Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 


 

ý

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30,, 2019

2020
 

OR

 

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                  to                       

 

Commission File Number  0-20191

 

INTRUSION INC.

(Exact name of registrant as specified in its charter)

 

Delaware

 

75-1911917

(State or other jurisdiction of
incorporation or organization)

 

(I.R.S. Employer
Identification No.)

 

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

(Address of principal executive offices)

(Zip Code)

 

(972) 234-6400

(Registrant’s telephone number, including area code)

 

Not Applicable

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

 

* * * * * * * * * *

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

Title of each classTrading Symbol(s)Name of each exchange on which registered
N/AN/AN/A

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

Yes ý No o

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

 

Yes ý No o

 

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 is a shell company (as defined in Rule 12b-2 of the Exchange Act): Yes o No ý

 

The number of shares outstanding of the Registrant’s Common Stock, $0.01 par value, on November 1, 20192020 was 13,539,736.17,394,279.

 




 

INTRUSION INC.

 

INDEX

 

PART I – FINANCIAL INFORMATION

 
  

Item 1.  Financial Statements

 
  

Unaudited Condensed Consolidated Balance Sheets as of September 30, 20192020 and December 31, 2018

2019
3
  

Unaudited Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 20192020 and 2018

2019
4
  

Unaudited Condensed Consolidated Statements of Changes in Stockholders’ Equity (Deficit) for the nine  months ended September 30, 20192020 and 2018

2019
5
  

Unaudited Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 20192020 and 2018

2019
6
  

Notes to Unaudited Condensed Consolidated Financial Statements

7
  

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

1113
  

Item 4.  Controls and Procedures

1417
  

PART II – OTHER INFORMATION

 
  

Item 1.  Legal Proceedings

15

Item 1A. Risk Factors

15

Item 6. Exhibits

18
  

Item 1A.  Risk Factors

18
Item 6.  Exhibits24
Signature Page

1925

 

2

 

PART I – FINANCIAL INFORMATION

 

Item 1. FINANCIAL STATEMENTS

 

INTRUSION INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except par value amounts)

 

 

September 30,

2019

  

December 31,
2018

  September 30
2020
  December 31,
2019
 

ASSETS

             

Current Assets:

                

Cash and cash equivalents

 $2,111  $1,652  $1,505  $3,334 

Accounts receivable

  2,704   1,967   1,030   1,566 

Prepaid expenses

  136   91   647   152 

Total current assets

  4,951   3,710   3,182   5,052 

Noncurrent Assets:

                

Property and equipment, net

  295   200   356   335 

Finance leases, right-of-use assets, net

  73   121   30   62 

Operating lease, right-of-use assets, net

  1,407    
Operating leases, right-of-use asset, net  1,160   1,348 

Other assets

  38   38   57   38 

Total noncurrent assets

  1,813   359   1,603   1,783 

TOTAL ASSETS

 $6,764  $4,069  $4,785  $6,835 
                

LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)

        
        
LIABILITIES AND STOCKHOLDERS’ EQUITY        

Current Liabilities:

                

Accounts payable and accrued expenses

 $1,078  $1,596  $1,420  $1,080 

Dividends payable

  32   594      20 

Finance leases liability, current portion

  43   58   31   43 

Operating lease liability, current portion

  277    
Operating leases liability, current portion  295   284 
PPP loan payable, current portion  392    

Deferred revenue

  643   1,004   58   516 

Total current liabilities

  2,073   3,252   2,196   1,943 

Noncurrent Liabilities:

                

Loan payable to officer

     1,815 

Finance leases liability, noncurrent portion

  32   64   1   21 

Operating lease liability, noncurrent portion

  1,389    
Operating leases liability, noncurrent portion  1,095   1,315 
PPP loan payable, noncurrent portion  239    

Total noncurrent liabilities

  1,421   1,879   1,335   1,336 
                

Commitments and contingencies

                

Stockholders’ equity (deficit):

        
        
Stockholders’ equity:        

Preferred stock, $0.01 par value: Authorized shares – 5,000

                

Series 1 shares issued and outstanding — 200 Liquidation preference of $1,025 in 2019 and $1,213 in 2018

  707   707 

Series 2 shares issued and outstanding — 460 Liquidation preference of $1,155 in 2019 and $1,385 in 2018

  724   724 

Series 3 shares issued and outstanding — 289 Liquidation preference of $633 in 2019 and $760 in 2018

  412   412 

Common stock, $0.01 par value:

        

Authorized shares — 80,000

        

Issued shares — 13,550 in 2019 and 13,259 in 2018 Outstanding shares — 13,540 in 2019 and 13,249 in 2018

  135   133 
Series 1 shares issued and outstanding — 0 in 2020 and 200 in 2019 Liquidation preference of $1,013 in 2019     707 
Series 2 shares issued and outstanding — 0 in 2020 and 460 in 2019 Liquidation preference of $1,155 in 2019     724 
Series 3 shares issued and outstanding — 0 in 2020 and 289 in 2019 Liquidation preference of $634 in 2019     412 
Common stock, $0.01 par value: Authorized shares — 80,000        
Issued shares — 14,939 in 2020 and 13,552 in 2019 Outstanding shares — 14,929 in 2020 and 13,542 in 2019  149   136 

Common stock held in treasury, at cost – 10 shares

  (362

)

  (362

)

  (362  (362

Additional paid-in capital

  56,770   56,609   58,877   56,759 

Accumulated deficit

  (55,073

)

  (59,242

)

  (57,367)  (54,777)

Accumulated other comprehensive loss

  (43

)

  (43

)

  (43  (43

Total stockholders’ equity (deficit)

  3,270   (1,062

)

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)

 $6,764  $4,069 
Total stockholders’ equity  1,254   3,556 
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY $4,785  $6,835 

 

See accompanying notes.

 

3

 

INTRUSION INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)

 

 

Three Months Ended

  

Nine Months Ended

  Three Months Ended Nine Months Ended 
 

September 30,

2019

  

September 30,

2018

  

September 30,

2019

  

September 30,

2018

  September 30, 2020  September 30, 2019  September 30, 2020  September 30, 2019 

Revenue

 $3,860  $2,665  $11,071  $7,296  $1,588  $3,860  $5,039  $11,071 

Cost of revenue

  1,465   967   4,339   2,744   652   1,465   2,050   4,339 
                                

Gross profit

  2,395   1,698   6,732   4,552   936   2,395   2,989   6,732 
                                

Operating expenses:

                                

Sales and marketing

  356   466   813   1,311   885   356   1,880   813 

Research and development

  297   329   775   832   1,081   297   2,741   775 

General and administrative

  277   243   930   828   377   277   962   930 
                                

Operating income

  1,465   660   4,214   1,581 
Operating income (loss)  (1,407)  1,465   (2,594)  4,214 
                                

Interest expense, net

  (1

)

  (43

)

  (45

)

  (144

)

Interest income        8    
Interest expense  (2)  (1)  (4)  (45)
                                

Net income

 $1,464  $617  $4,169  $1,437 
Net income (loss) $(1,409 $1,464  $(2,590 $4,169 
                                

Preferred stock dividends accrued

  (35

)

  (35

)

  (104

)

  (104

)

  (13)  (35)  (79)  (104)

Net income attributable to common stockholders

 $1,429  $582  $4,065  $1,333 
Net income (loss) attributable to common stockholders $(1,422) $1,429  $(2,669) $4,065 
                                

Net income per share attributable to common stockholders: Basic

 $0.11  $0.04  $0.30  $0.10 
Net income (loss) per share attributable to common stockholders:                 
Basic $(0.10) $0.11  $(0.19) $0.30 

Diluted

 $0.09  $0.04  $0.27  $0.09  $(0.10) $0.09  $(0.19) $0.27 
                                

Weighted average common shares outstanding: Basic

  13,523   13,062   13,466   13,009 
Weighted average common shares outstanding:                
Basic  14,450   13,523   13,981   13,466 

Diluted

  15,371   14,955   15,314   14,901   14,450   15,371   13,981   15,314 

 

See accompanying notes.

 

4

 

INTRUSION INC. AND SUBSIDIARIES

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

(In thousands)

 

 

Nine Months Ended

  Nine Months Ended 
 

September 30,

2019

  

September 30,

2018

  September 30, 2020  September 30, 2019 

NUMBER OF PREFERRED SHARES—ISSUED AND OUTSTANDING

             

Balance, beginning of year and end of nine month period

  949   949 
Balance, beginning of year  949   949 
Conversion of preferred shares to common shares  (949   
Balance, end of nine month period     949 

PREFERRED STOCK

                

Balance, beginning of year and end of nine month period

 $1,843  $1,843 
Balance, beginning of year $1,843  $1,843 
Conversion of preferred shares to common shares  (1,843   
Balance, end of nine month period $  $1,843 

NUMBER OF COMMON SHARES—ISSUED

                

Balance, beginning of year

  13,259   12,808   13,552   13,259 

Exercise of stock options

  291   322   320   291 
Conversion of preferred shares to common shares  1,067    

Balance, end of nine month period

  13,550   13,130   14,939   13,550 

COMMON STOCK

                

Balance, beginning of year

 $133  $128  $136  $133 

Exercise of stock options

  2   3   3   2 
Conversion of preferred shares to common shares  10    

Balance, end of nine month period

 $135  $131  $149  $135 

TREASURY SHARES

                

Balance, beginning of year and end of nine month period

 $(362

)

 $(362

)

 $(362 $(362

ADDITIONAL PAID-IN-CAPITAL

                

Balance, beginning of year

 $56,609  $56,518  $56,759  $56,609 

Stock-based compensation

  24   16   174   24 

Exercise of stock options

  234   108   190   234 
Conversion of preferred shares to common shares  1,833    

Preferred stock dividends declared, net of waived penalties by shareholders

  (97

)

  (70

)

  (79  (97)

Balance, end of nine month period

 $56,770  $56,572  $58,877  $56,770 

ACCUMULATED DEFICIT

                

Balance, beginning of year

 $(59,242

)

 $(61,529

)

 $(54,777 $(59,242

Net income

  4,169   1,437 
Net income (loss)  (2,590)  4,169 

Balance, end of nine month period

 $(55,073

)

 $(60,092

)

 $(57,367 $(55,073

ACCUMULATED OTHER COMPREHENSIVE LOSS

                

Balance, beginning of year and end of nine month period

 $(43

)

 $(43

)

 $(43 $(43)

TOTAL STOCKHOLDERS’ EQUITY (DEFICIT)

 $3,270  $(1,950

)

TOTAL STOCKHOLDERS’ EQUITY $1,254  $3,270 

 

See accompanying notes.

