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 substantial doubt that the Company may not be able to continue as a going concern.
As of December 31, 2023, we had
cash and cash equivalents of $139 thousand and negative working capital of $13.1 million. Our primary source of cash for funding operations
in 2023 has come from net proceeds received from a private offering of our common stock and warrants and net proceeds received from our
at-the-market (“ATM”) program in an aggregate amount of approximately $7.0 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 ATM 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 agreements we entered into in March 2022 with 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
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 25, 2024, our public float
calculated in accordance with General Instruction I.B.6 of Form S-3 was $6.8 million. These restrictions may delay or prevent us from
entering into funding arrangements or being able to access the capital markets on favorable terms or at all.
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 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 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 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.
We must increase revenue levels in order to
finance our current operations and to implement our business strategies.
For the year ended December 31,
2023, we had a net loss of $13.9 million and had an accumulated deficit of approximately $110.2 million as of December 31, 2023. 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 66.4% of our existing
revenues result from sales of TraceCop a cybersecurity solution. TraceCop revenues were $3.7 million for the
year ended December 31, 2023, compared to $6.1 million for the year ended December 31, 2022. 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 if 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 cybersecurity initiatives or to determine not to introduce
or implement any new or innovative cyber-solution products into their information networks.
Continuing events in many
regions around the world 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 cybersecurity 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. The factors that
could cause us to lose these U.S. government customers or otherwise materially harm our business, prospects, financial condition, or results
of operations include:
· re-allocation of government resources;
· disruptions in our customers’ ability to access funding from capital markets;
· the adoption of new laws or regulations pertaining to government procurement;
· delays in the payment of our invoices by government payment offices; and
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.
A decline in federal,
state, or local government spending would likely negatively affect our product revenues and earnings.
The success of the cybersecurity
solutions we sell depends substantially on the amount of funds budgeted by federal, state, and local government agencies that make up
our current and potential customers. Global credit and financial markets have experienced extreme disruptions in the recent past, including
severely diminished liquidity and credit availability, declines in consumer confidence, declines in economic growth, increases in unemployment
rates and uncertainty about economic stability. There can be no assurance that similar disruptions will not occur in the future. Deterioration
in general economic conditions may result in lower tax revenues that could lead to reductions in government spending. Poor economic conditions
could in turn lead to substantial decreases in our net sales or have a material adverse effect on our operating results, financial position,
and cash flows.
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, 2023, and 2022, we derived 2.6% and 31.5% 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 products 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 has 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 Darktrace, Trellix, and Recorded Futures. 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.
If we are unable to implement and maintain effective
internal control over financial reporting in the future, investors may lose confidence in the accuracy and completeness of our financial
reports and the market price of our common stock may decline.
As a public company, we are required
to maintain internal control over financial reporting and to report any material weaknesses in such internal control. Further, we are
required to report any changes in internal controls on a quarterly basis. In addition, we are required to furnish a report by management
on the effectiveness of internal control over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, as amended
(the “Sarbanes-Oxley Act”).
If we identify material weaknesses
in our internal control over financial reporting, if we are unable to comply with the requirements of Section 404 in a timely manner,
or if we assert that our internal control over financial reporting is ineffective, investors may lose confidence in the accuracy and completeness
of our financial reports and the market price of the common stock could be negatively affected. We also could become subject to investigations
by the stock exchange on which our securities are listed, the Securities Exchange Commission (“SEC”), or other regulatory
authorities, which could require additional financial and management resources, and could have a material adverse effect on the market
price of our common stock.
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.
Should any of the component
parts required for the hardware interface our customers use to access and to utilize the INTRUSION Shield product become
scarce, 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.
We incur significantly increased costs because
of operating as a public company, and our management is required to devote substantial time to compliance matters and initiatives.
As a public company with an obligation
to file reports with the SEC under the Exchange Act, we incur significant legal, accounting, and other expenses that we would not incur
as a private company. In addition, the Sarbanes-Oxley Act imposes various requirements on public companies, including requiring establishment
and maintenance of effective disclosure and financial controls. Our management and other personnel devote a substantial amount of time
to these compliance initiatives. We cannot predict or estimate the amount of additional costs we will incur to meet our additional disclosure
obligations under the Exchange Act or the timing of such costs.
The Sarbanes-Oxley Act requires,
among other things, that we maintain effective internal control over financial reporting and disclosure controls and procedures. We report
on the effectiveness of our internal control over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act. In addition,
in the first Annual Report on Form 10-K following the date on which we no longer qualify as a smaller reporting company, we will be required
to have our independent registered public accounting firm attest to the effectiveness of our internal control over financial reporting.
