INTRUSION INC - Quarter Report: 2023 September (Form 10-Q)

Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

INTRUSION INC.

(Exact name of registrant as specified in its charter)

101 East Park Blvd, Suite 1200, Plano, Texas 75074

(Address of principal executive offices)

(Zip Code)

(972) 234-6400

(Registrant’s telephone number, including area code)

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

* * * * * * * * * *

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

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.

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 13, 2023, was 34,401,395.

INTRUSION INC.

INDEX

PART I – FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

INTRUSION INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except par value amounts)

The accompanying notes are an integral part of these condensed consolidated financial statements.

INTRUSION INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)

The accompanying notes are an integral part of these condensed consolidated financial statements.

INTRUSION INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ DEFICIT

(In thousands)

The accompanying notes are an integral part of these condensed consolidated financial statements.

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

The accompanying notes are an integral part of these condensed consolidated financial statements.

INTRUSION INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. Description of Business

Intrusion, Inc. (together with its consolidated subsidiaries, the “Company”, “Intrusion”, “Intrusion Inc.”, “we”, “us”, “our”, or similar terms) was organized in Texas in September 1983 and reincorporated in Delaware in October 1995. Our principal executive offices are located at 101 East Park Boulevard, Suite 1200, Plano, Texas 75074, and our telephone number is (972) 234-6400. Our website URL is www.intrusion.com.

The Company develops, sells, and supports products that protect any-sized company or government organization by fusing advanced threat intelligence with real-time mitigation to kill cyberattacks as they occur – including Zero-Days. The Company markets and distributes the Company’s solutions through value-added resellers, managed service providers and a direct sales force. The Company’s end-user customers include U.S. federal government entities, state and local government entities, and companies ranging in size from mid-market to large enterprises.

TraceCop (“TraceCop™”) and Savant (“Savant™”) are registered trademarks of Intrusion Inc. The Company has applied for trademark protection for the Company’s new INTRUSION Shield cybersecurity solution.

2. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements of the Company have been prepared in accordance with Generally Accepted Accounting Principles in the United States of America (“GAAP”) 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 the information and disclosures required by GAAP for complete financial statements. All adjustments that, in the opinion of management, are necessary for a fair presentation of the results of operations for the interim periods have been made and are of a recurring nature unless otherwise disclosed herein. The results of operations for such interim periods are not necessarily indicative of results of operations for a full year. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and accompanying notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2022, filed with the U.S. Securities and Exchange Commission (the “SEC”) on March 31, 2023. All significant intercompany balances and transactions have been eliminated in consolidation.

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 the condensed 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 approximate their carrying amounts due to the relatively short maturity of these instruments. Notes payable and financing and operating leases approximate fair value as they bear market rates of interest. None of these instruments are held for trading purposes.

Going Concern

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As of September 30, 2023, the Company had cash and cash equivalents of $0.2 million and a working capital deficit of $14.8 million. In addition, the Company has incurred net operating losses during the last three years. The Company’s principal sources of cash for funding operations in 2022 was through the issuance of the two Streeterville notes which contributed $9.3 million, net of issuance costs and $6.4 million from the sale and issuance of common stock and warrants. The Company’s principal source of cash for funding operations in 2023 has been through the issuance of common stock using the Company’s at-the-market (“ATM”) program which provided $3.0 million net of fees through September 30, 2023. Subsequent to September 30, 2023, through the date of these financial statements, the Company has received $1.5 million in net proceeds from the sale of the ATM. Additionally, on November 8, 2023 the Company closed on the private offering of common stock and warrants that provided $2.4 million, net of fees. Management plans to fund the operations of the Company through additional debt or equity financing and the issuance of common stock. If the Company is not able to obtain additional debt or equity financing or raise adequate funds under the Company’s ATM program, the Company may be unable to implement the Company’s business plan, fund its liquidity needs or even continue its operations. The financial statements do not include any adjustments relating to the recoverability and classification of assets and liabilities that may be necessary if the Company is unable to continue as a going concern.

The audit opinion that accompanied the Company’s financial statements as of and for the year ended December 31, 2022, was qualified in that the Company’s auditors expressed substantial doubt about the Company’s ability to continue as a going concern.

3. Right-of-use Asset and Leasing Liabilities

The Company has operating and finance leases where it records the right-of-use assets and a related lease liability as required under ASC 842. The lease liabilities are determined by the net present value of total lease payments and amortized over the life of the lease. All obligations under the Company’s lease agreements are designed to terminate with the last scheduled payment. The Company’s leases are for the following types of assets:

In accordance with ASC 842, the Company has elected practical expedients to combine 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 agreements, the Company uses an estimated incremental borrowing rate to determine the initial present value of lease payments. This discount rate for the lease approximates the federal reserve’s prime rate.

For the three and nine months ended September 30, 2023, the Company had $0.1 and $0.3 million respectively, in lease payments related to operating leases. For the three and nine months ended September 30, 2023, the Company had $1 and $56 thousand respectively, in lease payments related to financing leases.

Schedule of Items Appearing on the Condensed Consolidated Statement of Operations (in thousands):

Future minimum lease obligations consisted of the following as of September 30, 2023 (in thousands):