 


5

 

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

 

 

Nine Months Ended

  Nine Months Ended 
 

September 30,

2019

  

September 30,

2018

  September 30,
2020
  September 30,
2019
 

Operating Activities:

                

Net income

 $4,169  $1,437 

Adjustments to reconcile net income to net cash provided by operating activities:

        
Net income (loss) (2,590 $4,169 
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:        

Depreciation and amortization

  136   96   164   136 

Stock-based compensation

  24   16   174   24 

Penalties on dividends

  6   34      6 

Extinguishment of U.K. cumulative translation adjustment

     65 
Noncash lease costs  186   364 

Changes in operating assets and liabilities:

                

Accounts receivable

  (737

)

  (155

)

  536   (737

Inventories

     15 

Prepaid expenses and other assets

  (45

)

  (120

)

  (514)  (45)

Operating lease, right-of-use asset

  364    

Accounts payable and accrued expenses

  (621

)

  191   134   (621

Deferred revenue

  (361

)

  213   (457)  (361

Net cash provided by operating activities

  2,935   1,792 
Net cash provided by (used in) operating activities  (2,367  2,935 
                

Investing Activities:

                

Purchases of property and equipment

  (183

)

  (173

)

  (153  (183
                

Financing Activities:

                

Borrowings on loan from officer

     150 
Proceeds from PPP loan payable  629    

Payments on loan from officer

  (1,815

)

  (1,200

)

     (1,815

Proceeds from stock options exercised

  236   111   193   236 

Payments of dividends

  (667

)

     (99  (667

Reduction of finance lease liability

  (47

)

  (51

)

  (32)  (47

Net cash used in financing activities

  (2,293

)

  (990

)

Net cash provided by (used in) financing activities  691   (2,293
                

Net increase in cash and cash equivalents

  459   629 
Net increase (decrease) in cash and cash equivalents  (1,829  459 

Cash and cash equivalents at beginning of period

  1,652   224   3,334   1,652 

Cash and cash equivalents at end of period

 $2,111  $853  $1,505  $2,111 
                
        

SUPPLEMENTAL DISCLOSURE OF NON CASH OPERATING AND FINANCING ACTIVITIES:

                
        

Preferred stock dividends accrued

 $103  $104  $79  $103 

Purchase of leased equipment per right-of-use finance lease

 $  $89 

Initial recognition of operating lease, right-of-use asset

 $1,771  $ 
Conversion of preferred stock to common $1,843  $ 

 

See accompanying notes.

 

6

INTRUSION INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

 

1.

Description of Business

 

We develop, market and support a family of entity identification, high speed data mining and cybersecurity solutions. Our products help detect, report and mitigate cybercrimes and advanced persistent threats.

Our product families include:

TraceCop for entity identification, cybercrime detection and disclosure, and;

Savant for high speed data mining. analytics, detection, reporting and mitigation of cybersecurity threats.

Intrusion’s products help protect critical information assets by quickly detecting, protecting, analyzing and reporting attacks or misuse of classified, private and regulated information for government and enterprise networks.

We market and distribute our products through a direct sales force to: Our product families include the following:

 

·

end-users,TraceCop. Our TraceCop solution family includes a database of more than 400 terabytes of worldwide IP addresses, registrant information and

value-added resellers.

their associations, along with a plurality of related IP information, some dating back nearly two decades. When combined with Intrusion’s multitude of cyber security ‘global threat feeds’, along with our TraceCop family of proprietary supporting tools, this vast and ever expanding capability is used in conjunction with our customer’s data to help identify areas of vulnerability and potential cyber security threats. In addition to its extensive capability, the TraceCop family includes analytical software with a GUI interface to assist the analysts in locating cybercriminals and other potential ‘bad actors’ or network anomalies.

 

Our end-user customers include:

·Savant. Savant is a high speed network data mining and analysis hardware and software solution that organizes the data into networks of relationships and associations. Its patented design exceeds performance expectations and ensures ‘deep dives’ into data-in-motion in order to quickly and accurately detect advanced persistent threats. Savant can operate on networks with data flows of over 20 gigabits per second, and still maintain a 100% inspection rate of all packets.

 

·

U.S.INTRUSION Shield.  Intrusion Shield is designed as a next generation intrusion detection and protection solution.  After 20 years of providing research, analysis, and tools to the federal government entities,

state and localenterprise corporations, Intrusion possesses a comprehensive and proprietary database of Internet activity, including information about the activities of malicious online actors.  Intrusion’s Shield solution combines the comprehensive database with artificial intelligence (AI) and real-time process flow technology to provide businesses and government entities,

largeagencies with a unique and diverse conglomerates,

manufacturing entities,affordable tool to detect, identify, and

other customers.

neutralize malware. The Shield AI has been specifically trained to identify and stop ransomware, the most prolific and crippling form of malware. Shield is a combination of plug-and-play hardware, software, global data, and AI services providing organizations with aggressive protection against unaddressed information security threats and the most robust defense possible against cybercrime. Unlike traditional industry approaches that rely heavily on human resources, which malicious actors have learned to bypass, Intrusion Shield uses our extensive database together with real-time AI technology to prevent illicit behavior.  Shield’s proprietary architecture isolates and neutralizes malicious traffic and network flows that existing solutions cannot identify. Most breaches today are caused by malware free compromises that trigger no alarms in a firewall or endpoint solution. The common denominator is network communications, and Shield monitors and analyses all network traffic and communications allowing it to identify and stop malware-free attacks. Shield’s capabilities will continuously evolve based on real-time.

 

We were organized in Texas in September 1983 and reincorporated in Delaware in October 1995. Our principal executive offices are located at 1101 East Arapaho Road, Suite 200, Richardson, Texas 75081, and our telephone number is (972) 234-6400. Our website URL is www.intrusion.com. References to the “Company”, “we”, “us”, “our”, “Intrusion” or “Intrusion Inc.” refer to Intrusion Inc. and its subsidiaries. TraceCop and Savant are trademarks of Intrusion Inc.

·Additional Shield Products In Development. In addition to INTRUSION Shield, we are developing complementary solutions to create a family of Shield offerings, including our first follow on offering, Shield CLOUD, which is targeted for use by businesses with a dedicated or hybrid Cloud network environment. We are in the process of Alpha testing Shield CLOUD, and we are developing additional solutions that will address cybersecurity needs in the areas of lateral traffic, remote employees, WiFi, and mobile devices.

 

2.

Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Item 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. The December 31, 20182019 balance sheet was derived from audited financial statements, but does not include all the disclosures required by accounting principles generally accepted in the United States. However, we believe that the disclosures are adequate to make the information presented not misleading. In our opinion, all the adjustments (consisting of normal recurring adjustments) considered necessary for fair presentation have been included. The results of operations for the three and nine month periods ended September 30, 20192020 are not necessarily indicative of the results that may be achieved for the full fiscal year or for any future period. The unaudited condensed consolidated financial statements included herein should be read in conjunction with the consolidated financial statements and notes thereto included in our annual report on Form 10-K for the year ended December 31, 2018,2019, filed with the U.S. Securities and Exchange Commission (the “SEC”) on March 28, 2019.27, 2020.

7

 

The Company calculates the fair value of its assets and liabilities which qualify as financial instruments and includes this additional information in the notes to consolidated financial statements when the fair value is different from the carrying value of these financial instruments. The estimated fair value of accounts receivable, accounts payable and accrued expenses, and dividends payable approximate their carrying amounts due to the relatively short maturity of these instruments. Loans payable to officer are with a related party and as a result do not bear market rates of interest.  Management believes based on its current financial position that it could not obtain comparable amounts of third party financing, and as such cannot estimate the fair value of the loans payable to officer. None of these instruments are held for trading purposes.

On January 1, 2018 we adopted ASU No. 2014-09, Revenue from Contracts with Customers, as amended, using the modified retrospective approach. At the date of adoption there was no impact on the balance sheet or statement of operations. ASU No. 2014-09 did not have a material effect on the Company’s financial position, results of operations or cash flows for the three and nine month periods ended September 30, 2019 and 2018.


