10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

☒	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2019
OR
☐	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)

* * * * * * * * * *

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 ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§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 ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer	☐	Accelerated filer	☐
Non-accelerated filer	☐	Smaller reporting company	☒
Emerging growth company	☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☐

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act): Yes ☐ No ☒

The number of shares outstanding of the Registrant’s Common Stock, $0.01 par value, on November 1, 2019 was 13,539,736.

1

INTRUSION INC.

INDEX

PART I – FINANCIAL INFORMATION
Item 1. Financial Statements
Unaudited Condensed Consolidated Balance Sheets as of September 30, 2019 and December 31, 2018	3
Unaudited Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2019 and 2018	4
Unaudited Condensed Consolidated Statements of Changes in Stockholders’ Equity (Deficit) for the nine months ended September 30, 2019 and 2018	5
Unaudited Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2019 and 2018	6
Notes to Unaudited Condensed Consolidated Financial Statements	7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	11
Item 4. Controls and Procedures	14
PART II – OTHER INFORMATION
Item 1. Legal Proceedings	15
Item 1A. Risk Factors	15
Item 6. Exhibits	18
Signature Page	19

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
ASSETS
Current Assets:
Cash and cash equivalents	$	2,111		$	1,652
Accounts receivable		2,704			1,967
Prepaid expenses		136			91
Total current assets		4,951			3,710
Noncurrent Assets:
Property and equipment, net		295			200
Finance leases, right-of-use assets, net		73			121
Operating lease, right-of-use assets, net		1,407			—
Other assets		38			38
Total noncurrent assets		1,813			359
TOTAL ASSETS	$	6,764		$	4,069
LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)
Current Liabilities:
Accounts payable and accrued expenses	$	1,078		$	1,596
Dividends payable		32			594
Finance leases liability, current portion		43			58
Operating lease liability, current portion		277			—
Deferred revenue		643			1,004
Total current liabilities		2,073			3,252
Noncurrent Liabilities:
Loan payable to officer		—			1,815
Finance leases liability, noncurrent portion		32			64
Operating lease liability, noncurrent portion		1,389			—
Total noncurrent liabilities		1,421			1,879
Commitments and contingencies
Stockholders’ equity (deficit):
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
Common stock held in treasury, at cost – 10 shares		(362	)		(362	)
Additional paid-in capital		56,770			56,609
Accumulated deficit		(55,073	)		(59,242	)
Accumulated other comprehensive loss		(43	)		(43	)
Total stockholders’ equity (deficit)		3,270			(1,062	)
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)	$	6,764		$	4,069

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
	September 30, 2019			September 30, 2018			September 30, 2019			September 30, 2018
Revenue	$	3,860		$	2,665		$	11,071		$	7,296
Cost of revenue		1,465			967			4,339			2,744
Gross profit		2,395			1,698			6,732			4,552
Operating expenses:
Sales and marketing		356			466			813			1,311
Research and development		297			329			775			832
General and administrative		277			243			930			828
Operating income		1,465			660			4,214			1,581
Interest expense, net		(1	)		(43	)		(45	)		(144	)
Net income	$	1,464		$	617		$	4,169		$	1,437
Preferred stock dividends accrued		(35	)		(35	)		(104	)		(104	)
Net income attributable to common stockholders	$	1,429		$	582		$	4,065		$	1,333
Net income per share attributable to common stockholders: Basic	$	0.11		$	0.04		$	0.30		$	0.10
Diluted	$	0.09		$	0.04		$	0.27		$	0.09
Weighted average common shares outstanding: Basic		13,523			13,062			13,466			13,009
Diluted		15,371			14,955			15,314			14,901

See accompanying notes.

4

INTRUSION INC. AND SUBSIDIARIES

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

(In thousands)

	Nine Months Ended
	September 30, 2019			September 30, 2018
NUMBER OF PREFERRED SHARES—ISSUED AND OUTSTANDING
Balance, beginning of year and end of nine month period		949			949
PREFERRED STOCK
Balance, beginning of year and end of nine month period	$	1,843		$	1,843
NUMBER OF COMMON SHARES—ISSUED
Balance, beginning of year		13,259			12,808
Exercise of stock options		291			322
Balance, end of nine month period		13,550			13,130
COMMON STOCK
Balance, beginning of year	$	133		$	128
Exercise of stock options		2			3
Balance, end of nine month period	$	135		$	131
TREASURY SHARES
Balance, beginning of year and end of nine month period	$	(362	)	$	(362	)
ADDITIONAL PAID-IN-CAPITAL
Balance, beginning of year	$	56,609		$	56,518
Stock-based compensation		24			16
Exercise of stock options		234			108
Preferred stock dividends declared, net of waived penalties by shareholders		(97	)		(70	)
Balance, end of nine month period	$	56,770		$	56,572
ACCUMULATED DEFICIT
Balance, beginning of year	$	(59,242	)	$	(61,529	)
Net income		4,169			1,437
Balance, end of nine month period	$	(55,073	)	$	(60,092	)
ACCUMULATED OTHER COMPREHENSIVE LOSS
Balance, beginning of year and end of nine month period	$	(43	)	$	(43	)
TOTAL STOCKHOLDERS’ EQUITY (DEFICIT)	$	3,270		$	(1,950	)

See accompanying notes.

