INTRUSION INC

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™”) andSavant (“Savant™”) are registered trademarks of Intrusion Inc. The Company has applied for trademark protection for the Company’s newINTRUSIONShield cybersecurity solution.

2. Summary of Significant Accounting Policies

Basis of Presentation

The Company’s Consolidated Financial Statements include its accounts and those of its wholly owned subsidiary and are prepared in accordance with Generally Accepted Accounting Principles in the United States of America (“GAAP”). All intercompany balances and transactions have been eliminated in consolidation.

Going Concern

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As of December 31, 2023, the Company had cash and cash equivalents of $0.1 million and a working capital deficit of $13.1 million. In addition, the Company has incurred net operating losses during the last four years. These conditions raise substantial doubt about the Company’s ability to continue as a going concern within one year after the date of these financial statements. The Company’s principal source of cash for funding operations in 2023 has been net proceeds received through the issuance of common stock using the Company’s ATM program which provided $4.7 million, a private placement offering completed in November 2023 of $2.3 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. Subsequent to December 31, 2023, through the date of these financial statements, the Company has received $0.5 million in net proceeds from the sale of the ATM. 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.

Reverse Stock Split

The Company effected areverse stock split of 1-for-20 on March 22, 2024. Unless otherwise stated, all share and per share amounts for all periods presented have been adjusted to reflect the reverse stock split.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Estimates are used for, but not limited to, the accounting for credit losses, revenue recognition, warranty costs, depreciation, and stock-based compensation and income taxes. Actual results could differ from these estimates.

Cash and Cash Equivalents

The Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents. The Company maintains cash balances that may at times exceed federally insured limits. The Company’s cash balances are maintained at a high-quality financial institution, and the Company believes the credit risk related to these cash balances is minimal. As of December 31, 2023, and 2022, the Company had approximately $0.1 million and $3.0 million, respectively, of cash and cash equivalents.

Accounts Receivable and Allowance for Credit Losses

Trade accounts receivable is stated at the amount the Company expects to collect. The Company maintains allowances for credit losses for estimated losses resulting from the inability of its customers to make the required payments. Management considers the following factors when determining the collectability of specific customer accounts: customer creditworthiness, past transaction history with the customer, current economic industry trends, and changes in customer payment trends. If the financial condition of the Company’s customers were to deteriorate, adversely affecting their ability to make payments, additional allowances would be required. Based on management’s assessment, the Company provides for estimated uncollectible amounts through a charge to earnings and an increase to allowance for credit losses. Balances that remain outstanding after the Company has made reasonable collection efforts are written off through a charge to the allowance credit losses.

The Company’s accounts receivable represents unconditional contract billings for sales per contracts with customers and are classified as current. As of December 31, 2023, 2022, and January 1, 2022, the Company had accounts receivable balances of $0.4 million, $0.5 million, and $1.0 million, respectively. As of December 31, 2023, the Company had an allowance for credit losses of $0.1 million. The Company didnot recognize an allowance for credit losses as of December 31, 2022.

Risk Concentration

Financial instruments, which potentially subject the Company to concentrations of credit risk, consist primarily of cash and cash equivalents, investments, and accounts receivable. Cash and cash equivalent deposits are at risk to the extent that they exceed Federal Deposit Insurance Corporation insured amounts. To minimize risk, the Company places its investments in U.S. government obligations, corporate securities, and money market funds. Substantially all the Company’s cash, cash equivalents and investments are maintained with one major U.S. financial institution. The Company does not believe that it is subject to any unusual financial risk with the Company’s banking arrangements. The Company has not experienced any significant losses on its cash and cash equivalents.

The Company sells its products to customers primarily in the U.S. The Company has begun to sell the Company’s products internationally. Fluctuations in currency exchange rates and adverse economic developments in foreign countries could adversely affect the Company’s operating results. The Company performs ongoing credit evaluations of its customers’ financial condition and generally requires no collateral. The Company maintains reserves for potential credit losses, and such losses, in aggregate, have historically been minimal.