4. Notes Payable

On March 10, 2022, Intrusion Inc. entered into a security purchase agreement (the “SPA”) with Streeterville Capital, LLC (“Streeterville”) whereby the Company issued two separate promissory notes of $5.4 million each, with an initial interest rate of 7%, subject to some increases in the case of among other things, an event of default. On March 10, 2022, the Company received $4.6 million in net funds from the first tranche (Note 1) pursuant to a promissory note executed contemporaneously with the execution of the loan agreement. On June 29, 2022, the Company received an additional $4.7 million in net funds from the second tranche (Note 2) pursuant to a promissory note. Each note had an 18-month maturity, may be prepaid subject to varying prepayment premiums, and may be redeemed at any time after six months into the term of such note in amounts up to $0.5 million per calendar month upon the noteholder’s election. On January 11, 2023, the Company amended the promissory notes issued pursuant to the unsecured loan agreement with Streeterville whereby the noteholder agreed to waive their redemption rights through March 31, 2023, in exchange for a fee equal to 3.75% of the outstanding principal balance which increased the outstanding indebtedness due at maturity with Streeterville and increased the associated debt issuance costs recorded on the Condensed Consolidated Balance Sheets by $0.4 million. On August 2, 2023, the Company entered into a Forbearance Agreement with Streeterville which was subsequently amended on August 7, 2023. The Forbearance Agreement and amendment extend the maturity dates for each Note by 12 months. In consideration of the extension of the maturity dates, the Company entered into a Security Agreement with Streeterville, dated August 2, 2023 (the “Security Agreement”), under which Streeterville was granted a first-position security interest in all assets of the Company. On October 11, and October 17, 2023, the Company agreed to exchange $0.4 million in aggregate principal on the Streeterville Note 1 for 1.0 million shares of the Company’s common stock. The issuance of the shares was made pursuant to the exemption from the registration requirements afforded by Section 3(a)(9) of the Securities Act of 1933, as amended.

There have been no redemptions in 2023. The Company has the option, in its sole discretion, to satisfy any redemption demands in cash or shares of its common stock that will be issued in an amount equal to the dollar amount of the redemption demand divided by the number that represents 85% of the average of the two lowest daily volume weighted average prices of common stock over a fifteen-day trailing period. This option to settle in shares at a 15% discount is deemed a beneficial conversion feature (“BCF”). Any remaining indebtedness at maturity is payable in cash.

The loan agreement and accompanying notes are subject to standard and customary events of default, including, without limitation, the Company’s continued listing on the Nasdaq or New York Stock Exchange. While the notes remain outstanding, the Company will be subject to certain conditions and restrictions, including, without limitation the following: the noteholder’s right to consent to any future variable rate transactions (excluding ATMs, equity offerings, or private placements without market adjustable features) and any debt (excluding bank loans, lines of credit, mortgagees, leases, or asset backed loans); the noteholder’s right to participate in any debt or equity financings, excluding (ATM, loans, lines of credit, mortgagees, leases, or asset backed loans); a prohibition on the Company’s ability to extend or enter into any agreement restricting the Company’s ability to issue common stock under the notes; as well as a prohibition on the Company’s ability to permit any other lender to participate alongside the noteholder via any debt financing structures.

The Company evaluated both the Note 1 and Note 2 in accordance with ASC 480 “Distinguishing Liabilities from Equity” because the promissory note (1) embodies an unconditional obligation, (2) may require the Company to settle the optional redemption obligation by issuing a variable number of its common shares, and (3) is based solely on a fixed monetary amount known at inception.

The lender does not benefit if the fair value of the Company’s common stock increases and does not bear the risk that the fair value of the Company’s common stock might decrease. In accordance with ASC 480, the promissory notes have been recorded as a liability and the Company is recording interest expense over the term of the promissory note, using the interest method from ASC 835-30, to accrete the carrying amount of the promissory note up to the redemption common stock settlement amount.

The Company has recorded debt issue costs totaling $1.8 million associated with the issuance and amendment of the notes which are being amortized over their respective terms. As of September 30, 2023, the balance of unamortized debt issuance costs for both notes were $0.5 million.

For the three and nine months ended September 30, 2023, the Company recorded $0.5 and $1.5 million respectively, of debt issuance costs and interest expense in the accompanying Condensed Consolidated Statement of Operations. The interest recorded associated with the promissory notes increases the associated notes payable on the accompanying Condensed Consolidated Balance Sheet. As a result of the Forbearance Agreement and subsequent amendment discussed above, the balance of the notes payable mature in September 2024 and December 2024. The effective interest rate of the notes payable including amortization of the debt issuance costs and accretion of BCF is 26.9%.

5. Commitments and Contingencies

The Company is periodically involved in various litigation claims asserted in the normal course of its business. The Company believes these actions are routine and incidental to the business. While the outcome of these actions cannot be predicted with certainty, the Company does not believe that any will have a material adverse impact on the Company’s business.

Class Action Litigation

On April 16, 2021, a class action lawsuit was filed in the United States District Court, Eastern District of Texas, Sherman Division, captioned Celeste v. Intrusion Inc. et al., Case No. 4:21-cv-00307 (E.D. Tex.) against the Company, the Company’s now-former chief financial officer, and now-former chief executive officer alleging, among other things, that the defendants made false and/or misleading statements or omissions about the Company’s business, operations, and prospects in violation of Section 10(b) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and Rule 10b-5 promulgated thereunder, as well as Section 20(a) of the Exchange Act. The Celeste lawsuit claimed compensatory damages and legal fees.

On May 14, 2021, a related class action lawsuit was filed in the United States District Court, Eastern District of Texas, Sherman Division, captioned Neely v. Intrusion Inc., et al., Case No. 4:12-cv-00374 (E.D. Tex.) against the Company, the Company’s now-former chief financial officer, and now-former chief executive officer. The Neely lawsuit alleged the same violations under the federal securities laws as those alleged in the Celeste lawsuit. The Neely lawsuit also sought compensatory damages and legal fees.

On November 23, 2021, the Court consolidated the Celeste and Neely actions, and appointed a lead plaintiff and lead plaintiff’s counsel. The lead plaintiff filed his amended complaint on February 7, 2022.

The parties to the consolidated action held a mediation on April 5, 2022, at the conclusion of which the parties executed a settlement term sheet setting forth the material terms associated with the resolution of the action, subject to the preparation of formal documents and a plan of distribution approved by the Court. The settlement agreement was subject to certain terms and conditions and received final approval by the Court on December 16, 2022. At that time, a final judgment was entered dismissing the case, with the Court retaining jurisdiction over the action for purposes of enforcing the terms of the class settlement agreement. The $3.3 million settlement was paid by the Company’s insurance provider under its insurance policy as the Company’s retention had previously been exhausted.

The lead plaintiff in the class action filed a motion for distribution of settlement funds on February 21, 2023. The Court approved the parties’ class action settlement and plan of allocation on March 22, 2023, and cancelled the previously rescheduled March 31, 2023, hearing on the motion for distribution, all remaining matters in the class action then-pending having been fully and finally adjudicated.