5

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

	Nine Months Ended
	September 30, 2019			September 30, 2018
Operating Activities:
Net income	$	4,169		$	1,437
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		136			96
Stock-based compensation		24			16
Penalties on dividends		6			34
Extinguishment of U.K. cumulative translation adjustment		—			65
Changes in operating assets and liabilities:
Accounts receivable		(737	)		(155	)
Inventories		—			15
Prepaid expenses and other assets		(45	)		(120	)
Operating lease, right-of-use asset		364			—
Accounts payable and accrued expenses		(621	)		191
Deferred revenue		(361	)		213
Net cash provided by operating activities		2,935			1,792
Investing Activities:
Purchases of property and equipment		(183	)		(173	)
Financing Activities:
Borrowings on loan from officer		—			150
Payments on loan from officer		(1,815	)		(1,200	)
Proceeds from stock options exercised		236			111
Payments of dividends		(667	)		—
Reduction of finance lease liability		(47	)		(51	)
Net cash used in financing activities		(2,293	)		(990	)
Net increase in cash and cash equivalents		459			629
Cash and cash equivalents at beginning of period		1,652			224
Cash and cash equivalents at end of period	$	2,111		$	853
SUPPLEMENTAL DISCLOSURE OF NON CASH OPERATING AND FINANCING ACTIVITIES:
Preferred stock dividends accrued	$	103		$	104
Purchase of leased equipment per right-of-use finance lease	$	—		$	89
Initial recognition of operating lease, right-of-use asset	$	1,771		$	—

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:

● end-users, and

● value-added resellers.

Our end-user customers include:

● U.S. federal government entities,

● state and local government entities,

● large and diverse conglomerates,

● manufacturing entities, and

● other customers.

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.

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, 2018 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, 2019 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, filed with the U.S. Securities and Exchange Commission (the “SEC”) on March 28, 2019.

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.

7

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, 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”). 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 Chief Executive Officer. 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 under the CEO Note officer accrued interest at a floating rate per annum equal to Silicon Valley Bank’s (“SVB”) prime rate plus 1%. Any outstanding borrowings and accrued but unpaid interest is due on March 31, 2021. As of September 30, 2019, there were no borrowings or accrued interest outstanding

As of October 24, 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, 2019 and 2018, the Company did not grant any stock options to employees or directors. The Company recognized $10,000 and $5,000, respectively, of stock-based compensation expense for the three month periods ended September 30, 2019 and 2018. During the nine month periods ended September 30, 2019 and 2018, the Company granted 24,000 and 24,000, respectively, of stock options to employees and directors. The Company recognized $24,000 and $16,000, respectively, of stock-based compensation expense for the nine month periods ended September 30, 2019 and 2018.

During the three month periods ended September 30, 2019 and 2018, 10,500 and 103,500 options were exercised under the 2005 Plan, respectively. During the nine month periods ended September 30, 2019 and 2018, 291,000 and 322,500 were exercised under the 2005 Plan, 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, 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

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.

8

5. Contract Assets and Contract Liabilities

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, 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.

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, 2019, the Company had contract liabilities balance of $643,000. At September 30, 2018, the Company had contract liabilities balance of $619,000.

6. Net Income Per Share

Basic net income per share is computed by dividing net income attributable to common stockholders for the period by the weighted average number of common shares outstanding for the period. Diluted net income per share is computed by dividing the net income 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 per share calculation for the three month periods ended September 30, 2019 and 2018 are 0 and 149,000, respectively. The aggregate number of common stock equivalents excluded from the diluted income per share calculation for the nine month periods ended September 30, 2019 and 2018 are 4,044 and 292,044, respectively.

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 90.9% of total revenues for the third quarter of 2019 compared to 84.5% of total revenues for the third quarter of 2018. During the third quarter of 2019, approximately 75.8% of total revenues were attributable to three government customers compared to approximately 66.4% of total revenues attributable to four government customers in the third quarter of 2018. In the third quarter of 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. 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

During the quarter ended September 30, 2019, we accrued $13,000 in dividends payable to the holders of our 5% Preferred Stock, $14,000 in dividends payable to the holders of our Series 2 5% Preferred Stock 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.

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.

9

10. Right-of-use Asset and Leasing Liabilities

Under 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 five years and two months as of September 30, 2019. The San Marcos operating lease liability has a life of eighteen months as of September 30, 2019.

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.

Schedule of Items Appearing on the Statement of Operations:

	Three Months Ended				Nine Months Ended
	September 30, 2019		September 30, 2018		September 30, 2019		September 30, 2018
Operating expense:
Amortization expense – Finance ROU		16		17		48		50
Lease expense – Operating ROU		82		65		244		197
Other expense:
Interest expense – Finance ROU		1		1		3		2

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

	Operating			Finance
Period ending September 30,	ROU Leases			ROU Leases			Total
2020	$	359		$	46		$	405
2021		362			31			393
2022		366			1			367
2023		378			—			378
2024		384			—			384
Thereafter		64			—			64
	$	1,913		$	78		$	1,991
Less Interest*		(247	)		(3	)
	$	1,666		$	75

*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.