Our compliance with Section 404 of the Sarbanes-Oxley Act could require that we incur substantial accounting expense and expend significant
management efforts including the potential of hiring additional accounting and financial staff with appropriate public company experience
and technical accounting knowledge. If we are not able to comply with the requirements of Section 404 in a timely manner, or if we or
our independent registered public accounting firm identify deficiencies in our internal control over financial reporting that are deemed
to be material weaknesses, the market price of our stock could decline and we could be subject to sanctions or investigations by the SEC
or other regulatory authorities, which would require additional financial and management resources.
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 (“Nasdaq") 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 $78.00 and $4.40
during the year ended December 31, 2023. 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 (“ATM”) program or otherwise.
Nasdaq may delist our common stock from
trading on its exchange, which could limit stockholders’ ability to trade our common stock.
Our common stock is listed
for trading on the Nasdaq Capital Market, which requires us to meet certain financial, public float, bid price and liquidity standards
on an ongoing basis to continue the listing of our common stock. If we fail to meet these continued listing requirements, our common stock
may be subject to delisting.
On September 26, 2023, the
Company received the Notification Letter from Nasdaq notifying the Company that the closing bid price of the Company’s common stock
over the thirty consecutive trading days from August 14, 2023, through September 25, 2023, had fallen below $1.00 per share and therefore,
was not in compliance with the Minimum Bid Requirement.
On October 26, 2023, we received
a letter from Nasdaq’s Listing Qualifications Staff (the “Staff Determination”) notifying us that, based on the Company's
non-compliance with the $35 million minimum value listing standard for continued listing on the Nasdaq, as set forth in Nasdaq Marketplace
Rule 5550(b)(2), the Company’s securities are subject to delisting from Nasdaq.
The Company requested a hearing
before the Hearings Panel. This hearing was held on February 1, 2024, at which time the Company presented a plan to regain and sustain
compliance with all the applicable requirements for continued listing on The Nasdaq Capital Market. The Hearings Panel granted the Company
an extension until April 23, 2024, in which to regain compliance and cure the deficiencies for continued listing.
The Company is executing
a plan to gain compliance with an alternative Nasdaq listing criteria, Nasdaq Listing Rule 5550(b)(1) (the equity standard) which requires
a minimum of $2.5 million in net equity. Pursuant to this multi-step plan, the Company: 1) is continuing to utilize its ATM program,
2) closed on a private offering in November 2023 and is anticipating closing on an additional private offering of common stock in the
near term, 3) sent warrant inducement letters to warrant holders from the Company’s 2022 registered direct offering and the November
2023 private offering temporarily reducing the exercise price of the outstanding warrants and 4) through a series of three transactions
in the fourth quarter 2023 and two transactions in March 2024 exchanged $10.0 million in senior debt for $750 thousand in common stock
and $9.3 million new preferred Series A stock.
In order to increase the share
price of our common stock above the $1.00 Minimum Bid Requirement, we completed a reverse stock split of one share for twenty which was
effective on March 22, 2024.
All of these steps combined provide
a path for regaining compliance, however, there can be no assurance that the Company will be able to regain or maintain compliance with
either Nasdaq listing criteria.
If our common stock is delisted
and we are not able to list our common stock on another national securities exchange, we expect our securities would be quoted on an over-the-counter
market. If this were to occur, our stockholders could face significant material adverse consequences, including limited availability of
market quotations for our common stock and reduced liquidity for the trading of our securities. In addition, we could experience a decreased
ability to issue additional securities and obtain additional financing in the future.
Shares eligible for future sale may adversely
affect the market.
Our equity incentive plans allow us to issue stock
options and award shares of our common stock. We may in the future create additional equity incentive plans, which may at that time require
us to file a registration statement under the Securities Act to cover the issuance of shares upon the exercise or vesting of awards granted
or otherwise purchased under those plans. As a result, any shares issued or granted under the plans may be freely tradable in the public
market. If equity securities are issued under the plans, if implemented, and it is perceived that they will be sold in the public market,
then the price of our common stock could decline substantially.
We have never paid dividends on our common stock
and have no plans to do so in the future.
Holders of shares of our common stock are entitled
to receive such dividends as may be declared by our Board. To date, we have paid no cash dividends on our shares of common stock, and
we do not expect to pay cash dividends on our common stock in the foreseeable future. We intend to retain future earnings, if any, to
provide funds for the operations of our business. Therefore, any return investors in our common stock may have will be in the form of
appreciation, if any, in the market value of their shares of common stock.
