General
The following discussion and analysis include information management believes is
relevant to understand and assess our consolidated financial condition and
results of operations. This section should be read in conjunction with our
consolidated financial statements, accompanying notes and the risk factors
contained in this report.
14
Overview
Intrusion Inc. offers businesses of all sizes and industries products and
services that leverage across our exclusive threat intelligence database which
contains the historical data, known associations, and reputational behavior of
over 8.5 billion IP addresses. After many years of gathering intelligence and
providing our INTRUSION TraceCop and Savant solutions exclusively to government
entities, we released our first commercial product in 2021, the INTRUSION
Shield. INTRUSION Shield was designed to allow businesses to incorporate a Zero
Trust, reputation-based security solution into their existing infrastructure and
to observe traffic flow and instantly block known malicious or unknown
connections from both entering or exiting a network, making it an ideal solution
for protecting from Zero-Day and ransomware attacks.
During 2022 we spent significant time and resources on:
· Addressing and correcting performance issues encountered with the Shield
On-Premise solution;
· Developing Shield Cloud and Shield End-Point; both released in September 2022;
· Further refining our go-to-market strategy by partnering with targeted new
value-added resellers, managed service providers and managed security service
providers, and
· Building out our management team.
We feel that these efforts provide the resources needed to implement our
business plan.
In 2022, we raised $15.6 million through the combined issuance of notes payable
pursuant to the Securities Purchase Agreement with Streeterville Capital, LLC
dated March 10, 2022, the sale of common stock through our at-the-market-program
and a registered direct offering. On December 31, 2022, we had $3.0 million in
cash. If we are not able to obtain additional debt or equity financing on terms
and conditions acceptable to us, we may be unable to implement our business plan
or even continue our operations.
Results of Operations
The following table set forth, the results of operations for the fiscal years
ended December 31, 2022, and 2021. Certain historical amounts have been
reclassified to be presented on a comparable basis. For additional details, see
Note 14 Correction of Immaterial Errors to the consolidated financial statements
(Part II, Item 8 of this Form 10-K).
15
Comparison of the years ended December 31, 2022, and December 31, 2021
Year Ended December 31, Year Ended December 31,
(in thousands) 2022 2021 2022 2021
Revenue $ 7,529 $ 7,277 100.0% 100.0%
Cost of revenue 3,354 3,621 44.5% 49.8%
Gross profit 4,175 3,656 55.5% 50.2%
Operating expenses:
Sales and marketing 6,510 10,935 86.5% 150.3%
Research and development 6,465 6,328 85.9% 87.0%
General and administrative 7,483 5,896 99.4% 81.0%
Operating loss (16,283 ) (19,503 ) -216.3% -268.0%
Interest and other income 2,028 722 26.9% 9.9%
Interest expense (2,359 ) (21 ) -31.3% -0.3%
Gain on lease termination 385 - 5.1% -
Loss from operations before
income taxes (16,229 ) (18,802 ) -215.6% -258.4%
Income tax provision - - - -
Net loss $ (16,229 ) $ (18,802 ) -215.6% -258.4%
Net Revenue
Total revenue increased 3.5% to $7.5 million in 2022 from $7.3 million in 2021.
Shield revenues increased $0.7 million year-over-year as a result of the full
year impact of sales from prior year, the expanded use of Shield from existing
customers and new customers signed in 2022. The increase in Shield revenues was
partially offset by a decline in consulting revenues of $0.4 million. The
decline in consulting revenues resulted primarily from the loss of a contract in
the fourth quarter in which Intrusion's prime sponsor chose not to renew the
final option year of a contract that had been in place since 2018. This contract
represented annual revenue totaling $2.6 million. While the loss of this
contract significantly impacts Intrusion's top-line revenue, the gross margin on
this contract was 14% and, as a result, has a marginal impact on profitability.
We will continue to pursue new consulting opportunities and expect to see an
increase in consulting revenues in 2023.
16
Concentration of Revenues. Revenues from sales to various U.S. government
entities totaled $5.0 million, or 65.8% of revenues, for the year ended December
31, 2022, compared to $5.2 million, or 71.3% of revenues, for the same period in
2021. In both 2022 and 2021, sales to three government entities individually
accounted for over 10% of total revenues. Sales to commercial customers totaled
$2.6 million or 34.2% of total revenue for year ended December 31, 2022,
compared to $2.1 million or 28.7% of total revenue for the same period in 2021.