 

On January 1, 2019 we adopted ASU No. 2016-02, Leases (topic 842). At the date of adoption there was no impact on the statement of operations, while the balance sheet reflects recording both assets and liabilities applicable to the operating right-of-use asset lease identified. ASU No. 2016-02 did not have a material effect on the Company’s results of operations or cash flows for the three and nine month periods ended September 30, 2020 and 2019.

 

3.

Loan Payable to Officer

 

On February 8, 2018, the Company entered into an unsecured revolving promissory note to borrow up to $3,700,000 from G. Ward Paxton, the Company’s Chief Executive Officer (the “CEO Note”).Paxton. Under the terms of the CEO Note, the Company had the ability to borrow, repay and reborrow on the loan as needed up to an outstanding principal balance due of $3,700,000 at any given time through March 2020.

 

On February 7, 2019, the Company amended the unsecured revolving promissory note to borrow up to $2,700,000 from G. Ward Paxton, the Company’s former Chief Executive Officer. Amounts borrowed under the CEO Note accrued interest at a floating rate per annum equal to Silicon Valley Bank’s (“SVB”) prime rate plus 1%. Under the terms of the note, the Company had the ability to borrow, repay and reborrow on the loan as needed up to an outstanding principal balance due of $2,700,000 at any given time through March 2021.

Amounts borrowed We reduced our borrowing under the CEO Note officer accrued interest at a floating rate per annum equalthis note to Silicon Valley Bank’s (“SVB”) prime rate plus 1%. Any outstanding borrowings and accrued but unpaid interest is due on March 31, 2021. Aszero as of September 30, 2019, there were no borrowings or accrued interest outstandingMay 2019.

 

As of October 24, 2019.2019, G. Ward Paxton passed away, terminating the CEO Note with the result that future borrowings thereunder will no longer be available to the Company. Our management will be assessing whether to replace this borrowing base and assessing what terms may be available to the Company, including whether any such terms are acceptable to the Company, if at all.

 

4.

Accounting for Stock-Based Compensation

 

During the three month periods ended September 30, 20192020 and 2018,2019, the Company did not grant anygranted 10,000 and none, respectively, of stock options to employees or directors. The Company recognized $10,000$100,000 and $5,000,$10,000, respectively, of stock-based compensation expense for the three month periods ended September 30, 20192020 and 2018.2019. During the nine month periods ended September 30, 20192020 and 2018,2019, the Company granted 24,000333,000 and 24,000, respectively, of stock options to employees and directors. The Company recognized $24,000$174,000 and $16,000,$24,000, respectively, of stock-based compensation expense for the nine month periods ended September 30, 20192020 and 2018.2019.

 

During the three month periods ended September 30, 2020 and 2019, 133,000 (30,000 under 2015 plan and 2018,103,000 under the 2005 Plan) and 10,500 and 103,500(2005 Plan) options were exercised, under the 2005 Plan, respectively. During the nine month periods ended September 30, 2020 and 2019, 319,600 (45,000 under the 2015 Plan and 2018, 291,000 and 322,500 were exercised274,600 under the 2005 Plan,Plan) and 291,000 (2005 Plan) options were exercised, respectively.

 

Valuation Assumptions

 

The fair values of employee and director option awards were estimated at the date of grant using a Black-Scholes option-pricing model with the following assumptions:

 

 

For Three

Months
Ended

September 30,
2020

  

For Three

Months
Ended

September 30,
2019

  

For Nine

Months
Ended
September 30,
2020

  For Nine
Months
Ended
September 30,
2019
 
Weighted average grant date fair value  4.98     $2.86  $3.61 
Weighted average assumptions used:                
Expected dividend yield  0.0     0.0  0.0
Risk-free interest rate  0.23%     0.42%  2.19%
Expected volatility  70.85%     76.85%  127.52%
Expected life (in years)  5.0      6.13   5.0 

  

For Three

Months Ended

September 30, 2019

  

For Three

Months Ended

September 30, 2018

  

For Nine

Months Ended

September 30, 2019

  

For Nine

Months Ended

September 30, 2018

 
                 

Weighted average grant date fair value

       $3.61  $0.99 

Weighted average assumptions used:

                

Expected dividend yield

        0.0

%

  0.0

%

Risk-free interest rate

        2.19

%

  2.93

%

Expected volatility

        127.52

%

  131.0

%

Expected life (in years)

        5.0   5.0 
8

 

Expected volatility is based on historical volatility and in part on implied volatility. The expected term considers the contractual term of the option as well as historical exercise and forfeiture behavior. The risk-free interest rate is based on the rates in effect on the grant date for U.S. Treasury instruments with maturities matching the relevant expected term of the award. Options granted to non-employees are valued using the fair market value on each measurement date of the option.

 


5.Revenue Recognition

 

We generally recognize product revenue upon shipment or after meeting certain performance obligations. These products can include hardware, perpetual software licenses and data sets. Data set updates are the majority of our sales. We do not currently offer software on a subscription basis. Warranty costs and sales returns have not been material.

We recognize sales of our data sets in accordance with FASB ASC Topic 606 whereby revenue from contracts with

customers is not recognized until all five of the following have been met:

5.

Contract Assetsi)

identify the contract with a customer;
ii)identify the performance obligations in the contract;
iii)determine the transaction price;
iv)allocate the transaction price to the separate performance obligations; and Contract Liabilities

v)recognize revenue upon satisfaction of a performance obligation.

Data updates are typically done monthly and revenue will be matched accordingly. Product sales may include maintenance and customer support allocated revenue in an arrangement using estimated selling prices of the delivered goods and services based on a selling price hierarchy using the relative selling price method. All of our product offering and service offering market values are readily determined based on current and prior stand-alone sales. We may defer and recognize maintenance, updates and support revenue over the term of the contract period, which is generally one year.

Service revenue, primarily including maintenance, training and installation are recognized upon delivery of the service and typically are unrelated to product sales. To date, training and installation revenue has not been material. These revenues are included in net customer support and maintenance revenues in the statement of operations.

Our normal payment terms offered to customers, distributors and resellers are net 30 days domestically and net 45 days internationally. We do not offer payment terms that extend beyond one year and rarely do we extend payment terms beyond our normal terms. If certain customers do not meet our credit standards, we do require payment in advance to limit our credit exposure.

Shipping and handling costs are billed to the customer and included in product revenue. Shipping and handling expenses are included in cost of product revenue. We have elected to account for shipping and handling costs as fulfillment costs after the customer obtains control of the goods.

 

Contract assets represent contract billings for sales per contracts with customers and are classified as current. Our contract assets include our accounts receivables. At September 30, 2020, the Company had contract assets balance of $1,030,000. At December 31, 2019, the Company had contract assets balance of $2,704,000. At September 30, 2018, the Company had contract assets balance of $1,117,000.$1,566,000.

 

Contract liabilities consist of cash payments in advance of the Company satisfying performance obligations and recognizing revenue. The Company currently classifies deferred revenue as a contract liability. At September 30, 2020, the Company had contract liabilities balance of $58,000. At December 31, 2019, the Company had contract liabilities balance of $643,000. At September 30, 2018, the Company had contract liabilities balance of $619,000.$516,000.

9

 

6.

Net Income (Loss) Per Share

 

Basic net income (loss) per share is computed by dividing net income (loss) attributable to common stockholders for the period by the weighted average number of common shares outstanding for the period. Diluted net income (loss) per share is computed by dividing the net income (loss) attributable to common stockholders by the weighted average number of common shares and dilutive common stock equivalents outstanding for the period. Our common stock equivalents include all common stock issuable upon conversion of preferred stock and the exercise of outstanding options. The aggregate number of common stock equivalents excluded from the diluted income (loss) per share calculation for the three month periods ended September 30, 2020 and 2019 are 1,071,952 and 2018 are 0, and 149,000, respectively. The aggregate number of common stock equivalents excluded from the diluted income (loss) per share calculation for the nine month periods ended September 30, 2020 and 2019 are 960,933 and 20184,044, respectively. Since the Company is in a net loss position for the three and nine month periods ending September 30, 2020, basic and dilutive net loss per share are 4,044 and 292,044, respectively.the same.

 

7.

Concentrations

 

Our operations are concentrated in one area—security software/entity identification. Sales to the U.S. Government through direct and indirect channels totaled 92.3% of total revenues for the third quarter of 2020 compared to 90.9% of total revenues for the third quarter of 2019 compared to 84.5% of total revenues for the third quarter of 2018.2019. During the third quarter of 2019,2020, approximately 75.8%92.3% of total revenues were attributable to threefour government customers compared to approximately 66.4%75.8% of total revenues attributable to fourthree government customers in the third quarter of 2018.2019. In the third quarter of 2020 and 2019, no individual commercial customer had revenues over 10.0% of total revenue compared to one individual commercial customer attributable for 14.5% of total revenue for the same period in 2018.revenue. Our similar product and service offerings are not viewed as individual segments, as our management analyzes the business as a whole and expenses are not allocated to each product offering.

 

8.

Commitments and Contingencies

 

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

 

9.

Dividends Payable

Preferred Stock Conversion

 

During August 2020, all current shares of issued and outstanding preferred stock were voluntarily converted, resulting in the quarter ended September 30, 2019, we accrued $13,000issuance of a total of 1,004,249 newly issued shares of the Company’s common stock. The addition of these newly issued shares has resulted in dividends payablethe dilution of each share of issued and outstanding common stock by a factor of 7.28%. The elimination of these three classes of preferred stock removed a number of the Company’s obligations to the holders of our 5% Preferred Stock, $14,000 in dividends payablepreferred stock (such as the obligation to pay continuing dividends) as well as a number of restrictions on the holders of our Series 2 5% Preferred StockCompany’s activities (such as restrictions on certain capital raising and $8,000 in dividends payable to the holders of our Series 3 5% Preferred Stock. As of September 30, 2019, we have $32,000 in accrued and unpaid dividends.funding transactions).