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 1B. Unresolved Staff Comments.
None.
Item 1C. Cybersecurity.
We recognize the importance of securing our data and information systems
and have a process for assessing, mitigating and managing cybersecurity and related risks.
Our VP of Engineering, who
reports to the CEO, leads our cybersecurity function and is responsible for managing our cybersecurity risk and the protection of our
networks, systems, and data. The VP of Engineering uses both internal and external resources to execute this process including our own
INTRUSION Shield technology, to help prevent, identify, escalate, investigate, and resolve security incidents in a timely
manner. The Company, with the oversight of the CTO, also requires all employees to complete an annual cybersecurity training course.
Our Board of Directors is responsible
for overseeing our enterprise risk management activities. The Board of Directors receives an update on the Company’s risk management
process and the risk trends related to cybersecurity at least annually.
Item 2. Properties.
Our corporate headquarters
are currently located in 10,705 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 March 2035. 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 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 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 parties to the consolidated
class action held a mediation on April 5, 2022, at the conclusion of which the parties executed a settlement term sheet setting forth
the material terms associated with the resolution of the action, subject to the preparation of formal documents and a plan of distribution
approved by the Court. The settlement agreement was subject to certain terms and conditions and received final approval by the Court on
December 16, 2022. At that time, a final judgement was entered dismissing the case, with the Court retaining jurisdiction over the action
for purposes of enforcing the terms of the class settlement agreement. The $3.3 million settlement was paid by our insurance provider
under our insurance policy as our retention had previously been exhausted.
The lead plaintiff in the class
action filed a motion for distribution of settlement funds on February 21, 2023. The court approved the parties’ class action settlement
and plan of allocation on March 22, 2023, and cancelled the previously-rescheduled March 31, 2023, hearing on the motion for distribution,
all remaining matters in the class action then-pending have been fully and finally adjudicated.
Securities Investigation
On August 8, 2021, we received
a notification from the SEC, Division of Enforcement, that it was conducting an investigation captioned In the Matter of Intrusion
Inc. and requesting we produce certain documents and information. On November 9, 2021, the SEC served a subpoena to us in connection with
this investigation which formally requested substantially similar information as in the prior request. On September 26, 2023, we consented
to the entry of final judgment, in the act styled Securities and Exchange Commission v Intrusion Inc, No. 4:23-CV-00859 (E.D. Tex.
Filed September 26, 2023). On October 5, 2023, the court approved the final judgment with no penalties assessed against the Company.
Stockholder Derivative Claim
On June 3, 2022, a stockholder
derivative complaint was filed in U.S. District Court, District of Delaware by plaintiff Nathan Prawitt (the “Plaintiff Stockholder”)
on behalf of Intrusion against certain of our current and former officers and directors (collectively the “Defendants”). Plaintiff
alleges that Defendants through various actions breached their fiduciary duties, wasted corporate assets, and unjustly enriched Defendants
by (a) incurring costs and expenses in connection with the ongoing SEC investigation, (b) incurring costs and expenses to defend us with
respect to the consolidated class action, (c) settling class-wide liability with respect to the consolidated class action, as well as
ancillary claims regarding sales of our common stock by certain of the Defendants. On September 28, 2023, we agreed to settle the claim.
On October 2, 2023, public notice of the settlement agreement was given. The settlement agreement provides in part for (i) an amendment
to our Bylaws, committee Charters, and other applicable corporate policies to implement certain measures set forth more fully therein,
to remain in effect for no less than three years; (ii) attorneys’ fees and expenses to plaintiff’s counsel of $0.3 million;
and (iii) the dismissal of all claims against the Defendants, including the Company, in connection with the action. The $0.3 million settlement
payment was paid by our insurance provider under our insurance policy since our $0.5 million retention was previously exhausted. A hearing
is scheduled for April 3, 2024, to obtain court approval of the settlement, agreement for the court to rule upon any objections to the
proposed settlement, and for entry of final judgment in the matter.
In addition to these legal
proceedings, we are subject to various other claims that may arise in the ordinary course of business. We do not believe that any claims
exist where the outcome of such matters would have a material adverse effect on our consolidated financial position, operating results,
or cash flows. However, there can be no assurance such legal proceedings will not have a material impact on our future results.
PART II
Item 5. Market for Common Equity and Related Stockholder Matters and
Business Issuer Purchases of Equity Securities.