Two commercial customers individually accounted for over 10% of total revenues
in 2022 compared to one commercial customer in 2021. We have increased our
Shield sales and marketing efforts by expanding our reseller channels. On
December 31, 2022, our Shield opportunities comprised a large percentage of our
sales pipeline. We anticipate our concentration of revenues will vary among
customers in future periods depending upon the timing of certain sales, we
anticipate that sales to government customers, while comprising a significant
portion of our revenues in future periods, will represent a lower percentage of
our revenue base as we gain traction selling our Shield products into commercial
markets.
Sales to the government present risks in addition to those involved in sales to
commercial customers which could adversely affect our revenues, including,
without limitation, potential disruption to appropriation and spending patterns
and the government's reservation of the right to cancel contracts and purchase
orders for its convenience which could have a material adverse effect on our
financial results. Currently, we are not aware of any additional proposed
cancellation or renegotiation of any of our existing arrangements with
government entities and, historically, cancellations or renegotiated orders by
government entities have not resulted in a material adverse effect on our
business.
The Company's similar product and service offerings are not viewed as individual
segments, as its management analyzes the business as a whole and expenses are
not allocated to each product offering.
Gross Profit
Gross profit for the 12-months ended December 31, 2022, and 2021 totaled $4.2
million or 55% compared to $3.7 million or 50%. The improved gross profit in
2022 is mostly due to Shield revenues representing a larger percentage of
revenues, 16% compared to 7% in 2021. To the extent Shield revenues become a
larger percentage of revenues, we anticipate we will continue to see favorable
growth in gross profit margins.
Sales and Marketing
Sales and marketing expenses decreased to $6.5 million in 2022, compared to
$10.9 million in 2021. In 2021, with the launch of the INTRUSION Shield
commercial product, we aggressively ramped up selling and marketing costs in
anticipation of driving revenue growth from Shield sales. As a result of our
inability to successfully market and gain traction with sales of the Shield
On-Premise solution, we implemented cost saving measures which included changing
our go-to-market strategy. We changed from primarily a direct sales effort to a
fully indirect channel program including value added resellers, managed service
providers, managed security service providers and strategic partners. This
change contributed to significantly lowering year-over-year spend with
reductions in sales and marketing headcount from a high of 40 in mid-2021 to 9
employees on December 31, 2021, and 2022. Other cost saving measures implemented
in late 2021 that carried forward into 2022 included reduced spend on web
marketing, trade shows and other forms of business development and advertising
costs. Sales and marketing expenses may vary in the future.
Research and Development
Research and development expenses increased to $6.5 million in 2022 compared to
$6.3 million in 2021. In 2022, we implemented the Agile methodology of software
development to manage and track our development costs. As a result, we are now
able to accurately quantify and capture the cost associated with each stage of
the development life cycle. As required under ASC Topic 350-40 Internal Use
Software Accounting-Capitalization, we began capitalization of costs incurred
during the application development stage. In 2022, we recorded $1.4 million of
research and development costs to internal use software. The net increased spend
year-over-year, when including amounts capitalized, of $1.6 million related to
costs to design, develop and launch the new Shield Cloud and End-Point solutions
as well as costs to support and enhance Shield On-Premise.
17
General and Administrative
General and administrative expenses increased to $7.5 million from $5.9 million
in 2021. The increase in general and administrative costs relates primarily to
increased legal defense costs associated with the various legal proceedings as
described in more detail in Item 3. Legal Proceedings of this report. In late
2022 we hired an in-house General Counsel which we believe will help to reduce
any remaining expense for the Legal Proceedings described herein and expense for
legal matters going forward. Also, in late 2021 and early 2022, we experienced
significant turnover in our finance department which resulted in higher contract
labor and recruiting costs. Insurance expense for our Directors' and Officers'
insurance policy increased in 2022 when compared to 2021 as a result of the
Class Action lawsuits and related claims activity and, increasing coverage
limits for our new policy year.
Interest Expense
Interest expense increased to $2.4 million in 2022 compared to $21 thousand for
the year ended December 31, 2021. The increase relates to the Streeterville
notes payable entered into in March and June of 2022 and related debt issuance
cost amortization as well as interest expense from finance leases. Interest
expense will vary in the future based on our cash flow and borrowing needs.