 

Delaware law provides that we may only pay dividends out of our capital surplus or, if no surplus is available, out of our net profits for the fiscal year the dividend is declared and/or the preceding fiscal year. These dividends continue to accrue on all our outstanding shares of preferred stock, regardless of whether we are legally able to pay them. If we are unable to pay dividends on our preferred stock, we will be required to accrue an additional late fee penalty of 18% per annum on the unpaid dividends for the Series 2 Preferred Stock and Series 3 Preferred Stock. Our late CEO, our Interim CEO and current CFO, and one outside board member who are holders of our Series 2 and Series 3 Preferred Stock have waived any possible late fee penalties. In addition to this late penalty, the holders of our Series 2 Preferred Stock and Series 3 Preferred Stock could elect to present us with written notice of our failure to pay dividends as scheduled, in which case we would have 45 days to cure such a breach. In the event that we failed to cure the breach, the holders of these shares of preferred stock would then have the right to require us to redeem their shares of preferred stock for a cash amount calculated in accordance with their respective certificates of designation. If we were required to redeem all shares of Series 2 Preferred Stock and Series 3 Preferred Stock as of September 30, 2019, the aggregate redemption price we would owe would be $1.8 million.


10.

Right-of-use Asset and Leasing Liabilities

 

UnderUnder the new lease accounting standard, we have determined that we have leases for right-of-use (ROU) assets. We have both finance right-of-use assets and operating right-of-use assets with a related lease liability. Our finance lease right-of-use assets consist of computer hardware and a copying machine. Our operating lease right-of-use assets include our rental agreements for our offices in Richardson and San Marcos, CA. Both types of lease liabilities are determined by the net present value of total payments and are amortized over the life of the lease. Both types of lease obligations are designed to terminate with the last scheduled payment. All of the finance lease right-of-use assets have a three year life and are in various stages of completion. The Richardson operating lease liability has a life of fivefour years and two months as of September 30, 2019.2020. The San Marcos operating lease liability has a life of eighteensix months as of September 30, 2020. The adoption of the lease accounting standard resulted in the recognition of an operating ROU asset of $1,553 thousand and a related lease liability of $1,744 thousand during the first quarter of 2019.

10

 

Additional qualitative and quantitative disclosures regarding the Company's leasing arrangements are also required. The Company adopted ASC 842 prospectively and elected the package of transition practical expedients that does not require reassessment of: (1) whether any existing or expired contracts are or contain leases, (2) lease classification and (3) initial direct costs. In addition, the Company has elected other available practical expedients to not separate lease and non-lease components, which consist principally of common area maintenance charges, for all classes of underlying assets and to exclude leases with an initial term of 12 months or less.

 

As the implicit rate is not readily determinable for the Company's lease agreement, the Company uses an estimated incremental borrowing rate to determine the initial present value of lease payments. This discount rate for the lease approximates SVB's prime rate. See the following tables for more information.

 

Supplemental cash flow information includes operating cash flows related to operating leases. For the nine months ended September 30, 2020 and 2019, the Company had $271 thousand and $177 thousand, respectively, in lease payments related to operating leases.

Schedule of Items Appearing on the Statement of Operations:Operations:

 

 

Three Months Ended

  

Nine Months Ended

  Three Months Ended Nine Months Ended 
 

September 30,

2019

  

September 30,

2018

  

September 30,

2019

  

September 30,

2018

  September 30, 2020  September 30, 2019  September 30, 2020  September 30, 2019 

Operating expense:

                                

Amortization expense – Finance ROU

  16   17   48   50  $11  $16  $32  $48 

Lease expense – Operating ROU

  82   65   244   197   82   82   248   244 

Other expense:

                                

Interest expense – Finance ROU

  1   1   3   2  $  $1  $2  $3 

 

Future minimum lease obligations consisted of the following at September 30,, 2019 2020 (in thousands):

 

 

Operating

  

Finance

      Operating Finance   

Period ending September 30,

 

ROU Leases

  

ROU Leases

  

Total

  ROU Leases  ROU Leases  Total 

2020

 $359  $46  $405 

2021

  362   31   393  $363  $31  $394 

2022

  366   1   367   367   2   369 

2023

  378      378   378      378 

2024

  384      384   384      384 
2025  62      62 

Thereafter

  64      64          
 $1,913  $78  $1,991  $1,554  $33  $1,587 

Less Interest*

  (247

)

  (3

)

      (164)  (1)    
 $1,666  $75      $1,390  $32     

 

*Interest is imputed for operating ROU leases and classified as lease expense and is included in operating expenses in the accompanying condensed consolidated statement of operations.

 


Item 2.

11.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

PPP Loan

 

Forward Looking StatementsOn March 27, 2020, the U.S. federal government enacted the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”), which includes provision for a Paycheck Protection Program (“PPP”) administered by the U.S. Small Business Administration (“SBA”). The PPP allows qualifying businesses to borrow up to $10 million calculated based on qualifying payroll costs. The loan is guaranteed by the federal government, and does not require collateral. On April 30, 2020 we entered into a PPP Loan with Silicon Valley Bank effective April 30, 2020, pursuant to the PPP under CARES for $629,000. The PPP Loan matures on April 30, 2022 and bears interest at a rate of 1.0% per annum. Monthly amortized principal and interest payments are deferred for six months after the date of disbursement. The PPP Loan funds were received on April 30, 2020. The PPP Loan contains events of default and other provisions customary for a loan of this type. The PPP provides that (1) the use of PPP Loan amount shall be limited to certain qualifying expenses, (2) 100 percent of the principal amount of the loan is guaranteed by the SBA and (3) an amount up to the full principal amount may qualify for loan forgiveness in accordance with the terms of CARES. As of September 30, 2020, the Company was in full compliance with all covenants with respect to the PPP Loan. The Company expects to use the full proceeds of the PPP loan in accordance with the provisions of CARES. As of September 30, 2020, the balance of the PPP Loan was $631,000, which includes $2.0 thousand in accrued interest. We have submitted the PPP Loan Forgiveness Application and expect full forgiveness as we have met all stated requirements.

11

Future minimum loan obligations consisted of the following at September 30, 2020 (in thousands):

Period ending September 30, PPP Loan 
2021 $392 
2022  249 
2023   
2024   
2025   
Thereafter   
  $641 
Less Interest*  (12)
  $629 

12.Coronavirus Outbreak in the United States

Uncertainties surrounding the effects of the coronavirus, particularly potential diversion of time and resources of federal government entities which make up a significant concentration of our customer base, could cause a material adverse effect on our results of operations and financial results. The extent of the impact of COVID-19 on our operational and financial performance will depend on certain developments, including the duration and spread of the outbreak, impact on our customers, employees and vendors all of which are uncertain and cannot be predicted. A material disruption in our workplace as a result of the coronavirus could affect our ability to carry on our business operations in the ordinary course and may require additional cost and effort should our employees not be able to be physically on-premises.

13.Subsequent Events

The Company completed a follow-on public offering of 3,565,000 shares of common stock at a price to the public of $8.00 per share, including 2,000,000 shares of common stock to be issued and sold by INTRUSION and 1,100,000 shares of common stock to be offered by the group of selling shareholders, together with 465,000 shares purchased when the underwriter exercised its option to purchase all of the available shares under the underwriter’s overallotment option (the “Secondary Public Offering”). Gross proceeds of the offering to the company, before deducting underwriting discounts, commissions and estimated offering expenses, were approximately $19,720,000. Net proceeds to INTRUSION of approximately $18,053,000 are intended to fund several growth initiatives, including the commercialization of its new INTRUSION Shield solutions designed for the enterprise market.

On October 9, 2020 and in connection with the closing of our Secondary Public Offering, our stock began trading on the Nasdaq Capital Market (“Nasdaq”) under the symbol “INTZ”.

12

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

This Quarterly Report on Form 10-Q, including, without limitation, the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Such forward-looking statements are generally accompanied by words such as “estimate,” “expect,” “believe,” “should,” “would,” “could,” “anticipate,” “may” or other words that convey uncertainty of future events or outcomes. These statements relate to future events or to our future financial performance, and involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance, or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these forward-looking statements. Factors that may cause actual results to differ materially from current expectations, which we describe in more detail elsewhere in this Quarterly Report on Form 10-Q, as well as in our 20182019 Annual Report on Form 10-K, filed March 28, 2019, in27, 2020, and our Quarterly Reports on Form 10-Q filed on May 15, 2020 and August 13, 2020 under Item 1A “Risk Factors” include, but are not limited to:

 

·

We had a net loss of $1.4 million for the transitionquarter ended September 30, 2020, and we have an accumulated deficit of responsibilities from$57.4 million as of September 30, 2020. To continue current financial performance, we must increase revenue levels.

·We may be unable to successfully market, promote, and sell our co-founder, G. Ward Paxton,new commercial solution, INTRUSION Shield, and the appointmentmarket it through new sales channels to a new set of prospective customers.
·We could experience damage to our current CFO, Michael L. Paxton, as a Director, Chairman of the Board, as well as Interim President and Interim CEO, may cause disruptionsreputation in the Company’s operations, take a significant portion ofcybersecurity industry in the event that our management’s time and attention, and may cause our suppliers, vendors, and customersINTRUSION Shield solution fails to be concerned about this transition;

insufficient cash to operate our business and inabilityperform as expected, to meet our liquidity requirements;

loss of revenues due to the failure of our newer productscustomers’ needs, or to achieve market acceptance;

acceptance.