The Company’s operations are concentrated in one area - security software/entity identification. Sales to the U.S. Government through direct and indirect channels totaled 46.2% of total revenues attributable to six government customers and 65.8% of total revenues attributable to seven government customers for the years ended December 31, 2023, and 2022, respectively. Two individual government customers and two individual commercial customers during the year ended December 31, 2023, individually accounted for over 10% of total revenues and during the year ended December 31, 2022, three government customers and two commercial customers, individually accounted for over 10% of total revenues. For 2023, four customers represent 86% of total revenue. For 2022, five customers represent 90% of total revenue. ForShield, one customer accounts for 79% and 68% ofShield revenue for 2023 and 2022, respectively. The Company’s similar product and service offerings are not viewed as individual segments, as the Company’s management analyzes the business as a whole and expenses are not allocated to each product offering.

Prepaid Expenses and Other Assets

The Company’s prepaid expenses and other assets balance is primarily related to prepaid insurance, prepaid software, and other services, which represents the unamortized balance of insurance premiums, or other prepaid services and products. These payments are amortized on a straight-line basis over the policy or service term.

Property and Equipment

Equipment, furniture, and fixtures are stated at cost less accumulated depreciation and depreciated on a straight-line basis over the estimated useful lives of the assets. Such lives vary fromone to five years. Capitalized software development is stated at cost less accumulated amortization on a straight line basis over its estimated useful life, which is generally three years. Leasehold improvements are stated at cost less accumulated amortization and are amortized on a straight-line basis over theshorter of estimated useful lives of the assets or the remaining terms of the leases. Such lives vary from two to five years. Expenditures for major renewals and betterments that extend the useful lives of property and equipment are capitalized. Repair and maintenance costs are expensed as incurred.

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.

Depreciation and amortization are recorded as operating expenses in the Consolidated Statement of Operations. Depreciation and amortization related to the Company’s property and equipment balances totaled approximately $1.0 million and $0.6 million for the years ended December 31, 2023, and 2022, respectively.

Long-Lived Assets

The Company reviews long-lived assets, including property and equipment for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future undiscounted cash flows to be generated by the asset. If the carrying value exceeds the future undiscounted cash flows, the assets are written down to fair value. During the years ended December 31, 2023, and 2022, there wasno impairment of long-lived assets.

Leases

The Company accounts for leases using the guidance in ASC Topic 842. The Company evaluates new contracts at inception to determine if the contract conveys the right to control the use of an identified asset for a period in exchange for periodic payments. A lease exists if the Company obtains substantially all the economic benefits of an asset, and the Company has the right to direct the use of that asset. When a lease exists, the Company records a right-of-use asset that represents its right to use the asset over the lease term and a lease liability that represents its obligation to make payments over the lease term. Lease liabilities are recorded at the sum of future lease payments discounted by the collateralized rate the Company could obtain to lease a similar asset over a similar period, and right-of-use assets are recorded equal to the corresponding lease liability, plus any prepaid or direct costs. The Company does not record a right-of-use asset for leases with initial terms of twelve months or less.

Commitments and Contingencies

Liabilities for loss contingencies arising from claims, assessments, litigation, fines and penalties, or other sources and are recorded when it is probable that a liability has been incurred and the amount of the assessment can be reasonably estimated. The Company is involved in various lawsuits, claims and administrative proceedings arising in the normal course of business. For additional information, see Note 7 –Commitments and Contingencies.

Foreign Currency

All assets and liabilities in the balance sheets of foreign subsidiaries whose functional currency is other than the U.S. dollar is translated at year-end exchange rates. All revenues and expenses in the statement of operations of these foreign subsidiaries are translated at average exchange rates for the year. Translation gains and losses are not included in determining net income but are shown in accumulated other comprehensive loss in the stockholders’ deficit section of the Consolidated Balance Sheets. Foreign currency transaction gains and losses are included in determining net loss and were not significant.

Fair Value of Financial Instruments

The Company calculates the fair value of the assets and liabilities which qualify as financial instruments and include additional information in the Notes to Consolidated Financial Statements when the fair value is different than the carrying value of these financial instruments. The estimated fair value of accounts receivable, accounts payable and accrued expenses approximate their carrying amounts due to the relatively short maturity of these instruments. Notes payable and financing and operating leases approximate fair value as they bear market rates of interest. None of these instruments are held for trading purposes.

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 SaaS. Warranty costs have not been material.