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

Forward Looking Statements

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 2018 Annual Report on Form 10-K, filed March 28, 2019, in Item 1A “Risk Factors” include, but are not limited to:

● the transition of responsibilities from our co-founder, G. Ward Paxton, and the appointment of our current CFO, Michael L. Paxton, as a Director, Chairman of the Board, as well as Interim President and Interim CEO, may cause disruptions in the Company’s operations, take a significant portion of our management’s time and attention, and may cause our suppliers, vendors, and customers to be concerned about this transition;

● insufficient cash to operate our business and inability to meet our liquidity requirements;

● loss of revenues due to the failure of our newer products to achieve market acceptance;

● our need to increase current revenue levels in order to achieve sustainable profitability;

● our unavailability to make future borrowings under the CEO Note;

● our ability to replace all or a portion of the borrowing base available to the Company under the CEO Note and whether any such terms would be available on terms acceptable to the Company, if at all;

● concentration of our revenues from U.S. government entities or commercial customers and the possibility 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 preferred stock would have on the price of our common stock;

● the ability of our preferred stockholders to hinder additional financing; and

● the influence that our management and larger stockholders have over actions taken by the Company.

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.

11

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.

	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	%

Net Revenues. Net revenues for the quarter and nine months ended September 30, 2019 were $3.9 million and $11.1 million, respectively, compared to $2.7 million and $7.3 million for the same periods in 2018. Product revenues increased $1.2 million for the quarter ended September 30, 2019, and $3.8 million for the nine months ended September 30, 2019 compared to the same periods in 2018. Increased product revenues were primarily due to an increase in sales of our TraceCop product line. TraceCop sales for the quarters ended September 30, 2019 and 2018 were $3.9 million and $2.7 million, respectively. Savant sales remained the same at $29 thousand for the quarters ended September 30, 2019 and 2018.

Concentration of Revenues. Revenues from sales to various U.S. government entities totaled $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. Revenues from sales to various U.S. government entities totaled $9.9 million, or 89.8% of revenues, for the nine months ended September 30, 2019, compared to $6.1 million, or 84.2% of revenues, for the same period in 2018. Sales to commercial customers totaled 9.1% of total revenue for the third quarter of 2019 compared to 15.5% of total revenue for the third quarter of 2018. During the third quarter of 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. 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.

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Gross Profit. Gross profit was $2.4 million or 62.0% of net revenues for the quarter ended September 30, 2019, compared to $1.7 million or 63.7% of net revenues for the quarter ended September 30, 2018. Gross profit was $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. 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 mainly due to a change in product mix. Gross profit increases 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.

Sales and Marketing. Sales and marketing expenses decreased to $0.4 million for the quarter ended September 30, 2019, compared to $0.5 million for same period in 2018. Sales and marketing expenses decreased to $0.8 million for the nine months ended September 30, 2019, compared to $1.3 million for the same period in 2018. For the nine months ended September 30, 2019, sales and marketing expenses decreased due to shifting expense to cost 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. Sales and marketing expenses may vary in the future. We believe that these costs may increase through the end of 2019.

Research and Development. Research and development expenses remained constant at $0.3 million for the quarter ended September 30, 2019, compared to the same period in 2018. Research and development remained constant at $0.8 million for the nine months ended September 30, 2019, compared to the same period in 2018. Research and development costs remained constant due to increased labor expense being allocated to cost of sales. Research and development costs are expensed in the period incurred. Research and development expenses may vary in the future; however, we believe that these costs will mainly be dependent on the amount of research and development expense allocated to cost of sales.

General and Administrative. General and administrative expenses increased to $0.3 million for the quarter ended September 30, 2019, compared to $0.2 million for the same period in 2018. General and administrative expenses increased to $0.9 million for the nine months ended September 30, 2019, compared to $0.8 million for the same period in 2018. It is expected that general and administrative expenses will remain relatively constant throughout the remainder of 2019.

Interest. Net interest expense decreased to $1 thousand for the quarter ended September 30, 2019, compared to $43 thousand for the same period in 2018. Net interest expense decreased to $45 thousand for the nine months ended September 30, 2019 compared to $144 thousand for the same period in 2018. The decrease in interest expense was due to elimination of the loan payable to an officer. Net interest expense may vary in the future based on our level of borrowing, which will be affected by our cash flow, operating income and capital expenditures.

Liquidity and Capital Resources

Our principal source of liquidity at September 30, 2019, was approximately $2.1 million of cash and cash equivalents. At September 30, 2019, we had working capital of $2.9 million compared to a $0.4 million working capital deficiency at September 30, 2018.

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 operating lease right-of-use assets, $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.

13

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

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.

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

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

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 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 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.

Based on projections of growth in revenue and net income in the coming quarters, we believe that we will have sufficient cash resources to finance our operations and expected capital expenditures for the next twelve months. 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, possible additional investments of private equity and debt, , 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, 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 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.

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, 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, 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, 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. 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. 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, 2018 filed on March 28, 2019. 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 have 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. The 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 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 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 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 even continue our operations.

15

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

For the quarter ended September 30, 2019, we generated a net income of $1.5 million and had an accumulated deficit of approximately $55.1 million as of September 30, 2019, compared to a net income of $617 thousand for the quarter ended September 30, 2018 and an accumulated deficit of approximately $60.1 million at September 30, 2018. We need to maintain current revenue levels from the sales of our products if we are to continue profitability. If we are unable to achieve these revenue levels, losses could happen for the near term and possibly longer, and we may not maintain profitability or generate positive cash flow from operations in the future.