·

our need to increase current revenue levelsWe have broad discretion in order to achieve sustainable profitability;

our unavailability to make future borrowings under the CEO Note;

our ability to replace all or a portionuse of the borrowing base available to the Company under the CEO Notenet proceeds from our Secondary Public Offering and whether any such terms would be available on terms acceptable to the Company, if at all;

may not use them effectively.

·

concentrationSubstantial blocks of our revenues from U.S. government entitiestotal outstanding shares may be sold into the market when “lock-up” or commercial customers and the possibility“market standoff” periods end. If there are substantial sales of loss of one of these customers and the unique risks associated with government customers;

our dependence on sales made through indirect channels;

the adverse effect that payment of accrued dividends on our preferred stock would have on our cash resources and the substantial dilution upon the conversion or redemption of our preferred stock;

the consequences of our inability to pay scheduled dividends on shares of our preferred stock;

the potentially detrimental impact that the conversion of preferredcommon stock, would have on the price of our common stock;

stock could decline.

·

Our common stock may experience volatility in trading or loss in value as a result of the abilityeffects of the coronavirus on the US and global economies.

·A large percentage of our preferred stockholderscurrent revenues are received from U.S. government entities, and the loss of these customers or our failure to hinder additional financing;widen the scope of our customer base to include general commercial enterprises could negatively affect our revenues.
·If we fail to respond to rapid technological changes in the network security industry, we may lose customers or our solutions may become obsolete.
·We face intense competition from both start-up and

established companies that may have significant advantages over us and our solutions.

·

the influence that ourOur management and larger stockholders currently exercise significant control over our Company and will continue to have influence over actions taken byour Company after the Company.

offering has concluded, and such influence may be in conflict to your interests.
·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.
·A breach of network security could harm public perception of our cybersecurity solutions, which could cause us to lose revenues.
·We must adequately protect our intellectual property in order to prevent loss of valuable proprietary information.
·We may incur substantial expenses defending ourselves against claims of infringement.
·The price of our common stock has been volatile in the past and may continue to be volatile in the future due to factors outside of our control.

 

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

 

13

 

Results of Operations

 

The following table sets forth, for the periods indicated, certain financial data as a percentage of net revenues. The period-to-period comparison of financial results is not necessarily indicative of future results. Furthermore, the results of operations as of the three and nine-months ended September 30, 2020 do not reflect the Company’s receipt of approximately $18,053,000 from the net proceeds of its Secondary Public Offering.

  

Three Months Ended

  

Nine Months Ended

 
  

September 30,

2019

  

September 30,

2018

  

September 30,

2019

  

September 30,

2018

 

Total revenue

  100.0

%

  100.0

%

  100.0

%

  100.0

%

                 

Total cost of revenue

  38.0   36.3   39.2   37.6 
                 

Gross profit

  62.0   63.7   60.8   62.4 
                 

Operating expenses:

                

Sales and marketing

  9.2   17.5   7.4   18.0 

Research and development

  7.7   12.3   7.0   11.4 

General and administrative

  7.1   9.1   8.4   11.3 
                 

Operating income

  38.0   24.8   38.0   21.7 
                 

Interest expense, net

  (0.1

)

  (1.6

)

  (0.4

)

  (2.0

)

                 

Income before income tax provision

  37.9   23.2   37.6   19.7 
                 

Income tax provision

            
                 

Net income

  37.9

%

  23.2

%

  37.6

%

  19.7

%

Preferred stock dividends accrued

  (0.9

)

  (1.4

)

  (0.9

)

  (1.4

)

                 

Net income attributable to common stockholders

  37.0

%

  21.8

%

  36.7

%

  18.3

%

 

 

  

Three Months Ended

  

Nine Months Ended

 
  

September 30,

2019

  

September 30,

2018

  

September 30,

2019

  

September 30,

2018

 

Domestic revenues

  100.0

%

  100.0

%

  100.0

%

  100.0

%

Export revenues

            
                 

Net revenues

  100.0

%

  100.0

%

  100.0

%

  100.0

%

  Three Months Ended  Nine Months Ended 
  September 30, 2020  September 30, 2019  September 30, 2020  September 30, 2019 
Total revenue  100.0%  100.0%  100.0%  100.0%
                 
Total cost of revenue  41.1   38.0   40.7   39.2 
                 
Gross profit  58.9   62.0   59.3   60.8 
                 
Operating expenses:                
Sales and marketing  55.7   9.2   37.3   7.4 
Research and development  68.1   7.7   54.4   7.0 
General and administrative  23.7   7.1   19.1   8.4 
                 
Operating income (loss)  (88.6)  38.0   (51.5)  38.0 
                 
Interest income        0.4    
Interest expense  (0.1)  (0.1)  (0.2)  (0.4)
                 
Income (loss) before income tax provision  (88.7)  37.9   (51.3)  37.6 
                 
Income tax provision            
                 
Net income (loss)  (88.7)%  37.9%  (51.3)%  37.6%
Preferred stock dividends accrued  (0.8)  (0.9)  (1.6)  (0.9)
                 
Net income (loss) attributable to common stockholders  (89.5)%  37.0%  (52.9)%  36.7%

14

  Three Months Ended  Nine Months Ended 
  September 30, 2020  September 30, 2019  September 30, 2020  September 30, 2019 
Domestic revenues  100.0%  100.0%  100.0%  100.0%
Export revenues            
                 
Net revenues  100.0%  100.0%  100.0%  100.0%

 

 

Net Revenues. Net revenues for the quarter and nine months ended September 30, 20192020 were $1.6 million and $5.0 million, respectively, compared to $3.9 million and $11.1 million, respectively, compared to $2.7 million and $7.3 million for the same periods in 2018.2019. Product revenues increased $1.2decreased $2.3 million for the quarter ended September 30, 2019,2020, and $3.8$6.1 million for the nine months ended September 30, 20192020 compared to the same periods in 2018. Increased2019. Decreased product revenues were primarily due to an increasea decrease in sales of our TraceCop product line. TraceCop sales for the quarters ended September 30, 2020 and 2019 were $1.5 million and 2018 were $3.9 million, and $2.7 million, respectively. TraceCop sales continue to be negatively affected due to Covid-19. Savant sales remainedincreased to $106 thousand for the same atquarter ended September 30, 2020 compared to $29 thousand for the quartersquarter ended September 30, 2019 and 2018.2019. We expect the launch of our INTRUSION Shield solution to begin to have positive effects on our net revenue in fiscal year 2021.

 

Concentration of Revenues. Revenues from sales to various U.S. government entities totaled $1.5 million, or 92.3% of revenues, for the quarter ended September 30, 2020 compared to $3.5 million, or 90.9% of revenues, for the quarter ended September 30, 2019 compared to $2.3 million, or 84.5% of revenues, for the same period in 2018.2019. Revenues from sales to various U.S. government entities totaled $9.9$4.3 million, or 89.8%84.4% of revenues, for the nine months ended September 30, 2019,2020, compared to $6.1$9.9 million, or 84.2%89.8% of revenues, for the same period in 2018.2019. Sales to commercial customers totaled 7.7% of total revenue for the third quarter of 2020 compared to 9.1% of total revenue for the third quarter of 2019 compared to 15.5% of total revenue for2019. During the third quarter of 2018. During the third quarter of2020 and 2019, no individual commercial customer had revenues over 10.0% of total revenue approximately compared to approximately 14.5% to one commercial customer in the third quarter of 2018. Although we expect our concentration of revenues to vary among customers in future periods depending upon the timing of certain sales, we anticipate that sales to government customers will continue to account for a significant portion of our revenues in future periods.revenue. Sales to the government present risks in addition to those involved in sales to commercial customers which could adversely affect our revenues, including, without limitation, potential disruption to appropriation and spending patterns and the government’s reservation of the right to cancel contracts and purchase orders for its convenience. Although we do not anticipate that any of our revenues with government customers will be renegotiated, a large number of cancelled or renegotiated government orders could have a material adverse effect on our financial results. Currently, we are not aware of any proposed cancellation or renegotiation of any of our existing arrangements with government entities and, historically, government entities have not cancelled or renegotiated orders which had a material adverse effect on our business. Although we expect our concentration of revenues to vary among customers in future periods depending upon the timing of certain sales, we anticipate that sales to government customers will decrease as a percentage of revenues to the extent our INTRUSION Shield solution and its follow-on solutions appeal to a wider customer base comprised of commercial customers who are distinct from and our historical customer base of governmental and regulatory customers.


 

Gross Profit. Gross profit was $0.9 million or 58.9% of net revenues for the quarter ended September 30, 2020, compared to $2.4 million or 62.0% of net revenues for the quarter ended September 30, 2019, compared to $1.72019. Gross profit was $3.0 million or 63.7%59.3% of net revenues for the quarternine months ended September 30, 2018. Gross profit was2020 compared to $6.7 million or 60.8% of net revenues for the nine months ended September 30, 2019 compared to $4.6 million or 62.4% of net revenues for the nine months ended September 30, 2018.2019. Gross profit on product revenues for the quarter and nine months ended September 30, trended from 63.7% and 62.4%, respectively, in 2018 to 62.0% and 60.8%, respectively, in 2019 to 58.9% and 59.3%, respectively, in 2020 mainly due to a change in product mix. Gross profit increasesdecreases can be attributed to such variables as labor hour rates and department overhead. Gross profit as a percentage of net revenues is impacted by several factors, including shifts in product mix, changes in channels of distribution, revenue volume, pricing strategies, and fluctuations in revenues of integrated third-party products. We expect our gross profit will be affected by the introduction, marketing, and sales of our new INTRUSION Shield solution and its follow on solutions to the extent that such products receive market acceptance.