Securities Investigation

On August 8, 2021, the Company received a notification from the Securities and Exchange Commission, Division of Enforcement, that it was investigating captioned In the Matter of Intrusion Inc. and requesting the Company produce certain documents and information. On November 9, 2021, the Securities and Exchange Commission served a subpoena to the Company in connection with this investigation which formally requested substantially similar information as in the prior request. On September 26, 2023, the Company consented to the entry of final judgment, in the action styled Securities and Exchange Commission v Intrusion Inc., No. 4:23-cv-00859 (E.D. Tex. filed September 26, 2023). On October 5, 2023, the court approved the final judgment with no penalties assessed against the Company.

Stockholder Derivative Claim

On June 3, 2022, a verified stockholder derivative complaint was filed in U.S. District Court, District of Delaware by plaintiff Nathan Prawitt (the “Plaintiff Stockholder”) on behalf of Intrusion against certain of the Company’s current and former officers and directors (the “Defendants”). Plaintiff alleges that Defendants through various actions breached their fiduciary duties, wasted corporate assets, and unjustly enriched Defendants by (a) incurring costs and expenses in connection with the ongoing SEC investigation, (b) incurring costs and expenses to defend the Company with respect to the consolidated class action, (c) settling class-wide liability with respect to the consolidated class action, as well as ancillary claims regarding sales of the Company’s common stock by certain of the Defendants. On September 28, 2023, the Company agreed to settle the claim. On October 2, 2023, public notice of the settlement was given. The settlement agreement provides in part for (i) an amendment to the Company’s Bylaws, committee Charters, and other applicable corporate policies to implement certain measures set forth more fully therein, to remain in effect for no less than three years; (ii) attorneys’ fees and expenses to plaintiff’s counsel of $0.3 million; and (iii) the dismissal of all claims against the defendants, including the Company, in connection with the action. The $0.3 million settlement payment will be paid by the Company’s insurance provider under its insurance policy since the Company’s $0.5 million retention was previously exhausted. A hearing is scheduled for January 17, 2024, to obtain court approval of the settlement, agreement for the court to rule upon any objections to the proposed settlement, and for entry of final judgment in the matter.

In addition to these legal proceedings, the Company is subject to various other claims that may arise in the ordinary course of business. The Company does not believe that any claims exist where the outcome of such matters would have a material adverse effect on the Company’s condensed consolidated financial position, operating results, or cash flows. However, there can be no assurance such legal proceedings will not have a material impact on the Company’s future results.

6. Common Stock

ATM Program

B. Riley Securities, Inc. acts as sales agent for the Company’s ATM program, which allows the Company to potentially sell up to $50.0 million of its common stock using a shelf registration statement on Form S-3 filed on August 5, 2021. On March 31, 2023, the date the Company filed its Annual Report on Form 10-K for the fiscal year ended December 31, 2022, the Company became subject to the offering limits in General Instruction I.B.6 of Form S-3. As a result, the Company filed a prospectus supplement to the prospectus relating to the registration of offerings under the program that reduced the amount the Company may sell to aggregate proceeds of up to $15 million. For the nine months ended September 30, 2023, the Company has received proceeds of approximately $3.0 million net of fees from the sale of common stock pursuant to the program. As of September 30, 2023, the Company has received proceeds of approximately $10.6 million net of fees from the sales of 5.0 million shares of common stock since the inception of the program.

Registered Direct Offering

On September 12, 2022, the Company entered in a Securities Purchase Agreement (the “Purchase Agreement”) with certain purchasers to issue and sell to the purchasers an aggregate of 1,378,677 shares of the Company’s common stock (the “Shares”) each of which was coupled with a warrant to purchase one share of common stock (the “Warrants”) at an aggregate offering price of $4.29 per share and warrant, such offering is hereinafter referred to as its “registered direct offering”. Each warrant has an exercise price of $5.22 per share of common stock, subject to adjustment for stock splits, reverse stock splits, stock dividends and similar transactions and is exercisable from the date of its issuance through September 14, 2027. The Company delivered 939,284 Shares and Warrants on or about September 14, 2022. After September 30, 2022, the company issued an additional 273,309 Shares and related Warrants as a result of delayed closings. On November 10, 2022, the Company, reached an agreement with the sole remaining delayed basis investor in the registered direct offering to reduce the purchaser’s subscription by $0.7 million and, accordingly, reduce the Company’s obligation to issue securities. Following the final closing, the Company had received from its registered direct offering total aggregate proceeds of $5.2 million in exchange for the issuance of an aggregate of 1,212,593 shares of common stock and warrants to purchase 1,212,593 shares of common stock.

7. Stock-Based Compensation

The Company accounts for stock-based compensation in accordance with ASC 718, Compensation – Stock Compensation, which requires that compensation related to all stock-based awards be recognized in the condensed consolidated financial statements. Stock-based compensation cost is valued at fair value at the date of grant, and the grant date fair value is recognized as expense over each award’s requisite service period with a corresponding increase to equity or liability based on the terms of each award and the appropriate accounting treatment under ASC 718.

The Company has three stock-based compensation plans as of September 30, 2023, and December 31, 2022. These plans include the 2021 Omnibus Incentive Plan, the 2015 Stock Incentive Plan and the 2005 Stock Incentive Plan. These plans are discussed in detail in the Company’s Annual Report Form 10-K for the year ended December 31, 2022, filed with the SEC.

The Company grants stock from both the 2021 Omnibus Incentive Plan and the 2015 Stock Incentive Plan. These plans provide a means through which the Company may attract and retain key personnel and to provide a means whereby directors, officers, employees, consultants and advisors of the Company can acquire and maintain an equity interest in the Company, or be paid incentive compensation, including incentive compensation measured by reference to the value of common stock, thereby strengthening their commitment to the welfare of the Company and aligning their interests with those of the Company’s stockholders.