The Company recognize sales of the Company’s data sets in accordance with ASC Topic 606 whereby revenue from contracts with customers are recognized once the criteria under the five steps below are 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 normal terms. If certain customers do not meet credit standards, the Company requires payments in advance to limit credit exposure.

With the Company’s newest product,INTRUSIONShield, the Company began offering software on a subscription basis.INTRUSIONShield is a hosted arrangement subject to SaaS guidance under ASC Topic 606. SaaS arrangements are accounted for as subscription services, not arrangements that transfer a license of intellectual property.

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

INTRUSIONShield 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 performance obligations when theINTRUSIONShield 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. As of December 31, 2023, and 2022, the Company had accounts receivable balance of $0.4 million and $0.5 million, respectively. As of December 31, 2023, the Company had an allowance for credit losses of $0.1 million. The Company didnot recognize an allowance for credit losses as of 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 liabilities during the years ended December 31, 2023, and 2022 (in thousands):

Accounting for Stock-based Compensation Awards

The Company accounts for stock-based compensation awards using the guidance in ASC Topic 718,Compensation-Stock Compensation (“ASC 718”). The Company’s stock-based compensation awards are granted to directors, officers, and employees. ASC 718 requires all such stock-based compensation, including grants of employee stock options, to be recognized in the financial statements based on their fair values. Stock-based compensation expense recognized in the statements of operations for the years ended 2023 and 2022 is based on awards ultimately expected to vest.

Research and Development Costs

The Company’s research and development of new software products are expensed until the application development stage is obtained. Once the application development stage is reached, internal and external costs are capitalized until the software is complete and ready for the intended use. The company incurs research and development costs that relate primarily to the development of new security software, appliances and integrated solutions, and major enhancements to existing services and products. Research and development costs are comprised primarily of sales and related benefit expenses, contract labor and prototype and other expenses incurred during research and development efforts.

Pursuant to ASC Topic 350-40,Internal Use Software Accounting-Capitalization, software development costs related to the Company’s products during the application development stage are capitalized.

Advertising Expenses

The cost of advertising is expensed as incurred or deferred until first use of advertising and expensed ratably over the applicable periods. Advertising expenses were $0.1 million and $0.5 million for 2023 and 2022, respectively.

Income Taxes

Deferred income taxes are determined using the liability method in accordance with ASC Topic 740,Accounting for Income Taxes. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period enacted. In addition, a valuation allowance is established to reduce any deferred tax asset for which it is determined that it is more likely than not that some portion of the deferred tax asset will not be realized.

ASC Topic 740 creates a single model to address accounting for uncertainty in tax positions by prescribing a minimum recognition threshold that a tax position is required to meet before being recognized in the financial statements. ASC Topic 740 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure, and transition. There are no unrecognized tax benefits to disclose in the Notes to the Consolidated Financial Statements.

The Company files income tax returns in the U.S. federal jurisdiction. On December 31, 2023, tax returns related to fiscal years ended December 31, 2020, through December 31, 2022, remain open to possible examination by most tax authorities while tax returns in a few states remain open related to fiscal years ended December 31, 2019, through December 31, 2022. No tax returns are currently under examination by any tax authorities.

Net Loss Per Share

The Company reports two separate net loss per shares 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 year by the weighted average number of common shares outstanding for the year. Diluted net loss attributable to common stockholders per share is computed by dividing the net loss attributable to common stockholders for the year by the weighted average number of common shares and dilutive common stock equivalents outstanding for the year. The common stock equivalents include all common stock issuable upon the 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 calculated for the year ended December 31, 2023, and 2022 totaled 182 thousand andsixty-six thousand, respectively. Since the Company is in a net loss position for the year ended December 31, 2023, and 2022, basic and dilutive net loss per share is the same.

Recent Accounting Pronouncements

In December 2023, FASB issued ASU 2023-09, Income Taxes: Improvements to Income Tax Disclosures. The new standard requires annual disclosure of the specific categories in the rate reconciliation, and additional information for reconciling items that meet a quantitative threshold. Additional information may be required on reconciling items. The new guidance is effective after December 15, 2024, early adoption is permitted. The Company is evaluating the impact of the new guidance on its Consolidated Financial Statements and related disclosures.

