a material breach of our information security systems occur, it would likely have a material
adverse impact on our business operations, our customer relations, and our current and future sales prospects, resulting in a significant
loss of revenue.
A breach of network security could
harm public perception of our cybersecurity solutions, which could cause us to lose revenues.
If an actual or perceived
breach of network security occurs in the network of a customer of our cybersecurity solutions, regardless of whether the breach is attributable
to our solutions, the market perception of the effectiveness of our solutions could be harmed. This could cause us to lose current and
potential end customers or cause us to lose current and potential value-added resellers and distributors. Because the techniques used
by computer hackers to access or sabotage networks change frequently and generally are not recognized until launched against a target,
we may be unable to anticipate these techniques.
If our solutions do not interoperate
with our customers’ networks, installations will be delayed or cancelled and could harm our business.
Our solutions are designed
to interface with our customers’ existing networks, each of which have different specifications and utilize multiple protocol standards
and products or solutions from other vendors. Many of our customers’ networks contain multiple generations of products that have
been added over time as these networks have grown and evolved. Our solutions will be required to interoperate with many products and solutions
within these networks as well as future products or solutions to meet our customers’ requirements. If we find errors in the existing
software or defects in the hardware used in our customers’ networks, we may have to modify our software or hardware to fix or overcome
these errors so that our solutions will interoperate and scale with the existing software and hardware, which could be costly and negatively
impact our operating results. In addition, if our solutions do not interoperate with those of our customers’ networks, demand for
our solutions could be adversely affected, orders for our solutions could be cancelled, or our solutions could be returned. This could
hurt our operating results, damage our reputation, and seriously harm our business and prospects.
We face intense competition from
both start-up and established companies that may have significant advantages over us and our solutions.
The market for our solutions
is intensely competitive. There are numerous companies competing with us in various segments of the data security markets, and their products
or solutions may have advantages over our solutions in areas such as conformity to existing and emerging industry standards, interoperability
with networking and other cybersecurity products, management and security capabilities, performance, price, ease of use, scalability,
reliability, flexibility, features, and technical support.
Our principal competitors
in the data mining and advanced persistent threat market include Niksun, NetScout and Darktrace. Our current and potential competitors
may have one or more of the following significant advantages over us:
· greater financial, technical, and marketing resources;
· better name recognition;
· more comprehensive security solutions;
· better or more extensive cooperative relationships; and
· larger customer base.
We cannot assure you that
we will be able to compete successfully with our existing or new competitors. Some of our competitors may have, in relation to us, one
or more of the following:
· longer operating histories;
· longer-standing relationships with OEM and end-user customers; and
· greater customer service, public relations, and other resources.
As a result, these competitors
may be able to more quickly develop or adapt to new or emerging technologies and changes in customer requirements, or devote greater resources
to the development, promotion and sale of their products or solutions. Additionally, it is likely that new competitors or alliances among
existing competitors could emerge and rapidly acquire significant market share.
The effect of the coronavirus,
particularly in the diversion of time and resources of the federal, state, and local governmental entities which make up a significant
concentration of our customer base have caused, and may continue to cause, material adverse effects on our operations and our financial
results.
A significant concentration
of our federal, state, and local governmental customers has been forced to allocate scarce and competing resources and balance budgetary
demands placed upon them because of the effects of the coronavirus, scarcity of commodities, and similar economic and operational effects
of the virus upon their own constituencies. These adverse effects have resulted in decreased demand by some of our customers for our current
product offerings and cybersecurity solutions, negatively affecting historic revenue levels for the Company. A continued decrease in orders
for our solutions by our government customers and losses of efficiency or diversions of resources in our own operations may continue to
cause material adverse effect on our operations and financial results.
Scarcity of products and materials
in the supply chain could hinder or prevent the deployment of our INTRUSION Shield for our customers who elect to use the wired version
of our solution.
Supply chain interruptions
have become frequent considering the lingering commercial effects of COVID and its related variants. Should any of the component parts
required for the hardware interface our customers use to access and to utilize the INTRUSION Shield product, we may have
to delay or cancel our fulfillment of orders that could defer potential revenues or even result in customer cancellations, which would
have a negative effect on our financial position and results of operations.
Investment Risks
We experience volatility in the market
for our common stock, particularly with respect to swings in the market price as well as volatility in the trading of our common stock.
We experience significant
shifts in the market value of our common stock as it trades on the Nasdaq Capital Market as well as volatility in the trading volume of
our shares on that market. For example, the market price of our common stock fluctuated between $1.74 and $5.77 during the year
ended December 31, 2022. These fluctuations may result in a hesitancy for investors to purchase and hold shares of our common stock, continued
depression of the market value of our stock, and ultimately negatively affect our ability to raise capital through the issuance and sale
of our common stock, particularly through our at-the-market program or otherwise.