A large percentage of our revenues are received from U.S. government entities/resellers, and the loss of any one of these customers could reduce our revenues and materially harm our business and prospects.

A large percentage of our revenues result from sales to U.S. government entities/resellers. If we were to lose one or more of these key relationships, our revenues could decline and our business and prospects may be materially harmed. 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. government 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 or that we will be able to diversify our customer portfolio to adequately mitigate the risk of loss of any of these customers.

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

Almost all of our revenues result from sales of one security product line. TraceCop revenues were $3.9 million for the quarter ended September 30, 2019, compared to $2.7 million for the third quarter 2018. Savant revenues remained constant at $29 thousand for the quarters ended September 30, 2019 and 2018. No individual commercial customer in the third quarter of 2019 had over 10.0% of total revenue compared to one individual customer with 14.5% of total revenue for the same period in 2018. If sales of this key product line and individual customer were to decrease, our revenues could decline and our business and prospects may be materially harmed.

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

We derived 90.9% of revenue in the third quarter of 2019 through indirect channels of mainly government resellers, compared to 84.5% of our revenues in the quarter ended September 30, 2018. We must continue to expand our sales through these indirect channels in order to increase our revenues. We cannot assure you that our products 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 through these indirect sales channels, which could result in lower prices and reduced profit margins for sales of our products.

16

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.

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

On November 1, 2019, we had 13,539,736 shares of common stock outstanding. Upon the exercising of current options exercisable at or below the exercise price of $2.73, we would have approximately 14,400,000 shares of common stock outstanding, a 6.4% increase in the number of shares of our common stock outstanding.

Our management and larger stockholders exercise significant control over our company and have the ability to approve or take actions that may be adverse to your interests.

As of November 1, 2019, our executive officers, directors and preferred stockholders beneficially own approximately 36% of our voting power. In addition, other related parties control approximately 26% of voting power. As a result, these stockholders will be 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 to the interests of holders of our Common Stock. Further, we contemplate the possible issuance of shares of our Common Stock or of securities exercisable or convertible into shares of our Common Stock in the future to our Chief Executive Officer 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.

17

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

18

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 13, 2019	/s/ Michael L. Paxton
	Michael L. Paxton
	Director, Chairman of the Board, Interim President & Interim Chief Executive Officer
	(Principal Executive Officer)
Date: November 13, 2019	/s/ Michael L. Paxton
	Michael L. Paxton
	Chief Financial Officer, Treasurer & Secretary
	(Principal Financial & Accounting Officer)

19

EX-31.1

EXHIBIT 31.1

I, Michael L. Paxton, Interim Chief Executive Officer of Intrusion Inc., certify that:

(1) I have reviewed this quarterly report on Form 10-Q of Intrusion Inc.;

(2) Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

(3) Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

(4) The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

(5) The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: November 13, 2019	/s/ Michael L. Paxton
	Michael L. Paxton
	Interim Chief Executive Officer

EX-31.2

EXHIBIT 31.2

I, Michael L. Paxton, Chief Financial Officer of Intrusion Inc., certify that:

(1) I have reviewed this quarterly report on Form 10-Q of Intrusion Inc.;

(2) Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

(3) Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

(4) The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

(5) The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: November 13, 2019	/s/ Michael L. Paxton
	Michael L. Paxton
	Chief Financial Officer

EX-32.1

EXHIBIT 32.1

CERTIFICATION PURSUANT TO RULE 13a-14(b) OF THE EXCHANGE ACT AND 18 U.S.C. SECTION 1350, AS ENACTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of Intrusion Inc. (the “Company”) on Form 10-Q, for the quarter ended September 30, 2019 (the “Report”) as filed with the Securities and Exchange Commission on the date hereof, each of the undersigned Officers of the Company does hereby certify, pursuant to 18 U.S.C. Section 1350, as enacted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

(1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)); and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

November 13, 2019	/s/ Michael L. Paxton
	Michael L. Paxton
	Interim Chief Executive Officer

November 13, 2019	/s/ Michael L. Paxton
	Michael L. Paxton
	Chief Financial Officer

The foregoing certification is being furnished solely pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and is not being filed as part of the Report or as a separate disclosure document.

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Note 10 - Right-of-use Asset and Leasing Liabilities (Tables)

9 Months Ended

Sep. 30, 2019

Notes Tables

Lease, Cost [Table Text Block]

	Three Months Ended				Nine Months Ended
	September 30, 201 9		September 30, 201 8		September 30, 201 9		September 30, 201 8
Operating expense:
Amortization expense – Finance ROU		16		17		48		50
Lease expense – Operating ROU		82		65		244		197
Other expense:
Interest expense – Finance ROU		1		1		3		2

Lessee, Operating and Finance Lease, Liability, Maturity [Table Text Block]

	Operating			Finance
Period ending September 30,	ROU Leases			ROU Leases			Total
2020	$	359		$	46		$	405
2021		362			31			393
2022		366			1			367
2023		378			—			378
2024		384			—			384
Thereafter		64			—			64
	$	1,913		$	78		$	1,991
Less Interest*		(247	)		(3	)
	$	1,666		$	75

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Note 8 - Commitments and Contingencies

9 Months Ended

Sep. 30, 2019

Notes to Financial Statements

Commitments and Contingencies Disclosure [Text Block]

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.