3. Prepaid Expenses and Other Assets

Prepaid expenses and other assets included the following (dollars in thousands):

The Company had no contract assets as of January 1, 2022.

4. Accrued Expenses

Accrued expenses consisted of the following (dollars in thousands):

5. Right-of-use Assets and Leasing Liabilities

The Company has operating, and finance leases and records right-of-use assets and related lease liabilities as required under ASC Topic 842. The lease liabilities are determined by the net present value of the total lease payments and amortized over the life of the lease. The Company leases are for the following types of assets:

Lease balances are recorded on the Consolidated Balance Sheets as follows (in thousands):

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 the federal reserves’ prime rate.

Certain of the Company’s lease agreements have options to extend the lease after the expiration of the initial term. The Company recognizes the cost of a lease over the expected total term of the lease, including optional renewal periods that the Company can reasonably expect to exercise. The Company does not have material obligations whereby the Company guarantees a residual value on assets the Company leases, nor do the Company’s lease agreements impose restrictions or covenants that could affect the Company’s ability to make distributions.

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

Other supplemental information related to the Company’s leases are as follows:

Future minimum lease obligations consisted of the following as of December 31, 2023 (in thousands):

On March 10, 2022, Intrusion Inc. entered into a SPA with 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 (First Note) 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 (Second Note) 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 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 twelve months to September 2024 and December 2024. 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.

The Company has the option, in its sole discretion, to satisfy any redemption demands in cash or shares of the Company’s 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 Company evaluated both the First and Second Note in accordance with ASC Topic 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 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 Topic 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 Topic 835-30, to accrete the carrying amount of the promissory note up to the redemption common stock settlement amount.

In 2023 and 2022, the Company paid $0.4 million and $1.5 million in cash principal payments on the notes, respectively. 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 December 31, 2023, the balance of unamortized debt issuance costs for both notes were $0.4 million.

On October 11, 2023, and October 17, 2023, the Company agreed to exchange $0.4 million in aggregate principal on the Streeterville First Note for 50.1 thousand shares of the Company’s common stock. On December 19, 2023, the Company exchanged an additional $0.2 million in principal for 43.5 thousand shares of common stock. The issuance of the shares was made pursuant to the exemption from the registration requirements afforded by the Securities Act.

For the years ended December 31, 2023, and 2022, the Company recorded $1.7 million and $2.3 million of interest expense, respectively, in the accompanying Consolidated Statement of Operations. The interest recorded associated with the promissory notes increases the associated notes payable on the accompanying Consolidated Balance Sheets. As a result of the Forbearance Agreement and subsequent amendment discussed above, the balance of the notes payable matures 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 20.3% and 18.1% for the First and Second Note , respectively.

On March 7, 2024, the Company exchanged an additional $0.2 million in principal on the Streeterville First Note for 52.2 thousand shares of common stock. Additionally, on March 15, 2024, the Company exchanged $9.3 million in aggregate principal for 9,275 shares of newly designated Series A preferred stock. The issuance of both the common and preferred shares was made pursuant to the exemption from the registration requirements afforded by the Securities Act. This most recent exchange resulted in the Streeterville Second Note being paid in full and $0.5 million remaining outstanding on the Streeterville First Note.

7. Commitments and Contingencies

Change of Control and Severance Agreements

Certain members of the Company’s management are parties to severance and change of control agreements with the Company. The severance and change in control agreements provide those individuals with severance payments in certain circumstances and prohibit such individuals from, among other things, competing with the Company during his or her employment. In addition, the severance and change of control agreements prohibit subject individuals from, among other things, disclosing confidential information about the Company and its products or interfering with a client or customer of the Company, in each case during his or her employment and for certain periods (including indefinite periods) following the termination of such person’s employment.

Legal Proceedings

The Company is periodically involved in various litigation claims asserted in the normal course of 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 captionedIn 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 styledSecurities 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 the Plaintiff Stockholder on behalf of Intrusion against certain of the Company’s 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 April 3, 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 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.