During the nine months ended September 30, 2023, the Company granted 213.7 thousand restricted stock awards (“RSAs”) compared to 131.6 thousand similar awards in the same period in 2022. The Company recognized compensation expense related to RSAs of $0.1 and $0.3 million, for the three and nine months ended September 30, 2023, compared to $0.2 and $0.5 million for the three and nine months ended September 30, 2022. As of September 30, 2023, the total unrecognized compensation cost related to non-vested RSAs not yet recognized in the condensed consolidated statement of operations totaled $0.2 million.

During the nine months ended September 30, 2023, the Company granted 626.4 thousand stock options compared to 233.5 thousand similar awards in the same period in 2022. The Company recognized compensation expenses related to stock options of $0.2 and $0.4 million, for the three and nine months ended September 30, 2023, compared to $0.1 and $0.6 million for the three and nine months ended September 30, 2022. As of September 30, 2023, the total unrecognized compensation cost related to non-vested options not yet recognized in the condensed consolidated statement of operations totaled $0.4 million.

The following table summarizes the activities for the Company’s stock options for the nine months ended September 30, 2023:

Valuation Assumptions

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

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 United States (“U.S.”) Treasury instruments with maturities matching the relevant expected term of the award.

8. Revenue Recognition

The Company recognizes product revenue upon shipment or after meeting certain performance obligations. These products can include hardware, software subscriptions and consulting services. The Company also offers software on a subscription basis subject to software as a service (“SAAS”). Warranty costs and sales returns have not been material.

The Company recognizes sales of its data sets in accordance with FASB ASC Topic 606 whereby revenue from contracts with customers are recognized once the criteria under the five steps below have been met:

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

Normal payment terms offered to customers, distributors and resellers are net 30 days domestically. The Company does not offer payment terms that extend beyond one year and rarely does it extend payment terms beyond its normal terms. If certain customers do not meet the Company’s credit standards, the Company typically requires payment in advance to limit its credit exposure.

With the Company’s newest product, INTRUSION Shield, Intrusion began offering software on a subscription basis. INTRUSION Shield is a hosted arrangement subject to software as a service (“SaaS”) guidance under ASC 606. SaaS arrangements are accounted for as service obligations, not arrangements that transfer a license of intellectual property.

The Company utilizes the five-step process, mentioned above, per FASB ASC Topic 606 to recognize sales and will follow that directive, also, to define revenue items as individual and distinct. INTRUSION Shield services provided to the Company’s customers for a fixed monthly subscription fee include:

INTRUSION Shield

Contracts provide for no other services, and the Company’s customers have no rebates or return rights, nor are any such rights anticipated to be offered as part of this service.

The Company satisfies its performance obligation when the INTRUSION Shield solution is available to detect and prevent unauthorized access to a client’s information networks. Revenue is recognized monthly over the term of the contract. The Company’s standard initial contract terms automatically renew unless notice is given 30 days before renewal. Upfront payment of fees is deferred and amortized into income over the period covered by the contract.

The Company’s accounts receivable represents unconditional contract billings for sales per contracts with customers and are classified as current assets. The Company had net accounts receivable balances of $0.5 million in both September 30, 2023, and December 31, 2022. The Company had an allowance for doubtful accounts on September 30, 2023, of $52 thousand. There was no allowance for doubtful accounts on December 31, 2022.

We had no material contract assets as of September 30, 2023, and December 31, 2022.

Contract liabilities consist of cash payments in advance of the Company satisfying performance obligations and recognizing revenue. The Company classifies contract liabilities as deferred revenue.

The following table presents changes in the Company’s contract liability during the nine months ended September 30, 2023, and the year ended December 31, 2022 (in thousands):

9. Capitalized Software Development

The Company capitalizes internally developed software using the Agile software development methodology which allows the Company to accurately track, and record costs associated with new software development and enhancements.

Pursuant to ASC Topic 350-40 Internal Use Software Accounting Capitalization, certain development costs related to the Company’s products during the application development stage are capitalized as part of property and equipment. Costs incurred in the preliminary stages of development are expensed as incurred. The preliminary stage includes such activities as conceptual formulation of alternatives, evaluation of alternatives, determination of existence of needed technology, and the final selection of alternatives. Once the application development stage is reached, internal and external costs are capitalized until the software is complete and ready for its intended use. Capitalized internal use software is amortized on a straight-line basis over its estimated useful life, which is generally three years.

10. Net Loss Per Share

The Company reports two separate net loss per share numbers, basic and diluted. Basic net loss attributable to common stockholders per share is computed by dividing net loss attributable to common stockholders for the period by the weighted average number of common shares outstanding for the period. Diluted net loss attributable to common stockholders per share is computed by dividing the net loss attributable to common stockholders for the period by the weighted average number of common shares and dilutive common stock equivalents outstanding for the period. The common stock equivalents include all common stock issuable upon exercise of outstanding warrants, options and vesting of restricted stock awards. The aggregate number of common stock equivalents excluded from the diluted loss per share calculation for the three months ended September 30, 2023, and 2022 totaled 2,465 and 950 thousand shares, respectively. The aggregate number of common stock equivalents excluded from the diluted loss per share calculation for the nine months ended September 30, 2023, and 2022 totaled 2,341 and 1,274 thousand shares, respectively. Since the Company is in a net loss position for the three and nine months ended September 30, 2023, and 2022, basic and dilutive net loss per share is the same.

11. Subsequent Events

Partial Conversion of Streeterville Note #1

On October 11, 2023, and October 17, 2023, the Company agreed to exchange $0.4 million in aggregate principal on Streeterville Note #1 for 1.0 million shares of the Company’s common stock. The issuance of the shares was made pursuant to the exemption from the registration requirements afforded by Section 3(a)(9) of the Securities Act of 1933 as amended.

Nasdaq Notification Regarding $35.0 Million Market Value of Listed Securities Continued Listing Requirements

On October 26, 2023, Intrusion Inc. received a letter from the Listing Qualifications Staff of Nasdaq (the “Staff Determination”) notifying the Company that, based upon the Company’s non-compliance with the $35.0 million market value of listed securities requirement for continued listing on the Nasdaq Capital Market, as set forth in Nasdaq Marketplace Rule 5550(b)(2), the Company’s securities are subject to delisting from Nasdaq unless the company requests a hearing before a Nasdaq Hearings Panel.