Interest and Other Income
Other income totaled $2.0 million for the year ended December 31, 2022, compared
to $0.7 million for the year ended December 31, 2021. In 2022 we recorded a $2.0
million to Other Income related to an Employee Retention Credit refund due from
the federal government as a result of amending 941 returns for the 2020 and 2021
tax periods. Other income in 2021 related to the forgiveness of our U.S. Small
Business Administration ("SBA") Payroll Protection Program ("PPP") loan
principal and accrued interest.
Gain on Lease Termination
In 2022 we recorded a gain of $0.4 million relating to the settlement of our
lease abandonment lawsuit.
Income Taxes
Our effective income tax rate was 0% in 2022 and 2021 as valuation allowances
have been recorded for the entire amount of the net deferred tax assets due to
uncertainty of realization.
Consolidated Statements of Cash Flows
Our cash flows for the years ended December 31, 2022, and 2021 were:
Year Ended
December 31, December 31,
2022 2021
Net cash used in operating activities $ (13,190 ) $ (16,557 )
Net cash used in investing activities
(1,479 ) (1,148 )
Net cash provided by financing activities 13,584 5,101
Change in cash and cash equivalents $ (1,085 ) $ (12,604 )
18
Operating Activities
Net cash used in operations for the year ended December 31, 2022, was ($13.2)
million due to a net loss of ($16.2) million offset by adjustments for non-cash
items of $5.0 million which are mostly comprised of depreciation, stock-based
compensation and interest related to Streeterville notes, and changes in working
capital consisting primarily of a reduction in trade receivables $0.5 million;
an increase in other receivables relating principally to the remaining Employee
Retention Credits ("ERC") refund outstanding ($1.5) million; an increase in
accounts payable and accrued expenses $0.2 million; and a decrease in operating
lease liabilities ($1.0) million.
Net cash used in operations for the year ended December 31, 2021 was ($16.6)
million due primarily to a net loss of ($18.8) million partially offset by the
following sources of cash and non-cash items: $0.4 million increase in deferred
revenue, primarily due to increases in cash advances from certain customers
shifting to making upfront payments for our services for their contract term of
one year and an increased customer base related to our INTRUSION Shield product,
a $0.2 million decrease in accounts receivable, primarily caused by timing in
receipt of receivables from our customers, a ($0.6) million in gain on the
extinguishment of the PPP Loan, $1.3 million in stock-based compensation, $0.8
million in depreciation and amortization expense and $0.2 in noncash lease
costs.
Investing Activities
Net cash used in investing activities for the year ended December 31, 2022,
totaled ($1.5) million and was primarily related to capitalized internal use
software of ($1.2) million for the new Shield Cloud and End Point solutions as
well as enhancements to the Shield On-Premise solution and, the purchase of
equipment for use with the Shield On-Premise solution, in the data center and by
employees of ($0.3) million.
Net cash used in investing activities for the year ended December 31, 2022, was
($1.1) million which consisted of the purchases of property and equipment and a
domain name.
Financing Activities
Net cash provided by financing activities was $13.6 million for the year ended
December 31, 2022. Primary sources of cash from financing activities included
proceeds from the issuance of the two Streeterville notes payable, net of
issuance costs, equal to $9.3 million (see Note 6 Notes Payableto the
consolidated financial statements in Part II, Item 8 of this Form 10-K), net
proceeds received from our registered direct offering of $4.3 million, net
proceeds from issuance of shares from our at-the-market program of $2.0 million,
and proceeds received from a private placement sale of common stock equal to
$0.1 million. Funds used in financing activities included ($1.5) million in
principal repayments on the Streeterville notes payable and ($0.6) million
payments on equipment financing leases.
Net cash provided by financing activities was $5.1 million for the year ended
December 31, 2021, which was primarily the result of net proceeds from our
at-the-market program public offering of $5.6 million, proceeds from exercise of
stock options of $0.2 million offset by the payment on principal of finance
right-of-use leases of ($0.7) million.