8. Common Stock

ATM Offering

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 the Company’s 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 year ended December 31, 2023, the Company has received proceeds of approximately $4.7 million net of fees from the sale of common stock pursuant to the program. As of December 31, 2023, the Company has received proceeds of approximately $12.2 million net of fees from the sales of 498 thousand 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 68,934 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 $85.80 per share and warrant, such offering is hereinafter referred to as the “registered direct offering”. Each warrant has an exercise price of $104.40 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 the issuance through September 14, 2027. The Company delivered 46,975 Shares and Warrants on or about September 14, 2022. After September 30, 2022, the Company issued an additional 13,666 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 the registered direct offering total aggregate proceeds of $5.2 million in exchange for the issuance of an aggregate of 60,641 Shares and Warrants to purchase 60,641 Shares.

Private Offering

On November 8, 2023, the Company entered into a Securities Purchase Agreement (the “2023 Purchase Agreement”) pursuant to which, among other things, the Company sold to certain purchasers an aggregate of 217,977 shares of our common stock, each of which was coupled with a warrant to purchase two shares of our common stock, at an aggregate offering price of $12.00 per share and warrant and received $2.3 million in proceeds, net of fees.

9. Common Stock Warrants

On December 31, 2023, the Company had 60,641 warrants to purchase one share of common stock at an exercise price of $104.40 and warrants to purchase 435,926 shares of common stock at an exercise price of $12.00.

**10. Stock-Based Compensation **

The Company accounts for equity-based compensation in accordance with ASC 718 which requires that compensation related to all equity-based awards be recognized in the Consolidated Financial Statements. Stock-based compensation 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 had four stock-based compensation plans on December 31, 2023, the 2023 Employee Stock Purchase Plan, the 2021 Omnibus Plan, the 2015 Stock Incentive Plan, and the 2005 Stock Incentive Plan. 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 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. These plans are described below.

2023 Employee Stock Purchase Plan (the “ESPP”)

During 2023, the Company adopted the ESPP. The ESPP provides for the issuance of up tofifty thousand shares of common stock to participating eligible employees and allows eligible employees to purchase shares of common stock at a 15% discount from the fair market value of the stock as determined on specific dates at six-month intervals. The offering periods under the ESPP commence on January 1 and July 1 of each year.

The 2021 Omnibus Incentive Plan (the “2021 Plan”)

The 2021 Plan provides a means through which the Company may attract and retain key personnel and 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.

The 2021 Plan is administered by the Compensation Committee of the Company’s Board of Directors and permits the grant of cash and equity-based awards, which may be awarded in the form of stock options, stock appreciation rights, restricted stock awards, performance awards, other stock-based awards, and other cash-based awards.

The aggregate number of shares of Common Stock that may be issued or used for reference purposes or with respect to which awards may be granted under the 2021 Plan shall not exceed 125 thousand shares and is subject to any increase or decrease, which shares may be either authorized and unissued common stock or common stock held in or acquired for the treasury of the Company or both.

The 2015 Stock Incentive Plan (“the “2015 Plan”)

The 2015 Plan provided for the issuance of up tothirty thousand shares of common stock. The 2015 Plan consists of three separate equity incentive programs: the Discretionary Option Grant Program; the Stock Issuance Program; and the Automatic Option Grant Program for non-employee Board members. Officers and employees, non-employee. Board members and independent contractors are eligible to participate in the Discretionary Option Grant and Stock Issuance Programs. During the year ended December 31, 2021, the Board of Directors (“Board”) approved a new clause to the 2015 Plan, to accelerate the vesting of any unvested equity grants held by outside directors upon their retirement from the Board.

The 2005 Stock Incentive Plan (the “2005 Plan”)

Grants can no longer be made from the 2005 Plan. The 2005 Plan will remain active until all outstanding options have been exercised, forfeited, expired, or cancelled.

Common shares reserved for future issuance, including options and restricted stock under all the stock option plans are as follows:

Total stock-based compensation expense is included in operating expense on the statement of operations of $1.0 and $1.5 million for the years ended December 31, 2023, and 2022, respectively.

Restricted Stock Awards

During the year ended December 31, 2023, the Company granted 10.7 thousand restricted stock awards (“RSAs”) compared to 6.6 thousand similar awards in the same period in 2022. The Company recognized compensation expense related to RSAs of $0.4 million, for the year ended December 31, 2023, compared to $0.6 million for the year ended December 31, 2022. As of December 31, 2023, the total unrecognized compensation cost related to non-vested RSAs not yet recognized in the Consolidated Statement of Operations totaled $0.1 million. This amount is expected to be recognized over a weighted-average period of 0.4 years.