Our common stock trades on
the Nasdaq Capital Market, where it is currently listed under the symbol “INTZ.” As of March 25, 2024, there were approximately
ninety-five registered holders of record of our common stock. The Company does not have a history of paying dividends on its common stock
and has no present intention to declare any dividends in the foreseeable future.
All equity compensation plans
under which our common stock is reserved for issuance have previously been approved by our stockholders. The following table provides
summary information as of December 31, 2023, for all our equity compensation plans (in thousands, except per share data). See Note 10
– Stock-Based Compensation to our Consolidated Financial Statements for additional discussion.
Equity compensation plans approved by security holders 50 $ 62.40 11 $ 26.20 82
Equity compensation plans not approved by security holders – – – – –
Item 7. Management’s Discussion and Analysis of Financial Condition
and Results of Operations.
General
The following discussion and
analysis include information management believes is relevant to understand and assess our consolidated financial condition and results
of operations. This section should be read in conjunction with our Consolidated Financial Statements, accompanying notes and the risk
factors contained in this report.
Overview
Intrusion Inc. offers businesses
of all sizes and industries products and services that leverage the Company’s exclusive threat intelligence database of over 8.5
billion IP addresses and domain names. After many years of gathering intelligence and providing our INTRUSION TraceCop and
Savant solutions exclusively to government entities, we released our first commercial product in 2021, the INTRUSION
Shield. INTRUSION Shield was designed to allow businesses to incorporate a Zero Trust, reputation-based security
solution into their existing infrastructure to observe traffic flow and instantly block known malicious or unknown connections from both
entering or exiting a network, making it an ideal solution for protecting from Zero-Day and ransomware attacks.
Much of 2022 was spent improving
the INTRUSION Shield On-Premise performance and developing the Shield Cloud and End-Point solutions, both
of which were released in September 2022. During 2023, our primary focus has been building out our sales reseller and channel platform
and working with those partners to 1) increase our sales pipeline and 2) progress customer prospects, leads and opportunities through
the sales lifecycle. Gaining traction with our Shield solutions has taken longer than initially anticipated. We feel that
the progress made with our reseller and channel community along with refining our product messaging will help to shorten the sales cycle
and grow revenues in future periods.
As discussed in more detail below,
on December 31, 2023, we had $0.1 million in cash. If we are not able to obtain additional debt or equity financing on terms and conditions
acceptable to us, we may be unable to implement our business plan, fund our liquidity needs or even continue our operations.
Results of Operations
Comparison of the Years ended December 31, 2023, and December 31, 2022
Year Ended December 31, Change
Operating Expenses:
Income Tax – – – –
Revenues
Total revenue decreased $1.9
million or 25.5% to $5.6 million in 2023 from $7.5 million in 2022. Consulting revenues decreased $2.3 million primarily resulting from
the loss of a contract in the fourth quarter 2022 in which Intrusion’s prime sponsor chose not to renew the final option year of
a contract that had been in place since 2018. This contract represented annual revenue totaling $2.6 million. While the loss of this
contract significantly impacted Intrusion’s top-line revenue, the gross margin on this contract was 14% and, as a result, had a
marginal impact on profitability. We are continuing to pursue new consulting opportunities and expect to see an increase in consulting
revenues in 2024. The decline in consulting revenues was partially offset by an increase of $0.4 million in Shield revenues
as a result of the expanded use of Shield from existing customers and new customers signed in 2023.
We announced a $5 million
multi-year Shield award in October 2023. The rollout of the Shield services to this customer has been delayed
due to factors outside of our control, we expect this project to be back on track beginning in the second quarter 2024. Additionally,
we were informed by our largest Shield customer that they will not be renewing their contract. This customer was one of
the original users of the product and had a non-standard custom implementation of INTRUSION Shield that is no longer supported.
This non-renewal will impact revenues beginning in the second quarter 2024. We are beginning to see traction with our Shield
products with multiple Shield sales that, essentially, are paid proof of values which have the potential for significant
Shield sales growth beyond the initial engagement. On December 31, 2023, our Shield opportunities comprised
a large percentage of our sales pipeline.
Concentration of Revenues.
Revenues from sales to various
U.S. government entities totaled $2.6 million, or 46.2% of revenues, for the year ended December 31, 2023, compared to $5.0 million, or
65.8% of revenues, for the same period in 2022. In 2023 we had two government entities that individually accounted for over 10% of our
revenues compared to three in 2022. Sales to commercial customers totaled $3.0 million or 53.8% of total revenue for year ended December
31, 2023, compared to $2.6 million or 34.2% of total revenue for the same period in 2022. Two commercial customers individually accounted
for over 10% of total revenues in both 2023 and 2022. We have increased our Shield sales and marketing efforts by expanding
our reseller channels. We anticipate our concentration of revenues will vary among customers in future periods depending upon the timing
of certain sales, we anticipate that sales to government customers, while comprising a significant portion of our revenues in future periods,
will represent a lower percentage of our revenue base as we gain traction selling our Shield products into commercial markets.