Liquidity and Capital Resources
As of December 31, 2022, we had cash and cash equivalents of $3.0 million, down
from $4.1 million as of December 31, 2021; and a working capital deficit of
($7.8) million on December 31, 2022, compared to $2.1 million in working capital
on December 31, 2021. As discussed above in Financing Activities, our principal
sources of cash for funding operations in 2022 was through the issuance of the
two Streeterville notes which contributed $9.3 million, net of issuance costs,
and $6.4 million from the sale and issuance of common stock and warrants. On
February 23, 2023 we sold a secured promissory note to Streeterville in the
aggregate principal amount of $1.4 million plus certain reimbursed expenses in
exchange for $1.3 million. The note provided for weekly principal payments of
$50 thousand until its maturity on March 31, 2023. The note was secured by all
employee retention credits ("ERC"), or other funds still owed or otherwise
payable to the Company under the Cares Act. We received payment for the ERC owed
to Intrusion on March 13, 2023 and on March 14, 2023 we repaid in full the
secured promissory note with Streeterville.
19
Current At-The Market Offering.
In August of 2021, we engaged B. Riley Securities, Inc. to act as sales agent
under our at-the-market program, which allows us to potentially sell up to $50.0
million of our common stock on a delayed or continuous basis through the use of
a shelf-registration statement on Form S-3. As of December 31, 2022, we have
received proceeds of approximately $7.5 million net of fees from the sale of
1,843 thousand shares of our common stock pursuant to the program.
For so long as our public float is less than $75 million, we will be subject to
the restrictions set forth in General Instruction I.B.6 to Form S-3, which limit
our ability to conduct primary offerings under a Form S-3 registration
statement, including with respect to issuances under our at-the-market program.
Under such limitations, we may not sell, during any 12-month period, securities
on Form S-3 having an aggregate market value of more than one-third of our
public float. As of March 24, 2023, our public float calculated in accordance
with General Instruction I.B.6 of Form S-3 was $28.7 million.
2022 Convertible Notes Issuance.
We entered into a securities purchase agreement (the "SPA") with Streeterville
Capital, LLC ("Streeterville") on March 10, 2022, pursuant to which
Streeterville purchased two unsecured promissory notes with substantively
identical terms. Streeterville purchased the first note on March 10th and the
second note on June 29th, each note with an aggregate principal amount of $5.4
million in exchange for $5.0 million less certain expenses. We received
approximately $9.3 million, net of transaction expenses, in connection with
these issuances.
The notes mature in September and December 2023 and, as a result, are reflected
as a current liability on our consolidated balance sheet. Beginning six months
following the issuance of each note, Streeterville has the right to redeem up to
$0.5 million of the outstanding balance of each note per month. Payments may be
made by the Company, generally at the Company's option, (a) in cash, (b) by
paying the redemption amount in the form of shares of common stock or (c) a
combination of cash and shares of common stock. If paid in common stock, the
number of redemption shares to be issued is based on a 15% discount to market,
as further defined in the note agreements. Through December 2022, Streeterville
made three separate redemption requests totaling $1.5 million, we made the
redemption payments in cash. In January 2023, the note agreements were amended
whereby Streeterville waived their right to redemptions through March 31, 2023,
in exchange for a fee equal to 3.75% of the outstanding note balance. This fee
was added to the outstanding principal balance to be paid at maturity. As of
March 24, 2023, our total outstanding indebtedness to Streeterville including
principal, accrued interest and fees was $10.2 million.
We need to raise additional funds in the near term to continue operations. We
intend to obtain these funds from sales of our common stock through registered
direct offerings and the use of our aftermarket program. While we can provide no
assurances that we will be able to raise additional funds through any future
equity or debt financings, the terms of those financings, if available at all,
may be on terms which are not favorable to us and, in the case of equity
financings, will result in dilution to our stockholders.
20
Critical Accounting Policies and Estimates
Management's discussion and analysis of financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the U.
S. The preparation of these financial statements requires us to make estimates
and judgments that affect the reported amounts of assets, liabilities, revenues
and expenses, and related disclosure of contingent assets and liabilities. On an
on-going basis, we evaluate our estimates, including those related to product
returns, bad debts, income taxes, warranty obligations, maintenance contracts
and contingencies. We base our estimates on historical experience and on various
other assumptions that are believed to be reasonable under the circumstances,
the results of which form the basis for making judgments about the carrying
values of assets and liabilities that are not readily apparent from other
sources. Actual results may differ from these estimates under different
assumptions or conditions.
We believe the following critical accounting policies affect our more
significant judgments and estimates used in the preparation of our consolidated
financial statements.
Capitalized Software Development
We capitalize internally developed software using the Agile software development
methodology which allows us to accurately track, and record costs associated
with new software development and enhancements.