Risks Related to our Intellectual Property
We must adequately protect our
intellectual property to prevent loss of valuable proprietary information.
We rely primarily on a combination
of patent, copyright, trademark and trade secret laws, confidentiality procedures, and non-disclosure agreements to protect our proprietary
technology. However, unauthorized parties may attempt to copy or reverse engineer aspects of our solutions or to obtain and use information
that we regard as proprietary. Policing unauthorized use of our solutions is difficult, and we cannot be certain that the steps we have
taken will prevent misappropriation of our intellectual property. This is particularly true in foreign countries whose laws may not protect
proprietary rights to the same extent as the laws of the U.S. and may not provide us with an effective remedy against unauthorized use.
If protection of our intellectual property proves to be inadequate or unenforceable, others may be able to use our proprietary developments
without compensation to us, resulting in potential cost advantages to our competitors.
We may incur substantial expenses defending ourselves against
claims of infringement.
There are numerous patents
held by many companies relating to the design and manufacture of network security systems. Third parties may claim that our solutions
infringe on their intellectual property rights. Any claim, with or without merit, could consume our management’s time, result in
costly litigation, cause delays in sales or implementations of our solutions or require us to enter into royalty or licensing agreements.
Royalty and licensing agreements, if required and available, may be on terms unacceptable to us or detrimental to our business. Moreover,
a successful claim of product infringement against us or our failure or inability to license the infringed or similar technology on commercially
reasonable terms could seriously harm our business.
Our solutions are highly technical
and if they contain undetected errors, our business could be adversely affected, and we might have to defend lawsuits or pay damages in
connection with any alleged or actual failure of our solutions and services.
Our solutions are highly
technical and complex, are critical to the operation of many networks and, in the case of ours, provide and monitor network security and
may protect valuable information. Our solutions have contained and may contain one or more undetected errors, defects, or security vulnerabilities.
Some errors in our solutions may only be discovered after a solution has been installed and used by end customers. Any errors or security
vulnerabilities discovered in our solutions after commercial release could result in loss of revenues or delay in revenue recognition,
loss of customers and increased service and warranty cost, any of which could adversely affect our business and results of operations.
In addition, we could face claims for product liability, tort, or breach of warranty. Defending a lawsuit, regardless of its merit, is
costly and may divert management’s attention. In addition, if our business liability insurance coverage is inadequate or future
coverage is unavailable on acceptable terms or at all, our financial condition could be harmed.
Item 2. Properties.
Our corporate headquarters
are currently located in 17,250 square feet of space at 101 East Park Blvd, Suite 1200, Plano Texas. This facility houses our corporate
administration, engineering, sales, and marketing operations. The lease for this facility extends until November 2023. We also have engineers
and other employees working remotely in Texas as well as several other states.
We believe that the existing
facility will be adequate to meet our operational requirements through the expiration of the lease. We are currently evaluating the office
rental market in proximity to our existing lease to identify and secure space or our future needs. We believe that our property insurance
provides adequate coverage for our leased facilities. See Note 5 – Right-of-use Asset and Leasing Liabilities to our Consolidated
Financial Statements for additional information regarding our obligations under leases.
Item 3. Legal Proceedings.
Class Action Litigation
On April 16, 2021, a class
action lawsuit was filed in the United States District Court, Eastern District of Texas, Sherman Division, captioned Celeste v. Intrusion
Inc. et al., Case No. 4:21-cv-00307 (E.D. Tex.) against us, our now-former chief financial officer, and now-former chief executive officer
alleging, among other things, that the defendants made false and/or misleading statements or omissions about our business, operations,
and prospects in violation of Section 10(b) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and Rule
10b-5 promulgated thereunder, as well as Section 20(a) of the Exchange Act. The Celeste lawsuit claimed compensatory damages and legal
fees.
On May 14, 2021, a related
class action lawsuit was filed in the United States District Court, Eastern District of Texas, Sherman Division, captioned Neely v. Intrusion
Inc., et al., Case No. 4:12-cv-00374 (E.D. Tex.) against us, our now-former chief financial officer, and now-former chief executive officer.
The Neely lawsuit alleged the same violations under the federal securities laws as those alleged in the Celeste lawsuit. The Neely lawsuit
also sought compensatory damages and legal fees.
On November 23, 2021, the
Court consolidated the Celeste and Neely actions, and appointed a lead plaintiff and lead plaintiff’s counsel. The lead plaintiff
filed his amended complaint on February 7, 2022. The amended complaint named the following additional parties as named defendants: Mr.
Michael Paxton, a former director and executive officer; Mr. Gary Davis, a former officer; Mr. Joe Head, the current chief technology