Sales to the government present
risks in addition to those involved in sales to commercial customers which could adversely affect our revenues, including, without limitation,
potential disruption to appropriation and spending patterns and the government’s reservation of the right to cancel contracts and
purchase orders for its convenience. Fourth quarter 2023 revenues declined 7% sequentially from third quarter 2023 primarily due to the
continuing resolution and the absence of an approved federal budget, which has resulted in many new spending decisions from government
customers being delayed. Specifically, a long-standing Department of Defense contract has not been funded for the 2024 government fiscal
year, this resulted in lower consulting revenues in the fourth quarter and has also impacted first quarter 2024 revenues. Currently, we
are not aware of any additional proposed cancellation or renegotiation of any of our existing arrangements with government entities and,
historically, cancellations or renegotiated orders by government entities have not resulted in a material adverse effect on our business.
The Company’s similar product
and service offerings are not viewed as individual segments, as its management analyzes the business as a whole and expenses are not allocated
to each product offering.
Gross Profit
Gross profit for the 12-months
ended December 31, 2023, and 2022 totaled $4.4 million or 77.6% compared to $4.2 million or 55.5%. The significantly improved gross margin
in 2023 is mostly due to the loss of the low margin contract discussed above and Shield revenues representing a larger percentage
of revenues, 28.4% compared to 15.6% in 2022. To the extent Shield revenues become a larger percentage of revenues, we anticipate
we will continue to see favorable growth in gross profit margins.
Operating Expenses
Operating expenses for the
year ended December 31, 2023, totaled $16.4 million, a decrease of 19.8% when compared to $20.5 million for the year ended December 31,
2022. The year over year change was most notably due to the reduced legal expense associated with the various litigation matters that
arose in 2021 that for the most part are fully settled, and reduced contractor labor and employee costs. Employee headcount on December
31, 2023, totaled forty-nine compared to sixty-seven on December 31, 2022.
Sales and
Marketing
Sales and marketing expenses
decreased to $5.7 million in 2023, compared to $6.5 million in 2022. Certain discretionary marketing spends inclusive of participation
in trade shows, utilization of third-party contractors for content and product messaging and travel, are likely to vary over time based
on savings initiatives that may be necessary.
Research and Development
Research and development expenses
decreased to $5.6 million in 2023 compared to $6.5 million in 2022. Many of the cost reduction measures taken in 2023 related to research
and development costs. Research and development costs may vary over time as we determine the frequency of new releases, improved functionality
and enhancements needed to be competitive with our product offering.
General and
Administrative
General and administrative
expenses totaled $5.2 million in 2023 compared to $7.5 million in 2022. The decrease in general and administrative expenses is primarily
due to a reduction in legal costs of $1.4 million associated with various litigation matters that arose in 2021 and continued through
2023. The majority of all matters have since settled as described in more detail in Item 3. Legal Proceedings of this report. In late
2022 we hired an in-house General Counsel which also contributed to the reduced outside legal costs in 2023. Other factors contributing
to the decreased spend include (i) reduced use of consultants and contractors in 2023, (ii) recruiting fees incurred in the 2022 period,
and (iii) voluntary temporary reductions in director and officer compensation. Insurance expense for our Directors’ and Officers’
insurance policy increased in 2023 when compared to 2022 as a result of the class action lawsuits and related claims activity and, increasing
coverage limits for our new policy year.
Interest Expense
Our interest expense consists
primarily of interest related to the Streeterville notes entered into in March and June of 2022 and related debt issuance cost amortization
as well as interest expense from finance leases. Interest expense for 2023 totaled $1.9 million, a decrease of $0.5 million. The decrease
primarily relates to the reversal of interest recorded to accrete the value of the Streeterville notes to the stock-settled value for
potential redemptions paid in stock as no redemption payments in cash or stock were made in 2023.
Interest and Other Income
Interest and other income were
negligible in 2023. 2022 included $2.0 million related to the Cares Act Employee Retention Credit (“ERC”).
Gain on Lease Termination
In 2022 we recorded a gain of
$0.4 million relating to the settlement of our lease abandonment lawsuit.