Pursuant to ASC Topic 250-40 Internal Use Software Accounting Capitalization,
certain development costs related to our products during the application
development stage are capitalized as part of property and equipment. Costs
incurred in the preliminary stages of development are expensed as incurred. The
preliminary stage includes such activities as conceptual formulation of
alternatives, evaluation of alternatives, determination of existence of needed
technology, and the final selection of alternatives. Once the application
development stage is reached, internal and external costs are capitalized until
the software is complete and ready for its intended use. Capitalized internal
use software is amortized on a straight-line basis over its estimated useful
life, which is generally three years.
Revenue Recognition
We recognize product revenue upon shipment or after meeting certain performance
obligations. These products can include hardware, software subscriptions and
consulting services. Most of our sales are from consulting services. We also
offer software on a subscription basis subject to software as a service
("SaaS"). Warranty costs and sales returns have not been material.
We recognize sales of its consulting services in accordance with FASB ASC Topic
606 whereby revenue from contracts with customers are recognized once the
criteria under the five steps below are met:
i) identification of the contract with a customer;
ii) identification of the performance obligations in the contract;
iii) determination of the transaction price;
iv) allocation of the transaction price to the separate performance obligations; and
v) Recognition of revenue upon satisfaction of a performance obligation.
21
Consulting services include reporting are typically done monthly, and revenue is
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 product offering and service offering market
values are readily determined based on current and prior stand-alone sales. We
defer and recognize maintenance, updates, and support revenue over the term of
the contract period, which is generally one year.
Normal payment terms offered to customers, distributors and resellers are net 30
days domestically. We do not offer payment terms that extend beyond one year and
rarely extend payment terms beyond our normal terms. If certain customers do not
meet our credit standards, we require payment in advance to limit our credit
exposure.
Shipping and handling costs are billed to the customer and included in revenue.
Shipping and handling expenses are included in cost of revenue. We have elected
to account for shipping and handling costs as fulfillment costs after the
customer obtains control of the goods.
With our newest product, INTRUSION Shield, we began offering software on a
subscription basis. INTRUSION Shield is a hosted arrangement subject to software
as a service guidance under ASC 606. SaaS arrangements are accounted for as
subscription services not arrangements that transfer a license of intellectual
property.
We utilize the five-step process, mentioned above, per FASB ASC Topic 606 to
recognize sales and will follow that directive, also, to define revenue items as
individual and distinct. INTRUSION Shield services provided to our customers for
a fixed monthly subscription fee include:
· Access to Intrusion's proprietary software and database to detect and
prevent unauthorized access to our clients' information networks;
· Use of all software, associated media, printed materials, data, files,
online documentation, and any equipment that Intrusion provides for
customers to access the INTRUSION Shield; and
· Tech support, post contract customer support (PCS) including daily program
releases or corrections are provided by Intrusion without additional charge.
Our contract provides for no other services, and our customers have no rebates
or return rights, nor are any such rights anticipated to be offered as part of
this service.
We satisfy our performance obligation when our INTRUSION Shield solution is
available to detect and prevent unauthorized access to a client's information
networks. Revenue is recognized monthly over the term of the contract. The
Company's standard initial contract terms automatically renew unless notice is
given 30 days before renewal. Upfront payment of fees is deferred and amortized
into income over the period covered by the contract.
Allowances for Doubtful Accounts
We maintain allowances for doubtful accounts for estimated losses resulting from
the inability of our customers to make required payments. Our receivables are
uncollateralized, and we expect to continue this policy in the future. If the
financial condition of our customers were to deteriorate, resulting in an
impairment of their ability to make payments, increased allowances may be
required. Historically, our estimate for sales returns and doubtful accounts
have not differed materially from actual results.
22
Fair Value of Financial Instruments
We calculate the fair value of our assets and liabilities which qualify as
financial instruments and include additional information in the notes to
consolidated financial statements when the fair value is different than the
carrying value of these financial instruments. The estimated fair value of
accounts receivable, accounts payable and accrued expenses approximate their
carrying amounts due to the relatively short maturity of these instruments.
Notes payable and financing and operating leases approximate fair value as they
bear market rates of interest. None of these instruments are held for trading
purposes.
Recent Accounting Pronouncements
See Note 2 to the consolidated financial statements (Part II, Item 8 of this
Form 10-K).
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