The Company requested a hearing before a Hearings Panel, which will stay any action with respect to the Staff Determination until the Nasdaq Hearings Panel renders a final decision subsequent to the hearing. At the hearing, the Company expects to present its plan for regaining and sustaining compliance with all applicable requirements for continued listing on The Nasdaq Capital Market. There can be no assurance that such Nasdaq Panel will grant the Company’s request for continued listing.

The notice has no immediate effect on the listing or trading of the Company’s common stock, which will continue to be listed and traded on the Nasdaq Capital Market.

Private Offering

On November 8, 2023, Intrusion Inc. entered into a Securities Purchase Agreement pursuant to which, among other things, the Company sold to certain purchasers, in a private offering, an aggregate of 4.4 million shares of its common stock, each of which is coupled with a warrant to purchase two shares of common stock, at an aggregate offering price of $0.60 per share and warrant. Wellington Shields & Co. LLC acted as placement agent in the offering. Each warrant will have an exercise price of $0.60 per share of common stock. The exercise prices for the warrants are subject to adjustment for stock splits, reverse stock splits, stock dividends and similar transactions. The warrants are exercisable from the date of issuance through the five-year anniversary of such date. The private offering is expected to result in net proceeds to the Company of approximately $2.4 million, after deducting placement agent fees. The Company intends to use the net proceeds from the private offering for working capital, general corporate purposes, and the potential partial repayment of outstanding indebtedness to Streeterville Capital, LLC.

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 (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), which statements involve substantial risks and uncertainties. All statements other than statements of historical facts contained in this Quarterly Report on Form 10-Q, including statements regarding our financial position; our ability to continue our business as a going concern; our business, sales, and marketing strategies and plans; our ability to successfully market, sell, and deliver our INTRUSION Shield commercial product and solutions to an expanding customer base; and our ability to secure additional financing; are forward-looking statements. In some cases, you can identify forward-looking statements because they contain words such as “anticipate,” “believe,” “contemplate,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “potential,” “predict,” “project,” “should,” “target,” “will,” or “would” or the negative of these words or other similar terms or expressions. Forward-looking statements contained in this Quarterly Report on Form 10-Q include, but are not limited to, such statements.

You should not rely on forward-looking statements as predictions of future events. We have based the forward-looking statements contained in this Quarterly Report on Form 10-Q primarily on our current expectations and projections about future events and trends that we believe may affect our business, financial condition, and operating results. The outcome of the events described in these forward-looking statements is subject to risks, uncertainties, and other factors described in the section titled “Risk Factors” and elsewhere in this Quarterly Report on Form 10-Q and our most recent Annual Report on Form 10-K, as the same may be amended or updated from time to time.

In addition, statements that “we believe” and similar statements reflect our beliefs and opinions on the relevant subject. These statements are based on information available to us as of the date of this Quarterly Report on Form 10-Q. While we believe that such information provides a reasonable basis for these statements, that information may be limited or incomplete. Our statements do not indicate that we have conducted an exhaustive inquiry into, or review of, all relevant information. These statements are inherently uncertain, and investors are cautioned not to unduly rely on these statements.

The forward-looking statements made in this Quarterly Report on Form 10-Q relate only to events as of the date on which the statements are made. We undertake no obligation to update any forward-looking statements made in this Quarterly Report on Form 10-Q to reflect events or circumstances after the date of this Quarterly Report on Form 10-Q or to reflect new information or the occurrence of unanticipated events, except as required by law.

Overview

Intrusion offers businesses of all sizes and industries products and services that leverage the Company’s exclusive threat intelligence database of over 8.5 billion IP addresses and domain names. After many years of gathering intelligence and providing our INTRUSION TraceCop and Savant solutions exclusively to government entities, we released our first commercial product in 2021, the INTRUSION Shield. INTRUSION Shield was designed to allow businesses to incorporate a Zero Trust, reputation-based security solution into their existing infrastructure to observe traffic flow and instantly block known malicious or unknown connections from both entering or exiting a network, making it an ideal solution for protecting from Zero-Day and ransomware attacks.

Much of 2022 was spent improving the INTRUSION Shield On-Premise performance and developing the Shield Cloud and End-Point solutions, both of which were released in September 2022. During the nine months ended September 30, 2023, our primary focus has been building out our sales reseller and channel platform and working with those partners to 1) increase our sales pipeline and 2) progress customer prospects, leads and opportunities through the sales lifecycle. Gaining traction with our Shield solutions has taken longer than initially anticipated. We feel that the progress made with our reseller and channel community along with refining our product messaging will help to shorten the sales cycle and grow revenues in future periods.

As discussed in more detail below on September 30, 2023, we had $0.2 million in cash. If we are not able to obtain additional debt or equity financing on terms and conditions acceptable to us, we may be unable to implement our business plan, fund our liquidity needs or even continue our operations.

Results of Operations

Revenues. Revenue for the three and nine month periods ended September 30, 2023, was $1.5 and $4.2 million compared to $2.2 and $6.1 million for the same periods in 2022. Revenue from our consulting business was $1.0 and $3.1 million for the three and nine month periods ended September 30, 2023, compared to $1.9 and $5.2 million for same periods in 2022. INTRUSION Shield revenues were $0.4 and $1.2 million for the three and nine month periods ended September 30, 2023, compared to $0.3 and $0.9 million for the three and nine month periods ended September 30, 2022.

Concentration of Revenues. For the three and nine month periods ended and September 30, 2023, revenues from sales to various U.S. government entities totaled $0.6 and $1.9 million, or 43.0% and 45.8% of revenues compared to $1.4 and $4.1 million, or 63.3% and 66.8% of revenues, for the same periods in 2022. 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 from government customers will be renegotiated, any cancelled or renegotiated government orders could have a material adverse effect on our financial results. We had two commercial customers in the three and nine months ended September 30, 2023, and 2022, that each contributed individually to more than 10% of our total revenue. Our similar product and service offerings are not viewed as individual segments, as its management analyzes the business as a whole and expenses are not allocated to each product offering.