Income Taxes
Our effective income tax rate
was 0% in 2023 and 2022 as valuation allowances have been recorded for the entire amount of the net deferred tax assets due to uncertainty
of realization.
Consolidated Statements of Cash Flows
Our cash flows for the years ended
December 31, 2023, and 2022 (in thousands) were:
Year Ended
Net cash used in operating activities $ (7,767 ) $ (13,190 )
Net cash used in investing activities (1,448 ) (1,479 )
Net cash provided by financing activities 6,339 13,584
Change in cash and cash equivalents $ (2,876 ) $ (1,085 )
Operating Activities
Net cash used in operations
for the year ended December 31, 2023, was ($7.8) million due to a net loss of ($13.9) million, offset by 1) adjustments for non-cash items
of $4.7 million which are mostly comprised of depreciation, stock-based compensation, and interest related to Streeterville notes and
2) $1.4 million provided from working capital principally relating to the cash receipt of amounts due relating to ERC.
Net cash used in operations for
the year ended December 31, 2022, was ($13.2) million due to a net loss of ($16.2) million offset by adjustments for non-cash items of
$5.0 million which are mostly comprised of depreciation, stock-based compensation and interest related to Streeterville notes, and changes
in working capital consisting primarily of a reduction in trade receivables of $0.5 million; an increase in other receivables relating
principally to the remaining ERC refund outstanding ($1.5) million; an increase in accounts payable and accrued expenses $0.2 million;
and a decrease in operating lease liabilities ($1.0) million.
Investing Activities
For the year ended December 31,
2023, net cash used in investing activities was ($1.4) million, which was principally the capitalization of internally developed software.
Net cash used in investing
activities for the year ended December 31, 2022, totaled ($1.5) million and was primarily related to capitalized internal use software
of ($1.2) million for the new Shield Cloud and End Point solutions as well as enhancements to the Shield On-Premise
solution and, the purchase of equipment for use with the Shield On-Premise solution, in the data center and by employees
of ($0.3) million.
Financing Activities
For year ended December 31,
2023, net cash provided by financing activities was $6.3 million which consisted principally of proceeds from sales of common stock using
our ATM program of $4.7 million and a private placement in November 2023 of $2.3 million offset partially by a $0.4 million paydown on
the Streeterville notes.
Net cash provided by financing
activities was $13.6 million for the year ended December 31, 2022. Primary sources of cash from financing activities included proceeds
from the issuance of the two Streeterville notes payable, net of issuance costs, equal to $9.3 million (see Note 6 Notes Payable
to the Consolidated Financial Statements in Part II, Item 8 of this Form 10-K), net proceeds received from our registered direct offering
of $4.3 million, net proceeds from issuance of shares from our ATM program of $2.0 million, and proceeds received from a private placement
sale of common stock equal to $0.1 million. Funds used in financing activities included ($1.5) million in principal repayments on the
Streeterville notes payable and ($0.6) million payments on equipment financing leases.
Liquidity and Capital Resources
As of December 31, 2023, we had
cash and cash equivalents of $0.1 million and a working capital deficit of ($13.1) million. We need to raise additional funds to continue
operations and comply with our financial obligations.
We are executing a plan to
regain compliance with the Nasdaq listing standards as described more fully in Item 1A Risk Factors. This multi-step plan includes: 1)
continued utilization of our ATM program, 2) private offerings of common stock, 3) a warrant inducement offer for the sale of common stock
at a reduced exercise price to warrant holders from the Company’s 2022 registered direct offering and November 2023 private offerings,
and 4) a series of three transactions in the fourth quarter 2023 and two transactions in March 2024 exchanging $10.0 million in senior
debt for $750 thousand in common stock and $9.3 million new preferred Series A stock. While the debt for equity exchanges does not provide
funding for operations, it substantially deleverages the company and reduces the working capital deficit. We can provide no assurances
that we will be able to close on or obtain such financing on acceptable terms or at all and, in the case of equity or equity-linked financings,
such financings will result in additional dilution to our stockholders.
Our principal sources of cash
for funding operations in 2023 has been net proceeds received from sales of common stock using our ATM program of $4.7 million, a private
placement offering completed in November 2023 of $2.3 million, and net funds through changes in working capital which includes receipt
of the remaining ERC refund in the March quarter of $1.4 million. Our principal source of cash for funding operations and growth in 2022
was issuance of the two Streeterville notes which contributed $9.3 million, net of issuance costs, and $6.4 million from the sale and
issuance of common stock and warrants.