The following table summarizes the activities for the Company’s unvested RSAs in Intrusion Inc. stock for the year ended December 31, 2023:

Stock Option Awards

During the year ended December 31, 2023, the Company granted 31.4 thousand stock options awards compared to 16.7 thousand similar awards in the same period in 2022. The Company recognized compensation expenses related to stock options of $0.6 million and $0.9 million, for the year ended December 31, 2023, and 2022, respectfully. As of December 31, 2023, the total unrecognized compensation cost related to non-vested options not yet recognized in the Consolidated Statement of Operations totaled $0.3 million. This amount is expected to be recognized over the weighted average period of 0.9 years.

A summary of the Company’s stock option activity and related information for the years ended December 31, 2023, and 2022 is as follows:

Information related to stock options outstanding on December 31, 2023, is summarized below:

Summarized information about outstanding stock options as of December 31, 2023, that are expected to vest in the future as well as stock options that are fully vested and currently exercisable, are as follows:

The fair values of option awards were estimated at the date of grant using a Black-Scholes option-pricing model with the following assumptions for fiscal years ended December 31, 2023, and 2022, respectively:

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.

11. Employee Benefit Plan

Employee 401(k) Plan

The Company has a plan known as the Intrusion Inc. 401(k) Savings Plan (the “Plan”) to provide retirement and incidental benefits for the Company’s employees. The Plan covers substantially all employees who meet minimum age and service requirements. As allowed under Section 401(k) of the Internal Revenue Code (“IRS”), the Plan provides tax deferred salary deductions for eligible employees.

Employees may contribute the lesser of 1% to 90% of their annual compensation to the Plan, limited to a maximum amount as set by the IRS. Participants who are over the age of 50 may contribute an additional amount of their salary per year, as defined annually by the IRS. The Company matches employee contributions at the rate of 0.25% per each 1% of contribution on the first 4% of compensation. Matching contributions to the Plan were approximately $0.1 million each for the years ended December 31, 2023, and 2022.

**12. Related Party Transactions **

During 2023 and 2022, the Company retained legal services of a third-party law firm for which the Company’s Chief Executive Officer is a senior advisor. The Company recognized $0.1 and $0.3 million for the years ended December 31, 2023, and 2022 respectively in general and administrative expense on the Consolidated Statements of Operations. On December 31, 2023, and 2022, $0.1 and $0.1 million payable to the third-party law firm was included in accounts payable, trade on the Consolidated Balance Sheets. The rates paid for legal services to the third-party firm were comparable to rates paid to other law firms providing legal services to the Company.

On October 10, 2023, the Company entered into an invoice financing arrangement pursuant to a note purchase agreement with James Gero, Director of the Company (“Gero”), according to which, among other things, Gero purchased from the Company a promissory note (the “Note”) in the aggregate principal amount of $.5 million in exchange for $465 thousand to the Company. Under the Note, the Company made principal payments to Gero in the amount $10 thousand per week each week prior to its maturity on November 2, 2023. Interest accrued at a rate of 7.0% per annum, compounded daily. The note was repaid in full on November 2, 2023. The Company recorded $40 thousand in interest expense related to this note.

13. Income Taxes

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company’s deferred tax assets (liabilities) as of December 31, 2023, and 2022 are as follows (in thousands):

Deferred tax assets are required to be reduced by a valuation allowance if it is more likely than not that some portion or all the deferred tax assets will not be realized. Realization of the future benefits related to the deferred tax assets is dependent on many factors, including the Company’s ability to generate taxable income within the near to medium term. Management has considered these factors in determining the valuation allowance for 2023 and 2022.

The differences between the provision for income taxes and income taxes computed using the federal statutory rate for the years ended December 31, 2023, and 2022 are as follows (in thousands):

On December 31, 2023, the Company had federal net operating loss carryforwards of approximately $76.1 million for income tax purposes that begin to expire in 2024 and are subject to the ownership change limitations under Internal Revenue Code Section 382.