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Note 4 - Accounting for Stock-based Compensation

9 Months Ended

Sep. 30, 2019

Notes to Financial Statements

Share-based Payment Arrangement [Text Block]

4. Accounting for Stock-Based Compensation

During the

three

month periods ended

September 30, 2019

and

2018,

the Company did

not

grant any stock options to employees or directors. The Company recognized

$10,000

and

$5,000,

respectively, of stock-based compensation expense for the

three

month periods ended

September 30, 2019

and

2018.

During the

nine

month periods ended

September 30, 2019

and

2018,

the Company granted

24,000

and

24,000,

respectively, of stock options to employees and directors. The Company recognized

$24,000

and

$16,000,

respectively, of stock-based compensation expense for the

nine

month periods ended

September 30, 2019

and

2018.

During the

three

month periods ended

September 30, 2019

and

2018,

10,500

and

103,500

options were exercised under the

2005

Plan, respectively. During the

nine

month periods ended

September 30, 2019

and

2018,

291,000

and

322,500

were exercised under the

2005

Plan, 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, 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

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.

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Unaudited Condensed Consolidated Statements of Cash Flows - USD ($) $ in Thousands	9 Months Ended
	Sep. 30, 2019	Sep. 30, 2018
Operating Activities:
Net income	$ 4,169	$ 1,437
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	136	96
Stock-based compensation	24	16
Penalties on dividends	6	34
Extinguishment of U.K. cumulative translation adjustment		65
Changes in operating assets and liabilities:
Accounts receivable	(737)	(155)
Inventories		15
Prepaid expenses and other assets	(45)	(120)
Operating lease, right-of-use asset	364
Accounts payable and accrued expenses	(621)	191
Deferred revenue	(361)	213
Net cash provided by operating activities	2,935	1,792
Investing Activities:
Purchases of property and equipment	(183)	(173)
Financing Activities:
Borrowings on loan from officer		150
Payments on loan from officer	(1,815)	(1,200)
Proceeds from stock options exercised	236	111
Payments of dividends	(667)
Reduction of finance lease liability	(47)	(51)
Net cash used in financing activities	(2,293)	(990)
Net increase in cash and cash equivalents	459	629
Cash and cash equivalents at beginning of period	1,652	224
Cash and cash equivalents at end of period	2,111	853
SUPPLEMENTAL DISCLOSURE OF NON CASH OPERATING AND FINANCING ACTIVITIES:
Preferred stock dividends accrued	103	104
Purchase of leased equipment per right-of-use finance lease		89
Initial recognition of operating lease, right-of-use asset	$ 1,771

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Unaudited Condensed Consolidated Balance Sheets - USD ($)	Sep. 30, 2019	Dec. 31, 2018
Current Assets:
Cash and cash equivalents	$ 2,111,000	$ 1,652,000
Accounts receivable	2,704,000	1,967,000
Prepaid expenses	136,000	91,000
Total current assets	4,951,000	3,710,000
Noncurrent Assets:
Property and equipment, net	295,000	200,000
Finance leases, right-of-use assets, net	73,000	121,000
Operating lease, right-of-use assets, net	1,407,000
Other assets	38,000	38,000
Total noncurrent assets	1,813,000	359,000
TOTAL ASSETS	6,764,000	4,069,000
Current Liabilities:
Accounts payable and accrued expenses	1,078,000	1,596,000
Dividends payable	32,000	594,000
Finance leases liability, current portion	43,000	58,000
Operating lease liability, current portion	277,000
Deferred revenue	643,000	1,004,000
Total current liabilities	2,073,000	3,252,000
Noncurrent Liabilities:
Loan payable to officer		1,815,000
Finance leases liability, noncurrent portion	32,000	64,000
Operating lease liability, noncurrent portion	1,389,000
Total noncurrent liabilities	1,421,000	1,879,000
Commitments and contingencies
Stockholders’ equity (deficit):
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	135,000	133,000
Common stock held in treasury, at cost – 10 shares	(362,000)	(362,000)
Additional paid-in capital	56,770,000	56,609,000
Accumulated deficit	(55,073,000)	(59,242,000)
Accumulated other comprehensive loss	(43,000)	(43,000)
Total stockholders’ equity (deficit)	3,270,000	(1,062,000)
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)	6,764,000	4,069,000
Series 1 Preferred Stock [Member]
Stockholders’ equity (deficit):
Preferred stock	707,000	707,000
Series 2 Preferred Stock [Member]
Stockholders’ equity (deficit):
Preferred stock	724,000	724,000
Series 3 Preferred Stock [Member]
Stockholders’ equity (deficit):
Preferred stock	$ 412,000	$ 412,000

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Note 10 - Right-of-use Asset and Leasing Liabilities (Details Textual)	Sep. 30, 2019
Lessee, Finance Lease, Term of Contract	3 years
Richardson Property [Member]
Lessee, Operating Lease, Term of Contract	5 years 62 days
The San Marcos Property [Member]
Lessee, Operating Lease, Term of Contract	1 year 180 days

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Note 5 - Contract Assets and Contract Liabilities (Details Textual) - USD ($)	Sep. 30, 2019	Dec. 31, 2018	Sep. 30, 2018
Contract with Customer, Asset, Net, Current, Total	$ 2,704,000		$ 1,117,000
Contract with Customer, Liability, Current	$ 643,000	$ 1,004,000	$ 619,000

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Note 1 - Description of Business

9 Months Ended

Sep. 30, 2019

Notes to Financial Statements

Nature of Operations [Text Block]

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:

● end-users, and

● value-added resellers.