 

Sales and Marketing. Sales and marketing expenses decreasedincreased to $0.4$0.9 million for the quarter ended September 30, 2019,2020, compared to $0.5$0.4 million for same period in 2018.2019. Sales and marketing expenses decreasedincreased to $0.8$1.9 million for the nine months ended September 30, 2019,2020, compared to $1.3$0.8 million for the same period in 2018.2019. For the nine months ended September 30, 2019,2020, sales and marketing expenses decreasedincreased due to shiftingincreased expense due to costplanned investment in the marketing of sales for various projects during the second quarter 2019 and the Company was able to collect payment of $200 thousand from a customer related expense that occurred during the year 2018.INTRUSION Shield. Sales and marketing expenses may vary in the future. We believe that these costs maywill increase through the end of 2019.2020 as we continue to invest in the marketing of INTRUSION Shield.

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Research and Development. Research and development expenses remained constant at $0.3increased to $1.1 million for the quarter ended September 30, 2019,2020 compared to $0.3 million for the same period in 2018.2019. Research and development remained constant at $0.8expenses increased to $2.7 million for the nine months ended September 30, 2019,2020 compared to $0.8 million for the same period in 2018. Research2019. The increase in research and development expense was due partly to increased costs remained constantrelated to the development of our INTRUSION Shield solution as well as an increase in labor expense due to increasedless direct labor expense being allocated to cost of sales.required on existing projects. Research and development costs are expensed in the period in which they are incurred. Research and development expenses may vary in the future; however, we believe that these costs will mainly be dependent on the amountlevels of research and development labor expense allocatedcharged to costprojects. We expect research and development expenses to increase through the end of2020 due to product development of sales.INTRUSION Shield as well as its follow-on product solutions.

 

General and Administrative. General and administrative expenses increased to $0.3$0.4 million for the quarter ended September 30, 2019,2020, compared to $0.2$0.3 million for the same period in 2018.2019. General and administrative expenses increased to $0.9$1.0 million for the nine months ended September 30, 2019,2020, compared to $0.8$0.9 million for the same period in 2018.2019. It is expected that general and administrative expenses will remain relatively constantincrease throughout the remainder of 2019.2020 due to increases in administrative expenses related to the implementation of INTRUSION Shield.

 

Interest. Net interestInterest expense decreasedincreased to $1$2 thousand for the quarter ended September 30, 2019,2020 compared to $43$1 thousand for the same period in 2018. Net interest2019. Interest expense decreased to $45$4 thousand for the nine months ended September 30, 20192020 compared to $144$45 thousand for the same period in 2018. The decrease in interest2019. Interest expense wasdecreased due to eliminationdecreased amount of Loan Payable to Officer culminating in our repayment of the loan payable to an officer. Net interestbalance in May 2019. Interest expense maywill vary in the future based on our level of borrowing, which will be affected by our cash flow operatingand borrowing needs. Interest income increased to $3 hundred for the quarter ended September 30, 2020 compared to none for the same period in 2019. Interest income increased to $8 thousand for the nine months ended September 30, 2020 compared to none for the same period in 2019. This is attributable to investing extra cash in money market accounts and capital expenditures.

getting better interest rates.

 

Liquidity and Capital Resources

 

Our principal source of liquidity at September 30, 2019,2020, was approximately $2.1$1.5 million of cash and cash equivalents. At September 30, 2019,2020, we had working capital deficiency of $2.9$1.0 million compared to a $0.4$2.9 million working capital deficiency at September 30, 2018.2019.

 

Net cash used by operations for the nine months ended September 30, 2020 was $2.4 million due primarily to a net loss of $2.6 million, a $514 thousand increase in prepaid expenses and other assets, and a $457 thousand decrease in deferred revenue. This was partially offset by the following sources of cash and non-cash items: a $536 thousand decrease in accounts receivable, $186 thousand expense in noncash lease costs, a $134 thousand decrease in accounts payable and accrued expenses, $164 thousand in depreciation and amortization expense and $174 thousand in stock-based compensation. Net cash provided by operations for the nine months ended September 30, 2019 was $2.9 million due primarily to a net income of $4.2 million and the following sources of cash and non-cash items: a $364 thousand decrease in operatingnoncash lease right-of-use assets,costs, $136 thousand in depreciation and amortization expense, $24 thousand in stock-based compensation, and $6 thousand in penalties and waived penalties on dividends. This was partially offset by a $737 thousand increase in accounts receivable, a $621 thousand decrease in accounts payable and accrued expenses, a $361 thousand decrease in deferred revenue, and a $45 thousand increase in prepaid expenses and other assets. Net cash provided by operations for the nine months ended September 30, 2018 was $1.8 million due primarily to a net income of $1.437 million and to the following sources of cash and non-cash items: $213 thousand increase in deferred revenue, $191 thousand increase in accounts payable and accrued expenses, $15 thousand decrease in Inventories, $34 thousand in penalties and waived penalties on dividends, $50 thousand in amortization expense of capital leases, $46 thousand in depreciation expense, $16 thousand in stock-based compensation, and a $65 thousand write-off of the United Kingdom’s cumulative translation adjustment. This was partially offset by a $120 thousand increase in prepaid expenses and other assets and a $155 thousand increase in accounts receivable. Future fluctuations in inventory balances, accounts receivable and accounts payable will be dependent upon several factors, including, but not limited to, quarterly sales volumes and timing of invoicing, and the accuracy of our forecasts of product demand and component requirements.

 


Net cash used in investing activities for the nine months ended September 30, 2019,2020, was $183$153 thousand for net purchases of property and equipment, compared to net cash used by investing activities for the nine months ended September 30, 2018,2019, was $173$183 thousand for net purchases of property and equipment.

 

Net cash provided by financing activities in 2020 was $691 thousand with proceeds of $629 thousand from a PPP loan and proceeds from exercise of stock options of $193 thousand. This was directly offset by the following uses of cash: payments for preferred stock dividends of $99 thousand and payment on principal of finance right-of-use leases of $32 thousand. Net cash used by financing activities in 2019 was $2.3 million with payments on the loan from an officer of $1.8 million, payments for preferred stock dividends of $667 thousand, and payment on principal of finance right-of-use leases of $47 thousand. This was directly offset by the following provisions of cash: proceeds from exercise of stock options of $236 thousand. Net cash used by financing activities in 2018 was $1.0 million due to payments to the CEO Note of $1.2 million and $51 thousand payment on principal on capital leases. This was directly offset by the following provisions of cash: proceeds from a loan by an officer of $150 thousand and $111 thousand from the exercise of stock options.

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At September 30, 2019,2020, the Company did not have any material commitments for capital expenditures.

 

During the nine months ended September 30, 2019,2020, the Company funded its operations through the use of cash and cash equivalents.

As of September 30, 2019,2020, we had cash and cash equivalents of approximately $2,111,000,$1,505,000, down from approximately $1,652,000$3,334,000 as of December 31, 2018.2019. We generated a net loss of $1,409,000 for the quarter ended September 30, 2020 compared to net income of $1,464,000 for the quarter ended September 30, 2019 compared to a net income of $617,000 for the quarter ended September 30, 2018. As of September 30, 2019, in addition to cash and cash equivalents of $2,111,000, we had $2.7 million of funding available2019. Based on funds received from a promissory note to borrow up to $2.7 million from G. Ward Paxton, the Company’s Chief Executive Officer (the “CEO Note”). We are obligated to make payments of accrued dividends on all our outstanding shares of preferredcommon stock that will reduce our available cash resources.

Based on projections of growth in revenue and net income in the coming quarters,offering, we believe that we will have sufficient cash resources to finance our operations and expected capital expenditures for the next twelve months. However, asAs of October 24, 2019, our funding available from the CEO Note terminated. Our management will be assessing whether to replace this borrowing base and assessing what terms may be available to the Company, including whether any such terms are available on terms acceptable to the Company, if at all (the “Potential Replacement Funding Facility”).

We expect to fund our operations through anticipated Company profits possibletogether with the approximately $18 million in net proceeds we received from our Secondary Public Offering, which we believe will be sufficient to finance our operations, the additional investmentsexpenses of private equitymarketing, promoting, and debt, ,selling our new INTRUSION Shield solution and the Potential Replacement Facility. Any equity or debt financings, if available at all, may be on terms which are not favorable to us and, indevelopment of its follow-on solutions, as well as other expected capital expenditures for the case of equity financings, may result in dilution to our stockholders. If our operations do not generate positive cash flow in the upcoming year, or if we are not able to obtain additional debt or equity financing on terms and conditions acceptable to us, if at all, we may be unable to implement our business plan, fund our liquidity needs or even continue our operations.

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

 

Item 4.

CONTROLS AND PROCEDURES

 

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

 

Our management, including our principal executive officer and principal financial officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of September 30, 2019,2020, and concluded that the disclosure controls and procedures were effective.