14. Cares Act Employee Retention Credit Receivable

Interest and other income in 2022 include $2.0 million, net of fees resulting from ERC claimed on amended IRS quarterly federal tax returns (“941s”). The ERC was established by the Coronavirus Aid, Relief and Economic Security Act (“Cares Act”). The Cares Act allows relief to business affected by the coronavirus pandemic, by providing payments to employers for qualified wages. The Company amended 941s for the periods from April 1, 2020, to September 31, 2021. On December 31, 2022, the Company had $1.4 million in receivables remaining outstanding included in prepaid expenses and other assets. The remaining $1.4 million was received in March 2023.

15. Subsequent Events

On January 2, 2024, the Company entered into an invoice financing arrangement pursuant to a note purchase agreement with Anthony Scott, President, and Chief Executive Officer of the Company (“Scott”), according to which, among other things, Scott purchased from the Company a promissory note (the “Promissory Note”) in the aggregate principal amount of $1.1 million in exchange for $1.0 million to the Company. Under the Promissory Note, the Company shall make principal payments to Scott in the amount $40 thousand per week each week prior to its maturity on June 15, 2024 (“Weekly Payments”). Interest accrues on the balance of the Promissory Note prior to its maturity at a rate of 7.0% per annum, compounded daily. In connection with the issuance of the Promissory Note, the Company and Scott also entered into a security agreement, which provides, according to its terms, a security interest in all accounts receivable or other receivables now existing or subsequently created prior to the payment of the Promissory Note, subject to prior permitted liens.

On February 1, 2024, the Company presented to the Nasdaq Hearings Panel its plan for regaining and sustaining compliance with all applicable requirements for continued listing on Nasdaq. On February 8, 2024, the Company was notified that the Panel had granted the Company’s request for continued listing, and on February 15, 2024, the Company received a revised written notice from Nasdaq (the “Nasdaq Letter”) regarding the Panel’s grant of the Company’s request for continued listing on the Nasdaq Capital Market until April 23, 2024.

On March 4, 2024, and March 11, 2024, the Company’s Board of Directors approved entry into a warrant inducement (the “Inducement Letters”) to lower the exercise price of the warrants issued in connection with the September 2022 registered direct offering and November 2023 private offering to the current Nasdaq minimum price. Pursuant to the terms of the Inducement Letters, the Company offered holders of the September 2022 and November 2023 warrants the opportunity to exercise the warrants at a reduced exercise price of $3.80 and $4.00 per share, respectively during the period beginning on March 4, 2024, and continuing through March 29, 2024.

On March 7, 2024, the Company agreed to exchange $0.2 million aggregate principal amount of that certain Promissory Note #1 dated March 10, 2022, in the original principal amount of $5.4 million, dated March 10, 2022, by and between Streeterville Capital, LLC, a Utah limited liability company, and the Company for an aggregate of 52,247 shares of its common stock, par value $0.01 per share. The issuance of the 52,247 shares of its common stock is pursuant to the exemption from the registration requirements afforded by Section 3(a)(9) of the Securities Act.

On March 15, 2024, the Company filed the Amended and Restated Certificate of Incorporation (the “A&R Certificate”) to (i) eliminate the Series 1, Series 2, and Series 3 preferred shares and filed a Certificate of Designations creating a new Series A preferred stock, $0.01 par value per share (the “Series A Stock”). Pursuant to the terms of the Series A Certificate, 20 thousand shares of Series A Stock are authorized, and each share of Series A Stock has a stated value of $1,100 and accrues a rate of return on the Stated Value of 10% per year, shall be compounded annually and is payable quarterly in cash or additional shares of Series A Stock. Commencing on the one-year anniversary of the issuance date of each share of Series A Stock, each share of Series A Stock shall accrue an automatic quarterly dividend, calculated on the stated value and shall be payable quarterly in cash or additional shares of Series A Stock. For the period from the one-year anniversary of the issuance date to the two-year anniversary of the issuance date, the Quarterly Dividend shall be 2.5% per quarter, and for all periods following the two-year anniversary of the issuance date, the Quarterly Dividend shall be 5% per quarter.

Also on March 15, 2024, the Company agreed to exchange $9.3 million aggregate principal of the Streeterville First and Second Note for 9,275 shares of Series A preferred stock. The issuance of the Series A is pursuant to the exemption from the registration requirements afforded by Section 3(a)(9) of the Securities Act.