Our end-user customers include:

● U.S. federal government entities,

● state and local government entities,

● large and diverse conglomerates,

● manufacturing entities, and

● other customers.

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.

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Unaudited Condensed Consolidated Balance Sheets (Parentheticals) - $ / shares shares in Thousands	Sep. 30, 2019	Dec. 31, 2018
Preferred stock, par value (in dollars per share)	$ 0.01	$ 0.01
Preferred stock, shares authorized (in shares)	5,000	5,000
Common stock, par value (in dollars per share)	$ 0.01	$ 0.01
Common stock, shares authorized (in shares)	80,000	80,000
Common stock, shares issued (in shares)	13,550	13,259
Common stock, shares outstanding (in shares)	13,540	13,249
Common stock held in treasury, at cost, shares (in shares)	10	10
Series 1 Preferred Stock [Member]
Preferred stock, shares issued (in shares)	200	200
Preferred stock, shares outstanding (in shares)	200	200
Preferred stock, liquidation preference (in dollars per share)	$ 1,025	$ 1,213
Series 2 Preferred Stock [Member]
Preferred stock, shares issued (in shares)	460	460
Preferred stock, shares outstanding (in shares)	460	460
Preferred stock, liquidation preference (in dollars per share)	$ 1,155	$ 1,385
Series 3 Preferred Stock [Member]
Preferred stock, shares issued (in shares)	289	289
Preferred stock, shares outstanding (in shares)	289	289
Preferred stock, liquidation preference (in dollars per share)	$ 633	$ 760

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Note 10 - Right-of-use Asset and Leasing Liabilities - Schedule of Items Appearing on the Statement of Operations (Details) - USD ($) $ in Thousands	3 Months Ended		9 Months Ended
	Sep. 30, 2019	Sep. 30, 2018	Sep. 30, 2019	Sep. 30, 2018
Amortization expense – Finance ROU	$ 16	$ 17	$ 48	$ 50
Lease expense – Operating ROU	82	65	244	197
Interest expense – Finance ROU	$ 1	$ 1	$ 3	$ 2

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Note 6 - Net Income Per Share (Details Textual) - shares	3 Months Ended		9 Months Ended
	Sep. 30, 2019	Sep. 30, 2018	Sep. 30, 2019	Sep. 30, 2018
Antidilutive Securities Excluded from Computation of Earnings Per Share, Amount	0	149,000	4,044	292,044

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Note 9 - Dividends Payable

9 Months Ended

Sep. 30, 2019

Notes to Financial Statements

Stockholders' Equity Note Disclosure [Text Block]

9. Dividends Payable

During the quarter ended

September 30, 2019,

we accrued

$13,000

in dividends payable to the holders of our

5%

Preferred Stock,

$14,000

in dividends payable to the holders of our Series

2

5%

Preferred Stock 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.

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.

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Note 5 - Contract Assets and Contract Liabilities

9 Months Ended

Sep. 30, 2019

Notes to Financial Statements

Revenue from Contract with Customer [Text Block]

5. Contract Assets and Contract Liabilities

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, 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.

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, 2019,

the Company had contract liabilities balance of

$643,000.

At

September 30, 2018,

the Company had contract liabilities balance of

$619,000.

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Note 3 - Loan Payable to Officer (Details Textual) - Revolving Credit Facility [Member] - Chief Executive Officer [Member] - USD ($)	9 Months Ended
	Sep. 30, 2019	Oct. 24, 2019	Feb. 07, 2019	Feb. 08, 2018
Line of Credit Facility, Maximum Borrowing Capacity			$ 2,700,000	$ 3,700,000
Debt Instrument, Basis Spread on Variable Rate	1.00%
Long-term Line of Credit, Total	$ 0
Subsequent Event [Member]
Line of Credit Facility, Maximum Borrowing Capacity		$ 0

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Note 9 - Dividends Payable (Details Textual)	3 Months Ended
	Sep. 30, 2019 USD ($)
Series 1 Preferred Stock [Member]
Dividends, Preferred Stock, Total	$ 13,000
Preferred Stock, Dividend Rate, Percentage	5.00%
Series 2 Preferred Stock [Member]
Dividends, Preferred Stock, Total	$ 14,000
Preferred Stock, Dividend Rate, Percentage	25.00%
Series 3 Preferred Stock [Member]
Dividends, Preferred Stock, Total	$ 8,000
Preferred Stock, Dividend Rate, Percentage	3.50%
Series 2 Preferred Stock and Series 3 Preferred Stock [Member]
Dividends, Preferred Stock, Total	$ 32,000
Preferred Stock Unpaid Dividends Additional Late Fee Penalty Percentage	18.00%
Period From Issuance of Written Notice For Failure to Pay Dividend Within Which Entity Must Cure Breach	45 days
Preferred Stock, Redemption Amount	$ 1,800,000

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Note 4 - Accounting for Stock-based Compensation - Valuation Assumptions (Details) - $ / shares	3 Months Ended		9 Months Ended
	Sep. 30, 2019	Sep. 30, 2018	Sep. 30, 2019	Sep. 30, 2018
Weighted average grant date fair value (in dollars per share)			$ 3.61	$ 0.99
Weighted average assumptions used:
Expected dividend yield			0.00%	0.00%
Risk-free interest rate			2.19%	2.93%
Expected volatility			127.52%	131.00%
Expected life (in years) (Year)			5 years	5 years

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Note 3 - Loan Payable to Officer

9 Months Ended

Sep. 30, 2019

Notes to Financial Statements

Related Party Transactions Disclosure [Text Block]

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”). 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 Chief Executive Officer. 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 under the CEO Note officer accrued interest at a floating rate per annum equal to Silicon Valley Bank’s (“SVB”) prime rate plus

1%.

