INTZ

Business Context and Reporting Period

Company: Intrusion Inc.
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2008
Business Overview: Intrusion Inc. develops, markets, and supports network security solutions, including entity identification (TraceCop), regulated information compliance (Compliance Commander), and network intrusion prevention/detection (SecureNet). The company shifted its focus from hardware networking to software-based security solutions. As of December 31, 2008, the company employed 26 people.

Key Financial Metrics

Debt and Liquidity:

• Line of Credit: $2.5 million facility with Silicon Valley Bank; $0 outstanding balance as of Dec 31, 2008, with $48,000 available.
• Officer Loan: $480,000 outstanding balance owed to CEO G. Ward Paxton.
• Preferred Stock Dividends: $187,000 accrued and unpaid dividends on preferred stock.

Material Changes vs. Prior Period

• Revenue Growth: Total revenue increased 18% to $4.14 million, driven by a 28.6% increase in product revenue ($3.57 million) due to higher sales of TraceCop products. Conversely, SecureNet product line revenue decreased 30%.
• Margin Expansion: Gross margin improved from 60.8% to 66.8% due to a shift toward higher-margin software products and the elimination of the Supply Chain department.
• Expense Reduction: Operating expenses decreased significantly. Sales and marketing expenses dropped 26.3% to $1.41 million, and R&D expenses fell to $1.14 million (down from $1.66 million).
• Customer Concentration: Dependence on U.S. government customers increased. Government sales accounted for 86.2% of 2008 revenue (up from 73.2% in 2007), with two specific government customers representing 73.1% of total revenue.
• Cash Flow: Net cash used in operating activities improved significantly to $112,000 in 2008 compared to $1.76 million in 2007, aided by a $778,000 increase in deferred revenue.

Guidance, Outlook, Risks, and Contingencies

Outlook and Guidance:

• Management projects continued growth in revenue and net income in coming quarters.
• The company expects to fund operations through profits, its line of credit, and borrowings from the CEO. Additional equity or debt financing may be required, which could dilute existing shareholders.
• Management believes current resources are sufficient to finance operations for the next twelve months.

Material Risks and Contingencies:

• Liquidity Risk: The company has a working capital deficiency and an accumulated deficit of $58.3 million. It has not had net profits for the last two fiscal years.
• Dividend Default: The company is unable to pay accrued dividends on preferred stock due to a lack of capital surplus or net profits. Failure to cure this breach could trigger a redemption obligation of approximately $2.0 million for Series 2 and Series 3 preferred stock.
• Customer Concentration: Loss of one or two key U.S. government customers could materially harm the business.
• Financing Restrictions: Terms of preferred stock and the credit line restrict the ability to incur additional debt or issue senior securities without approval.

Key Facts for Investor Verification

• Government Dependence: Verify the stability of contracts with the two U.S. government customers representing 73.1% of revenue.
• Preferred Stock Redemption: Assess the risk of a $2.0 million redemption trigger if the company fails to pay accrued preferred dividends.
• CEO Financing: Confirm the terms and availability of the $1.5 million commitment from CEO G. Ward Paxton and the $480,000 outstanding loan.
• Product Mix Transition: Monitor the continued decline of SecureNet hardware sales versus the growth of TraceCop and Compliance Commander software sales.
• Stock Dilution: Evaluate the potential dilution from converting outstanding preferred stock and warrants, which could increase common shares outstanding by approximately 25%.