Gross Profit. Gross profit was $1.1 and $3.3 million or 77.9% and 77.2% of revenues for the three and nine month periods ended September 30, 2023, compared to $1.2 and $3.3 million or 54.6% and 53.8% of revenues for the three and nine month periods ended September 30, 2022. The increased gross profit is largely due to the loss of the low margin government contract and a shift in product mix with Shield representing a greater percentage of sales.

Operating Expenses. Operating expenses for the three and nine months ended September 30, 2023, totaled $3.8 and $12.9 million, a decrease of 23.6% and 14.0% when compared to $5.0 and $15.0 million for the same periods in 2022. The period over period change was most notably due to reduced legal expense associated with the various litigation matters that arose in 2021, and reduced contract labor and employee costs. Employee headcount on September 30, 2023, totaled 48 compared to 64 on September 30, 2022.

In late March 2023, we implemented cost reduction measures that resulted in approximately $1.5 million in savings per quarter on a go-forward basis. There was no impact on operating expenses in the March quarter resulting from these reductions. In the quarters ended June 30, 2023, and September 30, 2023, we realized $1.5 million and $1.6 million in cost savings, respectively, excluding the impact of non-cash stock-based compensation and capitalized software development. The reductions included the voluntary reduction in compensation for certain of our executive officers for a 6-month period, elimination of 16 full-time positions (“RIF”) and decreased use of contractors. As a form of retention incentive for employees not impacted by the RIF and in exchange for the voluntary reduction in compensation, we issued 553 thousand options for the purchase of shares of common stock.

Sales and Marketing. Sales and marketing expenses were $1.4 and $4.5 million for the three and nine month periods ended September 30, 2023, compared to $1.7 and $4.5 million for the three and nine month periods in 2022. Certain discretionary marketing spend inclusive of participation in trade shows, utilization of third-party contractors for content and product messaging and travel, are likely to vary over time based on savings initiatives that may be necessary.

Research and Development. For the three and nine month periods ended September 30, 2023, research and development expenses were $1.2 and $4.4 million compared to $1.5 and $4.6 million for the three and nine month period ended September 30, 2022. In the second quarter of 2022, we implemented the Agile methodology of software development to manage and track our development costs. As a result, we are able to accurately quantify and capture the cost associated with each stage of the development life cycle and, accordingly, are capitalizing costs incurred during the application development stage. For the three and nine month periods ended September 30, 2023, we recorded $0.3 and $1.1 million of research and development costs to internal use software compared to $0.5 million and $0.9 million for the three and nine month periods ended September 30, 2022, respectively. The net increased spend for the nine month period, including amounts capitalized, of $0.3 million related to costs to harden the design and user interface related to the Shield suite of products. Research and development costs may vary over time as we determine the frequency of new releases, improved functionality and enhancements needed to be competitive with our product offering.

General and Administrative. General and administrative expenses were $1.3 and $4.0 million for the three and nine month periods ended September 30, 2023, compared to $1.9 and $6.0 million for the three and nine month periods ended September 30, 2022. The decrease in general and administrative expenses is primarily due to a reduction in legal costs of $0.2 and $1.1 million for the three and nine month periods associated with various litigation matters that arose in 2021. The reduction in legal for the nine month period is net of $0.3 million expense related to a registered direct offering and S-1 filing that were withdrawn. Additional items contributing to the reduction for the three and nine month periods included (i) reduced use of consultants and contractors in 2023 of $0.1 and $0.4 million, respectively (ii) recruiting fees incurred in the September 2022 period of $0.1 million, and (iii) voluntary temporary reductions in director and officer compensation of $0.1 and $0.2 million, respectively for the three and nine month periods.

Interest Expense. Our interest expense consists primarily of interest related to the Streeterville notes entered into in March and June of 2022 and related debt issuance cost amortization as well as interest expense from finance leases. Interest expense for the quarter ended September 30, 2023, decreased $0.5 million to $0.5 million. The decrease primarily relates to the reversal of interest recorded to accrete the value of the Streeterville notes to the stock-settled value for potential redemptions paid in stock as no redemption payments in cash or stock were made in the quarter. Interest expense for the nine months ended September 30, 2023, totaled $1.5 million compared to $1.7 million for the nine months ended September 30, 2022. The increase is due to the Streeterville notes not being outstanding for the full nine-months in 2022. Interest expense will vary in the future based on our cash flow and borrowing needs.

Interest and Other Income. Interest and other income were negligible for the three and nine month periods ended September 30, 2023. The September 2022 period included $2.0 million related to the Cares Act Employee Retention Credit.

Liquidity and Capital Resources

As of November 10, 2023, we had $2.4 million of cash which includes $2.4 million in net proceeds received from the sale of common stock through a private placement which closed on November 8, 2023.

On August 11, 2023, we filed an S-1 Registration Statement for a public offering of our common stock and warrants to purchase common stock. The filing was subsequently amended on August 25^th and September 18^th. On October 10, 2023, we withdrew the S-1 filing prior to going effective. We currently do not have plans to pursue an S-1 public offering in the near future.

However, we will need to raise additional funds to continue operations and comply with our financial obligations. We intend to obtain these funds through one or more offerings of debt or equity securities, including through private placements, and the use of our ATM program. We can provide no assurances that we will be able to obtain such financing on acceptable terms or at all and, in the case of equity or equity-linked financings, such financings will result in additional dilution to our stockholders.

As of September 30, 2023, we had cash and cash equivalents of $0.2 million, down from $3.0 million as of December 31, 2022, and a working capital deficit of ($14.8) million compared to ($7.8) million as of December 31, 2022.

Sources of Liquidity

Our principal sources of cash for funding operations in 2023 has been net proceeds received from sales of common stock using our ATM program of $3.0 million and net funds through changes in working capital which includes receipt of the remaining ERC refund in the March quarter of $1.4 million. Our principal source of cash for funding operations and growth in 2022 was issuance of the two Streeterville notes which contributed $9.3 million, net of issuance costs, and $6.4 million from the sale and issuance of common stock and warrants.