Any outstanding borrowings and accrued but unpaid interest is due on

March 31, 2021.

As of

September 30, 2019,

there were

no

borrowings or accrued interest outstanding

As of

October 24, 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.

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Unaudited Condensed Consolidated Statements of Changes In Stockholders' Equity (Deficit) - USD ($) $ in Thousands	Total	Preferred Stock [Member]	Common Stock [Member]	Treasury Stock [Member]	Additional Paid-in Capital [Member]	Retained Earnings [Member]	AOCI Attributable to Parent [Member]
Balance, beginning of year and end of nine month period (in shares)		(949,000)	(12,808,000)
Balance (in shares) at Dec. 31, 2017		949,000	12,808,000
Balance at Dec. 31, 2017		$ 1,843	$ 128		$ 56,518	$ (61,529)	$ (43)
Exercise of stock options (in shares)	322,500		322,000
Exercise of stock options			$ 3		108
Balance, beginning of year and end of nine month period (in shares)		(949,000)	(12,808,000)
Stock-based compensation					16
Preferred stock dividends declared, net of waived penalties by shareholders					(70)
Net income	$ 1,437					1,437
Balance at Sep. 30, 2018	(1,950)		$ 131		56,572	(60,092)
Balance, beginning of year and end of nine month period (in shares)			(13,130,000)	(362,000)
Balance, beginning of year and end of nine month period (in shares)		(949,000)	(13,259,000)
Balance (in shares) at Dec. 31, 2018		949,000	13,259,000
Balance at Dec. 31, 2018	$ (1,062)	$ 1,843	$ 133		56,609	(59,242)	$ (43)
Exercise of stock options (in shares)	291,000		291,000
Exercise of stock options			$ 2		234
Balance, beginning of year and end of nine month period (in shares)		(949,000)	(13,259,000)
Stock-based compensation					24
Preferred stock dividends declared, net of waived penalties by shareholders					(97)
Net income	$ 4,169					4,169
Balance at Sep. 30, 2019	$ 3,270		$ 135		$ 56,770	$ (55,073)
Balance, beginning of year and end of nine month period (in shares)			(13,550,000)	(362,000)

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Document And Entity Information - shares	9 Months Ended
	Sep. 30, 2019	Nov. 01, 2019
Document Information [Line Items]
Entity Registrant Name	Intrusion Inc
Entity Central Index Key	0000736012
Current Fiscal Year End Date	--12-31
Entity Filer Category	Non-accelerated Filer
Entity Current Reporting Status	Yes
Entity Emerging Growth Company	false
Entity Small Business	true
Entity Common Stock, Shares Outstanding (in shares)		13,539,736
Entity Shell Company	false
Document Type	10-Q
Document Period End Date	Sep. 30, 2019
Document Fiscal Year Focus	2019
Document Fiscal Period Focus	Q3
Amendment Flag	false

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Note 4 - Accounting for Stock-based Compensation (Tables)

9 Months Ended

Sep. 30, 2019

Notes Tables

Schedule of Share-based Payment Award, Stock Options, Valuation Assumptions [Table Text Block]

	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

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Note 7 - Concentrations

9 Months Ended

Sep. 30, 2019

Notes to Financial Statements

Concentration Risk Disclosure [Text Block]

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

90.9%

of total revenues for the

third

quarter of

2019

compared to

84.5%

of total revenues for the

third

quarter of

2018.

During the

third

quarter of

2019,

approximately

75.8%

of total revenues were attributable to

three

government customers compared to approximately

66.4%

of total revenues attributable to

four

government customers in the

third

quarter of

2018.

In the

third

quarter of

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.

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.

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Note 10 - Right-of-use Asset and Leasing Liabilities

9 Months Ended

Sep. 30, 2019

Notes to Financial Statements

Operating and Finance Leases Of Lessee Disclosure [Text Block]

10. Right-of-use Asset and Leasing Liabilities

Under 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

five

years and

two

months as of

September 30, 2019.

The San Marcos operating lease liability has a life of

eighteen

months as of

September 30, 2019.

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.

Schedule of Items Appearing on the Statement

of Operations

:

	Three Months Ended				Nine Months Ended
	September 30, 201 9		September 30, 201 8		September 30, 201 9		September 30, 201 8
Operating expense:
Amortization expense – Finance ROU		16		17		48		50
Lease expense – Operating ROU		82		65		244		197
Other expense:
Interest expense – Finance ROU		1		1		3		2

Future minimum lease obligations consisted of the following at

September

30

,

2019

(in thousands):

	Operating			Finance
Period ending September 30,	ROU Leases			ROU Leases			Total
2020	$	359		$	46		$	405
2021		362			31			393
2022		366			1			367
2023		378			—			378
2024		384			—			384
Thereafter		64			—			64
	$	1,913		$	78		$	1,991
Less Interest*		(247	)		(3	)
	$	1,666		$	75

*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.