 

Our management, with the participation of our principal executive officer and principal financial officer, evaluated our “internal control over financial reporting” (as defined in Rule 13a-15(f) under the Exchange Act) as of December 31, 2018,2019, and concluded that there have not been any changes in our internal control over financial reporting that occurred during the quarter ended September 30, 2019,2020, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II – OTHER INFORMATION

 

Item 1.

LEGAL PROCEEDINGS

 

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

 

Item 1A.

A

RISK FACTORS

 

Factors That May Affect Future Results of Operations

 

We are providing the following information regarding changes that have occurred to previously disclosed risk factors from our Annual Report on Form 10-K for the year ended December 31, 2018.2019. In addition to the other information set forth below and elsewhere in this report, you should consider the factors discussed under the heading “Risk Factors” in our Form 10-K for the year ended December 31, 20182019 filed on March 28, 2019.27, 2020 and in our Form 10-Q for the quarters ended March 31, 2020 filed on May 15, 2020 and June 30, 2020 filed on August 13, 2020. The risks described in our Annual Report on Form 10-K and our Quarterly Reports on Form 10-Q are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

 

We may be unsuccessful in the transition of responsibilities of our co-founder, G. Ward Paxton upon his unexpected passing on October 24, 2019, which may havehad a material adverse effect on our results of operations.

Mr. G. Ward Paxton co-founded the Company in 1983, and he served as President, Chief Executive Officer, Director, and Chairman of the Board for most of his 36 year tenure. He demonstrated dedication and leadership, and provided a unique insight and understanding of the Company’s operations and business strategy for decades. Thenet loss of that leadership and experience may cause the expenditure of Company’s and its managements time and attention as it works through this transition with the Company’s management, staff, vendors, suppliers and customers, any or all of whom may be apprehensive regarding the loss of Ward’s leadership. We can provide no assurance of the smoothness, the diversion of the Company’s resources, or the successfulness of this transition.

The appointment of our current CFO, Mr. Michael L. Paxton, to the positions of Director and Chairman of the Board, as well as his service as Interim President and Interim CEO, may take significant time, attention, and focus from our day to day operations and the Company’s goals and objectives, perhaps in a material way.

Mr. Michael Paxton has been an integral part of our management team for many years, and our Board has expressed confidence that he will provide a smooth transition going forward. However, Mr. Paxton will be tasked with continuing his current obligations of our Chief Financial Officer as well as taking on these additional roles and responsibilities. While we believe that Mike’s long tenure with and understanding of the Company’s operations will be an asset to his ability to quickly adapt to these additional duties, we can provide no assurances of such.

As of October 24, 2019, we have lost the ability to borrow, up to $2.7$1.4 million under the CEO Note, the loss of which may have a material adverse effect on our business, our results of operation, or even out ability to continue as a going concern.

With the passing of our former CEO, Mr. G. Ward Paxton, the CEO Note terminated, with the result that future borrowings thereunder will no longer be available to the Company. Our ability to draw funds under the CEO Note has been a major strength behind the Company’s liquidity for a number of years, the loss of which is unable to be measured at this time. However, the lack of this financial backstop could, in the future, have a material adverse effect on our business, our results of our operations, our ability to continue as a going concern, or to continue operations at all. Our management will be assessing whether to replace this borrowing base and assessing what terms may be available to the Company, including whether any such terms are acceptable to the Company, if at all; however we can make no such assurances as to the replacement of this borrowing facility.

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

As of September 30, 2019, we had cash and cash equivalents of approximately $2,111,000, down from approximately $1,652,000 as of December 31, 2018. We generated net income of $1,464,000 for the quarter ended September 30, 2019 compared to a net income2020, and we have an accumulated deficit of $617,000 for the quarter ended September 30, 2018. As$57.4 million as of September 30, 2019, in addition to cash and cash equivalents of $2,111,000, we had $2.7 million of funding available from a promissory note to borrow up to $2.7 million from G. Ward Paxton, the Company’s Chief Executive Officer (the "CEO Note). We are obligated to make payments of accrued dividends on all our outstanding shares of preferred stock that will reduce our available cash resources. However, as of October 24, 2019, our funding available from the CEO Note terminated. Our management will be assessing whether to replace this borrowing base and assessing what terms may be available to the Company, including whether any such terms are available on terms acceptable to the Company, if at all (the “Potential Replacement Funding Facility”). We expect to fund our operations through anticipated Company profits, possibly additional investments of private equity and debt, which, if we are able to obtain, will have the effect of diluting our existing common stockholders, perhaps significantly, and a possible Potential Replacement Facility. Any equity or debt financings, if available at all, may be on terms which are not favorable to us and, in the case of equity financings, may result in dilution to our stockholders. If our operations do not generate positive cash flow in the upcoming year, or if we are not able to obtain additional debt or equity financing on terms and conditions acceptable to us, if at all, we may be unable to implement our business plan, fund our liquidity needs or even2020. To continue our operations.


We had a net incomeof $1.5million for the quarter ended September 30, 2019, and we have an accumulated deficit of $55.1 million as of September 30, 2019. To continuecurrent financial performance,, we must sustain or increaseincrease revenue levels.

 

For the quarter ended September 30, 2019,2020, we generatedhad a net incomeloss of $1.5$1.4 million and had an accumulated deficit of approximately $55.1$57.4 million as of September 30, 2019,2020, compared to a net income of $617 thousand$1.5 million for the quarter ended September 30, 20182019 and an accumulated deficit of approximately $60.1$54.8 million at September 30, 2018.December 31, 2019. We need to maintainincrease current revenue levels from the sales of our productssolutions if we are to continueregain profitability. If we are unable to achieve these revenue levels, losses could happencontinue for the near term and possibly longer, and we may not maintainregain profitability or generate positive cash flow from operations in the future.

 

We do not anticipate significant changes in net revenue for the fourth quarter of fiscal year 2020 as compared with the third quarter, which was lower than previous quarters. Lack of increased revenue could adversely affect our results of operation, our liquidity position, and result in a decline in the price of our common stock.

The Company anticipates that we will not see significant changes in our net revenue for the quarterly period ending on December 31, 2020 as compared with the third quarter, which was lower than previous quarters. While it is premature to determine whether this depressed revenue is a trend or merely a reflection of our customers’ varying ordering patterns, our inability to increase our net revenue could result in lower operating results for the fiscal year 2020, have a negative effect on our cash flow and our overall liquidity position, and potentially affect the perception of the Company’s value in the marketplace and result in a decline in the price of our common stock.

Further, our expense levels are based, in part, upon our expectations as to future revenues and are largely fixed in the short term. Therefore, we may not be able to timely adjust our expenditures in order to compensate for an unanticipated shortfall in revenue in any given quarter. Any significant, unanticipated shortfall in revenues could have an immediate and significant effect on our operating results for that quarter and might lead to a reduced market price for our stock.

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We may be unable to successfully market, promote, and sell our new commercial solution, INTRUSION Shield, and market it through new sales channels to a new set of prospective customers.

We anticipate significant resources will be required in order to succeed in launching our new INTRUSION Shield solution, including the time, attention, and focus of our senior management and our research and development team, coordination of new marketing strategies highlighting this new offering and promoting it through new and expanded sales channels to a wider audience of prospective customers than we have historically marketed and sold our solutions and services. In addition, significant financial resources will be required to successfully manage the implementation of this new solution. This could result in diversion of those resources from critical areas of our company operations and a potential strain on our liquidity and ability to meet our current and these anticipated increases in our cash-flow needs.

We could experience damage to our reputation in the cybersecurity industry in the event that our INTRUSION Shield solution fails to perform as expected, to meet our customers’ needs, or to achieve market acceptance.

Our reputation in the industry as a leading provider of entity identification, data mining, and advanced persistent threat detection solutions may be harmed, perhaps significantly, in the event that our new INTRUSION Shield fails to perform as we expect it to. If Shield does not perform as we expect, if we experience delivery delays, or if our customers do not perceive the benefits of purchasing and using 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 our INTRUSION Shield. Any reputational damage could result in a decrease in orders for all of 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 operation.

Uncertainties surrounding the effects of the coronavirus, particularly potential diversion of time and resources of the federal, state, and local governmental entities which make up a significant concentration of our customer base, could cause a material adverse effect on our results of operations and financial results.

We have a concentration of customers that are federal, state, and local governmental entities. Such entities have had to allocate resources and adjust budgets to accommodate real and potential contingencies related to the effects of the coronavirus and measures required to be put in place to prevent and contain contamination of the virus. These uncertainties have resulted in decreased demand by some of our customers for our current solutions. A continued decrease in orders for our solutions by government customers could cause a material adverse effect on our operations and financial results. While we anticipate that widening the scope of our customer base through the introduction of our INTRUSION Shield solution will minimize the effect of this decrease in demand by our government customers, we can offer no assurances as to the effects the Coronavirus may continue to have on our current or future customers.

Our common stock may experience volatility in trading or loss in value as a result of the effects of the coronavirus on the US and global economies.

Uncertainties surrounding the effects of the coronavirus on the US and global economies has resulted in an increase in volatility and violent drops in the value of publicly traded securities. While the price of our common stock has not experienced such volatility or loss in value, we can offer no assurances that the long-term effects on the overall US economy will not negatively affect us in the future.

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.

19

Fluctuations in our quarterly revenues may cause the price of our common stock to decline.