Notes Payable

We entered into a SPA with Streeterville on March 10, 2022, pursuant to which Streeterville purchased two promissory notes with substantively identical terms. Streeterville purchased the first note on March 10, 2022, and the second note on June 29, 2022, each note with an aggregate principal amount of $5.4 million in exchange for $5.0 million less certain expenses. We received an aggregate of approximately $9.3 million, net of transaction expenses, in connection with these issuances.

The notes had original maturity dates in September and December 2023. In August 2023, we entered into a Forbearance Agreement with Streeterville whereby the maturity date for each note was extended by 12 months to September 2024 and December 2024, respectively.

Streeterville has the right to redeem up to $0.5 million of the outstanding balance of each note per month. Payments may be made by the Company, generally at the Company’s option, (a) in cash, (b) by paying the redemption amount in the form of shares of common stock or (c) a combination of cash and shares of common stock. If paid in common stock, the number of redemption shares to be issued is based on a 15% discount to market, as further defined in the note agreements. Through December 2022, Streeterville made three separate redemption requests totaling $1.5 million, which we satisfied in cash. In January 2023, the note agreements were amended whereby Streeterville waived their right to redemptions through March 31, 2023, in exchange for a fee equal to 3.75% of the outstanding note balance. This fee was added to the outstanding principal balance to be paid at maturity. No redemptions have been made in 2023. As of September 30, 2023, the total outstanding amount payable to Streeterville under the notes payable which includes principal, accrued interest and fees associated with agreement modifications was $10.6 million.

On October 11, and October 17, 2023, we agreed to exchange $0.4 million in aggregate principal on Note 1 for 1.0 million shares of our common stock. The issuance of the shares was made pursuant to the exemption from the registration requirements afforded by Section 3(a)(9) of the Securities Act of 1933, as amended.

There can be no assurance that we will improve our liquidity position or our ability to make redemption or principal payments.

ATM Program

In August of 2021, we engaged B. Riley Securities, Inc. to act as sales agent under our at-the-market program, which allows us to potentially sell up to $50.0 million of our common stock using the shelf-registration statement on Form S-3 filed on August 5, 2021. On April 11, 2023, as a result of limitations under General Instruction I.B.6 of Form S-3, and in agreement with the terms of the sales agreement, the Company revised the aggregate offering price of shares of common stock that we can sell pursuant to the ATM program to $15.0 million. For the nine months ended September 30, 2023, we received $3.0 million, net of fees for sales of common stock pursuant to the program.

For as long as our public float is less than $75 million, we will be subject to the limitations set forth in General Instruction I.B.6 of Form S-3, which limit our ability to conduct primary offerings. Under such limitations, we may not sell, during any 12-month period, securities on Form S-3 having an aggregate market value of more than one-third of our public float. As of November 13, 2023, our public float calculated in accordance with General Instruction I.B.6 of Form S-3 was $13.2 million.

Condensed Consolidated Statements of Cash Flows

Our cash flows for the nine months ended September 30, 2023, and 2022 (in thousands) were:

Operating Activities

Net cash used in operations for the nine months ended September 30, 2023, was ($4.8) million due to a net loss of ($11.1) million, offset by 1) adjustments for non-cash items of $3.5 million which are mostly comprised of depreciation, stock-based compensation, and interest related to Streeterville notes and 2) $2.8 million provided from working capital principally relating to the cash receipt of amounts due relating to Employee Retention Credit, and increased accounts payable of $1.0 million.

Net cash used in operations for the nine months ended September 30, 2022, was ($9.6) million due primarily to a net loss of ($11.0) million partially offset by the following sources of cash and non-cash items: $1.5 million add back of non-cash expense comprised mostly of depreciation and stock-based compensation and ($0.1) million changes in working capital.

Investing Activities

For the nine months ended September 30, 2023, net cash used in investing activities was ($1.0) million, which was principally the capitalization of internally developed software. Net cash used by investing activities, for the nine months ended September 30, 2022, was ($1.1) million consisting of ($0.9) million of capitalized internally developed software and ($0.2) million for purchases of property and equipment.

Financing Activities

For nine months ended September 30, 2023, net cash provided by financing activities was $3.0 million which consisted principally of proceeds from sales of common stock using our ATM program. Cash provided by financing activities for the 2022 period totaled $13.5 million which was primarily the result of proceeds from issuance of the Streeterville notes, net of issuance costs and principal repayment of $8.8 million, $3.3 million in net proceeds from the sale of shares and warrants pursuant to our registered direct offering and sales of stock using our ATM program of $1.9 million, partially offset by finance lease payments of ($0.6) million.

Critical Accounting Policies and Use of Estimates

Our condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these condensed consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expenses, and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances. We evaluate our estimates and assumptions on an ongoing basis. Actual results may differ from these estimates. To the extent that there are material differences between these estimates and our actual results, our future financial statements will be affected.

We believe the critical accounting policies and estimates discussed under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our Annual Report on Form 10-K for the year ended December 31, 2022, filed with the SEC on March 31, 2023, reflect our more significant judgments and estimates used in the preparation of the condensed consolidated financial statements. There have been no other significant changes to our critical accounting policies and estimates as filed in such report. 

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 must apply our reasonable judgment in evaluating the cost-benefit relationship of potential disclosure controls and procedures.

As of September 30, 2023, 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 and concluded that the disclosure controls and procedures were effective as of September 30, 2023.

There have not been any changes in our internal control over financial reporting that occurred during the quarter ended September 30, 2023, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II – OTHER INFORMATION

Item 1. LEGAL PROCEEDINGS

Class Action Litigation

On April 16, 2021, a class action lawsuit was filed in the United States District Court, Eastern District of Texas, Sherman Division, captioned Celeste v. Intrusion Inc. et al., Case No. 4:21-cv-00307 (E.D. Tex.) against us, our now-former chief financial officer, and now-former chief executive officer alleging, among other things, that the defendants made false and/or misleading statements or omissions about our business, operations, and prospects in violation of Section 10(b) of the Securities Exchange Act of 1934, as amended, and Rule 10b-5 promulgated thereunder, as well as Section 20(a) of the Exchange Act. The Celeste lawsuit claimed compensatory damages and legal fees.