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Note 6 - Net Income Per Share

9 Months Ended

Sep. 30, 2019

Notes to Financial Statements

Earnings Per Share [Text Block]

6. Net Income Per Share

Basic net income per share is computed by dividing net income attributable to common stockholders for the period by the weighted average number of common shares outstanding for the period. Diluted net income per share is computed by dividing the net income 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 per share calculation for the

three

month periods ended

September 30, 2019

and

2018

are

0

and

149,000,

respectively. The aggregate number of common stock equivalents excluded from the diluted income per share calculation for the

nine

month periods ended

September 30, 2019

and

2018

are

4,044

and

292,044,

respectively.

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Note 7 - Concentrations (Details Textual)	3 Months Ended		9 Months Ended
	Sep. 30, 2019	Sep. 30, 2018	Sep. 30, 2019
Number of Areas in Which Operations are Concentrated			1
Customer Concentration Risk [Member] | Revenue Benchmark [Member] | U.S. Government [Member]
Concentration Risk, Percentage	90.90%	84.50%
Customer Concentration Risk [Member] | Revenue Benchmark [Member] | Three Government Customers [Member]
Concentration Risk, Percentage	75.80%
Number of Major Customers	3
Customer Concentration Risk [Member] | Revenue Benchmark [Member] | Four Government Customers [Member]
Concentration Risk, Percentage		66.40%
Number of Major Customers		4
Customer Concentration Risk [Member] | Revenue Benchmark [Member] | One Commercial Customer [Member]
Concentration Risk, Percentage		14.50%
Number of Major Customers		1

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Note 4 - Accounting for Stock-based Compensation (Details Textual) - USD ($)	3 Months Ended		9 Months Ended
	Sep. 30, 2019	Sep. 30, 2018	Sep. 30, 2019	Sep. 30, 2018
Share-based Compensation Arrangement by Share-based Payment Award, Options, Grants in Period, Gross	0	0	24,000	24,000
Share-based Payment Arrangement, Expense	$ 10,000	$ 5,000	$ 24,000	$ 16,000
Share-based Compensation Arrangement by Share-based Payment Award, Options, Exercises in Period	10,500	103,500	291,000	322,500

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Note 10 - Right-of-use Asset and Leasing Liabilities - Future Minimum Lease Obligations (Details) $ in Thousands	Sep. 30, 2019 USD ($)
Operating ROU Leases, 2020	$ 359
Finance ROU Leases, 2020	46
2020	405
Operating ROU Leases, 2021	362
Finance ROU Leases, 2021	31
2021	393
Operating ROU Leases, 2022	366
Finance ROU Leases, 2022	1
2022	367
Operating ROU Leases, 2023	378
Finance ROU Leases, 2023
2023	378
Operating ROU Leases, 2024	384
Finance ROU Leases, 2024
2024	384
Operating ROU Leases, Thereafter	64
Finance ROU Leases, Thereafter
Thereafter	64
Operating ROU Leases Undiscounted Obligation	1,913
Finance ROU Leases Undiscounted Obligation	78
	1,991
Operating ROU Leases, Less Interest*	(247)	[1]
Finance ROU Leases, Less Interest*	(3)	[1]
Operating ROU Leases	1,666
Finance ROU Leases	$ 75

[1] 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.

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Unaudited Condensed Consolidated Statements of Operations - USD ($) shares in Thousands, $ in Thousands	3 Months Ended		9 Months Ended
	Sep. 30, 2019	Sep. 30, 2018	Sep. 30, 2019	Sep. 30, 2018
Revenue	$ 3,860	$ 2,665	$ 11,071	$ 7,296
Cost of revenue	1,465	967	4,339	2,744
Gross profit	2,395	1,698	6,732	4,552
Operating expenses:
Sales and marketing	356	466	813	1,311
Research and development	297	329	775	832
General and administrative	277	243	930	828
Operating income	1,465	660	4,214	1,581
Interest expense, net	(1)	(43)	(45)	(144)
Net income	1,464	617	4,169	1,437
Preferred stock dividends accrued	(35)	(35)	(104)	(104)
Net income attributable to common stockholders	$ 1,429	$ 582	$ 4,065	$ 1,333
Net income per share attributable to common stockholders: Basic (in dollars per share)	$ 0.11	$ 0.04	$ 0.30	$ 0.10
Net income per share attributable to common stockholders: Diluted (in dollars per share)	$ 0.09	$ 0.04	$ 0.27	$ 0.09
Weighted average common shares outstanding: Basic (in shares)	13,523	13,062	13,466	13,009
Weighted average common shares outstanding: Diluted (in shares)	15,371	14,955	15,314	14,901

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Note 2 - Basis of Presentation

9 Months Ended

Sep. 30, 2019

Notes to Financial Statements

Basis of Presentation and Significant Accounting Policies [Text Block]

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, 2018

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, 2019

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,

filed with the U.S. Securities and Exchange Commission (the “SEC”) on

March 28, 2019.

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, 2019.