Our operating results have varied significantly from quarter to quarter in the past, and we expect our operating results to vary from quarter to quarter in the future due to a variety of factors, many of which are outside of our control. Therefore, if revenues are below our expectations, this shortfall is likely to adversely and disproportionately affect our operating results. Accordingly, we may not attain positive operating margins in future quarters. Any of these factors could cause our operating results to be below the expectations of securities analysts and investors, which likely would negatively affect the price of our common stock.

A large percentage of our current revenues are received from U.S. government entities/resellers,entities, and the loss of any one of these customers or our failure to widen the scope of our customer base to include general commercial enterprises could reducenegatively affect our revenues and materially harm our business and prospects.revenues.

 

A large percentage of our current revenues result from sales to U.S. government entities/resellers.entities. If we were to lose one or more of these key relationships,customers, our revenues could decline and our business and prospects may be materially harmed. WeFurther, 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 even if we are successful in developing relationships with non-governmental customers our revenues will continue to be concentrated among government entities. For the quarter ended September 30, 2019, sales to U.S. government entities/resellers collectively accounted for 90.9% of our revenues, compared to 84.5% for the comparable period in 2018. The loss of any of these key relationships may send a negative message to other U.S. governmentmitigate or eliminate this dependence on, and risk from, serving governmental entities, or non-governmental customers concerning our product offering. We cannot assure you that U.S. government entities will be customers of ours in future periods orwe can offer no assurances that we will be able to sufficiently diversify our customer portfolio in a time and manner to adequately mitigate the risk of loss of any of these customers.this risk.

 

AlmostAlmost all of our revenues are currently from one product linefamily of solutions with a limited number of customers, and the decrease of revenue from sales of this product linefamily of solutions could materially harm our business and prospects. Timeliness of orders from customers may cause disruptionvolatility in growth.

 

Almost all of our revenues result from sales of one security product line.cybersecurity solution. TraceCop revenues were $3.9$1.5 million for the quarter ended September 30, 2019,2020, compared to $2.7$3.9 million for the third quarter 2018. Savant revenues remained constant at $29 thousand for2019. While we anticipate the quarters ended September 30, 2019introduction of our new INTRUSION Shield solution will minimize our dependence on this single solution, we can offer no assurances as such, and 2018. No individual commercial customer in the third quarterabsence of 2019 had over 10.0% of total revenue compareda shift in solution mix, we may continue to one individual customer with 14.5% of total revenue forface risks in the same period in 2018. Ifevent that sales of this key product line and individual customersolution to these limited customers were to decrease, our revenues could decline and our business and prospects may be materially harmed.decrease.

 

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

We derived 90.9%53.8% of revenue in the third quarter of 20192020 through indirect channels of mainly government resellers, compared to 84.5%90.9% of our revenues in the quarter ended September 30, 2018.2019. We must continue to expand sales of our salescurrent solutions as well as any new solutions, such as the INTRUSION Shield, through these indirect channels in order to increase our revenues. We cannot assure you that our productscurrent 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 sales of our products.


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

On November 1, 2019, we had 13,539,736 shares of common stock outstanding. Upon conversion of all outstanding shares of preferred stock, we would have 14,607,178 shares of common stock outstanding, approximately a 7.9% increase in the number of shares of our common stock outstanding.

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

Further, the occurrence of certain events could entitle holders of our Series 2 Preferred Stock and Series 3 Preferred Stock to require us to redeem their shares for a certain number of shares of our common stock. Assuming (i) we have paid all liquidated damages and other amounts to the holders, (ii) paid all outstanding dividends, (iii) a volume weighted average price of $4.50, which was the ten-day volume weighted average closing price of our common stock on November 1, 2019, and (iv) our 13,529,236 shares of common stock outstanding on November 1, 2019, upon exercise of their redemption right by the holders of the Series 3 Preferred Stock and the Series 2 Preferred Stock, we would be obligated to issue approximately 97,600 shares of our common stock. This would represent an increase of approximately 0.7% in the number of shares of our common stock as of November 1, 2019.

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

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

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

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

For the four weeks ended on November 1, 2019, the average daily trading volume of our common stock on the OTCQB was 8,350 shares. Consequently, if holders of preferred stock elect to convert their remaining shares and sell a material amount of their underlying shares of common stock on the open market, the increase in selling activity could cause a decline in the market price of our common stock. Furthermore, these sales, or the potential for these sales, could encourage short sales, causing additional downward pressure on the market price of our common stock.solutions.

 

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

On November 1, 2019,2020, we had 13,539,73617,394,279 shares of common stock outstanding. Upon the exercising of current options exercisable at or below the exercise price of $2.73,$4.25, we would have approximately 14,400,00018,015,782 shares of common stock outstanding, a 6.4%3.6% increase in the number of shares of our common stock outstanding.

 

We resemble a developmental stage company and our business strategy may not be successful.

We depend exclusively on revenues generated from the sale of our current network security/advanced persistent threat detection solution (Savant), which has received limited market acceptance, and our entity identification, data mining and analytic solution (TraceCop). We can provide no assurances that these solutions or our newly developed INTRUSION Shield solution will ever achieve widespread market acceptance or that an adequate market for these solutions will ever emerge. Consequently, we resemble a developmental stage company and will face the following inherent risks and uncertainties:

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·the need for our current and in-development solutions to achieve market acceptance and produce a sustainable revenue stream;
·our ability to manage costs and expenses;
·our dependence on key personnel;
·our ability to obtain financing on acceptable terms; and
·our ability to offer greater value than our competitors.

Our business strategy may not successfully address these risks. If we fail to recognize significant revenues from the sales of our current and in-development solutions, our business, financial condition and operating results would be materially adversely affected.

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 customer needs such as 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 in a timely manner such 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 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, Fireeye, 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.

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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.

Our management and larger stockholders currently exercise significant control over our companyCompany and will continue to have influence over our Company after the ability to approve or take actions thatoffering has concluded, and such influence may be adversein conflict to your interests.

As of November 1, 2019,2020, our executive officers directors and preferred stockholdersdirectors beneficially own approximately 36%20.7% of our voting power. In addition, other related non-affiliate parties control approximately 26%25.6% of voting power. As a result, these stockholders will behave been able to exercise significant control over all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions, which could delay or prevent someone from acquiring or merging with us. These stockholders may use their influence to approve or take actions that may be adverse toincluding the interestsdetails of holdersthis offering. Although we follow our policies regarding related party transactions and have, in fact, created a special committee of our Common Stock. Further,Board to negotiate, arrange, and complete this offering, including determining the extent of the participation of these stockholders in the offering, we contemplatecannot entirely eliminate the possible issuanceinfluence of sharesthese stockholders as long as they hold such a concentration of the voting power of our Common Stockcommon stock.

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 of securities exercisablepay damages in connection with any alleged or convertible into sharesactual failure of our Common Stock in the future to our Chief Executive Officersolutions and Chief Financial Officer. Any such issuance will increase the percentage of stock our Chief Executive Officer, Chief Financial Officer and our management group beneficially holds.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.

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 in order 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.

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We must adequately protect our intellectual property in order 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 United States 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.

The price of our common stock has been volatile in the past and may continue to be volatile in the future due to factors outside of our control.

The market price of our common stock has been highly volatile in the past and may continue to be volatile in the future. During fiscal year 2019, the market price of our common stock on the OTCQB fluctuated between $2.90 and $5.55 per share. For the nine months ended September 30, 2020, the market price of our common stock on the OTCQB fluctuated between $2.34 and $18.18 per share. The market price of our common stock may fluctuate significantly in the future in response to a number of factors, many of which are outside our control, including:

·variations in our quarterly operating results;
·changes in estimates of our financial performance by securities analysts;
·changes in market valuations of our competitors;
·thinly traded common stock;
·our ability to successfully produce, market, and sell our new INTRUSION Shield solution through new and broader sales channels to an expanded potential client market;
·announcements by us or our competitors of new products or solutions, significant contracts, acquisitions, strategic relationships, joint ventures or capital commitments;
·product or design flaws, product recalls or similar occurrences;
·additions or departures of key personnel;
·sales of common stock in the future; and
·fluctuations in stock market prices and volume, which are relatively typical for high technology companies.

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Item 6.

Exhibits

 

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

 

31.1

 

Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) of the Exchange Act.

31.2

 

Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) of the Exchange Act.

32.1

 

Certification Pursuant to Rule 13a-14(b) of the Exchange Act and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101.INS

 

XBRL Instance Document

101.SCH

 

XBRL Taxonomy Extension Schema Document

101.CAL

 

XBRL Taxonomy Extension Calculation Linkbase Document

101.LAB

 

XBRL Taxonomy Extension Label Linkbase Document

101.PRE

 

XBRL Taxonomy Extension Presentation Linkbase Document

101.DEF

 

XBRL Taxonomy Extension Definition Linkbase Document

 

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S I G N A T U R E S

 

 

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

 

 

INTRUSION INC.

Date: November 12, 2020        /s/ Jack B. Blount 
 

Date: November 13, 2019

        /s/ Michael L. Paxton

Jack B. Blount
 

Michael L. Paxton

Director, President & Chief Executive Officer
 

Director, Chairman of the Board, Interim President & Interim Chief Executive Officer

(Principal Executive Officer)

  
  

Date: November 13, 2019

12, 2020

        /s/ Michael L. Paxton

 
 

Michael L. Paxton

 

Director, Vice President, Chief Financial Officer,
Treasurer & Secretary

 

(Principal Financial & Accounting Officer)

 

 

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