On May 14, 2021, a related class action lawsuit was filed in the United States District Court, Eastern District of Texas, Sherman Division, captioned Neely v. Intrusion Inc., et al., Case No. 4:12-cv-00374 (E.D. Tex.) against us, our now-former chief financial officer, and now-former chief executive officer. The Neely lawsuit alleged the same violations under the federal securities laws as those alleged in the Celeste lawsuit. The Neely lawsuit also sought compensatory damages and legal fees.

On November 23, 2021, the Court consolidated the Celeste and Neely actions, and appointed a lead plaintiff and lead plaintiff’s counsel. The lead plaintiff filed his amended complaint on February 7, 2022.

The parties to the consolidated class action held a mediation on April 5, 2022, at the conclusion of which the parties executed a settlement term sheet setting forth the material terms associated with the resolution of the action, subject to the preparation of formal documents and a plan of distribution approved by the Court. The settlement agreement was subject to certain terms and conditions and received final approval by the Court on December 16, 2022. At that time, a final judgment was entered dismissing the case, with the Court retaining jurisdiction over the action for purposes of enforcing the terms of the class settlement agreement. The $3.3 million settlement was paid by our insurance provider under our insurance policy as our retention had previously been exhausted.

The lead plaintiff in the class action filed a motion for distribution of settlement funds on February 21, 2023. The Court approved the parties’ class action settlement and plan of allocation on March 22, 2023, and cancelled the previously rescheduled March 31, 2023, hearing on the motion for distribution, all remaining matters in the class action then-pending have been fully and finally adjudicated.

 
Securities Investigation

On August 8, 2021, we received a notification from the Securities and Exchange Commission, Division of Enforcement, that it was conducting an investigation captioned In the Matter of Intrusion Inc. and requesting we produce certain documents and information. On November 9, 2021, the Securities and Exchange Commission served a subpoena to us in connection with this investigation which formally requested substantially similar information as in the prior request. On September 26, 2023, we consented to the entry of final judgment, in the action styled Securities and Exchange Commission v Intrusion Inc., No. 4:23-cv-00859 (E.D. Tex. filed September 26, 2023). On October 5,2023, the court approved the final judgment with no penalties assessed against the Company.

Stockholder Derivative Claim

On June 3, 2022, a stockholder derivative complaint was filed in U.S. District Court, District of Delaware by plaintiff Nathan Prawitt on behalf of Intrusion against certain of our current and former officers and directors. Plaintiff alleges that Defendants through various actions breached their fiduciary duties, wasted corporate assets, and unjustly enriched Defendants by (a) incurring costs and expenses in connection with the ongoing SEC investigation, (b) incurring costs and expenses to defend us with respect to the consolidated class action, (c) settling class-wide liability with respect to the consolidated class action, as well as ancillary claims regarding sales of our common stock by certain of the Defendants. On September 28, 2023, we agreed to settle the claim. On October 2, 2023, public notice of the settlement agreement was given. The settlement agreement provides in part for (i) an amendment to our Bylaws, committee Charters, and other applicable corporate policies to implement certain measures set forth more fully therein, to remain in effect for no less than three years; (ii) attorneys’ fees and expenses to plaintiff’s counsel of $0.3 million; and (iii) the dismissal of all claims against the defendants, including the Company, in connection with the Action. The $0.3 million settlement payment will be paid by our insurance provider under our insurance policy since our $0.5 million retention was previously exhausted. A hearing is scheduled for January 17, 2024, to obtain court approval of the settlement, agreement for the court to rule upon any objections to the proposed settlement, and for entry of final judgment in the matter.

In addition to these legal proceedings, we are subject to various other claims that may arise in the ordinary course of business. We do not believe that any claims exist where the outcome of such matters would have a material adverse effect on our condensed consolidated financial position, operating results, or cash flows. However, there can be no assurance such legal proceedings will not have a material impact on our future results.

Item 1A. RISK FACTORS

In addition to the information set forth elsewhere in this Quarterly Report on Form 10-Q and the risk factor set forth below, you should carefully consider the risk factors we previously disclosed in our Annual Report on Form 10-K, filed with the SEC on March 31, 2023, as of and for the year ended December 31, 2022 (the “Annual Report”). These risks could materially and adversely affect our business, financial condition, results of operations, and cash flows. However, these risks are not the only risks we face. Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may impair our business, financial condition, results of operations, and cash flows.

Risks Related to Our Financial Position and Liquidity

We may not be able to implement our current business plan or continue operations unless we are able to raise additional funds through public or private financings.

As of November 10, 2023, we had $2.4 million in cash. We need to raise additional funds in the near term to continue operations and comply with our financial obligations. We intend to obtain these funds through one or more offerings of debt or equity securities, including through private placements, and the use of our ATM program. We can provide no assurances that we will be able to obtain such financing on acceptable terms or at all and, in the case of equity or equity-linked financings, such financings will result in additional dilution to our stockholders.

If we are unable to obtain additional debt or equity financing on acceptable terms, we may be unable to implement our business plan, fund our liquidity needs or even continue our operations. Specifically, we may have to further reduce our workforce, sell our assets, and reduce or cease activities to grow our business. Such actions may impact our ability to comply with the obligations under our commercial contracts, including those under the government contract for which we received prepayment of the full one-year term in April 2023. Failure to comply with such contracts may result in the termination of such contracts and us being obligated to return some or any prepayments we received. We may also fail to satisfy our obligations under the Streeterville notes.

Item 2. UNREGISTERED SALES OF EQUITY SECURITIES, USE OF PROCEEDS, AND ISSUER PURCHASES OF EQUITY SECURITIES

On October 11 and October 17, 2023, we agreed to exchange $0.4 million in aggregate principal on Streeterville Note #1 for 1.0 million shares of our common stock. The issuance of the shares was made pursuant to the exemption from the registration requirements afforded by Section 3(a)(9) of the Securities Act of 1933, as amended.

Item 6. EXHIBITS

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

SIGNATURES

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.